STATEMENT OF ADDITIONAL INFORMATION
Badgley Funds, Inc.
BADGLEY GROWTH FUND
BADGLEY BALANCED FUND
P.O. Box 701
Milwaukee, Wisconsin 53201-0701
1-877-BADGLEY
www.badgleyfunds.com
This Statement of Additional Information is not a
prospectus and should be read in conjunction with the
Prospectus of the Badgley Growth Fund (the "Growth
Fund") and the Badgley Balanced Fund (the "Balanced
Fund"), dated September 28, 1999, as supplemented March
13, 2000. The Growth Fund and the Balanced Fund are
each a series of the Badgley Funds, Inc. (the
"Corporation").
A copy of the Prospectus is available without
charge upon request to the above-noted address, toll-
free telephone number or website.
The Funds' audited financial statements for the
period June 25, 1998 to May 31, 1999, are incorporated
herein by reference to the Funds' Annual Report, which
is available without charge upon request to the above-
noted address, toll-free telephone number or website.
This Statement of Additional Information is dated September 28, 1999,
as supplemented December 9, 1999, March 13, 2000 and April 7, 2000.
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TABLE OF CONTENTS
Page No.
FUND ORGANIZATION 3
INVESTMENT RESTRICTIONS 3
IMPLEMENTATION OF INVESTMENT OBJECTIVES 4
DIRECTORS AND OFFICERS 21
PRINCIPAL SHAREHOLDERS 23
INVESTMENT ADVISER 23
FUND TRANSACTIONS AND BROKERAGE 24
CUSTODIAN 25
TRANSFER AGENT AND DIVIDEND-DISBURSING AGENT 25
ADMINISTRATOR 26
DISTRIBUTOR AND PLAN OF DISTRIBUTION 26
PURCHASE, REDEMPTION, EXCHANGE AND PRICING OF SHARES 28
TAXATION OF THE FUNDS 31
PERFORMANCE INFORMATION 31
ADDITIONAL INFORMATION 33
INDEPENDENT ACCOUNTANTS 33
FINANCIAL STATEMENTS 33
APPENDIX A-1
In deciding whether to invest in the Funds, you
should rely on the information in this Statement of
Additional Information and related Prospectus. The
Funds have not authorized others to provide additional
information. The Funds have not authorized the use of
this Statement of Additional Information in any state
or jurisdiction in which such offering may not legally
be made.
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FUND ORGANIZATION
The Corporation is an open-end, diversified,
management investment company, commonly referred to as
a mutual fund. Each Fund is a series of common stock
of the Corporation, a Maryland company incorporated on
April 28, 1998. The Corporation is authorized to issue
shares of common stock in series and classes. Each
share of common stock of each Fund is entitled to one
vote, and each share is entitled to participate equally
in dividends and capital gains distributions by the
respective series and in the individual assets of the
respective Fund in the event of liquidation. Each Fund
bears its own expenses and the shareholders of each
Fund have exclusive voting rights on matters pertaining
to the Fund's Rule 12b-1 plan. No certificates will be
issued for shares held in your account. You will,
however, have full shareholder rights. Generally, the
Corporation will not hold annual shareholders' meetings
unless required by the 1940 Act or Maryland law.
Shareholders have certain rights, including the right
to call an annual meeting upon a vote of 10% of the
Corporation's outstanding shares for the purpose of
voting to remove one or more directors or to transact
any other business. The 1940 Act requires the
Corporation to assist the shareholders in calling such
a meeting.
INVESTMENT RESTRICTIONS
The investment objective of the Growth Fund is to
seek long-term capital appreciation. The investment
objective of the Balanced Fund is to seek long-term
capital appreciation and income (i.e., risk-adjusted
total return). The following are the Funds'
fundamental investment restrictions which cannot be
changed without the approval of a majority of a Fund's
outstanding voting securities. As used herein, a
"majority of a Fund's outstanding voting securities"
means the lesser of (i) 67% of the shares of common
stock of the Fund represented at a meeting at which
more than 50% of the outstanding shares are present, or
(ii) more than 50% of the outstanding shares of common
stock of the Fund.
Each Fund:
1. May not with respect to 75% of its total assets,
purchase the securities of any issuer (except
securities issued or guaranteed by the U.S.
government or its agencies or instrumentalities)
if, as a result, (i) more than 5% of the Fund's
total assets would be invested in the securities
of that issuer, or (ii) the Fund would hold more
than 10% of the outstanding voting securities of
that issuer.
2. May (i) borrow money from banks for temporary or
emergency purposes (but not for leveraging or the
purchase of investments) and (ii) make other
investments or engage in other transactions
permissible under the Investment Company Act of
1940, as amended (the "1940 Act"), which may
involve a borrowing, including borrowing through
reverse repurchase agreements, provided that the
combination of (i) and (ii) shall not exceed 33
1/3% of the value of the Fund's total assets
(including the amount borrowed), less the Fund's
liabilities (other than borrowings). If the
amount borrowed at any time exceeds 33 1/3% of the
Fund's total assets, the Fund will, within three
days thereafter (not including Sundays, holidays
and any longer permissible period), reduce the
amount of the borrowings such that the borrowings
do not exceed 33 1/3% of the Fund's total assets.
