MANAGED HIGH YIELD PLUS FUND INC.
51 WEST 52ND STREET
NEW YORK, NEW YORK 10019-6114
STATEMENT OF ADDITIONAL INFORMATION
This Statement of Additional Information relates specifically to the
proposed Reorganization wherein Managed High Yield Plus Fund Inc. ("Plus Fund")
would acquire all of the assets of Managed High Yield Fund Inc. ("High Yield
Fund") in exchange solely for shares of Plus Fund and the assumption by Plus
Fund of all High Yield Fund's liabilities.
Mitchell Hutchins Asset Management Inc. ("Mitchell Hutchins"), a wholly
owned subsidiary of PaineWebber, serves as investment adviser and administrator
to Plus Fund and High Yield Fund. This Statement of Additional Information is
not a prospectus and should be read only in conjunction with the Proxy
Statement/Prospectus dated March 31, 2000, relating to the above-referenced
matter. A copy of the Proxy Statement/Prospectus may be obtained without charge
by calling toll-free 1-800-852-4750. This Statement of Additional Information is
dated March 31, 2000.
TABLE OF CONTENTS
PAGE
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Investment Objectives and Policies.............................................2
Hedging and Other Strategies Using Derivative Instruments.....................20
Directors and Officers........................................................29
Control Persons and Principal Holders of Securities...........................29
Investment Advisory Arrangements..............................................30
Custodian and Independent Auditors............................................31
Portfolio Transactions........................................................31
Net Asset Value of Shares.....................................................33
Taxation......................................................................34
Additional Information........................................................37
Ratings Information...........................................................37
Appendix A: PRO FORMA Financial Statements...................................A-1
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The following supplements the information contained in the Proxy
Statement/Prospectus concerning Managed High Yield Plus Fund Inc. ("Plus Fund"
or "Fund").
INVESTMENT OBJECTIVES AND POLICIES
LEVERAGE
The premise underlying the use of leverage is that the costs of
leveraging generally will be based on short-term rates, which normally will be
lower than the return (including the potential for capital appreciation) that
Plus Fund can earn on the longer-term portfolio investments that it makes with
the proceeds obtained through the leverage. Thus, the stockholders would benefit
from an incremental return. However, if the differential between the return on
Plus Fund's investments and the cost of leverage were to narrow, the incremental
benefit would be reduced and could be eliminated or even become negative.
Furthermore, if long-term rates rise, the NAV of the shares will reflect the
resulting decline in value of a larger aggregate amount of portfolio assets than
Plus Fund would hold if it had not leveraged. Thus, leveraging exaggerates
changes in the value and in the yield on Plus Fund's portfolio. This, in turn,
may result in greater volatility of both the NAV and the market price of Fund
shares.
Plus Fund may borrow from affiliates of Mitchell Hutchins, provided
that the terms of such borrowings are no less favorable than those available
from comparable sources of funds in the marketplace. Plus Fund may borrow
through reverse repurchase transactions or engage in dollar rolls. In a reverse
repurchase agreement, the Fund sells securities to a bank, securities dealer or
one of their respective affiliates and agrees to repurchase them on demand or on
a specified future date and at a specified price. Reverse repurchase agreements
involve the risk that the buyer of the securities sold by Plus Fund might be
unable to deliver them when the Fund seeks to repurchase. If the buyer of the
securities under the reverse repurchase agreement files for bankruptcy or
becomes insolvent, the buyer or a trustee or receiver may receive an extension
of time to determine whether to enforce the Fund's obligation to repurchase the
securities, and the Fund's use of the proceeds of the reverse repurchase
agreement may effectively be restricted pending that decision. In a dollar roll,
Plus Fund sells mortgage-backed or other securities for delivery on the next
regular settlement date and, simultaneously, contracts to purchase substantially
identical securities for delivery on a later settlement date.
Plus Fund may also issue preferred stock or debt securities. The
issuance of debt securities or preferred stock by the Fund would involve
offering expenses and other costs, including dividends or interest payments,
which would be borne by the stockholders. The terms of any borrowing, other Fund
indebtedness or preferred stock issued by Plus Fund may impose asset coverage
requirements, dividend limitations and voting right requirements on the Fund
that are more stringent than those imposed under the Investment Company Act of
1940 ("1940 Act"). Such terms also may impose special restrictions on Plus
Fund's portfolio composition or on its use of various investment techniques or
strategies. The Fund also might be further limited in any of these respects by
guidelines established by any Rating Agencies that issue ratings for debt
securities or preferred stock issued by the Fund. These requirements may have an
adverse effect on Plus Fund. For example, limitations on Plus Fund's ability to
pay dividends or make other distributions could impair its ability to maintain
its qualification for treatment as a regulated investment company for federal
tax purposes.
The 1940 Act imposes a 200% asset coverage requirement with respect to
any preferred stock that Plus Fund may issue. Immediately after any such
issuance, Plus Fund's total assets (including the proceeds of the preferred
stock and of any indebtedness constituting senior securities) must be at least
equal to 200% of the liquidation value of the outstanding preferred stock (I.E.,
such liquidation value may not exceed 50% of Plus Fund's total assets, including
the proceeds of the preferred stock and any outstanding indebtedness
constituting senior securities). Following the issuance of preferred stock, Plus
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Fund would not be permitted to declare any cash dividend or other distribution
on its shares or purchase any of the shares (through tender offers or
otherwise), unless it would satisfy this 200% asset coverage after deducting the
amount of the dividend, other distribution, or share purchase price, as the case
may be. If Plus Fund were to have senior securities in the form of both
indebtedness and preferred stock outstanding at the same time, it would be
subject to the 300% asset coverage requirement imposed by the 1940 Act (a fund
is not permitted to incur indebtedness constituting senior securities unless
immediately thereafter the fund has total assets, including the proceeds of the
indebtedness, at least equal to 300% of the amount of the indebtedness) with
respect to the amount of the indebtedness and the 200% asset coverage
requirement with respect to the preferred stock. Under the 1940 Act, holders of
any outstanding preferred stock, voting separately as a single class, must be
entitled to elect at least two members of Plus Fund's Board of Directors. Also,
under certain circumstances, the holders of any senior securities that are in
default may be entitled to elect a majority of the Board.
For further information about leveraging, see "Comparison of Principal
Risk Factors--Primary Differences in the Investment Risks of the Funds" in the
Proxy Statement/Prospectus."
YIELD FACTORS AND CREDIT RATINGS
Standard & Poor's, a division of The McGraw-Hill Companies, Inc. ("S&P"),
Moody's Investors Service, Inc. ("Moody's"), and other nationally recognized
statistical rating organizations (collectively with Moody's and S&P, "Rating
Agencies") are private services that provide ratings of the credit quality of
debt obligations (bonds) and certain other securities. A description of the
range of ratings assigned to bonds by S&P and Moody's is included in this SAI.
The Fund may use these ratings in determining whether to purchase, sell or hold
a security. Credit ratings attempt to evaluate the safety of principal and
interest payments, but they do not evaluate the volatility of a bond's value or
its liquidity and do not guarantee the performance of the issuer. Rating
Agencies may fail to make timely changes in credit ratings in response to
subsequent events, so that an issuer's current financial condition may be better
or worse than the rating indicates. There is a risk that Rating Agencies may
downgrade a bond's rating. Subsequent to a bond's purchase by the Fund, it may
cease to be rated or its rating may be reduced below the minimum rating required
for purchase by the Fund. The Fund may use these ratings in determining whether
to purchase, sell or hold a security. It should be emphasized, however, that
ratings are general and are not absolute standards of quality. Consequently,
bonds with the same maturity, interest rate and rating may have different market
prices. Mitchell Hutchins will consider such an event in determining whether the
Fund should continue to hold the bond.
Securities ratings are based largely on the issuer's historical
financial condition and the Rating Agencies' analysis at the time of rating.
Securities ratings are not a guarantee of quality and may be lowered after the
Fund has acquired the security. Also, Rating Agencies may fail to make timely
changes in credit ratings in response to subsequent events. Consequently, the
rating assigned to any particular security is not necessarily a reflection of
the issuer's current financial condition, which may be better or worse than the
rating would indicate. The rating assigned to a security by a Rating Agency does
not reflect an assessment of the volatility of the security's market value or of
the liquidity of an investment in the security.
In addition to ratings assigned to individual bond issues, Mitchell
Hutchins analyzes interest rate trends and developments that may affect
individual issuers, including factors such as liquidity, profitability and asset
quality. The yields on bonds are dependent on a variety of factors, including
general money market conditions, general conditions in the bond market, the
financial condition of the issuer, the size of the offering, the maturity of the
obligation and its rating. There is a wide variation in the quality of bonds,
both within a particular classification and between classifications. An issuer's
obligations under its bonds are subject to the provisions of bankruptcy,
insolvency and other laws affecting the rights and remedies of bond holders or
other creditors of an issuer; litigation or other conditions may also adversely
affect the power or ability of issuers to meet their obligations for the payment
of interest and principal on their bonds.
Investment grade bonds are rated in one of the four highest rating
categories by Moody's or S&P, comparably rated by another Rating Agency or, if
unrated, determined by Mitchell Hutchins to be of comparable quality. Moody's
considers bonds rated Baa (its lowest investment grade rating) to have
speculative characteristics. This means that changes in economic conditions or
other circumstances are more likely to lead to a weakened capacity to make
principal and interest payments than is the case for higher-rated bonds.
High yield bonds (commonly known as "junk bonds") are non-investment grade
bonds. This means they are rated Ba or lower by Moody's, BB or lower by S&P,
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comparably rated by another Rating Agency or determined by Mitchell Hutchins to
be of comparable quality. The Fund's investments in non-investment grade bonds
entail greater risk than its investments in higher-rated bonds. Non-investment
grade bonds are considered predominantly speculative with respect to the
issuer's ability to pay interest and repay principal and may involve significant
risk exposure to adverse conditions. Non-investment grade bonds generally offer
a higher current yield than that available for investment grade issues; however,
they involve higher risks, in that they are especially sensitive to adverse
changes in general economic conditions and in the industries in which the
issuers are engaged, to changes in the financial condition of the issuers and to
price fluctuations in response to changes in interest rates. During periods of
economic downturn or rising interest rates, highly leveraged issuers may
experience financial stress which could adversely affect their ability to make
payments of interest and principal and increase the possibility of default. In
addition, such issuers may not have more traditional methods of financing
available to them and may be unable to repay debt at maturity by refinancing.
The risk of loss due to default by such issuers is significantly greater because
such securities frequently are unsecured by collateral and will not receive
payment until more senior claims are paid in full.
The market for non-investment grade bonds, especially those of foreign
issuers, has expanded rapidly in recent years, which has been a period of
generally expanding growth and lower inflation. These securities will be
susceptible to greater risk when economic growth slows or reverses and when
inflation increases or deflation occurs. This has been reflected in recent
volatility in emerging market securities. In the past, many lower rated bonds
experienced substantial price declines reflecting an expectation that many
issuers of such securities might experience financial difficulties. As a result,
the yields on lower-rated bonds rose dramatically. However, those higher yields
did not reflect the value of the income stream that holders of such securities
expected. Rather, they reflected the risk that holders of such securities could
lose a substantial portion of their value due to the issuers' financial
restructurings or defaults by the issuers. There can be no assurance that those
declines will not recur.
The market for non-investment grade bonds generally is thinner and less
active than that for higher quality securities, which may limit the Fund's
ability to sell such securities at fair value in response to changes in the
economy or financial markets. Adverse publicity and investor perceptions,
whether or not based on fundamental analysis, may also decrease the values and
liquidity of non-investment grade bonds, especially in a thinly traded market.
SPECIAL CHARACTERISTICS OF FOREIGN AND EMERGING MARKET SECURITIES
GENERAL. The costs attributable to and risks of foreign investing
frequently are higher than those attributable to domestic investing; this is
particularly true with respect to emerging capital markets. For example, the
cost of maintaining custody of foreign securities exceeds custodian costs for
domestic securities, and transaction and settlement costs of foreign investing
also frequently are higher than those attributable to domestic investing. Costs
associated with the exchange of currencies also make foreign investing more
expensive than domestic investing. Investment income, and gains realized, on
certain foreign securities may be subject to foreign withholding or other
government taxes that could reduce the return of these securities. Tax treaties
between the United States and foreign countries, however, may reduce or
eliminate the amount of foreign tax to which the Fund would be subject. In
addition, substantial limitations may exist in certain countries with respect to
the Fund's ability to repatriate investment capital or the proceeds of sales of
securities. Moreover, individual foreign economies may differ favorably or
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unfavorably from the U.S. economy in such respects as growth of gross national
product, rate of inflation, capital reinvestment, resource self-sufficiency and
balance of payments position. In those European countries that have begun using
the Euro as a common currency unit, individual national economies may be
adversely affected by the inability of national governments to use monetary
policy to address their own economic or political concerns.
Securities of many foreign companies may be less liquid and their prices
more volatile than securities of comparable U.S. companies. From time to time
foreign securities may be difficult to liquidate rapidly without significantly
depressing the price of such securities. Transactions in foreign securities may
be subject to less efficient settlement practices. Foreign securities trading
practices, including those involving securities settlement where the Fund's
assets may be released prior to receipt of payment, may expose the Fund to
increased risk in the event of a failed trade or the insolvency of a foreign
broker-dealer. Legal remedies for defaults and disputes may have to be pursued
in foreign courts, whose procedures differ substantially from those of U.S.
courts.
Foreign markets have different clearance and settlement procedures, and in
certain markets there have been times when settlements have failed to keep pace
with the volume of securities transactions, making it difficult to conduct such
transactions. Delays in settlement could result in the temporary periods when
assets of the Fund are uninvested and no return is earned thereon. The inability
of the Fund to make intended security purchases due to settlement problems could
cause the Fund to miss attractive investment opportunities. Inability to dispose
of a portfolio security due to settlement problems could result either in losses
to the Fund due to subsequent declines in the value of such portfolio security
or, if the Fund has entered into a contract to sell the security, could result
in possible liability to the purchaser.
Emerging market countries typically have economic and political systems
that are less fully developed and can be expected to be less stable than those
of developed countries. Emerging market countries may have policies that
restrict investment by foreigners, and there is a higher risk of government
expropriation or nationalization of private property. The possibility of low or
nonexistent trading volume in the securities of companies in emerging markets
also may result in a lack of liquidity and in price volatility. Issuers in
emerging markets typically are subject to a greater degree of change in earnings
and business prospects than are companies in developed markets.
INVESTMENT AND REPATRIATION RESTRICTIONS. Foreign investment in the
securities markets of several emerging market countries is restricted or
controlled to varying degrees. These restrictions may limit the Fund's
investment in these countries and may increase its expenses. For example,
certain countries may require governmental approval prior to investments by
foreign persons in a particular company or industry sector or limit investment
by foreign persons to only a specific class of securities of a company, which
may have less advantageous terms (including price) than securities of the
company available for purchase by nationals. Certain countries may restrict or
prohibit investment opportunities in issuers or industries deemed important to
national interests. In addition, the repatriation of both investment income and
capital from some emerging market countries is subject to restrictions, such as
the need for certain government consents. Even where there is no outright
restriction on repatriation of capital, the mechanics of repatriation may affect
certain aspects of the Fund's operations. These restrictions may in the future
make it undesirable to invest in the countries to which they apply. In addition,
if there is a deterioration in a country's balance of payments or for other
reasons, a country may impose restrictions on foreign capital remittances
abroad. The Fund could be adversely affected by delays in, or a refusal to
grant, any required governmental approval for repatriation, as well as by the
application to it of other restrictions on investments.
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If, because of restrictions on repatriation or conversion, the Fund were
unable to distribute substantially all of its net investment income and capital
gains within applicable time periods, the Fund could be subject to federal
income and excise taxes that would not otherwise be incurred and could cease to
qualify for the favorable tax treatment afforded to regulated investment
companies under the Internal Revenue Code. In such case, it would become subject
to federal income tax on all of its net income and gains. To avoid these adverse
consequences, the Fund might be required to distribute amounts that are greater
than the total amount of cash it actually receives. These distributions would
have to be made from the Fund's cash assets or, if necessary, from the proceeds
of sales of portfolio securities. The Fund would not be able to purchase
additional securities with cash used to make such distributions, and its current
income and the value of its shares might ultimately be reduced as a result.
SOCIAL, POLITICAL AND ECONOMIC FACTORS. Many emerging market countries may
be subject to a greater degree of social, political and economic instability
than is the case in the United States. Any change in the leadership or policies
of these countries may halt the expansion of or reverse any liberalization of
foreign investment policies now occurring. Such instability may result from,
among other things, the following: (i) authoritarian governments or military
involvement in political and economic decision making, and changes in government
through extra-constitutional means; (ii) popular unrest associated with demands
for improved political, economic and social conditions; (iii) internal
insurgencies; (iv) hostile relations with neighboring countries; and (v) ethnic,
religious and racial disaffection. Such social, political and economic
instability could significantly disrupt the financial markets in those countries
and elsewhere and could adversely affect the value of the Fund's assets. In
addition, there may be the possibility of asset expropriations or future
confiscatory levels of taxation affecting the Fund.
The economies of many emerging markets are heavily dependent upon
international trade and are accordingly affected by protective trade barriers
and the economic conditions of their trading partners, principally the United
States, Japan, China and the European Union. The enactment by the United States
or other principal trading partners of protectionist trade legislation,
reduction of foreign investment in the local economies and general declines in
the international securities markets could have a significant adverse effect
upon the securities markets of these countries. In addition, the economies of
some countries are vulnerable to weakness in world prices for their commodity
exports.
Many foreign and emerging market securities are not registered with the
Securities and Exchange Commission ("SEC"), and the issuers of those securities
are not subject to SEC reporting requirements. Accordingly, there may be less
publicly available information concerning foreign issuers of securities held by
the Fund than is available concerning U.S. companies. Disclosure and regulatory
standards in many respects are less stringent in emerging market countries than
in U.S. and other major markets. There also may be a lower level of monitoring
and regulation of emerging markets and the activities of investors in such
markets, and enforcement of existing regulations may be extremely limited.
Foreign companies and, in particular, companies in smaller and emerging capital
markets are not generally subject to uniform accounting, auditing and financial
reporting standards or to other regulatory requirements comparable to those
applicable to U.S. companies.
In addition, existing laws and regulations are often inconsistently
applied. As legal systems in some of the emerging market countries develop,
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foreign investors may be adversely affected by new laws and regulations, changes
to existing laws and regulations and preemption of local laws and regulations by
national laws. In circumstances where adequate laws exist, it may not be
possible to obtain swift and equitable enforcement of the law.
SOVEREIGN DEBT. Sovereign debt includes bonds that are issued by foreign
governments or their agencies, instrumentalities or political subdivisions or by
foreign central banks. Sovereign debt also may be issued by quasi-governmental
entities that are owned by foreign governments but are not backed by their full
faith and credit or general taxing powers. Investment in sovereign debt involves
special risks. The issuer of the debt or the governmental authorities that
control the repayment of the debt may be unable or unwilling to repay principal
and/or interest when due in accordance with the terms of such debt, and the
funds may have limited legal recourse in the event of a default.
Sovereign debt differs from debt obligations issued by private entities in
that, generally, remedies for defaults must be pursued in the courts of the
defaulting party. Legal recourse is, therefore, limited. Political conditions,
especially a sovereign entity's willingness to meet the terms of its debt
obligations, are of considerable significance. Also, there can be no assurance
that the holders of commercial bank loans to the same sovereign entity may not
contest payments to the holders of sovereign debt in the event of default under
commercial bank loan agreements.