Each Fund may also borrow money from other persons
to the extent permitted by applicable law.
3. May not issue senior securities, except as
permitted under the 1940 Act.
4. May not act as an underwriter of another issuer's
securities, except to the extent that the Fund may
be deemed to be an underwriter within the meaning
of the Securities Act of 1933, as amended (the
"Securities Act"), in connection with the purchase
and sale of portfolio securities.
5. May not purchase or sell physical commodities
unless acquired as a result of ownership of
securities or other instruments (but this shall
not prevent the Fund from purchasing or selling
options, futures contracts, or other derivative
instruments, or from investing in securities or
other instruments backed by physical commodities).
6. May not make loans if, as a result, more than 33
1/3% of the Fund's total assets would be lent to
other persons, except through (i) purchases of
debt securities or other debt instruments, or (ii)
engaging in repurchase agreements.
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7. May not purchase the securities of any issuer if,
as a result, more than 25% of the Fund's total
assets would be invested in the securities of
issuers, the principal business activities of
which are in the same industry.
8. May not purchase or sell real estate unless
acquired as a result of ownership of securities or
other instruments (but this shall not prohibit the
Fund from purchasing or selling securities or
other instruments backed by real estate or of
issuers engaged in real estate activities).
The following are each Fund's non-fundamental
operating policies which may be changed by the Board of
Directors without shareholder approval.
Each Fund may not:
1. Sell securities short, unless the Fund owns or has
the right to obtain securities equivalent in kind
and amount to the securities sold short, or unless
it covers such short sale as required by the
current rules and positions of the Securities and
Exchange Commission (the "SEC") or its staff, and
provided that transactions in options, futures
contracts, options on futures contracts, or other
derivative instruments are not deemed to
constitute selling securities short.
2. Purchase securities on margin, except that the
Fund may obtain such short-term credits as are
necessary for the clearance of transactions; and
provided that margin deposits in connection with
futures contracts, options on futures contracts,
or other derivative instruments shall not
constitute purchasing securities on margin.
3. Invest in illiquid securities if, as a result of
such investment, more than 10% of its net assets
would be invested in illiquid securities.
4. Purchase securities of other investment companies
except in compliance with the 1940 Act and
applicable state law.
5. Engage in futures or options on futures
transactions which are impermissible pursuant to
Rule 4.5 under the Commodity Exchange Act (the
"CEA") and, in accordance with Rule 4.5, will use
futures or options on futures transactions solely
for bona fide hedging transactions (within the
meaning of the CEA), provided, however, that the
Fund may, in addition to bona fide hedging
transactions, use futures and options on futures
transactions if the aggregate initial margin and
premiums required to establish such positions,
less the amount by which any such options
positions are in the money (within the meaning of
the CEA), do not exceed 5% of the Fund's net
assets.
6. Make any loans, except through (i) purchases of
debt securities or other debt instruments, or (ii)
engaging in repurchase agreements.
7. Borrow money except from banks or through reverse
repurchase agreements or mortgage dollar rolls,
and will not purchase securities when bank
borrowings exceed 5% of its total assets.
Except for the fundamental investment limitations
listed above and each Fund's investment objective, the
Funds' other investment policies are not fundamental
and may be changed with approval of the Corporation's
Board of Directors. Unless noted otherwise, if a
percentage restriction is adhered to at the time of
investment, a later increase or decrease in percentage
resulting from a change in the Fund's assets (i.e., due
to cash inflows or redemptions) or in market value of
the investment or the Fund's assets will not constitute
a violation of that restriction.
IMPLEMENTATION OF INVESTMENT OBJECTIVES
The following information supplements the
discussion of the Funds' investment objectives and
strategies described in the Prospectus under the
captions "Investment Objectives" and "How the Funds
Invest."
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Illiquid Securities
Each Fund may invest up to 10% of its respective
net assets in illiquid securities (i.e., securities
that are not readily marketable). For purposes of this
restriction, illiquid securities include, but are not
limited to, restricted securities (securities the
disposition of which is restricted under the federal
securities laws), repurchase agreements with maturities
in excess of seven days, and other securities that are
not readily marketable. The Board of Directors of the
Corporation, or its delegate, has the ultimate
authority to determine, to the extent permissible under
the federal securities laws, which securities are
liquid or illiquid for purposes of this 10% limitation.
Certain securities exempt from registration or issued
in transactions exempt from registration under the
Securities Act, such as securities that may be resold
to institutional investors under Rule 144A under the
Securities Act, may be considered liquid under
guidelines adopted by the Board of Directors. Each
Fund may invest up to 5% of its respective net assets
in such securities. However, investing in securities
which may be resold pursuant to Rule 144A under the
Securities Act could have the effect of increasing the
level of a Fund's illiquidity to the extent that
institutional investors become, for a time,
uninterested in purchasing such securities.
The Board of Directors has delegated to the
Adviser the day-to-day determination of the liquidity
of any security, although it has retained oversight and
ultimate responsibility for such determinations.
Although no definitive liquidity criteria are used, the
Board of Directors has directed the Adviser to look to
such factors as (i) the nature of the market for a
security (including the institutional private resale
market), (ii) the terms of certain securities or other
instruments allowing for the disposition to a third
party or the issuer thereof (e.g., certain repurchase
obligations and demand instruments), (iii) the
availability of market quotations (e.g., for securities
quoted in the PORTAL system), and (iv) other
permissible relevant factors.
Restricted securities may be sold only in
privately negotiated transactions or in a public
offering with respect to which a registration statement
is in effect under the Securities Act. Where
registration is required, a 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 that which prevailed when it
decided to sell. Restricted securities will be priced
at fair value as determined in good faith by the Board
of Directors. If, through the appreciation of
restricted securities or the depreciation of
unrestricted securities, a Fund should be in a position
where more than 10% of the value of its net assets are
invested in illiquid securities, including restricted
securities which are not readily marketable (except for
Rule 144A securities deemed to be liquid by the
Adviser), the affected Fund will take such steps as is
deemed advisable, if any, to protect liquidity.
Fixed Income Securities
Fixed Income Securities in General. The Balanced
Fund may invest a portion of its assets in a wide
variety of fixed income securities, including bonds and
other debt securities and non-convertible preferred
stocks. Each Fund may hold a limited portion of its
assets (generally not to exceed 15% of its total
assets) in short-term money market securities. See
"Temporary Strategies."
Changes in market interest rates affect the value
of fixed income securities. If interest rates
increase, the value of fixed income securities
generally decrease. Similarly, if interest rates
decrease, the value of fixed income securities
generally increase. Shares in the Balanced Fund are
likely to fluctuate in a similar manner. In general,
the longer the remaining maturity of a fixed income
security, the greater its fluctuations in value based
on interest rate changes. Longer-term fixed income
securities generally pay a higher interest rate. The
Balanced Fund invests in fixed income securities of
varying maturities.
Changes in the credit quality of the issuer also
affect the value of fixed income securities. Lower-
rated fixed income securities generally pay a higher
interest rate. Although the Balanced Fund only invests
in investment grade debt securities, the value of these
securities may decrease due to changes in ratings over
time.
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Types of Fixed Income Securities. The Balanced
Fund may invest in the following types of fixed income
securities:
* Corporate debt securities, including bonds,
debentures and notes;
* U.S. government securities;
* Mortgage and asset-backed securities;
* Preferred stocks;
* Convertible securities;
* Commercial paper (including variable amount
master demand notes);
* Bank obligations, such as certificates of
deposit, banker's acceptances and time
deposits of domestic and foreign banks,
domestic savings association and their
subsidiaries and branches (in amounts in
excess of the current $100,000 per account
insurance coverage provided by the Federal
Deposit Insurance Corporation); and
* Repurchase agreements.
Ratings. The Balanced Fund will limit investments
in fixed income securities to those that are rated at
the time of purchase as at least investment grade by at
least one national rating organization, such as S&P or
Moody's, or, if unrated, are determined to be of
equivalent quality by the Adviser. Within the
investment grade categories, the Balanced Fund will
limit its purchases to the following criteria:
* U.S. government securities;
* Bonds or bank obligations rated in one of the
three highest categories (e.g., A- or higher
by S&P);
* Short-term notes rated in one of the two
highest categories (e.g., SP-2 or higher by S&P);
* Commercial paper or short-term bank
obligations rated in one of the three highest
categories (e.g., A-3 or higher by S&P); and
* Repurchase agreements involving investment
grade fixed income securities.
Investment grade fixed income securities are generally
believed to have a lower degree of credit risk. If a
security's rating falls below the above criteria, the
Adviser will determine what action, if any, should be
taken to ensure compliance with the Balanced Fund's
investment objective and to ensure that the Balanced
Fund will at no time have 5% or more of its net assets
invested in non-investment grade debt securities.
Additional information concerning securities ratings is
contained in the Appendix.
Government Securities. U.S. government securities
are issued or guaranteed by the U.S. government or its
agencies or instrumentalities. These securities may
have different levels of government backing. U.S.
Treasury obligations, such as Treasury bills, notes,
and bonds are backed by the full faith and credit of
the U.S. Treasury. Some U.S. government agency
securities are also backed by the full faith and credit
of the U.S. Treasury, such as securities issued by the
Government National Mortgage Association (GNMA). Other
U.S. government securities may be backed by the right
of the agency to borrow from the U.S. Treasury, such as
securities issued by the Federal Home Loan Bank, or may
be backed only by the credit of the agency. The U.S.
government and its agencies and instrumentalities only
guarantee the payment of principal and interest and not
the market value of the securities. The market value
of U.S. government securities will fluctuate based on
interest rate changes and other market factors.