A sovereign debtor's willingness or ability to pay interest and repay
principal in a timely manner may be affected by, among other factors, its cash
flow situation, the extent of its foreign reserves, the availability of
sufficient foreign exchange on the date a payment is due, the relative size of
the debt service burden to the economy as a whole, the sovereign debtor's policy
toward principal international lenders and the political constraints to which a
sovereign debtor may be subject. A country whose exports are concentrated in a
few commodities could be vulnerable to a decline in the international price of
such commodities. Increased protectionism on the part of a country's trading
partners, or political changes in those countries, could also adversely affect
its exports. Such events could diminish a country's trade account surplus, if
any, or the credit standing of a particular local government or agency. Another
factor bearing on the ability of a country to repay sovereign debt is the level
of the country's international reserves. Fluctuations in the level of these
reserves can affect the amount of foreign exchange readily available for
external debt payments and, thus, could have a bearing on the capacity of the
country to make payments on its sovereign debt.
The occurrence of political, social or diplomatic changes in one or more
of the countries issuing sovereign debt could adversely affect the Fund's
investments. Political changes or a deterioration of a country's domestic
economy or balance of trade may affect the willingness of countries to service
their sovereign debt. While the Fund's portfolio is managed in a manner that is
intended to minimize the exposure to such risks, there can be no assurance that
adverse political changes will not cause the Fund to suffer a loss of interest
or principal on any of its sovereign debt holdings.
To the extent that a country has a current account deficit (generally when
exports of merchandise and services are less than the country's imports of
merchandise and services plus net transfers (e.g., gifts of currency and goods)
to foreigners), it will need to depend on loans from foreign governments,
multilateral organizations or private commercial banks, aid payments from
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foreign governments and inflows of foreign investment. The access of a country
to these forms of external funding may not be certain, and a withdrawal of
external funding could adversely affect the capacity of a government to make
payments on its obligations. In addition, the cost of servicing debt obligations
can be affected by a change in international interest rates, since the majority
of these obligations carry interest rates that are adjusted periodically based
upon international rates.
With respect to sovereign debt of emerging market issuers, investors
should be aware that certain emerging market countries are among the largest
debtors to commercial banks and foreign governments. Some emerging market
countries have from time to time declared moratoria on the payment of principal
and interest on external debt.
Some emerging market countries have experienced difficulty in servicing
their sovereign debt on a timely basis which led to defaults on certain
obligations and the restructuring of certain indebtedness. Restructuring
arrangements have included, among other things, reducing and rescheduling
interest and principal payments by negotiating new or amended credit agreements
or converting outstanding principal and unpaid interest to Brady Bonds, and
obtaining new credit to finance interest payments. Holders of sovereign debt,
including the Fund, may be requested to participate in the rescheduling of such
debt and to extend further loans to sovereign debtors. The interests of holders
of sovereign debt could be adversely affected in the course of restructuring
arrangements or by certain other factors referred to below. Furthermore, some of
the participants in the secondary market for sovereign debt may also be directly
involved in negotiating the terms of these arrangements and may, therefore, have
access to information not available to other market participants. Obligations
arising from past restructuring agreements may affect the economic performance
and political and social stability of certain issuers of sovereign debt. There
is no bankruptcy proceeding by which sovereign debt on which a sovereign has
defaulted may be collected in whole or in part.
Foreign investment in certain sovereign debt is restricted or controlled
to varying degrees. These restrictions or controls may at times limit or
preclude foreign investment in such sovereign debt and increase the costs and
expenses of the Fund. Certain countries in which the Fund may invest require
governmental approval prior to investments by foreign persons, limit the amount
of investment by foreign persons in a particular issuer, limit the investment by
foreign persons only to a specific class of securities of an issuer that may
have less advantageous rights than the classes available for purchase by
domiciliaries of the countries or impose additional taxes on foreign investors.
Certain issuers may require governmental approval for the repatriation of
investment income, capital or the proceeds of sales of securities by foreign
investors. In addition, if a deterioration occurs in a country's balance of
payments the country could impose temporary restrictions on foreign capital
remittances. The Fund could be adversely affected by delays in, or a refusal to
grant, any required governmental approval for repatriation of capital, as well
as by the application to the Fund of any restrictions on investments. Investing
in local markets may require the Fund to adopt special procedures, seek local
government approvals or take other actions, each of which may involve additional
costs to the Fund.
ASSET-BACKED SECURITIES
Asset-backed securities are similar to mortgage-backed securities,
except that the underlying assets are different. These underlying assets may be
nearly any type of financial asset or receivable, such as motor vehicle
installment sales contracts, home equity loans, leases of various types of real
and personal property and receivables from revolving credit (credit card)
agreements. Such assets are securitized through the use of trusts or special
purpose corporations. Payments or distributions of principal and income may be
guaranteed up to a certain amount and for a certain time period by a letter of
credit or pool insurance policy issued by a financial institution unaffiliated
with the issuer, or other credit enhancements may be present.
MORTGAGE-BACKED SECURITIES
Mortgage-backed securities are debt or pass-through securities that are
backed by specific types of assets. These securities represent direct or
indirect participations in, or are secured by and payable from, mortgage loans
secured by real property and include single- and multi-class pass-through
securities and collateralized mortgage obligations. The U.S. government
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mortgage-backed securities are issued or guaranteed as to the payment of
principal and interest (but not as to market value) by Ginnie Mae (also known as
the Government National Mortgage Association), Fannie Mae (also known as the
Federal National Mortgage Association) or Freddie Mac (also known as the Federal
Home Loan Mortgage Corporation) or other government-sponsored enterprises. Other
domestic mortgage-backed securities are sponsored or issued by private entities,
generally originators of and investors in mortgage loans, including savings
associations, mortgage bankers, commercial banks, investment bankers and special
purpose entities (collectively "Private Mortgage Lenders"). Payments of
principal and interest (but not the market value) of such private
mortgage-backed securities may be supported by pools of mortgage loans or other
mortgage-backed securities that are guaranteed, directly or indirectly, by the
U.S. government or one of its agencies or instrumentalities, or they may be
issued without any government guarantee of the underlying mortgage assets but
with some form of non-government credit enhancement. Foreign mortgage-backed
securities may be issued by mortgage banks and other private or governmental
entities outside the United States and are supported by interests in foreign
real estate. New types of mortgage- and asset-backed securities are developed
and marketed from time to time and, consistent with its investment limitations,
Plus Fund expects to invest in those new types of mortgage- and asset- backed
securities that Mitchell Hutchins believes may assist in achieving its
investment objectives. Similarly, the Fund may invest in mortgage-backed
securities issued by new or existing governmental or private issuers other than
those identified herein.
GINNIE MAE CERTIFICATES. Ginnie Mae guarantees certain mortgage
pass-through certificates ("Ginnie Mae certificates") that are issued by Private
Mortgage Lenders and that represent ownership interests in individual pools of
residential mortgage loans. These securities are designed to provide monthly
payments of interest and principal to the investor. Timely payment of interest
and principal is backed by the full faith and credit of the U.S. government.
Each mortgagor's monthly payments to his lending institution on his residential
mortgage are "passed through" to certificate holders such as the Fund. Mortgage
pools consist of whole mortgage loans or participations in loans. The terms and
characteristics of the mortgage instruments are generally uniform within a pool
but may vary among pools. Lending institutions that originate mortgages for the
pools are subject to certain standards, including credit and other underwriting
criteria for individual mortgages included in the pools.
FANNIE MAE CERTIFICATES. Fannie Mae facilitates a national secondary
market in residential mortgage loans insured or guaranteed by U.S. government
agencies and in privately insured or uninsured residential mortgage loans
(sometimes referred to as "conventional mortgage loans" or "conventional loans")
through its mortgage purchase and mortgage-backed securities sales activities.
Fannie Mae issues guaranteed mortgage pass-through certificates ("Fannie Mae
certificates"), which represent pro rata shares of all interest and principal
payments made and owed on the underlying pools. Fannie Mae guarantees timely
payment of interest and principal on Fannie Mae certificates. The Fannie Mae
guarantee is not backed by the full faith and credit of the U.S. government.
FREDDIE MAC CERTIFICATES. Freddie Mac also facilitates a national
secondary market for conventional residential and U.S. government-insured
mortgage loans through its mortgage purchase and mortgage-backed securities
sales activities. Freddie Mac issues two types of mortgage pass-through
securities: mortgage participation certificates ("PCs") and guaranteed mortgage
certificates ("GMCs"). Each PC represents a pro rata share of all interest and
principal payments made and owed on the underlying pool. Freddie Mac generally
guarantees timely monthly payment of interest on PCs and the ultimate payment of
principal, but it also has a PC program under which it guarantees timely payment
of both principal and interest. GMCs also represent a pro rata interest in a
pool of mortgages. These instruments, however, pay interest semiannually and
return principal once a year in guaranteed minimum payments. The Freddie Mac
guarantee is not backed by the full faith and credit of the U.S. government.
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PRIVATE MORTGAGE-BACKED SECURITIES. Mortgage-backed securities issued by
Private Mortgage Lenders are structured similarly to the pass-through
certificates and collateralized mortgage obligations ("CMOs") issued or
guaranteed by Ginnie Mae, Fannie Mae and Freddie Mac. Such mortgage-backed
securities may be supported by pools of U.S. government or agency insured or
guaranteed mortgage loans or by other mortgage-backed securities issued by a
government agency or instrumentality, but they generally are supported by pools
of conventional (I.E., non-government guaranteed or insured) mortgage loans.
Since such mortgage-backed securities normally are not guaranteed by an entity
having the credit standing of Ginnie Mae, Fannie Mae and Freddie Mac, they
normally are structured with one or more types of credit enhancement. See
"--TYPES OF CREDIT ENHANCEMENT" below. These credit enhancements do not protect
investors from changes in market value.
COMMERCIAL MORTGAGE-BACKED SECURITIES. Commercial mortgage-backed
securities generally are multi-class debt or pass-through certificates secured
by mortgage loans on commercial properties. The market for commercial
mortgage-backed securities developed more recently, and in terms of total
outstanding principal amount of issues is relatively small, compared to the
market for residential single-family mortgage-backed securities. In addition,
commercial lending generally is viewed as exposing the lender to a greater risk
of loss than one- to four-family residential lending. Commercial lending, for
example, typically involves larger loans to single borrowers or groups of
related borrowers than residential one- to four-family mortgage loans. In
addition, the repayment of loans secured by income producing properties
typically is dependent upon the successful operation of the related real estate
project and the cash flow generated therefrom. Consequently, adverse changes in
economic conditions and circumstances are more likely to have an adverse impact
on mortgage-backed securities secured by loans on commercial properties than on
those secured by loans on residential properties.
COLLATERALIZED MORTGAGE OBLIGATIONS AND MULTI-CLASS MORTGAGE
PASS-THROUGHS. CMOs are debt obligations that are collateralized by mortgage
loans or mortgage pass-through securities (such collateral collectively being
called "Mortgage Assets"). CMOs may be issued by Private Mortgage Lenders or by
government entities such as Fannie Mae or Freddie Mac. Multi-class mortgage
pass-through securities are interests in trusts that are comprised of Mortgage
Assets and that have multiple classes similar to those in CMOs. Unless the
context indicates otherwise, references herein to CMOs include multi-class,
mortgage pass-through securities. Payments of principal of, and interest on, the
Mortgage Assets (and in the case of CMOs, any reinvestment income thereon)
provide the funds to pay debt service on the CMOs or to make scheduled
distributions on the multi-class mortgage pass-through securities. CMOs involve
special risks, and evaluating them requires special knowledge.
In a CMO, a series of bonds or certificates is issued in multiple classes.
Each class of CMO, also referred to as a "tranche," is issued at a specific
fixed or floating coupon rate and has a stated maturity or final distribution
date. Principal prepayments on the Mortgage Assets may cause CMOs to be retired
substantially earlier than their stated maturities or final distribution dates.
Interest is paid or accrued on all classes of a CMO (other than any
principal-only class) on a monthly, quarterly or semiannual basis. The principal
and interest on the Mortgage Assets may be allocated among the several classes
of a CMO in many ways. In one structure, payments of principal, including any
principal prepayments, on the Mortgage Assets are applied to the classes of a
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CMO in the order of their respective stated maturities or final distribution
dates so that no payment of principal will be made on any class of the CMO until
all other classes having an earlier stated maturity or final distribution date
have been paid in full. In some CMO structures, all or a portion of the interest
attributable to one or more of the CMO classes may be added to the principal
amounts attributable to such classes, rather than passed through to certificate
holders on a current basis, until other classes of the CMO are paid in full.
Parallel pay CMOs are structured to provide payments of principal on each
payment date to more than one class. These simultaneous payments are taken into
account in calculating the stated maturity date or final distribution date of
each class, which, as with other CMO structures, must be retired by its stated
maturity date or final distribution date but may be retired earlier.
Some CMO classes are structured to pay interest at rates that are adjusted
in accordance with a formula, such as a multiple or fraction of the change in a
specified interest rate index, so as to pay at a rate that will be attractive in
certain interest rate environments but not in others. For example, an inverse
floating rate CMO class pays interest at a rate that increases as a specified
interest rate index decreases but decreases as that index increases. For other
CMO classes, the yield may move in the same direction as market interest
rates--I.E., the yield may increase as rates increase and decrease as rates
decrease--but may do so more rapidly or to a greater degree. The market value of
such securities generally is more volatile than that of a fixed rate obligation.
Such interest rate formulas may be combined with other CMO characteristics. For
example, a CMO class may be an inverse interest-only class on which the holders
are entitled to receive no payments of principal and are entitled to receive
interest at a rate that will vary inversely with a specified index or a multiple
thereof.
TYPES OF CREDIT ENHANCEMENT. To lessen the effect of failures by obligors
on the underlying assets to make payments, mortgage- and asset-backed securities
may contain elements of credit enhancement. Such credit enhancement falls into
two categories: (1) liquidity protection and (2) protection against losses
resulting after default by an obligor on the underlying assets and collection of
all amounts recoverable directly from the obligor and through liquidation of the
collateral. Liquidity protection refers to the provision of advances, generally
by the entity administering the pool of assets (usually the bank, savings
association or mortgage banker that transferred the underlying loans to the
issuer of the security), to ensure that the receipt of payments on the
underlying pool occurs in a timely fashion. Protection against losses resulting
after default and liquidation ensures ultimate payment of the obligations on at
least a portion of the assets in the pool. Such protection may be provided
through guarantees, insurance policies or letters of credit obtained by the
issuer or sponsor, from third parties, through various means of structuring the
transaction or through a combination of such approaches. The Fund will not pay
any additional fees for such credit enhancement, although the existence of
credit enhancement may increase the price of a security. Credit enhancements do
not provide protection against changes in the market value of the security.
Examples of credit enhancement arising out of the structure of the transaction
include "senior-subordinated securities" (multiple class securities with one or
more classes subordinate to other classes as to the payment of principal thereof
and interest thereon, with the result that defaults on the underlying assets are
borne first by the holders of the subordinated class), creation of "spread
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accounts" or "reserve funds" (where cash or investments, sometimes funded from a
portion of the payments on the underlying assets, are held in reserve against
future losses) and "over-collateralization" (where the scheduled payments on, or
the principal amount of, the underlying assets exceed that required to make
payment of the securities and pay any servicing or other fees). The degree of
credit enhancement provided for each issue generally is based on historical
information regarding the level of credit risk associated with the underlying
assets. Delinquency or loss in excess of that anticipated could adversely affect
the return on an investment in such a security.
INVESTMENTS IN SUBORDINATED SECURITIES. The Fund may invest in
subordinated classes of senior-subordinated securities ("Subordinated
Securities"). Subordinated Securities have no governmental guarantee, and are
subordinated in some manner as to the payment of principal and/or interest to
the holders of more senior mortgage- or asset-backed securities arising out of
the same pool of assets. The holders of Subordinated Securities typically are
compensated with a higher stated yield than are the holders of more senior
securities. On the other hand, Subordinated Securities typically subject the
holder to greater risk than senior securities and tend to be rated in a lower
rating category, and frequently a substantially lower rating category, than the
senior securities issued in respect of the same pool of assets. Subordinated
Securities generally are likely to be more sensitive to changes in prepayment
and interest rates, and the market for such securities may be less liquid than
is the case for traditional fixed-income securities and senior mortgage- or
asset-backed securities.
SPECIAL CHARACTERISTICS OF MORTGAGE- AND ASSET-BACKED SECURITIES. The
yield characteristics of mortgage-and asset-backed securities differ from those
of traditional debt securities. Among the major differences are that interest
and principal payments are made more frequently, usually monthly, and that
principal may be prepaid at any time because the underlying mortgage loans or
other obligations generally may be prepaid at any time. Prepayments on a pool of
mortgage loans are influenced by a variety of economic, geographic, social and
other factors, including changes in mortgagors' housing needs, job transfers,
unemployment, mortgagors' net equity in the mortgaged properties and servicing
decisions. Generally, however, prepayments on fixed-rate mortgage loans will
increase during a period of falling interest rates and decrease during a period
of rising interest rates. Similar factors apply to prepayments on asset-backed
securities, but the receivables underlying asset-backed securities generally are
of a shorter maturity and thus less likely to experience substantial
prepayments. Such securities, however, often provide that for a specified time
period the issuers will replace receivables in the pool that are repaid with
comparable obligations. If the issuer is unable to do so, repayment of principal
on the asset-backed securities may commence at an earlier date. Mortgage- and
asset-backed securities may decrease in value as a result of increases in
interest rates and may benefit less than other fixed-income securities from
declining interest rates because of the risk of prepayment.
The rate of interest on mortgage-backed securities is lower than the
interest rates paid on the mortgages included in the underlying pool due to the
annual fees paid to the servicer of the mortgage pool for passing through
monthly payments to certificate holders and to any guarantor, and due to any
yield retained by the issuer. Actual yield to the holder may vary from the
coupon rate, even if adjustable, if the mortgage-backed securities are purchased
or traded in the secondary market at a premium or discount. In addition, there
is normally some delay between the time the issuer receives mortgage payments
from the servicer and the time the issuer makes the payments on the
mortgage-backed securities, and this delay reduces the effective yield to the
holder of such securities.
Yields on pass-through securities are typically quoted by investment
dealers and vendors based on the maturity of the underlying instruments and the
associated average life assumption. The average life of pass-through pools
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varies with the maturities of the underlying mortgage loans. A pool's term may
be shortened by unscheduled or early payments of principal on the underlying
mortgages. Because prepayment rates of individual pools vary widely, it is not
possible to predict accurately the average life of a particular pool. In the
past, a common industry practice was to assume that prepayments on pools of
fixed rate 30-year mortgages would result in a 12-year average life for the
pool. At present, mortgage pools, particularly those with loans with other
maturities or different characteristics, are priced on an assumption of average
life determined for each pool. In periods of declining interest rates, the rate
of prepayment tends to increase, thereby shortening the actual average life of a
pool of mortgage-backed securities. Conversely, in periods of rising interest
rates, the rate of prepayment tends to decrease, thereby lengthening the actual
average life of the pool. The value of securities with longer average lives
generally fluctuates more widely in response to changes in interest rates than
the value of securities with shorter average lives. However, these effects may
not be present, or may differ in degree, if the mortgage loans in the pools have
adjustable interest rates or other special payment terms, such as a prepayment
charge. Actual prepayment experience may cause the yield of mortgage-backed
securities to differ from the assumed average life yield. Reinvestment of
prepayments may occur at lower interest rates than the original investment, thus
adversely affecting the yield of the Fund.