Mortgage- and Asset-Backed Securities. Mortgage-
backed securities represent direct or indirect
participations in, or are secured by and payable from,
mortgage loans secured by real property, and include
single- and
<PAGE>
multi-class pass-through securities and
collateralized mortgage obligations. Such securities
may be issued or guaranteed by U.S. government agencies
or instrumentalities, such as the Government National
Mortgage Association and the Federal National Mortgage
Association, or by private issuers, generally
originators and investors in mortgage loans, including
savings associations, mortgage bankers, commercial
banks, investment bankers, and special purpose entities
(collectively, "private lenders"). Mortgage-backed
securities issued by private lenders 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
governmental guarantee of the underlying mortgage
assets but with some form of non-governmental credit
enhancement.
Asset-backed securities have structural
characteristics similar to mortgage-backed securities.
Asset-backed debt obligations represent direct or
indirect participations in, or are secured by and
payable from, assets such as motor vehicle installment
sales contracts, other installment loan contracts, home
equity loans, leases of various types of property, and
receivables from credit card or other revolving credit
arrangements. The credit quality of most asset-backed
securities depends primarily on the credit quality of
the assets underlying such securities, how well the
entity issuing the security is insulated from the
credit risk of the originator or any other affiliated
entities, and the amount and quality of any credit
enhancement of the securities. Payments or
distributions of principal and interest on asset-backed
debt obligations may be supported by non-governmental
credit enhancements including letters of credit,
reserve funds, overcollateralization, and guarantees by
third parties. The market for privately issued asset-
backed debt obligations is smaller and less liquid than
the market for government sponsored mortgage-backed
securities.
The rate of principal payment on mortgage- and
asset-backed securities generally depends on the rate
of principal payments received on the underlying assets
which in turn may be effected by a variety of economic
and other factors. As a result, the yield on any
mortgage- and asset-backed security is difficult to
predict with precision and actual yield to maturity may
be more or less than the anticipated yield to maturity.
The yield characteristics of mortgage- and asset-backed
securities differ from those of traditional debt
securities. Among the principal differences are that
interest and principal payments are made more
frequently on mortgage- and asset-backed securities,
usually monthly, and that principal may be prepaid at
any time because the underlying mortgage loans or other
assets generally may be prepaid at any time. As a
result, if the Balanced Fund purchases these securities
at a premium, a prepayment rate that is faster than
expected will reduce yield to maturity, while a
prepayment rate that is slower than expected will have
the opposite effect of increasing the yield to
maturity. Conversely, if the Balanced Fund purchases
these securities at a discount, a prepayment rate that
is faster than expected will increase yield to
maturity, while a prepayment rate that is slower than
expected will reduce yield to maturity. Accelerated
prepayments on securities purchased by the Balanced
Fund at a premium also impose a risk of loss of
principal because the premium may not have been fully
amortized at the time the principal is prepaid in full.
In addition, prepayments typically occur when interest
rates are declining. As a result, any debt securities
purchased by the Balanced Fund with such prepayment
proceeds will likely be at a lower interest rate than
the original investment.
While many mortgage- and asset-backed securities
are issued with only one class of security, many are
issued in more than one class, each with different
payment terms. Multiple class mortgage- and asset-
backed securities are issued for two main reasons.
First, multiple classes may be used as a method of
providing credit support. This is accomplished
typically through creation of one or more classes whose
right to payments on the security is made subordinate
to the right to such payments of the remaining class or
classes. Second, multiple classes may permit the
issuance of securities with payment terms, interest
rates, or other characteristics differing both from
those of each other and from those of the underlying
assets. Examples include so-called "strips" (mortgage-
and asset-backed securities entitling the holder to
disproportionate interests with respect to the
allocation of interest and principal of the assets
backing the security), and securities with class or
classes having characteristics which mimic the
characteristics of non-mortgage- or asset-backed
securities, such as floating interest rates (i.e.,
interest rates which adjust as a specified benchmark
changes) or scheduled amortization of principal.
Mortgage- and asset-backed securities backed by
assets, other than as described above, or in which the
payment streams on the underlying assets are allocated
in a manner different than those described above may be
issued in the future. The Balanced Fund may invest in
such securities if such investment is otherwise
consistent with its investment objectives, policies and
restrictions.
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Convertible Securities. Each 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 normally 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 (i)
have higher yields than common stocks, but lower yields
than comparable non-convertible securities, (ii) are
less subject to fluctuation in value than the
underlying stock since they have fixed income
characteristics, and (iii) provide the potential for
capital appreciation if the market price of the
underlying common stock increases. A convertible
security may be subject to redemption at the option of
the issuer at a price established in the convertible
security's governing instrument. If a convertible
security held by a 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. The Adviser will
limit investments in convertible debt securities to
those that are rated at the time of purchase as
investment grade by at least one national rating
organization, such as S&P or Moody's, or, if unrated,
are determined to be of equivalent quality by the
Adviser. With respect to the Balanced Fund's
investments in convertible securities, the Balanced
Fund will only include that portion of convertible
senior securities with fixed income characteristics in
computing whether the Balanced Fund has at least 25% of
its total assets in fixed income convertible
securities.
Variable- or Floating-Rate Securities. The
Balanced Fund may invest in securities which offer a
variable- or floating-rate of interest. Variable-rate
securities provide for automatic establishment of a new
interest rate at fixed intervals (e.g., daily, monthly,
semi-annually, etc.). Floating-rate securities
generally provide for automatic adjustment of the
interest rate whenever some specified interest rate
index changes. The interest rate on variable- or
floating-rate securities is ordinarily determined by
reference to or is a percentage of a bank's prime rate,
the 90-day U.S. Treasury bill rate, the rate of return
on commercial paper or bank certificates of deposit, an
index of short-term interest rates, or some other
objective measure.
Variable- or floating-rate securities frequently
include a demand feature entitling the holder to sell
the securities to the issuer at par. In many cases,
the demand feature can be exercised at any time on
seven days notice, in other cases, the demand feature
is exercisable at any time on 30 days notice or on
similar notice at intervals of not more than one year.
Some securities which do not have variable or floating
interest rates may be accompanied by puts producing
similar results and price characteristics.
Variable-rate demand notes include master demand
notes which are obligations that permit the Balanced
Fund to invest fluctuating amounts, which may change
daily without penalty, pursuant to direct arrangements
between the Balanced Fund, as lender, and the borrower.
The interest rates on these notes fluctuate from time
to time. The issuer of such obligations normally has a
corresponding right, after a given period, to prepay in
its discretion the outstanding principal amount of the
obligations plus accrued interest upon a specified
number of days' notice to the holders of such
obligations. The interest rate on a floating-rate
demand obligation is based on a known lending rate,
such as a bank's prime rate, and is adjusted
automatically each time such rate is adjusted. The
interest rate on a variable-rate demand obligation is
adjusted automatically at specified intervals.
Frequently, such obligations are secured by letters of
credit or other credit support arrangements provided by
banks. Because these obligations are direct lending
arrangements between the lender and borrower, it is not
contemplated that such instruments will generally be
traded. There generally is not an established
secondary market for these obligations, although they
are redeemable at face value. Accordingly, where the
obligations are not secured by letters of credit or
other credit support arrangements, the Balanced Fund's
right to redeem is dependent on the ability of the
borrower to pay principal and interest on demand. Such
obligations frequently are not rated by credit rating
agencies and, if not so rated, the Balanced Fund may
invest in them only if the Adviser determines that at
the time of investment other obligations are of
comparable quality to the other obligations in which
the Balanced Fund may invest.
The Balanced Fund will not invest more than 10% of
its net assets in variable- and floating-rate demand
obligations that are not readily marketable (a variable-
or floating-rate demand obligation that may be disposed
of on not more than seven days notice will be deemed
readily marketable and will not be subject to this
limitation). See "Investment Policies and Techniques
- -- Illiquid Securities" and "Investment Restrictions."
In addition, each variable- and floating-rate
obligation must meet the credit quality requirements
applicable to all the Balanced Fund's investments
<PAGE>
at the time of purchase. When determining whether such an
obligation meets the Balanced Fund's credit quality
requirements, the Balanced Fund may look to the credit
quality of the financial guarantor providing a letter
of credit or other credit support arrangement. The
Growth Fund may invest in such securities as described
under "Temporary Strategies."
Repurchase Agreements. The Funds may enter into
repurchase agreements with certain banks or non-bank
dealers. In a repurchase agreement, a Fund buys a
security at one price, and at the time of sale, the
seller agrees to repurchase the obligation at a
mutually agreed upon time and price (usually within
seven days). The repurchase agreement, thereby,
determines the yield during the purchaser's holding
period, while the seller's obligation to repurchase is
secured by the value of the underlying security. The
Adviser will monitor, on an ongoing basis, the value of
the underlying securities to ensure that the value
always equals or exceeds the repurchase price plus
accrued interest. Repurchase agreements could involve
certain risks in the event of a default or insolvency
of the other party to the agreement, including possible
delays or restrictions upon a Fund's ability to dispose
of the underlying securities. Although no definitive
creditworthiness criteria are used, the Adviser reviews
the creditworthiness of the banks and non-bank dealers
with which the Funds enter into repurchase agreements
to evaluate those risks.
Reverse Repurchase Agreements
The Funds may, with respect to up to 5% of its net
assets, engage in reverse repurchase agreements. In a
reverse repurchase agreement, a Fund would sell a
security and enter into an agreement to repurchase the
security at a specified future date and price. A Fund
generally retains the right to interest and principal
payments on the security. Since a Fund receives cash
upon entering into a reverse repurchase agreement, it
may be considered a borrowing. When required by
guidelines of the SEC, the Fund will set aside
permissible liquid assets in a segregated account to
secure its obligations to repurchase the security.