The market for privately issued mortgage- and asset-backed securities
is smaller and less liquid than the market for U.S. government mortgage-backed
securities. The markets for foreign mortgage-backed securities are substantially
smaller than U.S. markets. Foreign mortgage-backed securities are structured
differently than domestic mortgage-backed securities, but they normally present
substantially similar risks, as well as the other risks normally associated with
foreign securities. CMO classes may be specially structured in a manner that
provides any of a wide variety of investment characteristics, such as yield,
effective maturity and interest rate sensitivity. As market conditions change,
however, and especially during periods of rapid or unanticipated changes in
market interest rates, the attractiveness of some CMO classes and the ability of
the structure to provide the anticipated investment characteristics may be
significantly reduced. These changes can result in volatility in the market
value, and in some instances reduced liquidity, of the CMO class. Inverse
floating rate CMO classes may be extremely volatile. These classes pay interest
at a rate that decreases when a specified index of market rates increases.
During 1994, the value and liquidity of many mortgage-backed securities
declined sharply due primarily to increases in interest rates. There can be no
assurance that such declines will not recur. The market value of certain
mortgage-backed securities can be extremely volatile and these securities may
become illiquid. Mitchell Hutchins seeks to manage Plus Fund's investments in
mortgage-backed securities so that the volatility of the Fund's portfolio, taken
as a whole, is consistent with the Fund's investment objectives. If market
interest rates or other factors that affect the volatility of securities held by
the Fund change in ways that Mitchell Hutchins does not anticipate, the Fund's
ability to meet its investment objectives may be reduced.
ADJUSTABLE RATE MORTGAGE- AND FLOATING RATE MORTGAGE-BACKED SECURITIES.
Adjustable rate mortgage-backed securities (sometimes referred to as "ARM
securities") are mortgage-backed securities that represent a right to receive
interest payments at a rate that is adjusted to reflect the interest earned on a
pool of mortgage loans bearing variable or adjustable rates of interest (such
mortgage loans are referred to as "ARMs"). Floating rate mortgage-backed
securities are classes of mortgage-backed securities that have been structured
to represent the right to receive interest payments at rates that fluctuate in
accordance with an index but that generally are supported by pools comprised of
fixed-rate mortgage loans. Because the interest rates on ARM and floating rate
mortgage-backed securities are reset in response to changes in a specified
market index, the values of such securities tend to be less sensitive to
interest rate fluctuations than the values of fixed-rate securities. As a
result, during periods of rising interest rates, ARM securities generally do not
decrease in value as much as fixed rate securities. Conversely, during periods
of declining rates, ARM securities generally do not increase in value as much as
fixed rate securities. ARM securities represent a right to receive interest
payments at a rate that is adjusted to reflect the interest earned on a pool of
ARMs. ARMs generally specify that the borrower's mortgage interest rate may not
be adjusted above a specified lifetime maximum rate or, in some cases, below a
minimum lifetime rate. In addition, certain ARMs specify limitations on the
maximum amount by which the mortgage interest rate may adjust for any single
adjustment period. ARMs also may limit changes in the maximum amount by which
the borrower's monthly payment may adjust for any single adjustment period. In
the event that a monthly payment is not sufficient to pay the interest accruing
on the ARM, any such excess interest is added to the mortgage loan ("negative
amortization"), which is repaid through future payments. If the monthly payment
exceeds the sum of the interest accrued at the applicable mortgage interest rate
and the principal payment that would have been necessary to amortize the
outstanding principal balance over the remaining term of the loan, the excess
reduces the principal balance of the ARM. Borrowers under ARMs experiencing
negative amortization may take longer to build up their equity in the underlying
property and may be more likely to default.
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ARMs also may be subject to a greater rate of prepayments in a declining
interest rate environment. For example, during a period of declining interest
rates, prepayments on ARMs could increase because the availability of fixed
mortgage loans at competitive interest rates may encourage mortgagors to
"lock-in" at a lower interest rate. Conversely, during a period of rising
interest rates, prepayments on ARMs might decrease. The rate of prepayments with
respect to ARMs has fluctuated in recent years.
The rates of interest payable on certain ARMs, and, therefore, on certain
ARM securities, are based on indices, such as the one-year constant maturity
Treasury rate, that reflect changes in market interest rates. Others are based
on indices, such as the 11th District Federal Home Loan Bank Cost of Funds Index
("COFI"), that tend to lag behind changes in market interest rates. The values
of ARM securities supported by ARMs that adjust based on lagging indices tend to
be somewhat more sensitive to interest rate fluctuations than those reflecting
current interest rate levels, although the values of such ARM securities still
tend to be less sensitive to interest rate fluctuations than fixed-rate
securities.
Floating rate mortgage-backed securities are classes of mortgage-backed
securities that have been structured to represent the right to receive interest
payments at rates that fluctuate in accordance with an index but that generally
are supported by pools comprised of fixed-rate mortgage loans. As with ARM
securities, interest rate adjustments on floating rate mortgage-backed
securities may be based on indices that lag behind market interest rates.
Interest rates on floating rate mortgage-backed securities generally are
adjusted monthly. Floating rate mortgage-backed securities are subject to
lifetime interest rate caps, but they generally are not subject to limitations
on monthly or other periodic changes in interest rates or monthly payments.
DURATION
Duration is a measure of the expected life of a fixed income security that
was developed as a more precise alternative to the concept "term to maturity."
Duration incorporates the debt security's yield, coupon interest payments, final
maturity and call features into one measure and is one of the fundamental tools
used by Mitchell Hutchins in portfolio selection and yield curve positioning for
the Fund's debt investments. Traditionally, a debt security's "term to maturity"
has been used as a proxy for the sensitivity of the security's price to changes
in interest rates (which is the "interest rate risk" or "volatility" of the
security). However, "term to maturity" measures only the time until a debt
security provides for a final payment, taking no account of the pattern of the
security's payments prior to maturity.
Duration takes the length of the time intervals between the present time
and the time that the interest and principal payments are scheduled or, in the
case of a callable debt security, expected to be made, and weights them by the
present values of the cash to be received at each future point in time. For any
fixed income security with interest payments occurring prior to the payment of
principal, duration is always less than maturity. For example, depending upon
its coupon and the level of market yields, a Treasury note with a remaining
maturity of five years might have a duration of 4.5 years. For mortgage-backed
and other securities that are subject to prepayments, put or call features or
adjustable coupons, the difference between the remaining stated maturity and the
duration is likely to be much greater.
Duration allows Mitchell Hutchins to make certain predictions as to the
effect that changes in the level of interest rates will have on the value of the
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Fund's portfolio of debt securities. For example, when the level of interest
rates increases by 1%, a debt security having a positive duration of three years
generally will decrease by approximately 3%. Thus, if Mitchell Hutchins
calculates the duration of the Fund's portfolio of debt securities as three
years, it normally would expect the portfolio to change in value by
approximately 3% for every 1% change in the level of interest rates. However,
various factors, such as changes in anticipated prepayment rates, qualitative
considerations and market supply and demand, can cause particular securities to
respond somewhat differently to changes in interest rates than indicated in the
above example. Moreover, in the case of mortgage-backed and other complex
securities, duration calculations are estimates and are not precise. This is
particularly true during periods of market volatility. Accordingly, the net
asset value of the Fund's portfolio of debt securities may vary in relation to
interest rates by a greater or lesser percentage than indicated by the above
example.
Futures, options and options on futures have durations that, in general,
are closely related to the duration of the securities that underlie them.
Holding long futures or call option positions will lengthen a security's
duration by approximately the same amount as would holding an equivalent amount
of the underlying securities. Short futures or put options have durations
roughly equal to the negative duration of the securities that underlie these
positions, and have the effect of reducing portfolio duration by approximately
the same amount as would selling an equivalent amount of the underlying
securities.
There are some situations in which the standard duration calculation does
not properly reflect the interest rate exposure of a security. For example,
floating and variable rate securities often have final maturities of ten or more
years; however, their interest rate exposure corresponds to the frequency of the
coupon reset. Another example where the interest rate exposure is not properly
captured by the standard duration calculation is the case of mortgage-backed
securities. The stated final maturity of such securities is generally 30 years,
but current prepayment rates are critical in determining the securities'
interest rate exposure. In these and other similar situations, Mitchell Hutchins
uses more sophisticated analytical techniques that incorporate the economic life
of a security into the determination of its duration and, therefore, its
interest rate exposure.
CONVERTIBLE SECURITIES
The Fund may invest in convertible securities, which are bonds,
debentures, notes, preferred stocks or other securities that may be converted
into or exchanged for a specified amount of common stock of the same or a
different issuer within a particular period of time at a specified price or
formula. A convertible security entitles the holder to receive interest
generally paid or accrued on debt or the dividend paid on preferred stock until
the convertible security matures or is redeemed, converted or exchanged.
Convertible securities have unique investment characteristics in that they
generally (1) have higher yields than common stocks, but lower yields than
comparable non-convertible securities, (2) are less subject to fluctuation in
value than the underlying stock since they have fixed income characteristics,
and (3) provide the potential for capital appreciation if the market price of
the underlying common stock increases. Most convertible securities currently are
issued by U.S. companies, although a substantial Eurodollar convertible
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securities market has developed, and the markets for convertible securities
denominated in foreign currencies are increasing. While no securities investment
is without some risk, investments in convertible securities generally entail
less risk than the issuer's common stock, although the extent to which such risk
is reduced depends in large measure upon the degree to which the convertible
security sells above its value as a fixed income security.
Before conversion, convertible securities have characteristics similar to
non-convertible debt securities in that they ordinarily provide a stable stream
of income with generally higher yields than those of common stocks of the same
or similar issuers. Convertible securities rank senior to common stock in a
corporation's capital structure but are usually subordinated to comparable
non-convertible securities. The value of a convertible security is a function of
its "investment value" (determined by its yield in comparison with the yields of
other securities of comparable maturity and quality that do not have a
conversion privilege) and its "conversion value" (the security's worth, at
market value, if converted into the underlying common stock). The investment
value of a convertible security is influenced by changes in interest rates, with
investment value declining as interest rates increase and increasing as interest
rates decline. The credit standing of the issuer and other factors also may have
an effect on the convertible security's investment value. The conversion value
of a convertible security is determined by the market price of the underlying
common stock. If the conversion value is low relative to the investment value,
the price of the convertible security is governed principally by its investment
value. Generally, the conversion value decreases as the convertible security
approaches maturity. To the extent the market price of the underlying common
stock approaches or exceeds the conversion price, the price of the convertible
security will be increasingly influenced by its conversion value. In addition, a
convertible security generally will sell at a premium over its conversion value
determined by the extent to which investors place value on the right to acquire
the underlying common stock while holding a fixed income security.
A convertible security might be subject to redemption at the option of the
issuer at a price established in the convertible security's governing
instrument. If a convertible security held by the Fund is called for redemption,
the Fund will be required to permit the issuer to redeem the security, convert
it into the underlying common stock or sell it to a third party. Any of these
actions could have an adverse effect on the Fund's ability to achieve its
investment objective.
REPURCHASE AGREEMENTS
Repurchase agreements are transactions in which the Fund purchases
securities or other obligations from a bank or securities dealer (or its
affiliate) and simultaneously commits to resell those securities to the seller
at an agreed-upon date or upon demand and at a price reflecting a market rate of
interest unrelated to the coupon rate or maturity of the purchased securities.
The Fund maintains custody of the underlying securities prior to their
repurchase; thus, the obligation of the seller to pay the repurchase price on
the date agreed to is, in effect, secured by such securities. If the value of
such securities becomes less than the repurchase price, plus any agreed-upon
additional amount, the seller will be required to provide additional collateral
so that at all times the collateral will be at least equal to the repurchase
price, plus any agreed-upon additional amount. The difference between the total
amount to be received upon repurchase of the securities and the price paid by
the Fund upon acquisition is accrued as interest and included in the Fund's net
investment income.
Repurchase agreements carry certain risks not associated with direct
investments in securities, including possible declines in the market value of
the underlying securities and delays and costs to the Fund if the other party to
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the repurchase agreement becomes insolvent. The Fund intends to enter into
repurchase agreements only with banks, securities dealers or their respective
affiliates in transactions believed by Mitchell Hutchins to present minimal
credit risks in accordance with guidelines established by the Fund's Board.
Mitchell Hutchins receives and monitors the creditworthiness of such
institutions under the Board's general supervision.
ILLIQUID SECURITIES
The Fund may invest without limit in illiquid securities, which for this
purpose include, among other things, purchased over-the-counter ("OTC")
options, repurchase agreements maturing in more than seven days, certain loan
participations and assignments, and restricted securities other than those
Mitchell Hutchins has determined are liquid pursuant to guidelines established
by the Fund's Board of Directors.
Restricted securities are not registered under the Securities Act of 1933
("1933 Act") and may be sold only in privately negotiated transactions or other
exempted transactions or after a 1933 Act registration statement has become
effective. Where registration is required, the Fund may be obligated to pay all
or part of the registration expenses and a considerable period may elapse
between the time of the decision to sell and the time the Fund may be permitted
to sell a security under an effective registration statement. If, during such a
period, adverse market conditions were to develop, the Fund might obtain a less
favorable price than prevailed when it decided to sell. Restricted securities
also include those that are subject to restrictions contained in the securities
laws of other countries.
However, not all restricted securities are illiquid. To the extent that
foreign securities are freely tradable in the country where they are principally
traded they are not considered illiquid, even if they are restricted securities
in the United States. In addition, an institutional market has developed for
certain securities that are not registered under the 1933 Act, including private
placements, repurchase agreements, commercial paper, foreign securities and
corporate bonds and notes. Institutional investors generally will not seek to
sell these instruments to the general public, but instead will often depend
either on an efficient institutional market in which such unregistered
securities can be readily resold or on an issuer's ability to honor a demand for
repayment. Therefore, the fact that there are contractual or legal restrictions
on resale to the general public or certain institutions is not dispositive of
the liquidity of such investments.
Institutional markets for restricted securities also have developed as a
result of Rule 144A. Rule 144A establishes a "safe harbor" from the registration
requirements of the 1933 Act for resales of certain securities to qualified
institutional buyers, providing both readily ascertainable values for restricted
securities and the ability to liquidate an investment. Such markets include
automated systems for the trading, clearance and settlement of unregistered
securities of domestic and foreign issuers, such as the PORTAL System sponsored
by the National Association of Securities Dealers, Inc. An insufficient number
of qualified buyers interested in purchasing Rule 144A-eligible restricted
securities held by the Fund, however, could affect adversely the marketability
of such portfolio securities, and the Fund might be unable to dispose of such
securities promptly or at favorable prices.
The Fund may sell OTC options and, in connection therewith, segregate
assets or cover its obligations with respect to OTC options written by the Fund.
The assets used as cover for OTC options written by the Fund will be considered
illiquid unless the OTC options are sold to qualified dealers who agree that the
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Fund may repurchase any OTC option it writes at a maximum price to be calculated
by a formula set forth in the option agreement. The cover for an OTC option
written subject to this procedure would be considered illiquid only to the
extent that the maximum repurchase price under the formula exceeds the intrinsic
value of the option.
MUNICIPAL OBLIGATIONS
Municipal obligations generally include debt obligations issued to obtain
funds for various public purposes as well as certain industrial development
bonds issued by or on behalf of public authorities. Municipal obligations are
classified as general obligation bonds, revenue bonds and notes. General
obligation bonds are supported by the issuer's pledge of its full faith, credit
and taxing power for the payment of principal and interest. Revenue bonds are
payable from the revenue derived from a particular facility or class of
facilities, or, in some cases, from the proceeds of a special excise or other
specific revenue source, but not from general taxing power. Industrial
development bonds, in most cases, are revenue bonds that generally do not carry
the pledge of the credit of the issuing municipality, but generally are
guaranteed by the corporate entity on whose behalf they are issued. Notes are
short-term instruments which are obligations of the issuing municipalities or
agencies and normally are sold in anticipation of a bond sale, collection of
taxes or receipt of other revenues. Municipal obligations include municipal
lease/purchase agreements which are similar to installment purchase contracts
for property or equipment issued by municipalities.
Municipal obligations bear fixed, floating or variable rates of interest.
Certain municipal obligations are subject to redemption at a date earlier than
their stated maturity pursuant to call options, which may be separated from the
related municipal obligations and purchased and sold separately. The Fund also
may acquire call options on specific municipal obligations. The Fund generally
would purchase these call options to protect the Fund from the issuer of the
related municipal obligation redeeming, or other holder of the call option from
calling away, the municipal obligation before maturity.
While, in general, municipal obligations are tax-exempt securities having
relatively low yields as compared to taxable, non-municipal obligations of
similar quality, certain municipal obligations are taxable obligations, offering
yields comparable to, and in some cases greater than, the yields available on
other permissible Fund investments. The portion of dividends received by
stockholders from the Fund that is attributable to interest income received by
the Fund from municipal obligations will not be exempt from federal income tax.
PRIVATE PLACEMENTS
The Fund may invest in securities that are sold in private placement
transactions between their issuers and their purchasers and that are neither
listed on an exchange nor traded in the OTC secondary market. In many cases,
privately placed securities will be subject to contractual or legal restrictions
on transfer. As a result of the absence of a public trading market, privately
placed securities may in turn be less liquid and more difficult to value than
publicly traded securities. Although privately placed securities may be resold
in privately negotiated transactions, the prices realized from the sales could,
due to illiquidity, be less than those originally paid by the Fund or less than
if such securities were more widely traded. In addition, issuers whose
securities are not publicly traded may not be subject to the disclosure and
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other investor protection requirements that may be applicable if their
securities were publicly traded. If any privately placed securities held by the
Fund are required to be registered under the securities laws of one or more
jurisdictions before being resold, the Fund may be required to bear the expenses
of registration.
MONEY MARKET INSTRUMENTS
The Fund may invest in money market instruments which may include
securities issued or guaranteed by the U.S. government, its agencies or
instrumentalities, obligations of foreign and domestic banks or other depository
institutions, commercial paper, short-term corporate obligations and repurchase
agreements secured by any of the foregoing.
Certificates of deposit are negotiable certificates evidencing the
obligation of a bank to repay funds deposited with it for a specified period of
time. Time deposits are non-negotiable deposits maintained in a banking
institution for a specified period of time at a stated interest rate. Bankers'
acceptances are credit instruments evidencing the obligation of a bank to pay a
draft drawn on it by a customer. These instruments reflect the obligation both
of the bank and the drawer to pay the face amount of the instrument upon
maturity. Other short-term bank obligations may include uninsured, direct
obligations bearing fixed, floating or variable interest rates.
Commercial paper consists of short-term, unsecured promissory notes issued
to finance short-term credit needs. Other short-term corporate obligations
include variable amount master demand notes, which are obligations that permit
the Fund to invest fluctuating amounts at varying rates of interest pursuant to
direct arrangements between the Fund, as lender, and the borrower. These notes
permit daily changes in the amounts borrowed. There generally is no established
secondary market for these obligations, although they are redeemable at face
value, plus accrued interest, at any time.
SHORT SALES "AGAINST THE BOX"
The Fund may engage in short sales of securities it owns or has the right
to acquire at no added cost through conversion or exchange of other securities
it owns (short sales "against the box"). To make delivery to the purchaser in a
short sale, the executing broker borrows the securities being sold short on
behalf of the Fund, and the Fund is obligated to replace the securities borrowed
at a date in the future. When the Fund sells short, it establishes a margin
account with the broker effecting the short sale and deposits collateral with
the broker. In addition, the Fund maintains, in a segregated account with its
custodian, securities that could be used to cover the short sale. The Fund
incurs transaction costs, including interest expense, in connection with
opening, maintaining and closing short sales "against the box."
The Fund might make a short sale "against the box" in order to hedge
against market risks when Mitchell Hutchins believes that the price of a
security may decline, thereby causing a decline in the value of a security owned
by the Fund or a security convertible into or exchangeable for a security owned
by the Fund. In such case, any loss in the Fund's long position after the short
sale should be reduced by a corresponding gain in the short position.