Temporary Strategies
Prior to investing the proceeds from sale of Fund
shares and to meet ordinary daily cash needs, the
Adviser may hold cash and/or invest all or a portion of
the Fund's assets in money market instruments, which
are short-term fixed income securities issued by
private and governmental institutions and may include
commercial paper, short-term U.S. government
securities, repurchase agreements, banker's
acceptances, certificates of deposit, time deposits and
other short-term fixed-income securities. All money
market instruments will be rated investment-grade.
Derivative Instruments
In General. Although it does not currently intend
to engage in derivative transactions, each Fund may
invest up to 5% of its respective net assets in
derivative instruments. Derivative instruments may be
used for any lawful purpose consistent with a Fund's
investment objective such as hedging or managing risk,
but not for speculation. Derivative instruments are
commonly defined to include securities or contracts
whose value depend on (or "derive" from) the value of
one or more other assets, such as securities,
currencies, or commodities. These "other assets" are
commonly referred to as "underlying assets."
A derivative instrument generally consists of, is
based upon, or exhibits characteristics similar to
options or forward contracts. Options and forward
contracts are considered to be the basic "building
blocks" of derivatives. For example, forward-based
derivatives include forward contracts, swap contracts,
as well as exchange-traded futures. Option-based
derivatives include privately negotiated, over-the-
counter (OTC) options (including caps, floors, collars,
and options on forward and swap contracts) and exchange-
traded options on futures. Diverse types of
derivatives may be created by combining options or
forward contracts in different ways, and by applying
these structures to a wide range of underlying assets.
An option is a contract in which the "holder" (the
buyer) pays a certain amount (the "premium") to the
"writer" (the seller) to obtain the right, but not the
obligation, to buy from the writer (in a "call") or
sell to the writer (in a "put") a specific asset at an
agreed upon price at or before a certain time. The
holder pays the premium at inception and has no further
financial obligation. The holder of an option-based
derivative generally will benefit from favorable
movements in the price of the underlying asset but is
not exposed to corresponding losses due to adverse
movements in
<PAGE>
the value of the underlying asset. The
writer of an option-based derivative generally will
receive fees or premiums but generally is exposed to
losses due to changes in the value of the underlying
asset.
A forward is a sales contract between a buyer
(holding the "long" position) and a seller (holding the
"short" position) for an asset with delivery deferred
until a future date. The buyer agrees to pay a fixed
price at the agreed future date and the seller agrees
to deliver the asset. The seller hopes that the market
price on the delivery date is less than the agreed upon
price, while the buyer hopes for the contrary. The
change in value of a forward-based derivative generally
is roughly proportional to the change in value of the
underlying asset.
Hedging. A Fund may use derivative instruments to
protect against possible adverse changes in the market
value of securities held in, or are anticipated to be
held in, the Fund's portfolio. Derivatives may also be
used by a Fund to "lock-in" its realized but
unrecognized gains in the value of its portfolio
securities. Hedging strategies, if successful, can
reduce the 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 the opportunity for
gain by offsetting the positive effect of favorable
price movements in the hedged investments.
Managing Risk. A Fund may also use derivative
instruments to manage the risks of the Fund's
portfolio. Risk management strategies include, but are
not limited to, facilitating the sale of portfolio
securities, managing the effective maturity or duration
of debt obligations in a Fund's portfolio, establishing
a position in the derivatives markets as a substitute
for buying or selling certain securities, or creating
or altering exposure to certain asset classes, such as
equity, debt, and foreign securities. The use of
derivative instruments may provide a less expensive,
more expedient or more specifically focused way for a
Fund to invest than "traditional" securities (i.e.,
stocks or bonds) would.
Exchange or OTC Derivatives. Derivative
instruments may be exchange-traded or traded in OTC
transactions between private parties. Exchange-traded
derivatives are standardized options and futures
contracts traded in an auction on the floor of a
regulated exchange. Exchange contracts are generally
liquid. The exchange clearinghouse is the counterparty
of every contract. Thus, each holder of an exchange
contract bears the credit risk of the clearinghouse
(and has the benefit of its financial strength) rather
than that of a particular counterparty. Over-the-
counter transactions are subject to additional risks,
such as the credit risk of the counterparty to the
instrument, and are less liquid than exchange-traded
derivatives since they often can only be closed out
with the other party to the transaction.
Risks and Special Considerations. The use of
derivative instruments involves risks and special
considerations as described below. Risks pertaining to
particular derivative instruments are described in the
sections that follow.
(1) Market Risk. The primary risk of derivatives
is the same as the risk of the underlying assets;
namely, that the value of the underlying asset may go
up or down. Adverse movements in the value of an
underlying asset can expose a Fund to losses.
Derivative instruments may include elements of leverage
and, accordingly, the fluctuation of the value of the
derivative instrument in relation to the underlying
asset may be magnified. The successful use of
derivative instruments depends upon a variety of
factors, particularly the Adviser's ability to predict
movements of the securities, currencies, and
commodities markets, which requires different skills
than predicting changes in the prices of individual
securities. There can be no assurance that any
particular strategy adopted will succeed. A decision
to engage in a derivative transaction will reflect the
Adviser's judgment that the derivative transaction will
provide value to the Fund and its shareholders and is
consistent with the Fund's objectives, investment
limitations, and operating policies. In making such a
judgment, the Adviser will analyze the benefits and
risks of the derivative transaction and weigh them in
the context of the Fund's entire portfolio and
investment objective.
(2) Credit Risk. A Fund will be subject to the
risk that a loss may be sustained by the Fund as a
result of the failure of a counterparty to comply with
the terms of a derivative instrument. The counterparty
risk for exchange-traded derivative instruments is
generally less than for privately-negotiated or OTC
derivative instruments, since generally a clearing
agency, which is the issuer or counterparty to each
exchange-traded instrument, provides a guarantee of
performance. For privately-negotiated instruments,
there is no similar clearing agency guarantee. In all
transactions, a Fund will bear the risk that the
counterparty will default, and this could result in a
loss of the expected benefit of the derivative
transaction and possibly other losses to the Fund. A
Fund will enter into transactions in
<PAGE>
derivative instruments only with counterparties that the
Adviser reasonably believes are capable of performing under
the contract.
(3) Correlation Risk. When a derivative
transaction is used to completely hedge another
position, changes in the market value of the combined
position (the derivative instrument plus the position
being hedged) result from an imperfect correlation
between the price movements of the two instruments.
With a perfect hedge, the value of the combined
position remains unchanged for any change in the price
of the underlying asset. With an imperfect hedge, the
value of the derivative instrument and its hedge are
not perfectly correlated. Correlation risk is the risk
that there might be imperfect correlation, or even no
correlation, between price movements of an instrument
and price movements of investments being hedged. For
example, if the value of a derivative instrument used
in a short hedge (such as writing a call option, buying
a put option, or selling a futures contract) increased
by less than the decline in value of the hedged
investments, the hedge would not be perfectly
correlated. Such a lack of correlation might occur due
to factors unrelated to the value of the investments
being hedged, such as speculative or other pressures on
the markets in which these instruments are traded. The
effectiveness of hedges using instruments on indices
will depend, in part, on the degree of correlation
between price movements in the index and price
movements in the investments being hedged.
(4) Liquidity Risk. Derivatives are also subject
to liquidity risk. Liquidity risk is the risk that a
derivative instrument cannot be sold, closed out, or
replaced quickly at or very close to its fundamental
value. Generally, exchange contracts are very liquid
because the exchange clearinghouse is the counterparty
of every contract. OTC transactions are less liquid
than exchange-traded derivatives since they often can
only be closed out with the other party to the
transaction. A Fund might be required by applicable
regulatory requirement to maintain assets as "cover,"
maintain segregated accounts, and/or make margin
payments when it takes positions in derivative
instruments involving obligations to third parties
(i.e., instruments other than purchased options). If a
Fund is unable to close out its positions in such
instruments, it might be required to continue to
maintain such assets or accounts or make such payments
until the position expired, matured, or is closed out.
The requirements might impair a 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. A Fund's ability to sell or
close out a position in an 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 the counterparty
to enter into a transaction closing out the position.
Therefore, there is no assurance that any derivatives
position can be sold or closed out at a time and price
that is favorable to a Fund.
(5) Legal Risk. Legal risk is the risk of loss
caused by the legal unenforceability of a party's
obligations under the derivative. While a party
seeking price certainty agrees to surrender the
potential upside in exchange for downside protection,
the party taking the risk is looking for a positive
payoff. Despite this voluntary assumption of risk, a
counterparty that has lost money in a derivative
transaction may try to avoid payment by exploiting
various legal uncertainties about certain derivative
products.
(6) Systemic or "Interconnection" Risk.
Interconnection risk is the risk that a disruption in
the financial markets will cause difficulties for all
market participants. In other words, a disruption in
one market will spill over into other markets, perhaps
creating a chain reaction. Much of the OTC derivatives
market takes place among the OTC dealers themselves,
thus creating a large interconnected web of financial
obligations. This interconnectedness raises the
possibility that a default by one large dealer could
create losses for other dealers and destabilize the
entire market for OTC derivative instruments.
General Limitations. The use of derivative
instruments is subject to applicable regulations of the
SEC, the several options and futures exchanges upon
which they may be traded, and the Commodity Futures
Trading Commission ("CFTC").
The Corporation has filed a notice of eligibility
for exclusion from the definition of the term
"commodity pool operator" with the CFTC and the
National Futures Association, which regulate trading in
the futures markets. In accordance with Rule 4.5 of
the regulations under the CEA, the notice of
eligibility for the Funds includes representations that
each Fund will use futures contracts and related
options solely for bona fide hedging purposes within
the meaning of CFTC regulations, provided that a Fund
may hold other positions in futures contracts and
related options that do not qualify as a bona fide
hedging position if the aggregate initial margin
deposits and premiums
<PAGE>
required to establish these
positions, less the amount by which any such futures
contracts and related options positions are "in the
money," do not exceed 5% of the Fund's net assets. To
the extent the Fund were to engage in derivative
transactions, it will limit such transactions to no
more than 5% of its net assets.