Conversely, any gain in the long position after the short sale should be reduced
by a corresponding loss in the short position. The extent to which gains or
losses in the long position are reduced will depend upon the amount of the
securities sold short relative to the amount of the securities the Fund owns,
either directly or indirectly, and in the case where the Fund owns convertible
securities, changes in the investment values or conversion premiums of such
securities.
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INVESTMENT LIMITATIONS
FUNDAMENTAL LIMITATIONS. The following fundamental investment limitations
cannot be changed without the affirmative vote of the lesser of (a) more than
50% of the outstanding shares of the Fund or (b) 67% or more of the shares
present at a stockholders' meeting if more than 50% of the outstanding shares
are represented at the meeting in person or by proxy. If a percentage
restriction is adhered to at the time of an investment or transaction, a later
increase or decrease in percentage resulting from a change in values of
portfolio securities or the amount of total assets will not be considered a
violation of any of the following limitations or of any of the Fund's investment
policies.
The Fund will not:
(1) purchase securities of any one issuer if, as a result,
more than 5% of the Fund's total assets would be invested in securities of
that issuer or the Fund would own or hold more than 10% of the outstanding
voting securities of that issuer, except that up to 25% of the Fund's
total assets may be invested without regard to this limitation, and except
that this limitation does not apply to securities issued or guaranteed by
the U.S. government, its agencies and instrumentalities or to securities
issued by other investment companies.
The following interpretation applies to, but is not a part of,
this fundamental restriction: Mortgage- and asset-backed securities will
not be considered to have been issued by the same issuer by reason of the
securities having the same sponsor, and mortgage- and asset-backed
securities issued by a finance or other special purpose subsidiary that
are not guaranteed by the parent company will be considered to be issued
by a separate issuer from the parent company.
(2) purchase any security if, as a result of that purchase,
25% or more of the Fund's total assets would be invested in securities of
issuers having their principal business activities in the same industry,
except that this limitation does not apply to securities issued or
guaranteed by the U.S. government, its agencies or instrumentalities or to
municipal securities.
(3) issue senior securities or borrow money, except as
permitted under the 1940 Act and then not in excess of 33 1/3% of the
Fund's total assets (including the amount of the senior securities issued
but reduced by any liabilities not constituting senior securities) at the
time of the issuance or borrowing, except that the Fund may borrow up to an
additional 5% of its total assets (not including the amount borrowed) for
temporary or emergency purposes.
(4) make loans, except through loans of portfolio securities
or through repurchase agreements, provided that for purposes of this
restriction, the acquisition of bonds, debentures, other debt securities or
instruments, or participations or other interests therein and investments
in government obligations, commercial paper, certificates of deposit,
bankers' acceptances or similar instruments will not be considered the
making of a loan.
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(5) engage in the business of underwriting securities of other
issuers, except to the extent that the Fund might be considered an
underwriter under the federal securities laws in connection with its
disposition of portfolio securities.
(6) purchase or sell real estate, except that investments in
securities of issuers that invest in real estate and investments in
mortgage-backed securities, mortgage participations or other instruments
supported by interests in real estate are not subject to this limitation,
and except that the Fund may exercise rights under agreements relating to
such securities, including the right to enforce security interests and to
hold real estate acquired by reason of such enforcement until that real
estate can be liquidated in an orderly manner.
(7) purchase or sell physical commodities unless acquired as a
result of owning securities or other instruments, but the Fund may
purchase, sell or enter into financial options and futures, forward and
spot currency contracts, swap transactions and other financial contracts or
derivative instruments.
Except for the investment restrictions listed above and the Fund's
investment objectives, the other investment policies described in the Proxy
Statement/Prospectus and this Statement of Additional Information are not
fundamental and may be changed with approval of the Board of Directors and
without a stockholder vote.
HEDGING AND OTHER STRATEGIES USING DERIVATIVE INSTRUMENTS
GENERAL DESCRIPTION OF DERIVATIVE INSTRUMENTS
Mitchell Hutchins may use a variety of financial instruments ("Derivative
Instruments"), including certain options, futures contracts (sometimes referred
to as "futures"), options on futures contracts and forward currency contracts to
attempt to hedge the Fund's portfolio and to attempt to enhance income or to
realize gains. Mitchell Hutchins also may attempt to hedge the Fund's portfolio
through the use of swap transactions. The Fund may enter into transactions using
one or more types of Derivatives Instruments under which the full value of its
portfolio is at risk. Under normal circumstances, however, the Fund's use of
these instruments will place at risk a much smaller portion of its assets. The
Fund may use the following Derivative Instruments:
OPTIONS ON DEBT AND EQUITY SECURITIES AND FOREIGN CURRENCIES. A call
option is a short-term contract pursuant to which the purchaser of the option,
in return for a premium, has the right to buy the security or currency
underlying the option at a specified price at any time during the term, or upon
the expiration, of the option. The writer of a call option, who receives the
premium, has the obligation, upon exercise of the option, to deliver the
underlying security or currency against payment of the exercise price. A put
option is a similar contract that gives its purchaser, in return for a premium,
the right to sell the underlying security or currency at a specified price
during the option term. The writer of a put option, who receives the premium,
has the obligation, upon timely exercise of the option, to buy the underlying
security or currency at the exercise price.
OPTIONS ON INDICES OF DEBT AND EQUITY SECURITIES. A securities index
assigns relative values to the securities included in the index and fluctuates
with changes in the market values of such securities. Index options operate in
the same way as more traditional options except that exercises of index options
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are effected with cash payments and do not involve delivery of securities. Thus,
upon exercise of an index option, the purchaser will realize, and the writer
will pay, an amount based on the difference between the exercise price and the
closing price of the index.
DEBT AND EQUITY SECURITY INDEX FUTURES CONTRACTS. A securities index
futures contract is a bilateral agreement pursuant to which one party agrees to
accept, and the other party agrees to make, delivery of an amount of cash equal
to a specified dollar amount times the difference between the index value at the
close of trading of the contract and the price at which the futures contract is
originally struck. No physical delivery of the securities comprising the index
is made; generally contracts are closed out prior to the expiration date of the
contract.
DEBT SECURITY AND CURRENCY FUTURES CONTRACTS. A debt security futures
contract is a bilateral agreement pursuant to which one party agrees to accept,
and the other party agrees to make, delivery of the specific type of debt
security or currency called for in the contract at a specified future time and
at a specified price. Although such futures contracts by their terms call for
actual delivery or acceptance of debt securities or currency, in most cases the
contracts are closed out before the settlement date without the making or taking
of delivery.
OPTIONS ON FUTURES CONTRACTS. Options on futures contracts are similar to
options on securities, except that an option on a futures contract gives the
purchaser the right, in return for the premium paid, to assume a position in a
futures contract (a long position if the option is a call and a short position
if the option is a put), rather than to purchase or sell a security or currency,
at a specified price at any time during the option term. Upon exercise of the
option, the delivery of the futures position to the holder of the option will be
accompanied by delivery of the accumulated balance that represents the amount by
which the market price of the futures contract exceeds, in the case of a call,
or is less than, in the case of a put, the exercise price of the option on the
future. The writer of an option, upon exercise, will assume a short position in
the case of a call, and a long position in the case of put.
FORWARD CURRENCY CONTRACTS. A forward currency contract involves an
obligation to purchase or sell a specific currency at a specified future date,
which may be any fixed number of days from the contract date agreed upon by the
parties, at a price set at the time the contract is entered into.
GENERAL DESCRIPTION OF STRATEGIES USING DERIVATIVE INSTRUMENTS
Hedging strategies using Derivative Instruments can be broadly categorized
as "short hedges" and "long hedges." A short hedge is a purchase or sale of a
Derivative Instrument intended partially or fully to offset potential declines
in the value of one or more investments held in the Fund's portfolio. Thus, in a
short hedge, the Fund takes a position in a Derivative Instrument whose price is
expected to move in the opposite direction of the price of the investment being
hedged. For example, the Fund might purchase a put option on a security to hedge
against a potential decline in the value of that security. If the price of the
security declined below the exercise price of the put, the Fund could exercise
the put and thus limit its loss below the exercise price to the premium paid
plus transaction costs. In the alternative, because the value of the put option
can be expected to increase as the value of the underlying security declines,
the Fund might be able to close out the put option and realize a gain to offset
the decline in the value of the security.
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Conversely, a long hedge is a purchase or sale of a Derivative Instrument
intended partially or fully to offset potential increases in the acquisition
cost of one or more investments that the Fund intends to acquire. Thus, in a
long hedge, the Fund takes a position in a Derivative Instrument whose price is
expected to move in the same direction as the price of the prospective
investment being hedged. For example, the Fund might purchase a call option on a
security it intends to purchase in order to hedge against an increase in the
cost of the security. If the price of the security increased above the exercise
price of the call, the Fund could exercise the call and thus limit its
acquisition cost to the exercise price plus the premium paid and transaction
costs. Alternatively, the Fund might be able to offset the price increase by
closing out an appreciated call option and realizing a gain.
Derivative Instruments on securities generally are used to hedge against
price movements in one or more particular securities positions that the Fund
owns or intends to acquire. Derivative Instruments on indices, in contrast,
generally are used to hedge against price movements in broad market sectors in
which the Fund has invested or expects to invest. Derivative Instruments on debt
securities may be used to hedge either individual securities or broad fixed
income market sectors.
The use of Derivative Instruments is subject to applicable regulations of
the SEC, the several options and futures exchanges upon which they are traded
and the Commodity Futures Trading Commission ("CFTC"). In addition, the Fund's
ability to use Derivative Instruments may be limited by tax considerations. See
"Taxation."
In addition to the products, strategies and risks described below and in the
Proxy Statement/Prospectus, Mitchell Hutchins may discover additional
opportunities in connection with Derivative Instruments and with hedging, income
and gain strategies. These new opportunities may become available as regulatory
authorities broaden the range of permitted transactions and as new Derivative
Instruments and techniques are developed. Mitchell Hutchins may utilize these
opportunities for the Fund to the extent that they are consistent with the
Fund's investment objective and permitted by its investment limitations and
applicable regulatory authorities.
SPECIAL RISKS OF STRATEGIES USING DERIVATIVE INSTRUMENTS
The use of Derivative Instruments involves special considerations and
risks, as described below. Risks pertaining to particular Derivative Instruments
are described in the sections that follow.
(1) Successful use of most Derivative Instruments depends upon Mitchell
Hutchins' ability to predict movements of the overall securities, currency or
interest rate markets, which requires different skills than predicting changes
in the prices of individual securities. While Mitchell Hutchins is experienced
in the use of Derivative Instruments, there can be no assurance that any
particular hedging strategy adopted will succeed.
(2) There might be imperfect correlation, or even no correlation, between
price movements of a Derivative Instrument and price movements of the
investments being hedged. For example, if the value of a Derivative Instrument
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used in a short hedge increased by less than the decline in value of the hedged
investment, the hedge would not be fully successful. Such a lack of correlation
might occur due to factors affecting the markets in which Derivative Instruments
are traded rather than the value of the investments being hedged. The
effectiveness of hedges using Derivative Instruments on indices will depend on
the degree of correlation between price movements in the index and price
movements in the securities being hedged.
(3) Hedging strategies, if successful, can reduce risk of loss by wholly
or partially offsetting the negative effect of unfavorable price movements in
the investments being hedged. However, hedging strategies can also reduce
opportunity for gain by offsetting the positive effect of favorable price
movements in the hedged investments. For example, if the Fund entered into a
short hedge because Mitchell Hutchins projected a decline in the price of a
security in the Fund's portfolio, and the price of that security increased
instead, the gain from that increase might be wholly or partially offset by a
decline in the price of the Derivative Instrument. Moreover, if the price of the
Derivative Instrument declined by more than the increase in the price of the
security, the Fund could suffer a loss. In either such case, the Fund would have
been in a better position had it not hedged at all.
(4) As described below, the Fund might be required to maintain assets as
"cover," maintain segregated accounts or make margin payments when it takes
positions in Derivative Instruments involving obligations to third parties
(I.E., Derivative Instruments other than purchased options). If the Fund were
unable to close out its positions in such Derivative Instruments, it might be
required to continue to maintain such assets or accounts or make such payments
until the position expired or matured. These requirements might impair the
Fund's ability to sell a portfolio security or make an investment at a time when
it would otherwise be favorable to do so, or require that the Fund sell a
portfolio security at a disadvantageous time. The Fund's ability to close out a
position in a Derivative Instrument prior to expiration or maturity depends on
the existence of a liquid secondary market or, in the absence of such a market,
the ability and willingness of a counterparty to enter into a transaction
closing out the position. Therefore, there is no assurance that any position in
a Derivative Instrument can be closed out at a time and price that is favorable
to the Fund.
COVER FOR STRATEGIES USING DERIVATIVE INSTRUMENTS
Transactions using Derivative Instruments, other than purchased options,
expose the Fund to an obligation to another party. The Fund will not enter into
any such transactions unless it owns either (1) an offsetting ("covered")
position in securities, currencies or other options, forward currency contracts
or futures contracts or (2) cash or liquid securities, with a value sufficient
at all times to cover its potential obligations to the extent not covered as
provided in (1) above. The Fund will comply with SEC guidelines regarding cover
for such transactions and will, if the guidelines so require, set aside cash or
liquid securities in a segregated account with its custodian in the prescribed
amount.
Assets used as cover or held in a segregated account cannot be sold while
the position in the corresponding Derivative Instrument is open, unless they are
replaced with similar assets. As a result, the committing of a large portion of
the Fund's assets to cover positions or to segregated accounts could impede
portfolio management or the Fund's ability to meet current obligations.
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OPTIONS
The Fund may purchase put and call options, and write (sell) covered put
and call options, on debt and equity securities and foreign currencies. The
purchase of call options may serve as a long hedge, and the purchase of put
options may serve as a short hedge. Writing covered put or call options can
enable the Fund to enhance income by reason of the premiums paid by the
purchases of such options. In addition, writing covered put options may serve as
a limited long hedge because increases in the value of the hedged investment
would be offset to the extent of the premium received for writing the option.
However, if the market price of the security underlying a covered put option
declines to less than the exercise price of the option, minus the premium
received, the Fund would expect to suffer a loss. Writing covered call options
may serve as a limited short hedge, because declines in the value of the hedged
investment would be offset to the extent of the premium received for writing the
option. However, if the security or currency appreciates to a price higher than
the exercise price of the call option, it can be expected that the option will
be exercised and the Fund will be obligated to sell the security or currency at
less than its market value. If the covered call option is an OTC option, the
securities or other assets used as cover would be considered illiquid to the
extent described under the section entitled "Investment Objectives and
Policies--Illiquid Securities."
The value of an option position will reflect, among other things, the
current market value of the underlying investment, the time remaining until
expiration, the relationship of the exercise price to the market price of the
underlying investment, the historical price volatility of the underlying
investment and general market conditions. Options normally have expiration dates
of up to nine months. Generally, OTC options on foreign currencies and debt
securities are European-style options. This means that the option is only
exercisable immediately prior to its expiration. This is in contrast to
American-style options, which are exercisable at any time prior to the
expiration date of the option. There are also other types of options exercisable
on certain specified dates before expiration. Options that expire unexercised
have no value.
The Fund may effectively terminate its right or obligation under an option
by entering into a closing transaction. For example, the Fund may terminate its
obligation under a call or put option that it had written by purchasing an
identical call or put option; this is known as a closing purchase transaction.
Conversely, the Fund may terminate a position in a put or call option it had
purchased by writing an identical put or call option; this is known as a closing
sale transaction. Closing transactions permit the Fund to realize profits or
limit losses on an option position prior to its exercise or expiration.
The Fund may purchase or write both exchange-traded and OTC options.
Exchange markets for options on debt securities and foreign currencies exist but
are relatively new and these instruments are primarily traded on the OTC market.
Exchange-traded options in the United States are issued by a clearing
organization affiliated with the exchange on which the option is listed which,
in effect, guarantees completion of every exchange-traded option transaction. In
contrast, OTC options are contracts between the Fund and its counterparty
(usually a securities dealer or a bank) with no clearing organization guarantee.
Thus, when the Fund purchases or writes an OTC option, it relies on the
counterparty to make or take delivery of the underlying investment upon exercise
of the option. Failure by the counterparty to do so would result in the loss of
any premium paid by the Fund as well as the loss of any expected benefit of the
transaction.
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The Fund's ability to establish and close out positions in exchange-listed
options depends on the existence of a liquid market. The Fund intends to
purchase or write only those exchange-traded options for which there appears to
be a liquid secondary market. However, there can be no assurance that such a
market will exist at any particular time. Closing transactions can be made for
OTC options only by negotiating directly with the counterparty, or by a
transaction in the secondary market if any such market exists. Although the Fund
will enter into OTC options only with counterparties that are expected to be
capable of entering into closing transactions with the Fund, there is no
assurance that the Fund will in fact be able to close out an OTC option position
at a favorable price prior to expiration. In the event of insolvency of the
counterparty, the Fund might be unable to close out an OTC option position at
any time prior to its expiration. The Fund will enter into OTC option
transactions only with counterparties deemed creditworthy by Mitchell Hutchins.
If the Fund were unable to effect a closing transaction for an option it
had purchased, it would have to exercise the option to realize any profit. The
inability to enter into a closing purchase transaction for a covered call option
written by the Fund could cause material losses because the Fund would be unable
to sell the investment used as cover for the written option until the option
expires or is exercised.
The Fund may purchase and write put and call options on indices of debt
and equity securities in much the same manner as the more traditional options
discussed above, except that index options may serve as a hedge against overall
fluctuations in the debt securities market (or market sectors) rather than
anticipated increases or decreases in the value of a particular security.
FUTURES
The Fund may purchase and sell interest rate, debt and equity security
index and foreign currency futures and options thereon. The purchase of futures
or call options thereon may serve as a long hedge, and the sale of futures or
the purchase of put options thereon may serve as a short hedge. Writing covered
call options on futures contracts may serve as a limited short hedge, using a
strategy similar to that used for writing covered call options on securities,
currencies or indices. Similarly, writing put options on futures contracts may
serve as a limited long hedge.
Futures strategies also can be used to manage the average duration of the
Fund's portfolio. If Mitchell Hutchins wishes to shorten the average duration of
the Fund's portfolio, the Fund may sell an interest rate futures contract or a
call option thereon, or purchase a put option on that futures contract. If
Mitchell Hutchins wishes to lengthen the average duration of the Fund's
portfolio, the Fund may buy an interest rate or futures contract or a call
option thereon or sell a put option thereon.
No price is paid upon entering into a futures contract. Instead, at the
inception of a futures contract the Fund is required to deposit with the futures
broker through which the transaction was effected, "initial margin" consisting
of cash, obligations of the United States or obligations that are fully
guaranteed as to principal and interest by the United States, in an amount
generally equal to 10% or less of the contract value. Margin must also be
deposited when writing a call option on a futures contract, in accordance with
applicable exchange rules. Unlike margin in securities transactions, initial
margin on futures contracts does not represent a borrowing, but rather is in the
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nature of a performance bond or good-faith deposit that is returned to the Fund
at the termination of the transaction if all contractual obligations have been
satisfied. Under certain circumstances, such as periods of high volatility, the
Fund may be required by an exchange to increase the level of its initial margin
payment, and initial margin requirements might be increased generally in the
future by regulatory action.
Subsequent "variation margin" payments are made to and from the futures
broker daily as the value of the futures position varies, a process known as
"marking to market." Variation margin does not involve borrowing, but rather
represents a daily settlement of the Fund's obligations with respect to or from
a futures broker. When the Fund purchases an option on a future, the premium
paid plus transaction costs is all that is at risk. In contrast, when the Fund
purchases or sells a futures contract or writes a put or call option thereon, it
is subject to daily variation margin calls that could be substantial in the
event of adverse price movements. If the Fund has insufficient cash to meet
daily variation margin requirements, it might need to sell securities at a time
when such sales are disadvantageous.
Holders and writers of futures positions and options on futures can enter
into offsetting closing transactions, similar to closing transactions on
options, by selling or purchasing, respectively, an instrument identical to the
instrument held or written. Positions in futures and options on futures may be
closed only on an exchange or board of trade that provides a secondary market.
The Fund intends to enter into such transactions only on exchanges or boards of
trade where there appears to be a liquid secondary market. However, there can be
no assurance that such a market will exist for a particular contract at a
particular time.
Under certain circumstances, futures exchanges may establish daily limits
on the amount that the price of a futures or related option can vary from the
previous day's settlement price; once that limit is reached, no trades may be
made that day at a price beyond the limit. Daily price limits do not limit
potential losses because prices could move to the daily limit for several
consecutive days with little or no trading, thereby preventing liquidation of
unfavorable positions.
If the Fund were unable to liquidate a futures or options position due to
the absence of a liquid secondary market or the imposition of price limits, it
could incur substantial losses. The Fund would continue to be subject to market
risk with respect to the position. In addition, except in the case of purchased
options, the Fund would continue to be required to make daily variation margin
payments and might be required to maintain the position being hedged by the
future or option or to maintain cash or securities in a segregated account.
Certain characteristics of the futures market might increase the risk that
movements in the prices of futures contracts or related options might not
correlate perfectly with movements in the prices of the investments being
hedged. For example, all participants in the futures and options markets are
subject to daily variation margin calls and might be compelled to liquidate
futures or related options positions whose prices are moving unfavorably to
avoid being subject to further calls. These liquidations could increase price
volatility of the instruments and distort the normal price relationship between
the futures or options and the investments being hedged. Also, because initial
margin deposit requirements in the futures market are less onerous than margin
requirements in the securities markets, there might be increased participation
by speculators in the futures markets. This participation also might cause
temporary price distortions. In addition, activities of large traders in both
the futures and securities markets involving arbitrage, "program trading" and
other investment strategies might result in temporary price distortions.
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FOREIGN CURRENCY HEDGING STRATEGIES--SPECIAL CONSIDERATIONS
The Fund may use options on foreign currencies, as described above, and
forward currency contracts, as described below, to hedge against movements in
the values of the foreign currencies in which portfolio securities are
denominated and to attempt to enhance income or to realize gains. Currency
hedges can protect against price movements in a security the Fund owns or
intends to acquire that are attributable to changes in the value of the currency
in which it is denominated. Such hedges do not, however, protect against price
movements in the securities that are attributable to other causes.
The Fund might seek to hedge against changes in the value of a particular
currency when no Derivative Instruments on that currency are available or such
Derivative Instruments are more expensive than certain other Derivative
Instruments. In such cases, the Fund may hedge against price movements in that
currency by entering into transactions using Derivative Instruments on another
currency or basket of currencies, the value of which Mitchell Hutchins believes
will have a positive correlation to the value of the currency being hedged. The
risk that movements in the price of the Derivative Instrument will not correlate
perfectly with movements in the price of the currency being hedged is magnified
when this strategy is used.
The value of Derivative Instruments on foreign currencies depends on the
value of the underlying currency relative to the U.S. dollar. Because foreign
currency transactions occurring in the interbank market might involve
substantially larger amounts than those involved in the use of such Derivative
Instruments, the Fund could be disadvantaged by having to deal in the odd-lot
market (generally consisting of transactions of less than $1 million) for the
underlying foreign currencies at prices that are less favorable than for round
lots.
There is no systematic reporting of last sale information for foreign
currencies or any regulatory requirement that quotations available through
dealers or other market sources be firm or revised on a timely basis. Quotation
information generally is representative of very large transactions in the
interbank market and thus might not reflect odd-lot transactions where rates
might be less favorable. The interbank market in foreign currencies is a global,
round-the-clock market. To the extent the U.S. options or futures markets are
closed while the markets for the underlying currencies remain open, significant
price and rate movements might take place in the underlying markets that cannot
be reflected in the markets for the Derivative Instruments until they reopen.
Settlement of Derivative Instruments involving foreign currencies might be
required to take place within the country issuing the underlying currency. Thus,
the Fund might be required to accept or make delivery of the underlying foreign
currency in accordance with any U.S. or foreign regulations regarding the
maintenance of foreign banking arrangements by U.S. residents and might be
required to pay any fees, taxes and charges associated with such delivery
assessed in the issuing country.
COMBINED TRANSACTIONS
The Fund may enter into multiple transactions, including multiple options
transactions, multiple futures transactions and any combination of futures and
options transactions (each a "component" transaction), instead of a single
Derivative Instrument, as part of a single or combined strategy when, in the
opinion of Mitchell Hutchins, it is in the best interests of the Fund to do so.
A combined transaction will usually contain elements of risk that are present in
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each of its component transactions. Although combined transactions are normally
entered into based on Mitchell Hutchins' judgment that the combined strategies
will reduce risk or otherwise more effectively achieve the desired portfolio
management goal, it is possible that the combination will instead increase such
risks or hinder achievement of the portfolio management objective.
GUIDELINE FOR FUTURES AND OPTIONS
To the extent that the Fund enters into futures contracts, options on
futures positions and options on foreign currencies traded on a commodities
exchange, which are not for BONA FIDE hedging purposes (as defined by the CFTC),
the aggregate initial margin and premiums on these positions (excluding the
amount by which options are "in-the-money") may not exceed 5% of the Fund's net
assets. This guideline may be modified by the Fund's Board of Directors without
a stockholder vote. Adoption of this guideline does not limit the percentage of
the Fund's assets at risk to 5%.
FORWARD CURRENCY CONTRACTS
The Fund may enter into forward currency contracts to purchase or sell
foreign currencies for a fixed amount of U.S. dollars or another foreign
currency. Such transactions may serve as long hedges--for example, the Fund may
purchase a forward currency contract to lock in the U.S. dollar price of a
security denominated in a foreign currency that the Fund intends to acquire.
Forward currency contract transactions may also serve as short hedges--for
example, the Fund may sell a forward currency contract to lock in the U.S.
dollar equivalent of the proceeds from the anticipated sale of a security
denominated in a foreign currency.
As noted above, the Fund also may seek to hedge against changes in the
value of a particular currency by using forward contracts on another foreign
currency or a basket of currencies, the value of which Mitchell Hutchins
believes will have a positive correlation to the values of the currency being
hedged. In addition, the Fund may use forward currency contracts to shift its
exposure to foreign currency fluctuations from one country to another. For
example, if the Fund owned securities denominated in a foreign currency and
Mitchell Hutchins believed that currency would decline relative to another
currency, it might enter into a forward contract to sell an appropriate amount
of the first foreign currency, with payment to be made in the second foreign
currency. Transactions that use two foreign currencies are sometimes referred to
as "cross hedging." Use of a different foreign currency magnifies the risk that
movements in the price of the Derivative Instrument will not correlate or will
correlate unfavorably with the foreign currency being hedged.
The cost to the Fund of engaging in forward currency contracts varies with
factors such as the currency involved, the length of the contract period and the
market conditions then prevailing. Because forward currency contracts are
usually entered into on a principal basis, no fees or commissions are involved.
When the Fund enters into a forward currency contract, it relies on the
counterparty to make or take delivery of the underlying currency at the maturity
of the contract. Failure by the counterparty to do so would result in the loss
of any expected benefit of the transaction.
As in the case with futures contracts, holders and writers of forward
currency contracts can enter into offsetting closing transactions, similar to
closing transactions on futures, by selling or purchasing, respectively, an
instrument identical to the instrument purchased or sold. Secondary markets
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generally do not exist for forward currency contracts, with the result that
closing transactions generally can be made for forward currency contracts only
by negotiating directly with the counterparty. Thus, there can be no assurance
that the Fund will in fact be able to close out a forward currency contract at a
favorable price prior to maturity. In addition, in the event of insolvency of
the counterparty, the Fund might be unable to close out a forward currency
contract at any time prior to maturity. In either event, the Fund would continue
to be subject to market risk with respect to the position, and would continue to
be required to maintain a position in the securities or currencies that are the
subject of the hedge or to maintain cash or liquid securities in a segregated
account.
The precise matching of forward currency contract amounts and the value of
the securities involved generally will not be possible because the value of such
securities, measured in the foreign currency, will change after the forward
currency contract has been established. Thus, the Fund might need to purchase or
sell foreign currencies in the spot (cash) market to the extent such foreign
currencies are not covered by forward contracts. The projection of short-term
currency market movements is extremely difficult, and the successful execution
of a short-term hedging strategy is highly uncertain.
LIMITATIONS ON THE USE OF FORWARD CURRENCY CONTRACTS
The Fund may enter into forward currency contracts or maintain a net
exposure to such contracts only if (1) the consummation of the contracts would
not obligate the Fund to deliver an amount of foreign currency in excess of the
value of the position being hedged by such contracts or (2) the Fund maintains
cash or liquid securities in a segregated account in an amount not less than the
value of its total assets committed to the consummation of the contract and not
covered as provided in (1) above, as marked to market daily.
SWAP TRANSACTIONS
The Fund may enter into interest rate swap transactions. Swap transactions
include caps, floors and collars. Interest rate swap transactions involve an
agreement between two parties to exchange payments that are based, respectively,
on variable and fixed rates of interest and that are calculated on the basis of
a specified amount of principal ("notional principal amount") for a specified
period of time. Interest rate cap and floor transactions involve an agreement
between two parties in which one party agrees to make payments to its
counterparty when a designated market interest rate goes above (in the case of a
cap) or below (in the case of a floor) a designated level on predetermined dates
or during a specified time period. Interest rate collar transactions involve an
agreement between two parties in which payments are made when a designated
market interest rate either goes above a designated level or goes below a
designated floor level on predetermined dates or during a specified time period.
The Fund would enter into swap transactions to preserve a return or spread
on a particular investment or portion of its portfolio or to protect against any
increase in the price of securities it anticipates purchasing at a later date.
The Fund would use these transactions as a hedge and not as a speculative
investment. Interest rate swap transactions are subject to risks comparable to
those described above with respect to other Derivative Instruments.
The Fund may enter into interest rate swaps, caps, floors and collars on
either an asset-based or liability-based basis, depending on whether it is
hedging its assets or its liabilities, and will usually enter into interest rate
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swaps on a net basis, I.E., the two payment streams are netted out, with the
Fund receiving or paying, as the case may be, only the net amount of the two
payments. Inasmuch as these swap transactions are entered into for good faith
hedging purposes and inasmuch as segregated accounts will be established with
respect to such transactions, Mitchell Hutchins and the Fund believe such
obligations do not constitute senior securities and, accordingly, will not treat
them as being subject to its borrowing restrictions. The net amount of the
excess, if any, of the Fund's obligations over its entitlements with respect to
each interest rate swap will be accrued on a daily basis and appropriate Fund
assets having an aggregate net asset value at least equal to the accrued excess
will be maintained in a segregated account by a custodian that satisfies the
requirements of the 1940 Act. The Fund also will establish and maintain such
segregated accounts with respect to its total obligations under any interest
rate swaps that are not entered into on a net basis and with respect to any
interest rate caps, floors and collars that are written by the Fund.
The Fund will enter into swap transactions only with banks, securities
dealers and their respective affiliates believed by Mitchell Hutchins to present
minimal credit risks in accordance with guidelines established by the Fund's
Board. If there is a default by the other party to such a transaction, the Fund
will have to rely on its contractual remedies (which may be limited by
bankruptcy, insolvency or similar laws) pursuant to the agreements related to
the transaction.
DIRECTORS AND OFFICERS
The Fund pays its Directors who are not "interested persons" of the Fund
$1,000 annually and up to $150 for each Board meeting and for each separate
meeting of a Board committee. The chairmen of the audit and contract review
committees of individual funds within the PaineWebber fund complex each receive
additional compensation aggregating $15,000 annually from the relevant funds.
All Directors are reimbursed for any expenses incurred in attending meetings.
Because Mitchell Hutchins performs substantially all of the services necessary
for the operation of the Fund, the Fund requires no employees. No officer,
director or employee of PaineWebber or Mitchell Hutchins presently receives any
compensation from the Fund for acting as a Director or officer.
The table below includes certain information relating to the compensation
of the Fund's Directors.
COMPENSATION TABLE +
AGGREGATE TOTAL COMPENSATION
COMPENSATION FROM THE FUND AND THE FUND
NAME OF PERSONS POSITION FROM THE FUND* COMPLEX**
Richard Q. Armstrong, Director $1,327 $104,650
Richard R. Burt, Director $1,297 $102,850
Meyer Feldberg, Director $1,816 $119,650
George W. Gowen, Director $1,327 $119,650
Frederic Malek, Director $1,327 $104,650
Carl W. Schafer, Director $1,327 $104,650
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- --------
+ Only independent members of the Board of Directors are compensated by the
Fund and identified above; Directors who are "interested persons," as defined
in the 1940 Act, do not receive compensation.
* Represents fees paid to each Director during the fiscal period ended May 31,
1999 by the Fund.
** Represents total compensation paid to each Director during the calendar year
ended December 31, 1999; no fund within the complex has a bonus, pension,
profit sharing or retirement plan.
CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES
As of March 1, 2000, Cede & Co. (the nominee for The Depository Trust
Company) owned of record 31,577,290 shares or 99.1% of the outstanding shares.
To the knowledge of the Fund, no person is the beneficial owner of 5% or more of
its shares. As of March 1, 2000, the Directors and officers of the Fund
beneficially owned less than 1% of the outstanding Fund shares.
INVESTMENT ADVISORY ARRANGEMENTS
Mitchell Hutchins is the Fund's investment adviser and administrator
pursuant to a contract dated June 22, 1998 ("Advisory Contract"). Mitchell
Hutchins is a wholly owned asset management subsidiary of PaineWebber, which is
a wholly owned subsidiary of Paine Webber Group Inc., a publicly held financial
services holding company. Mitchell Hutchins provides investment advisory and
portfolio management services to investment companies, pension funds, and other
institutional, corporate and individual clients.
Pursuant to the Advisory Contract, Mitchell Hutchins provides a continuous
investment program for the Fund and makes investment decisions and places orders
to buy, sell or hold particular securities. As administrator, Mitchell Hutchins
supervises all matters relating to the operation of the Fund and obtain for it
corporate, administrative and clerical personnel, office space, equipment and
services, including arranging for the periodic preparation, updating, filing and
dissemination of proxy materials, tax returns and reports to the Fund's Board,
stockholders and regulatory authorities.
The Advisory Contract between Mitchell Hutchins and the Fund provides
Mitchell Hutchins with a fee, computed weekly and payable monthly, in an amount
equal to the annual rate of 0.70% of the Fund's average weekly total assets
minus liabilities other than the aggregate indebtedness constituting leverage
("Managed Assets"). During periods in which the Fund is utilizing leverage, the
investment advisory and administrative fee payable to Mitchell Hutchins will be
higher than if the Fund did not utilize a leveraged capital structure because
the fee is calculated as a percentage of the Fund's Managed Assets, including
those purchased with leverage.
In addition to the payments to Mitchell Hutchins under the Advisory
Contract described above, the Fund pays certain other costs, including (1) the
costs (including brokerage commissions) of securities purchased or sold by the
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Fund and any losses incurred in connection therewith; (2) fees payable to and
expenses incurred on behalf of the Fund by Mitchell Hutchins; (3) organizational
and offering expenses of the Fund, whether or not advanced by Mitchell Hutchins;
(4) filing fees and expenses relating to the registration and qualification of
the Fund's shares and the Fund under federal securities laws and/or state laws
and maintaining such registration and qualifications; (5) fees and salaries
payable to Fund's Directors and officers who are not interested persons of the
Fund or Mitchell Hutchins; (6) all expenses incurred in connection with the
Fund's Directors' services, including travel expenses; (7) taxes (including any
income or franchise taxes) and governmental fees; (8) costs of any liability,
uncollectible items of deposit and any other insurance or fidelity bonds; (9)
any costs, expenses or losses arising out of a liability of or claims for
damages or other relief asserted against the Fund for violation of any law; (10)
legal, accounting and auditing expenses, including legal fees of special counsel
for those Directors of the Fund who are not interested persons of the Fund; (11)
charges of custodians, transfer agents and other agents (including any lending
agent); (12) costs of preparing share certificates; (13) expenses of setting in
type and printing prospectuses and supplements thereto, statements of additional
information and supplements thereto, reports and proxy materials for existing
stockholders; (14) costs of mailing prospectuses and supplements thereto,
statements of additional information and supplements thereto, reports and proxy
materials to existing stockholders; (15) any extraordinary expenses (including
fees and disbursements of counsel, costs of actions, suits or proceedings to
which the Fund is a party and the expenses the Fund may incur as a result of its
legal obligation to provide indemnification to its officers, Directors, agents
and stockholders) incurred by the Fund; (16) fees, voluntary assessments and
other expenses incurred in connection with membership in investment company
organizations; (17) costs of mailing and tabulating proxies and costs of
meetings of stockholders, the Board and any committees thereof; (18) the costs
of investment company literature and other publications provided by the Fund to
its Directors and officers; (19) costs of mailing, stationery and communications
equipment; (20) expenses incident to any dividend reinvestment plan; (21)
changes and expenses of any outside pricing service used to value portfolio
securities; (22) interest on borrowings of the Fund; (23) fees and expenses of
listing and maintaining any listing of the Fund's shares on any national
securities exchange; and (24) costs and expenses (including rating agency fees)
associated with the issuance of any preferred stock.
The Advisory Contract was approved by the Fund's Board and by a majority
of the Directors who are not parties to the Advisory Contract or interested
persons of any such party ("Independent Directors") on May 13, 1998 and by its
initial stockholder on June 22, 1998. Unless sooner terminated, the Advisory
Contract will continue automatically for successive annual periods, provided
that such continuance is specifically approved at least annually (1) by a
majority vote of the Independent Directors cast in person at a meeting called
for the purpose of voting on such approval; and (2) by the Board or by vote of a
majority of the Fund's outstanding voting securities.
Under the Advisory Contract, Mitchell Hutchins is not liable for any error
of judgment or mistake of law or for any loss suffered by the Fund in connection
with the Advisory Contract, except a loss resulting from willful misfeasance,
bad faith or gross negligence on the part of Mitchell Hutchins in the
performance of its duties or from reckless disregard of its duties and
obligations under the Advisory Contract. The Advisory Contract is terminable by
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vote of the Board or by the holders of a majority of the outstanding voting
securities of the Fund, at any time without penalty, on 60 days' written notice
to Mitchell Hutchins. The Advisory Contract may also be terminated by Mitchell
Hutchins on 60 days' written notice to the Fund. The Advisory Contract
terminates automatically upon its assignment.
The Fund, its investment adviser and its principal underwriter each have
adopted a code of ethics under rule 17j-1 of the 1940 Act, which permits
personnel covered by the rule to invest in securities that may be purchased or
held by the Fund but prohibits fraudulent, deceptive or manipulative conduct in
connection with that personal investing.
For the fiscal period ended May 31, 1999, the Fund paid or accrued to
Mitchell Hutchins investment advisory and administration fees totaling $3,433,
461.
CUSTODIAN AND INDEPENDENT AUDITORS
State Street Bank and Trust Company ("State Street"), One Heritage Drive,
North Quincy, Massachusetts 02171, serves as custodian of the Fund's assets. As
custodian of the Fund, State Street responsibility's include the safekeeping of
securities, cash and other assets of the Fund; settling portfolio purchases and
sales; identifying and collecting portfolio income; and performing portfolio
accounting functions. State Street also employs foreign sub-custodians approved
by the Board of Directors, in accordance with applicable requirements under the
1940 Act, to provide custody of the Fund's foreign assets. Ernst & Young LLP
("Ernst & Young"), 787 Seventh Avenue, New York, New York 10019, serves as the
Fund's independent auditors. As independent auditors, Ernst & Young reviews the
books and records of the Fund. Moreover, it advises management on accounting
issues. Ernst and Young also issues audit reports to the Board of Directors,
stockholders, and the SEC.
PORTFOLIO TRANSACTIONS
Subject to policies established by the Board of Directors, Mitchell
Hutchins is responsible for the execution of the Fund's portfolio transactions
and the allocation of brokerage transactions. In executing portfolio
transactions, Mitchell Hutchins seeks to obtain the best net results for the
Fund, taking into account such factors as the price (including the applicable
dealer spread or brokerage commission), size of order, difficulty of execution
and operational facilities of the firm involved. Generally, debt securities are
traded on the OTC market on a "net" basis without a stated commission through
dealers acting for their own account and not as brokers. Prices paid to dealers
in principal transactions generally include a "spread," which is the difference
between the prices at which the dealer is willing to purchase and sell a
specific security at that time.
The Fund has no obligation to deal with any broker or group of brokers in
the execution of portfolio transactions. The Fund contemplates that, consistent
with obtaining the best net results, brokerage transactions may be conducted
through Mitchell Hutchins or any of its affiliates, including PaineWebber. The
Fund's Board of Directors adopted procedures in conformity with Rule 17e-1 under
the 1940 Act to ensure that all brokerage commissions paid to Mitchell Hutchins
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or any of its affiliates are reasonable and fair. Specific provisions in the
Advisory Contract authorize Mitchell Hutchins and any affiliate thereof that is
a member of a national securities exchange to effect portfolio transactions for
the Fund on such exchange and to retain compensation in connection with such
transactions. Any such transactions will be effected and related compensation
paid only in accordance with applicable SEC regulations.
Transactions in futures contracts are executed through futures commission
merchants ("FCMs") who receive brokerage commissions for their services. The
Fund's procedures in selecting FCMs to execute the Fund's transactions in
futures contracts, including procedures permitting the use of Mitchell Hutchins
and its affiliates, are similar to those in effect with respect to brokerage
transactions in securities. For the fiscal period ended May 31, 1999, the Fund
did not pay any commissions to FCMs.
Consistent with the Fund's interests and subject to the review of the
Fund's Board of Directors, Mitchell Hutchins may cause the Fund to purchase and
sell portfolio securities through brokers who provide the Fund with research,
analysis, advice and similar services. In return for such services, the Fund may
pay to those brokers a higher commission than may be charged by other brokers,
provided that Mitchell Hutchins determines in good faith that such commission is
reasonable in terms either of that particular transaction or of the overall
responsibility of Mitchell Hutchins to the Fund and its other clients and that
the total commissions paid by the Fund will be reasonable in relation to the
benefits to the Fund over the long term. For purchases or sales with
broker-dealer firms which act as principal, Mitchell Hutchins seeks best
execution. Although Mitchell Hutchins may receive certain research or execution
services in connection with these transactions, Mitchell Hutchins will not
purchase securities at a higher price or sell securities at a lower price than
would otherwise be paid if no weight was attributed to the services provided by
the executing dealer. Moreover, Mitchell Hutchins does not enter into any
explicit soft dollar arrangements relating to principal transactions and does
not receive in principal transactions the types of services which could be
purchased for hard dollars. Mitchell Hutchins may engage in agency transactions
in OTC equity and debt securities in return for research and execution services.
These transactions are entered into only in compliance with procedures ensuring
that the transaction (including commissions) is at least as favorable as it
would have been if effected directly with a market-maker that did not provide
research or execution services. These procedures include Mitchell Hutchins
receiving multiple quotes from dealers before executing the transaction on an
agency basis.
Research services furnished by dealers or brokers with or through which
the Fund effects securities transactions may be used by Mitchell Hutchins in
advising other funds or accounts and, conversely, research services furnished to
Mitchell Hutchins by dealers or brokers in connection with other funds or
accounts Mitchell Hutchins advisers may be used by Mitchell Hutchins in advising
the Fund. Information and research received from such brokers or dealers will be
in addition to, and not in lieu of, the services required to be performed by
Mitchell Hutchins under the Advisory Contract.
Investment decisions for the Fund and for other investment accounts
managed by Mitchell Hutchins are made independently of each other in light of
differing considerations for the various accounts. The same investment decision,
however, may occasionally be made for the Fund and one or more such accounts. In
such cases, simultaneous transactions are inevitable. Purchases or sales are
then averaged as to price and allocated between the Fund and such other
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account(s) as to amount according to a formula deemed equitable to the Fund and
such account(s). While in some cases this practice could have a detrimental
effect upon the price or value of the security as far as the Fund is concerned,
or upon its ability to complete its entire order, in other cases it is believed
that coordination and the ability to participate in volume transactions are
beneficial to the Fund.
The Fund does not purchase securities that are offered in underwritings in
which PaineWebber, Mitchell Hutchins or any of their affiliates is a member of
the underwriting or selling group, except pursuant to procedures adopted by the
Fund's Board of Directors pursuant to Rule 10f-3 under the 1940 Act. Among other
things, these procedures require that the commission or spread paid in
connection with such a purchase be reasonable and fair, that the purchase be at
not more than the public offering price prior to the end of the first business
day after the date of the public offering and that PaineWebber, Mitchell
Hutchins and their affiliates not participate in or benefit from the sale to the
Fund.
For the fiscal period ended May 31, 1999, Mitchell Hutchins did not direct
any brokerage commissions to brokers chosen because they provided research and
analysis. For the fiscal period ended May 31, 1999, Plus Fund paid no brokerage
commissions.
PORTFOLIO TURNOVER
The Fund's portfolio turnover rate was 52% for the fiscal period June 26,
1998 (commencement of operations) to May 31, 1999. Portfolio turnover may vary
from year to year and will not be a limiting factor when Mitchell Hutchins deems
portfolio changes appropriate. Higher portfolio turnover (100% or more) will
result in higher Fund expenses, including brokerage commissions, dealer mark-ups
and other transaction costs on the sale of securities and on reinvestment in
other securities. The portfolio turnover rate is calculated by dividing the
lesser of the Fund's annual sales or purchases of portfolio securities
(exclusive of purchases or sales of securities whose maturities at the time of
acquisition were one year or less) by the monthly average value of the long-term
securities in the portfolio during the year.
NET ASSET VALUE OF SHARES
The net asset value of the Fund's shares is determined as of the close of
regular trading on the New York Stock Exchange ("NYSE") on each Business Day,
which is defined as each Monday through Friday the NYSE is open for trading. The
net asset value of the shares also is determined monthly at the close of regular
trading on the NYSE on the last day of the month on which the NYSE is open for
trading. The net asset value per share is computed by dividing the value of the
securities held by the Fund plus any cash or other assets (including interest
and dividends accrued but not yet received and earned discount) minus all
liabilities (including accrued expenses) by the total number of shares
outstanding at such time.
When market quotations are readily available, the Fund's debt securities
are valued based upon those quotations. When market quotations for options and
futures positions held by the Fund are readily available, those positions are
valued based upon such quotations. Market quotations generally are not available
for options traded in the OTC market. When market quotations for options or
futures positions are not readily available, they are valued at fair value as
determined in good faith by or under the direction of the Board of Directors.
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When market quotations are not readily available for any of the Fund's debt
securities, such securities are valued based upon appraisals received from a
pricing service using a computerized matrix system or based upon appraisals
derived from information concerning the security or similar securities received
from recognized dealers in those securities. Notwithstanding the above, debt
securities with maturities of 60 days or less generally are valued at amortized
cost if their original term to maturity was 60 days or less, or by amortizing
the difference between their fair value as of the 61st day prior to maturity and
their maturity value if their original term to maturity exceeded 60 days, unless
in either case the Board of Directors or its delegate determines that this does
not represent fair value.
Securities and other instruments that are listed on U.S. and foreign stock
exchanges and for which market quotations are readily available are valued at
the last sale price on the exchange on which the securities are traded, as of
the close of business on the day the securities are being valued or, lacking any
sales on such day, at the last bid price available. In cases where securities or
other instruments are traded on more than one exchange, such securities or other
instruments generally are valued on the exchange designated by Mitchell Hutchins
under the direction of the Board of Directors as the primary market. Securities
traded in the OTC market and listed on the Nasdaq are valued at the last
available sale price on Nasdaq prior to the time of valuation; other OTC
securities and instruments are valued at the last available bid price prior to
the time of valuation. Other securities and assets for which reliable market
quotations are not readily available (including restricted securities subject to
limitations as to their sale) are valued at fair value as determined in good
faith by or under the direction of the Board of Directors.
All securities and other assets quoted in foreign currency and forward
currency contracts are valued daily in U.S. dollars on the basis of the foreign
currency exchange rate prevailing at the time such valuation is determined by
the Fund's custodian. Foreign currency exchange rates are generally determined
prior to the close of the NYSE. Occasionally, events affecting the value of
foreign securities and such exchange rates occur between the time at which they
are determined and the close of the NYSE, which events will not be reflected in
a computation of the Fund's net asset value. If events materially affecting the
value of such securities or assets or currency exchange rates occurred during
such time period, the securities or assets would be valued at their fair value
as determined in good faith by or under the direction of the Board of Directors.
The foreign currency exchange transactions of the Fund conducted on a spot basis
are valued at the spot rate for purchasing or selling currency prevailing on the
foreign exchange market. Under normal market conditions this rate differs from
the prevailing exchange rate by an amount generally less than one-tenth of one
percent due to the costs of converting from one currency to another.
TAXATION
GENERAL
The following discussion of federal income tax consequences is for general
information only. Investors should consult their tax advisors regarding the
specific federal tax consequences of purchasing, holding and disposing of
shares, as well as the effects thereon of state, local and foreign tax laws and
any proposed tax law changes.
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In order to continue to qualify for treatment as a regulated investment
company ("RIC") under the Internal Revenue Code of 1986 ("Code"), the Fund must
distribute to its stockholders for each taxable year at least 90% of its
investment company taxable income (consisting generally of net investment
income, net short-term capital gain and net gains from certain foreign currency
transactions) ("Distribution Requirement") and must meet several additional
requirements. These requirements include the following: (1) the Fund must derive
at least 90% of its gross income each taxable year from dividends, interest,
payments with respect to securities loans and gains from the sale or other
disposition of securities or foreign currencies, or other income (including
gains from options, futures or forward contracts) derived with respect to its
business of investing in securities or those currencies ("Income Requirement");
(2) at the close of each quarter of the Fund's taxable year, at least 50% of the
value of its total assets must be represented by cash and cash items, U.S.
government securities, securities of other RICs and other securities that are
limited, in respect of any one issuer, to an amount that does not exceed 5% of
the value of the Fund's total assets and that does not represent more than 10%
of the issuer's outstanding voting securities; and (3) at the close of each
quarter of the Fund's taxable year, not more than 25% of the value of its total
assets may be invested in securities (other than U.S. government securities or
the securities of other RICs) of any one issuer. By qualifying as a RIC, the
Fund (but not its stockholders) will be relieved of federal income tax on the
part of its investment company taxable income and net capital gain (I.E., the
excess of net long-term capital gain over net short-term capital loss) that it
distributes to stockholders. If the Fund failed to qualify for treatment as a
RIC for any taxable year, (a) it would be taxed as an ordinary corporation on
the full amount of its taxable income for that year without being able to deduct
the distributions it makes to its stockholders and (b) the stockholders would
treat all those distributions, including distributions of net capital gain, as
dividends (that is, ordinary income) to the extent of the Fund's earnings and
profits. In addition, the Fund could be required to recognize unrealized gains,
pay substantial taxes and interest, and make substantial distributions before
requalifying for RIC treatment.
Dividends and other distributions declared by the Fund in October,
November or December of any year and payable to stockholders of record on a date
in any of those months will be deemed to have been paid by the Fund and received
by the stockholders on December 31st of that year if the distributions are paid
by the Fund during the following January.
If the Fund retains any net capital gain (the excess of net long-term
capital gain over net short-term capital loss), it may designate the retained
amount as undistributed capital gains in a notice to its stockholders. If the
Fund makes such a designation, it will be required to pay federal income tax at
the rate of 35% on the undistributed gains ("Fund tax") and each stockholder
subject to federal income tax (1) will be required to include in income, as
long-term capital gains, his or her proportionate share of the undistributed
gains, (2) will be allowed a credit or refund, as the case may be, for his or
her proportionate share of the Fund tax and (3) will increase the tax basis of
his or her Fund shares by the difference between the included income and such
share of the Fund tax.
A portion of the dividends from the Fund's investment company taxable
income (whether paid in cash or reinvested in additional shares) may be eligible
for the dividends-received deduction allowed to corporations. The eligible
portion may not exceed the aggregate dividends the Fund receives from U.S.
corporations. However, dividends received by a corporate stockholder and
deducted by it pursuant to the dividends-received deduction are subject
indirectly to the federal alternative minimum tax. It is not expected that a
significant portion of the Fund's dividends will qualify for this deduction.
If the Fund has both shares of common stock and preferred stock
outstanding, it intends to designate distributions made to each such class in
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any year as consisting of no more than the class's proportionate share of
particular types of income based on the total distributions paid to each class
for the year, including distributions out of net capital gain.
Income from investments in foreign securities, and gains realized thereon,
may be subject to foreign withholding or other taxes. Tax conventions between
certain countries and the United States may reduce or eliminate foreign taxes,
however, and many foreign countries do not impose taxes on capital gains in
respect of investments by foreign investors. Stockholders will not be able to
claim any foreign tax credit or deduction with respect to those foreign taxes.
The Fund will be subject to a nondeductible 4% excise tax ("Excise Tax")
to the extent it fails to distribute by the end of any calendar year
substantially all of its ordinary income for that year and capital gain net
income for the one-year period ending on October 31st of that year, plus certain
other amounts. For these purposes, any such income retained by the Fund, and on
which it pays federal income tax, will be treated as having been distributed.
PASSIVE FOREIGN INVESTMENT COMPANIES
The Fund may invest in the stock of "passive foreign investment companies"
("PFICs"). A PFIC is a foreign corporation (with certain exceptions) that, in
general, meets either of the following tests: (1) at least 75% of its gross
income is passive or (2) an average of at least 50% of its assets produce, or
are held for the production of, passive income. Under certain circumstances, the
Fund will be subject to federal income tax on a portion of any "excess
distribution" received on the stock of a PFIC or of any gain on disposition of
that stock (collectively "PFIC income"), plus interest thereon, even if the Fund
distributes the PFIC income as a taxable dividend to its stockholders. The
balance of the PFIC income will be included in the Fund's investment company
taxable income and, accordingly, will not be taxable to it to the extent that
income is distributed to its stockholders.
If the Fund invests in a PFIC and elects to treat the PFIC as a "qualified
electing fund," then, in lieu of the foregoing tax and interest obligation, the
Fund will be required to include in income each year its pro rata share of the
qualified electing fund's annual ordinary earnings and net capital gain--which
most likely would have to be distributed by the Fund to satisfy the Distribution
Requirement and avoid imposition of the Excise Tax--even if the qualified
electing fund does not distribute those earnings and gain to the Fund. In most
instances it will be very difficult, if not impossible, to make this election
because of certain requirements for making the election.
The Fund may elect to "mark to market" its stock in any PFIC.
"Marking-to-market," in this context, means including in ordinary income each
taxable year the excess, if any, of the fair market value of the PFIC's stock
over the Fund's adjusted basis therein as of the end of that year. Pursuant to
the election, the Fund also will be allowed to deduct (as an ordinary, not
capital, loss) the excess, if any, of its adjusted basis in PFIC stock over the
fair market value thereof as of the taxable year-end, but only to the extent of
any net mark-to-market gains with respect to that stock included by the Fund for
prior taxable years (and under regulations proposed in 1992 that provided a
similar election with respect to the stock of certain PFICs). The Fund's
adjusted basis in each PFIC's stock with respect to which it makes this election
will be adjusted to reflect the amounts of income included and deductions taken
under the election.
39
<PAGE>
STRATEGIES USING DERIVATIVE INSTRUMENTS
Strategies using Derivative Instruments, such as selling (writing) and
purchasing options and futures and entering into forward currency contracts,
involve complex rules that will determine for income tax purposes the amount,
character and timing of recognition of the gains and losses the Fund realizes in
connection therewith. These rules also may require the Fund to "mark to market"
(that is, treat as sold for their fair market value) at the end of each taxable
year certain positions in its portfolio, which may cause the Fund to recognize
income and/or gain without receiving cash with which to make distributions
necessary to satisfy the Distribution Requirement and avoid imposition of the
Excise Tax. Gains from the disposition of foreign currencies (except certain
gains that may be excluded by future regulations), and gains from options,
futures and forward currency contracts derived by the Fund with respect to its
business of investing in securities or foreign currencies, will qualify as
permissible income under the Income Requirement.
If the Fund has an "appreciated financial position"--generally, an
interest (including an interest through an option, futures or forward currency
contract, or short sale) with respect to any stock, debt instrument (other than
"straight debt") or partnership interest the fair market value of which exceeds
its adjusted basis--and enters into a "constructive sale" of the same or
substantially similar property, the Fund will be treated as having made an
actual sale thereof, with the result that gain will be recognized at that time.
A constructive sale generally consists of a short sale, an offsetting notional
principal contract or futures or forward currency contract entered into by the
Fund or a related person with respect to the same or substantially similar
property. In addition, if the appreciated financial position is itself a short
sale or such a contract, acquisition of the underlying property or substantially
similar property will be deemed a constructive sale. The foregoing will not
apply, however, to the Fund's transaction during any taxable year that otherwise
would be treated as a constructive sale if the transaction is closed within 30
days after the end of that year and the Fund holds the appreciated financial
position unhedged for 60 days after that closing (I.E., at no time during that
60-day period is the Fund's risk of loss regarding that position reduced by
reason of certain specified transactions with respect to substantially similar
or related property, such as having an option to sell, being contractually
obligated to sell, making a short sale or granting an option to buy
substantially identical stock or securities).
ADDITIONAL INFORMATION
STOCK REPURCHASES AND TENDERS
The Fund's Board of Directors may authorize the Fund to tender for its
shares to reduce or eliminate the discount to net asset value at which the
Fund's shares might trade. Even if a tender offer has been made, it will be the
Board's announced policy, which may be changed by the Board, not to accept
tenders or effect repurchases (or, if a tender offer has not been made, not to
initiate a tender offer) if (1) such transactions, if consummated, would (a)
result in the delisting of the Fund's shares from the NYSE (the NYSE having
advised the Fund that it would consider delisting if the aggregate market value
of the outstanding shares is less than $5,000,000, the number of publicly held
shares falls below 600,000 or the number of round-lot holders falls below 1,200)
or (b) impair the Fund's status as a RIC (which would eliminate the Fund's
eligibility to deduct dividends paid to its stockholders, thus causing its
income to be fully taxed at the corporate level in addition to the taxation of
stockholders on distributions received from the Fund); (2) the Fund would not be
able to liquidate portfolio securities in an orderly manner and consistent with
the Fund's investment objective and policies in order to repurchase its shares;
or (3) there is, in the Board's judgment, any (a) material legal action or
40
<PAGE>
proceeding instituted or threatened challenging such transactions or otherwise
materially adversely affecting the Fund, (b) suspension of trading or limitation
on prices of securities generally on the NYSE or any other exchange on which
portfolio securities of the Fund are traded, (c) declaration of a banking
moratorium by federal or state authorities or any suspension of payment by banks
in the United States, New York State or any state in which the Fund invests, (d)
limitation affecting the Fund or the issuers of its portfolio securities imposed
by federal or state authorities on the extension of credit by lending
institutions, (e) commencement of war, armed hostilities or other international
or national calamity directly or indirectly involving the United States or (f)
other events or conditions that would have a material adverse effect on the Fund
or its stockholders if shares were repurchased. The Board of Directors may
modify these conditions in light of experience.
RATINGS INFORMATION
DESCRIPTION OF MOODY'S CORPORATE BOND RATINGS
Aaa. Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred to as
"gilt edged." Interest payments are protected by a large or by an exceptionally
stable margin and principal is secure. While the various protective elements are
likely to change, such changes as can be visualized are most unlikely to impair
the fundamentally strong position of such issues; Aa. Bonds which are rated Aa
are judged to be of high quality by all standards. Together with the Aaa group
they comprise what are generally known as high-grade bonds. They are rated lower
than the best bonds because margins of protection may not be as large as in Aaa
securities or fluctuation of protective elements may be of greater amplitude or
there may be other elements present which make the long-term risk appear
somewhat larger than the Aaa securities; A. Bonds which are rated A possess many
favorable investment attributes and are to be considered as upper-medium-grade
obligations. Factors giving security to principal and interest are considered
adequate, but elements may be present which suggest a susceptibility to
impairment some time in the future; Baa. Bonds which are rated Baa are
considered as medium-grade obligations, I.E., they are neither highly protected
nor poorly secured. Interest payments and principal security appear adequate for
the present but certain protective elements may be lacking or may be
characteristically unreliable over any great length of time. Such bonds lack
outstanding investment characteristics and in fact have speculative
characteristics as well; Ba. Bonds which are rated Ba are judged to have
speculative elements; their future cannot be considered 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.
Note: Moody's applies numerical modifiers, 1, 2 and 3 in each generic
rating classification from Aa through Caa. The modifier 1 indicates that the
obligation ranks in the higher end of its generic rating category, the modifier
2 indicates a mid-range ranking, and the modifier 3 indicates a ranking in the
lower end of that generic rating category.
41
<PAGE>
DESCRIPTION OF S&P CORPORATE DEBT RATINGS
AAA. An obligation rated AAA has the highest rating assigned by S&P. The
obligor's capacity to meet its financial commitment on the obligation is
extremely strong; AA. An obligation rated AA differs from the highest rated
obligations only in small degree. The obligor's capacity to meet its financial
commitment on the obligation is very strong; A. An obligation rated A is
somewhat more susceptible to the adverse effects of changes in circumstances and
economic conditions than obligations in higher rated categories. However, the
obligor's capacity to meet its financial commitment on the obligation is still
strong; BBB. An obligation rated BBB exhibits adequate protection parameters.
However, adverse economic conditions or changing circumstances are more likely
to lead to a weakened capacity of the obligor to meet its financial commitment
on the obligation. Obligations rated BB, B, CCC, CC and C are regarded as having
significant speculative characteristics. BB indicates the least degree of
speculation and C the highest. While such obligations will likely have some
quality and protective characteristics, these may be outweighed by large
uncertainties or major exposures to adverse conditions; BB. An obligation rated
BB is less vulnerable to nonpayment than other speculative issues. However, it
faces major ongoing uncertainties or exposure to adverse business, financial, or
economic conditions which could lead to the obligor's inadequate capacity to
meet its financial commitment on the obligation; B. An obligation rated B is
more vulnerable to nonpayment than obligations rated BB, but the obligor
currently has the capacity to meet its financial commitment on the obligation.
Adverse business, financial, or economic conditions will likely impair the
obligor's capacity or willingness to meet its financial commitment on the
obligation; CCC. An obligation rated CCC is currently vulnerable to nonpayment
and is dependent upon favorable business, financial and economic conditions for
the obligor to meet its financial commitment on the obligation. In the event of
adverse business, financial, or economic conditions, the obligor is not likely
to have the capacity to meet its financial commitment on the obligation; CC. An
obligation rated CC is currently highly vulnerable to nonpayment; C. A
subordinated debt or preferred stock obligation rated C is currently highly
vulnerable to nonpayment. The C rating may be used to cover a situation where a
bankruptcy petition has been filed or similar action has been taken, but
payments on this obligation are being continued. A C also will be assigned to a
preferred stock issue in arrears on dividends or sinking fund payments, but that
is currently paying. D. An obligation rated D is in payment default. The D
rating category is used when payments on an obligation are not made on the date
due even if the applicable grace period has not expired, unless S&P believes
that such payments will be made during such grace period. The D rating also will
be used upon the filing of a bankruptcy petition or the taking of a similar
action if payments on an obligation are jeopardized.
CI. The rating CI is reserved for income bonds on which no interest is
being paid.
Plus (+) or Minus (-): The ratings from "AA" to "CCC" may be modified by
the addition of a plus or minus sign to show relative standing within the major
rating categories.
R. This symbol is attached to the ratings of instruments with significant
noncredit risks. It highlights risks to principal or volatility of expected
returns which are not addressed in the credit rating. Examples include:
obligations linked or indexed to equities, currencies, or commodities;
obligations exposed to severe prepayment risk--such as interest-only or
principal-only mortgage securities; and obligations with unusually risky
interest terms, such as inverse floaters.
42
<PAGE>
<TABLE>
<CAPTION> APPENDIX A
- ------------------------------------------------------------------------------------------------------------------------------------
PRO FORMA PORTFOLIO OF INVESTMENTS
JANUARY 31, 2000 (UNAUDITED)
- ------------------------------------------------------------------------------------------------------------------------------------
MANAGED HIGH MANAGED HIGH
Principal YIELD PLUS FUND YIELD FUND COMBINED
Amount
(combined) Maturity Interest
(000) Dates Rates Value Value Value
- -------------- ---------------- ----------- ----------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Corporate Bonds - 126.80%
Automotive - 2.14%
$5,250 HDA Parts Systems Incorporated 08/01/05 12.000 % $4,072,500 $678,750 $4,751,250
4,750 JL French Automotive Castings** 06/01/09 11.500 4,040,000 757,500 4,797,500
--------------------------------------------
8,112,500 1,436,250 9,548,750
--------------------------------------------
Cable - 15.73%
13,000 21st Century Telecom Group Incorporated 02/15/08 12.250 + 8,190,000 682,500 8,872,500
7,000 Charter Communications Holdings 04/01/09 10.000 6,930,000 0 6,930,000
15,250 Knology Holdings Incorporated 10/15/07 11.875 + 8,844,375 1,335,000 10,179,375
6,000 NTL Incorporated 10/01/08 11.500 5,300,000 1,060,000 6,360,000
13,575 Park 'N View Incorporated 05/15/08 13.000 8,381,250 1,800,000 10,181,250
11,250 RCN Corporation 10/15/07 11.125 + 6,900,000 862,500 7,762,500
5,000 UIH Australia/Pacific Incorporated 05/15/06 14.000 + 2,580,000 1,720,000 4,300,000
9,250 United Pan Europe** 08/01/09 10.875 4,714,250 327,000 5,041,250
19,250 United Pan Europe** 08/01/09 - 11/01/09 12.500 to 13.375+ 10,137,000 354,250 10,491,250
--------------------------------------------
61,976,875 8,141,250 70,118,125
--------------------------------------------
Chemicals - 2.69%
7,500 Lyondell Chemical Company 05/01/07 9.875 6,698,000 689,500 7,387,500
4,500 ZSC Specialty** 07/01/09 11.000 4,080,000 510,000 4,590,000
--------------------------------------------
10,778,000 1,199,500 11,977,500
--------------------------------------------
Communications - Fixed - 28.80%
9,687 Alestra S.A.** 05/15/06 12.125 8,752,153 1,007,500 9,759,653
5,000 Allegiance Telecom Incorporated 05/15/08 12.875 5,650,000 0 5,650,000
9,250 Barak ITC 11/15/07 12.500 + 4,340,000 840,000 5,180,000
2,500 Carrier1 International S.A.# 02/15/09 13.250 2,520,000 280,000 2,800,000
4,543 Esprit Telecom Group PLC 06/15/08 10.875 3,882,200 388,220 4,270,420
5,250 Flag Limited 01/30/08 8.250 4,550,000 227,500 4,777,500
2,000 Focal Communication Corporation 01/15/00 11.875 2,040,000 0 2,040,000
5,000 Global Crossing Holdings Limited** 11/15/09 9.500 4,825,000 0 4,825,000
6,500 GlobeNet Communications Group** 07/15/07 13.000 5,880,000 490,000 6,370,000
7,000 GST Equipment Funding Incorporated 05/01/07 13.250 6,000,000 1,000,000 7,000,000
7,750 GT Group Telecom Incorporated 02/01/10 1.000 4,126,875 0 4,126,875
9,150 Hyperion Telecommunications Incorporated 11/01/07 12.000 8,040,625 1,475,000 9,515,625
3,000 ICG Services Incorporated 02/15/08 10.000 1,120,000 565,000 1,685,000
4,025 Intelcom Group USA Incorporated 09/15/05 1.000 3,662,750 0 3,662,750
5,640 KMC Telecom Holdings Incorporated 05/15/09 13.500 5,140,000 500,000 5,640,000
5,750 Metromedia Fiber Network Incorporated 11/15/08 10.000 5,012,500 751,875 5,764,375
5,550 NEXTLINK Communications Incorporated 06/01/09 10.750 5,163,437 428,188 5,591,625
8,500 NorthEast Optic Network Incorporated 08/15/08 12.750 8,882,500 0 8,882,500
8,475 Pathnet Incorporated 04/15/08 12.250 4,933,500 660,000 5,593,500
5,000 Tele1 Europe BV** 05/15/09 13.000 4,916,250 258,750 5,175,000
11,000 Viatel Incorporated 04/15/08 12.500 + 5,800,000 580,000 6,380,000
9,750 Williams Communications Group 10/01/09 10.875 8,497,500 1,545,000 10,042,500
4,000 World Access Incorporated 01/15/08 13.250 3,180,625 454,375 3,635,000
--------------------------------------------
116,915,915 11,451,408 128,367,323
--------------------------------------------
Communications - Mobile - 7.75%
1,000 Crown Castle International Corporation 08/01/11 9.500 0 605,000 605,000
7,000 ICO Global Communications Limited#(b) 08/01/05 15.000 3,185,000 245,000 3,430,000
7,500 Nextel Communications Incorporated 02/15/08 9.950 + 3,462,500 1,731,250 5,193,750
14,000 Nextel International Incorporated 04/15/08 12.125 + 7,812,500 937,500 8,750,000
7,875 PTC International Finance** 12/01/09 11.250 7,462,500 373,125 7,835,625
10,625 Spectrasite Holdings Incorporated 04/15/09 11.250 + 6,162,500 0 6,162,500
2,500 Voicestream Wire** 11/15/09 10.375 2,562,500 0 2,562,500
--------------------------------------------
30,647,500 3,891,875 34,539,375
--------------------------------------------
A-1
<PAGE>
- ------------------------------------------------------------------------------------------------------------------------------------
PRO FORMA PORTFOLIO OF INVESTMENTS
JANUARY 31, 2000 (UNAUDITED)
- ------------------------------------------------------------------------------------------------------------------------------------
MANAGED HIGH MANAGED HIGH
Principal YIELD PLUS FUND YIELD FUND COMBINED
Amount
(combined) Maturity Interest
(000) Dates Rates Value Value Value
- ---------- -------------------- ----------- ----------------------------------------
Corporate Bonds -(continued)
Consumer Manufacturing - 3.30%
$5,250 Commemorative Brands Incorporated 01/15/07 11.000 % $2,200,000 $687,500 $2,887,500
5,500 Decora Industries Incorporated 05/01/05 11.000 3,870,000 860,000 4,730,000
4,000 Desa International Incorporated 12/15/07 9.875 3,040,000 0 3,040,000
4,250 Jafra Cosmetics International Incorporated 05/01/08 11.750 4,037,500 0 4,037,500
--------------------------------------------
13,147,500 1,547,500 14,695,000
--------------------------------------------
Energy - 7.86%
1,650 GulfMark Offshore Incorporated 06/01/08 8.750 1,518,000 0 1,518,000
4,500 Key Energy Services Incorporated 01/15/09 14.000 4,360,000 545,000 4,905,000
5,000 Northern Offshore ASA 05/15/05 10.000 2,360,000 590,000 2,950,000
8,791 Orion Refining Corporation** 12/01/03 15.000 7,396,966 514,603 7,911,569
3,000 Pride International Incorporated 06/01/09 10.000 2,700,000 300,000 3,000,000
7,250 R & B Falcon Corporation 12/15/08 9.500 5,606,250 1,462,500 7,068,750
8,250 Tesoro Petroleum Corporation 07/01/08 9.000 6,975,000 697,500 7,672,500
--------------------------------------------
30,916,216 4,109,603 35,025,819
--------------------------------------------
Finance - 5.43%
6,488 Airplanes Pass-Through Trust 03/15/19 10.875 4,466,937 1,340,081 5,807,018
5,000 Morgan Stanley Aircraft Finance 03/15/23 8.700 4,275,000 0 4,275,000
6,250 Olympic Financial Limited 03/15/07 11.500 5,733,750 781,875 6,515,625
13,000 Signet Capital Trust I 08/15/27 9.500 4,290,000 0 4,290,000
5,550 Superior National Insurance Group 12/01/17 10.750 3,030,000 300,000 3,330,000
--------------------------------------------
21,795,687 2,421,956 24,217,643
--------------------------------------------
Food & Beverage - 4.94%
8,125 Iowa Select Farms L.P.** 12/01/05 10.750 3,250,000 812,500 4,062,500
16,625 Mrs Field's Holdings Company Incorporated**# 12/01/05 14.000 + 8,890,000 420,000 9,310,000
1,000 Mrs Field's Original Cookies Incorporated** 12/01/04 10.125 0 800,000 800,000
8,808 Packaged Ice Incorporated 02/01/05 9.750 6,504,120 1,335,000 7,839,120
--------------------------------------------
18,644,120 3,367,500 22,011,620
--------------------------------------------
Gaming - 2.06%
4,250 Hollywood Casino Corporation 05/01/07 11.250 4,100,000 256,250 4,356,250
5,125 Park Place Entertainment Corporation 12/15/05 7.875 4,359,063 471,250 4,830,313
--------------------------------------------
8,459,063 727,500 9,186,563
--------------------------------------------
General Industrial - 5.04%
7,000 Aqua Chemical Incorporated 07/01/08 11.250 3,710,000 0 3,710,000
8,250 Blount Incorporated** 08/01/09 13.000 7,931,250 793,125 8,724,375
3,750 J.B. Poindexter & Company Incorporated 05/15/04 12.500 2,835,000 708,750 3,543,750
8,000 Sabreliner Corporation** 06/15/08 11.000 5,670,000 810,000 6,480,000
--------------------------------------------
20,146,250 2,311,875 22,458,125
--------------------------------------------
Healthcare - 2.33%
4,000 Fresenius Medical Care Capital Trust 02/01/08 7.875 2,685,000 895,000 3,580,000
4,000 Tenet Healthcare Corporation 12/01/08 8.125 3,228,750 461,250 3,690,000
3,000 Triad Hospitals Holdings Incorporated** 05/15/09 11.000 2,794,500 310,500 3,105,000
--------------------------------------------
8,708,250 1,666,750 10,375,000
--------------------------------------------
Hotels & Lodging - 2.35%
4,650 Host Marriott L.P. 02/15/06 8.375 4,301,250 0 4,301,250
2,875 Signature Resorts Incorporated 05/15/06 9.250 1,926,250 0 1,926,250
6,322 Silverleaf Resorts Incorporated 04/01/08 10.500 3,398,240 837,500 4,235,740
--------------------------------------------
9,625,740 837,500 10,463,240
--------------------------------------------
Media- 0.40%
3,250 Inter Act Systems Incorporated(b) 08/01/03 14.000 1,375,000 412,500 1,787,500
--------------------------------------------
Metals - 1.24%
7,250 Metal Management Incorporated 05/15/08 10.000 4,560,000 950,000 5,510,000
--------------------------------------------
Real Estate - 1.67%
9,400 American Architectural Products Corporation 12/01/07 11.750 3,360,000 400,000 3,760,000
4,075 D.R. Horton Incorporated 02/01/09 8.000 3,235,375 452,500 3,687,875
--------------------------------------------
6,595,375 852,500 7,447,875
--------------------------------------------
A-2
<PAGE>
- ------------------------------------------------------------------------------------------------------------------------------------
PRO FORMA PORTFOLIO OF INVESTMENTS
JANUARY 31, 2000 (UNAUDITED)
- ------------------------------------------------------------------------------------------------------------------------------------
MANAGED HIGH MANAGED HIGH
Principal YIELD PLUS FUND YIELD FUND COMBINED
Amount
(combined) Maturity Interest
(000) Dates Rates Value Value Value
- -------------- ---------------- ----------- ----------------------------------------
Corporate Bonds - (concluded)
Restaurants - 1.11%
$6,230 American Restaurant Group Incorporated 02/15/03 11.500 % $4,370,300 $598,125 $4,968,425
--------------------------------------------
Retail - 3.18%
7,210 Advance Holding Corporation 04/15/09 12.875 + 2,999,800 821,500 3,821,300
5,350 Advance Stores Company Incorporated 04/15/08 10.250 3,956,000 645,000 4,601,000
6,000 Ames Department Stores Incorporated 04/15/06 10.000 5,252,500 477,500 5,730,000
--------------------------------------------
12,208,300 1,944,000 14,152,300
--------------------------------------------
Service - 8.83%
8,500 Allied Waste North America Incorporated** 08/01/09 10.000 6,525,000 870,000 7,395,000
6,995 American Eco Corporation 05/15/08 9.625 2,937,550 490,000 3,427,550
6,750 Ameriserve Food Distribution Incorporated 07/15/07 10.125 2,328,750 0 2,328,750
7,135 Atlantic Express Transportation Corporation 02/01/04 10.750 6,193,450 727,500 6,920,950
8,750 Budget Group Incorporated 04/01/06 9.125 7,110,625 917,500 8,028,125
4,000 Nationwide Credit Incorporated 01/15/08 10.250 2,520,000 0 2,520,000
5,750 Premier Graphics Incorporated 12/01/05 11.500 2,137,500 450,000 2,587,500
6,500 Waste Systems International Incorporated# 01/15/06 11.500 5,197,500 945,000 6,142,500
--------------------------------------------
34,950,375 4,400,000 39,350,375
--------------------------------------------
Supermarkets & Drugstores - 1.29%
6,000 The Pantry Incorporated 10/15/07 10.250 5,760,000 0 5,760,000
--------------------------------------------
Technology - 12.21%
7,000 Ampex Corporation* 03/15/03 12.000 6,532,500 502,500 7,035,000
4,000 Chippac International Limited** 08/01/09 12.750 3,622,500 517,500 4,140,000
8,000 Earthwatch Incorporated**# 07/15/07 13.000 + 5,600,000 0 5,600,000
6,690 Fairchild Semiconductor Corporation 03/15/07 10.125 6,015,000 691,725 6,706,725
3,000 Globix Corporation 02/01/10 12.500 3,030,000 0 3,030,000
8,500 Intersil Corporation**# 08/15/09 13.250 8,400,000 1,120,000 9,520,000
4,750 SCG Holdings Corporation** 08/01/09 12.000 4,515,625 531,250 5,046,875
5,775 Verio Incorporated 12/01/08 11.250 5,525,563 523,750 6,049,313
13,000 Wam! Net Incorporated 03/01/05 13.250 + 6,160,000 1,120,000 7,280,000
--------------------------------------------
49,401,188 5,006,725 54,407,913
--------------------------------------------
Transportation - 4.85%
1,465 Eletson Holdings Incorporated 11/15/03 9.250 1,274,550 0 1,274,550
8,000 Equimar Shipholdings Limited 07/01/07 9.875 4,290,000 990,000 5,280,000
1,250 Navigator Gas Transport PLC**# 06/30/07 12.000 0 37,500 37,500
6,000 Millenium Seacarriers Incorporated 07/15/05 12.000 3,420,000 0 3,420,000
6,750 Stena AB 06/15/07 8.750 5,125,000 410,000 5,535,000
10,000 TFM S.A. de C.V. 06/15/09 11.750 + 5,747,500 302,500 6,050,000
--------------------------------------------
19,857,050 1,740,000 21,597,050
--------------------------------------------
Utilities - 1.62%
5,500 AES Corporation 06/01/09 9.500 4,975,000 497,500 5,472,500
1,750 Panda Funding Corporation 08/20/12 11.625 1,314,423 436,490 1,750,913
--------------------------------------------
6,289,423 933,990 7,223,413
--------------------------------------------
Total Corporate Bonds (cost - $560,029,486, $69,008,986, $629,038,472) 505,240,626 59,948,306 565,188,932
--------------------------------------------
Convertible Bonds - 0.50%
Communications - Fixed- 0.05%
215 GST Telecommunications Incorporated 12/15/05 13.875 0 204,250 204,250
--------------------------------------------
Service - 0.45%
2,496 Waste Systems International Incorporated** 05/13/05 7.000 1,215,000 807,079 2,022,079
--------------------------------------------
Total Convertible Bonds (cost - $1,194,375, $1,183,711, $2,378,086) 1,215,000 1,011,329 2,226,329
--------------------------------------------
A-3
<PAGE>
- ------------------------------------------------------------------------------------------------------------------------------------
PRO FORMA PORTFOLIO OF INVESTMENTS
JANUARY 31, 2000 (UNAUDITED)
- ------------------------------------------------------------------------------------------------------------------------------------
MANAGED HIGH MANAGED HIGH
Number YIELD PLUS FUND YIELD FUND COMBINED
of Shares
(combined)
- --------------
VALUE VALUE VALUE
--------------------------------------------
Common Stock(a) - 1.66%
Cable- 0.00%
2,000 Knology Holdings Incorporated 0 $10,500 $10,500
--------------------------------------------
Communications - Fixed - 0.96%
110,549 Viatel Incorporated $4,083,404 0 4,083,404
12,568 World Access Incorporated 189,698 27,100 216,798
--------------------------------------------
4,273,102 27,100 4,300,202
--------------------------------------------
Food & Beverage - 0.04%
40,949 Packaged Ice Incorporated 130,208 59,182 189,390
--------------------------------------------
Gaming- 0.01%
10,000 Hollywood Casino Corporation 0 42,500 42,500
--------------------------------------------
Media- 0.11%
2,000 MediaNews Group Incorporated 0 500,000 500,000
--------------------------------------------
Retail- 0.08%
47,500 Samuel Jewelers Incorporated* 0 368,125 368,125
--------------------------------------------
Service - 0.27%
289,744 Waste Systems International Incorporated 970,509 224,685 1,195,194
--------------------------------------------
Technology - 0.17%
239,676 Ampex Corporation* 325,000 453,947 778,947
--------------------------------------------
Total Common Stock (cost - $4,865,535, $1,211,625, $6,077,160) 5,698,819 1,686,038 7,384,857
--------------------------------------------
Preferred Stock(a) - 3.18%
Cable - 0.98%
4,714 21st Century Telecommunications Group Incorporated** 4,384,020 0 4,384,020
--------------------------------------------
Communications - Fixed 0.56%
2750 ICG Holdings Corporation 2,502,500 0 2,502,500
--------------------------------------------
Communications - Mobile - 0.95%
4,192 Crown Castle International Corporation 4,254,880 0 4,254,880
--------------------------------------------
Energy - 0.02%
104,029 Orion Refining Corporation 56,869 14,183 71,052
--------------------------------------------
Media - 0.36%
6,500 InterAct systems Incorporated** 1,250,000 375,000 1,625,000
--------------------------------------------
Paper & Packaging - 0.20%
7,935 Packaging Corporation of America 872,850 0 872,850
--------------------------------------------
Restaurants- 0.11%
592 American Restaurant Group Incorporated 0 473,600 473,600
--------------------------------------------
Total Preferred Stock (cost - $10,212,394, $1,177,870, $11,390,264) 13,321,119 862,783 14,183,902
--------------------------------------------
A-4
<PAGE>
- ------------------------------------------------------------------------------------------------------------------------------------
PRO FORMA PORTFOLIO OF INVESTMENTS
JANUARY 31, 2000 (UNAUDITED)
- ------------------------------------------------------------------------------------------------------------------------------------
MANAGED HIGH MANAGED HIGH
YIELD PLUS FUND YIELD FUND COMBINED
Number
of Warrants Maturity Interest
(combined) Dates Rates Value Value Value
- -------------- ---------------- ----------- ----------------------------------------
Warrants(a) - 1.33%
Cable - 0.44%
3,500 21st Century Telecommunications Group Incorporated $962,500 0 $962,500
14,575 Park 'N View Incorporated 791,375 $156,000 947,375
2,000 UIH Australia Pacific Incorporated 0 60,000 60,000
--------------------------------------------
1,753,875 216,000 1,969,875
--------------------------------------------
Communications - Fixed - 0.23%
8,475 Pathnet Incorporated 74,750 10,000 84,750
5,000 Tele1 Europe BV** 902,500 47,500 950,000
--------------------------------------------
977,250 57,500 1,034,750
--------------------------------------------
Communications - Mobile 0.00%
1,750 McCaw International Limited 0 5,250 5,250
--------------------------------------------
Energy - 0.05%
4,500 Key Energy Services Incorporated 200,000 25,000 225,000
--------------------------------------------
Financial Services 0.00%
750 Olympic Financial Limited 0 750 750
--------------------------------------------
Media- 0.04%
6,500 InterAct Electronic Marketing Incorporated 50 15 65
6,500 InterAct Systems Incorporated 125,000 37,500 162,500
--------------------------------------------
125,050 37,515 162,565
--------------------------------------------
Restaurants- 0.00%
500 American Restaurants Group Incorporated 0 5 5
--------------------------------------------
Service - 0.02%
97,500 Waste Systems International Incorporated** 61,875 11,250 73,125
--------------------------------------------
Technology - 0.55%
800 Electronic Retailing Systems International Incorporated 0 800 800
8,500 Intersil Corporation 1,875,000 250,000 2,125,000
30,000 Wam! Net Incorporated 264,000 66,000 330,000
--------------------------------------------
2,139,000 316,800 2,455,800
--------------------------------------------
Transportation - 0.00%
6,000 Millenium Seacarriers Incorporated 750 0 750
--------------------------------------------
Total Warrants (cost - $188, $85,134, $85,322) 5,257,800 670,070 5,927,870
--------------------------------------------
A-5
<PAGE>
- ------------------------------------------------------------------------------------------------------------------------------------
PRO FORMA PORTFOLIO OF INVESTMENTS
JANUARY 31, 2000 (UNAUDITED)
- ------------------------------------------------------------------------------------------------------------------------------------
Principal
Amount
(combined)
(000)
- --------------
Repurchase Agreements - 2.18%
$7,595 Repurchase Agreement dated 01/31/2000 with Zions Bank,
collateralized by $7,865,000 U.S. Treasury Notes, 5.500%
due 07/31/2001 (value-$7,747,025);
proceeds; $7,596,198 02/01/00 5.680 % 7,595,000 0 7,595,000
--------------------------------------------
2,128 Repurchase Agreement dated 01/31/2000 with Zions Bank,
collateralized by $2,160,000 U.S. Treasury Notes, 5.500%
due 08/31/2001 (value-$2,175,012);
proceeds; $2,128,336 02/01/00 5.680 0 2,128,000 2,128,000
--------------------------------------------
Total Repurchase Agreements (Cost - $7,595,000, $2,128,000, $9,723,000) -- 7,595,000 2,128,000 9,723,000
--------------------------------------------
Total Investments (Cost - $583,896,978, 135.65% 538,328,364 66,306,526 604,634,890
$74,795,326, $658,692,304)
Liabilities in excess of other assets -35.65% (160,822,811) 1,920,609 (158,902,202)
--------------------------------------------
Net Assets 100.00% $377,505,553 $68,227,135 $445,732,688
============================================
</TABLE>
- --------------------------------------------
# Security represents a unit which is composed of the stated bond
with attached warrants or common stock.
+ Denotes a step-up bond or zero coupon bond that converts to the
noted fixed rate at a designated future date.
* Illiquid securities representing 1.84% of combined net assets.
These securities are valued at fair value as determined in good
faith by a valuation committee under the direction of the Funds'
board of directors.
** Security exempt from registration under Rule 144A of the Securities
Act of 1933. These securities may be resold in transactions exempt
from registration, normally to qualified institutional buyers.
(a) Non-income producing securities.
(b) Bond interest in default
See accompanying notes to PRO FORMA financial statements
A-6
<PAGE>
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------------
PRO FORMA STATEMENT OF ASSETS AND LIABILITIES JANUARY 31, 2000 (UNAUDITED)
- ------------------------------------------------------------------------------------------------------------------------------------
Managed High Managed High Combined
Yield Plus Fund Yield Fund
<S> <C> <C> <C>
ASSETS
Investments in securities, at value (cost - $583,896,978,
$74,795,326, and $658,692,304, respectively) .......... $538,328,364 $ 66,306,526 $604,634,890
Cash .................................................... 0 14,113 14,113
Receivables for investments sold......................... 5,593,260 646,250 6,239,510
Interest receivable...................................... 12,153,394 1,429,610 13,583,004
Interest receivable on swap contract..................... 459,607 0 459,607
Unrealized appreciation on interest rate swap............ 20,325 0 20,325
--------------- --------------- ------------
Total assets ............................................ 556,554,950 68,396,499 624,951,449
--------------- --------------- ------------
LIABILITIES
Bank loan payable ....................................... 167,000,000 0 167,000,000
Payable for investments purchased........................ 9,552,222 13,154 9,565,376
Payable for interest on bank loan........................ 945,434 0 945,434
Payable to investment adviser and administrator......... 325,503 52,568 378,071
Accrued expenses and other liabilities................... 1,226,238 103,642 1,329,880
--------------- --------------- ------------
Total liabilities........................................ 179,049,397 169,364 179,218,761
--------------- --------------- ------------
NET ASSETS
Capital Stock-$0.001 par value; 200,000,000
shares authorized (31,858,651, 6,031,667,
and 37,616,221 shares outstanding, respectively)....... 474,998,612 90,447,851 565,446,463
Undistributed net investment income...................... 5,727,200 131,923 5,859,123
Accumulated net realized loss from investment
transactions.......................................... (57,671,970) (13,863,839) (71,535,809)
Net unrealized depreciation of investments and
interest rate swap..................................... (45,548,289) (8,488,800) (54,037,089)
--------------- --------------- ------------
Net assets applicable to shares outstanding.............. $377,505,553 $ 68,227,135 $445,732,688
=============== =============== ============
Net asset value per share................................ $11.85 $11.31 $11.85
====== ====== ======
</TABLE>
See accompanying notes to PRO FORMA financial statements
A-7
<PAGE>
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------------------
PRO FORMA STATEMENT OF OPERATIONS
For the Twelve Months Ended January 31, 2000 (unaudited)
- ----------------------------------------------------------------------------------------------------------------------------------
Managed High Managed High
Yield Plus Fund Yield Fund Adjustments Combined
<S> <C> <C> <C> <C>
INVESTMENT INCOME:
Interest $61,710,622 $ 8,243,842 $ 3,246,492 (a) $ 73,200,956
------------------ ----------------- -------------- --------------
EXPENSES:
Bank loan interest expense...................... 8,591,719 0 1,650,000 (a) 10,241,719
Investment advisory and administration fees..... 3,703,061 634,026 61,331 (b) 4,398,418
Transfer agency fees and expenses............... 16,934 11,622 0 28,556
Custody and accounting.......................... 326,484 42,430 15,000 (c) 383,914
Reports and notices to shareholders............. 72,543 45,716 (30,000)(d) 88,259
Legal and audit................................. 392,975 58,954 (58,954)(d) 392,975
Amortization of organizational expenses......... 45,053 0 0 45,053
Trustees' fees and expenses..................... 11,040 10,303 (10,303)(d) 11,040
Other expenses.................................. 107,760 63,129 (20,000)(d) 150,889
------------------ ----------------- -------------- --------------
13,267,569 866,180 1,607,074 15,740,823
------------------ ----------------- -------------- --------------
Net investment income........................... 48,443,053 7,377,662 1,639,418 57,460,133
------------------ ----------------- -------------- --------------
REALIZED AND UNREALIZED GAINS (LOSSES) FROM
INVESTMENT TRANSACTIONS:
Net realized losses from:
Investment transactions..................... (42,248,727) (5,032,949) (47,281,676)
Net change in unrealized
appreciation/depreciation of:
Investments..................................... 13,889,843 (408,158) 13,481,685
------------------ ----------------- --------------
Net realized and unrealized losses from
investment transactions ......................... (28,358,884) (5,441,107) (33,799,991)
------------------ ----------------- -------------- --------------
Net increase in net assets resulting from
operations.................................. $20,084,169 $1,936,555 $ 1,639,418 $23,660,142
================== ================= ============== ==============
</TABLE>
------------
(a) Reflects the anticipated additional income generated and interest
expense incurred after the merger, through leverage of Managed High
Yield's assets.
(b) Reflects increase in fees charged on the leveraged assets of the
Managed High Yield Plus Fund.
(c) Reflects the anticipated additional custody charges after the merger,
as a result of additional leverage.
(d) Reflects the anticipated savings of the merger.
See accompanying notes to PRO FORMA financial statements
A-8
<PAGE>
Notes To PRO FORMA Combined Financial Statements (Unaudited)
Basis of Presentation:
Subject to the approval of the Plan of Reorganization by the stockholders of
Managed High Yield Fund Inc. ("High Yield Fund"), Managed High Yield Plus Fund
Inc. ("Plus Fund") would acquire the assets of High Yield Fund in exchange
solely for the assumption by Plus Fund of High Yield Fund's liabilities and
shares of Plus Fund that correspond to the outstanding shares of High Yield
Fund. The number of shares to be received would be based on the relative net
asset value of High Yield Fund shares and Plus Fund shares on the effective date
of the Plan of Reorganization and High Yield Fund will be terminated as soon as
practicable thereafter.
The PRO FORMA combined financial statements reflect the financial position of
High Yield Fund and Plus Fund at January 31, 2000 and the combined results of
operations of High Yield Fund and Plus Fund for the year ended January 31, 2000.
As a result of the plan of reorganization, the investment advisory and
administration fee may increase due to the fee schedule of Plus Fund being based
on total assets minus liabilities other than the aggregate indebtedness
constituting leverage. As closed-end funds, High Yield Fund and Plus Fund
currently pay no Rule 12b-1 distribution or service fees. Other fixed expenses
will be reduced due to the elimination of duplicate expenses. In addition, the
PRO FORMA combined statement of assets and liabilities has not been adjusted as
a result of the proposed transaction because such adjustment would not be
material. IT IS ESTIMATED THAT THE COST OF APPROXIMATELY $245,000 ASSOCIATED
WITH THE MERGER WILL BE CHARGED TO EACH FUND SO THAT EACH FUND BEARS ITS OWN
EXPENSES OF THE REORGANIZATION. These costs are not included in the PRO FORMA
statement of operations since they are not recurring.
The PRO FORMA combined financial statements are presented for the information of
the reader and may not necessarily be representative of what the actual combined
financial statements would have been had the Plan of Reorganization occurred on
January 31, 2000. The PRO FORMA combined financial statements should be read in
conjunction with the historical financial statements of the constituent Funds
included in or incorporated by reference in the statement of additional
information.
Significant Accounting Policies:
The Fund's financial statements are prepared in accordance with generally
accepted accounting principles which may require the use of management accruals
and estimates. These unaudited financial statements reflect all adjustments
which are, in the opinion of management, necessary to a fair statement of the
results for the interim period presented. The Fund's Common Stock is listed on
the New York Stock Exchange under the symbol HYF. The following is a summary of
significant accounting policies followed by the Fund.
VALUATION OF INVESTMENTS-The Fund calculates its net asset value based on the
current market value for its portfolio securities. The Fund normally obtains
market values for its securities from independent pricing sources and
broker-dealers. Independent pricing sources may use last reported sale prices,
current market quotations or valuations from computerized "matrix" systems that
derive values based on comparable securities. Securities traded in the
over-the-counter ("OTC") market and listed on The Nasdaq Stock Market,
Inc.("Nasdaq") normally are valued at the last sale price on the Nasdaq prior to
valuation. Other OTC securities are valued at the last bid price available prior
to valuation. Securities which are listed on U.S. and foreign stock exchanges
normally are valued at the last sale price on the day the securities are valued
or, lacking any sales on such day, at the last available bid price. In cases
where securities are traded on more than one exchange, the securities are valued
on the exchange designated as the primary market by Mitchell Hutchins Asset
Management Incorporated ("Mitchell Hutchins"), a wholly owned asset management
subsidiary of PaineWebber Incorporated ("PaineWebber") and investment adviser
and administrator of the Fund. If a market value is not available from an
independent pricing source for a particular security, that security is valued at
fair value as determined in good faith by or under the direction of the Fund's
board of directors (the "board"). The amortized cost method of valuation, which
approximates market value, generally is used to value short-term debt
instruments with sixty days or less remaining to maturity, unless the board
determines that this does not represent fair value. All investments quoted in
foreign currencies will be valued daily in U.S. dollars on the basis of the
foreign currency exchange rates prevailing at the time such valuation is
determined by the Fund's custodian.
REPURCHASE AGREEMENTS-The Fund's custodian takes possession of the collateral
pledged for investments in repurchase agreements. The underlying collateral is
valued daily on a mark-to-market basis to ensure that the value, including
accrued interest, is at least equal to the repurchase price. In the event of
default of the obligation to repurchase, the Fund has the right to liquidate the
collateral and apply the proceeds in satisfaction of the obligation. Under
certain circumstances, in the event of default or bankruptcy by the other party
to the agreement, realization and/or retention of the collateral may be subject
to legal proceedings. The Fund occasionally participates in joint repurchase
agreement transactions with other funds managed by Mitchell Hutchins.
A-9
<PAGE>
INVESTMENT TRANSACTIONS AND INVESTMENT INCOME-Investment transactions are
recorded on the trade date. Realized gains and losses from investment
transactions are calculated using the identified cost method. Interest income is
recorded on an accrual basis. Discounts are accreted and premiums are amortized
as adjustments to interest income and the identified cost of investments.
DIVIDENDS AND DISTRIBUTIONS-Dividends and distributions to stockholders are
recorded on the ex-dividend date. Dividends from net investment income and
distributions from net realized capital gains are determined in accordance with
federal income tax regulations which may differ from generally accepted
accounting principles. These "book/tax" differences are either considered
temporary or permanent in nature. To the extent these differences are permanent
in nature, such amounts are reclassified within the capital accounts based on
the federal tax basis treatment; temporary differences do not require
reclassification.
BORROWINGS-The Fund has a $200 million dollar committed credit facility
("facility"). Under the terms of the facility, the Fund borrows at the London
Interbank Overnight Rate ("LIBOR") plus facility and administrative fees. In
addition, the Fund pays a liquidity fee on the unused portion of the facility.
The Fund may borrow up to 33 1/3% of its total assets up to the committed
amount. In accordance with the terms of the debt agreement, the Fund pledges
assets as collateral for the bank loan.
A-10