The SEC has identified certain trading practices
involving derivative instruments that involve the
potential for leveraging a Fund's assets in a manner
that raises issues under the 1940 Act. In order to
limit the potential for the leveraging of a Fund's
assets, as defined under the 1940 Act, the SEC has
stated that a Fund may use coverage or the segregation
of a Fund's assets. The Funds will also set aside
permissible liquid assets in a segregated custodial
account if required to do so by SEC and CFTC
regulations. Assets used as cover or held in a
segregated account cannot be sold while the derivative
position is open, unless they are replaced with similar
assets. As a result, the commitment of a large portion
of a Fund's assets to segregated accounts could impede
portfolio management or the Fund's ability to meet
redemption requests or other current obligations.
In some cases a Fund may be required to maintain
or limit exposure to a specified percentage of its
assets to a particular asset class. In such cases,
when a Fund uses a derivative instrument to increase or
decrease exposure to an asset class and is required by
applicable SEC guidelines to set aside liquid assets in
a segregated account to secure its obligations under
the derivative instruments, the Adviser may, where
reasonable in light of the circumstances, measure
compliance with the applicable percentage by reference
to the nature of the economic exposure created through
the use of the derivative instrument and not by
reference to the nature of the exposure arising from
the assets set aside in the segregated account (unless
another interpretation is specified by applicable
regulatory requirements).
Options. A Fund may use options for any lawful
purpose consistent with the Fund's investment objective
such as hedging or managing risk but not for
speculation. An option is a contract in which the
"holder" (the buyer) pays a certain amount (the
"premium") to the "writer" (the seller) to obtain the
right, but not the obligation, to buy from the writer
(in a "call") or sell to the writer (in a "put") a
specific asset at an agreed upon price (the "strike
price" or "exercise price") at or before a certain time
(the "expiration date"). The holder pays the premium
at inception and has no further financial obligation.
The holder of an option will benefit from favorable
movements in the price of the underlying asset but is
not exposed to corresponding losses due to adverse
movements in the value of the underlying asset. The
writer of an option will receive fees or premiums but
is exposed to losses due to changes in the value of the
underlying asset. A Fund may purchase (buy) or write
(sell) put and call options on assets, such as
securities, currencies, commodities, and indices of
debt and equity securities ("underlying assets") and
enter into closing transactions with respect to such
options to terminate an existing position. Options
used by the Funds may include European, American, and
Bermuda style options. If an option is exercisable
only at maturity, it is a "European" option; if it is
also exercisable prior to maturity, it is an "American"
option. If it is exercisable only at certain times, it
is a "Bermuda" option.
Each Fund may purchase (buy) and write (sell) put
and call options and enter into closing transactions
with respect to such options to terminate an existing
position. The purchase of call options serves as a
long hedge, and the purchase of put options serves as a
short hedge. Writing put or call options can enable a
Fund to enhance income by reason of the premiums paid
by the purchaser of such options. Writing call options
serves 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 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 at less than its
market value or will be obligated to purchase the
security at a price greater than that at which the
security must be sold under the option. All or a
portion of any assets used as cover for OTC options
written by a Fund would be considered illiquid to the
extent described under "Investment Policies and
Techniques Illiquid Securities." Writing put options
serves 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 security depreciates to a price lower
than the exercise price of the put option, it can be
expected that the put option will be exercised and the
Fund will be obligated to purchase the security at more
than its market value.
The value of an option position will reflect,
among other things, the historical price volatility of
the underlying investment, 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, and
general market conditions.
<PAGE>
A Fund may effectively terminate its right or
obligation under an option by entering into a closing
transaction. For example, a 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, a 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 a Fund to
realize the profit or limit the loss on an option
position prior to its exercise or expiration.
The Funds may purchase or write both exchange-
traded and OTC options. Exchange-traded options are
issued by a clearing organization affiliated with the
exchange on which the option is listed that, in effect,
guarantees completion of every exchange-traded option
transaction. In contrast, OTC options are contracts
between a Fund and the other party to the transaction
("counterparty") (usually a securities dealer or a
bank) with no clearing organization guarantee. Thus,
when a 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.
A Fund's ability to establish and close out
positions in exchange-listed options depends on the
existence of a liquid market. Each 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 each Fund will enter into OTC options
only with counterparties that are expected to be
capable of entering into closing transactions with the
Funds, there is no assurance that the Funds will in
fact be able to close out an OTC option at a favorable
price prior to expiration. In the event of insolvency
of the counterparty, a Fund might be unable to close
out an OTC option position at any time prior to its
expiration. If a 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 Funds may engage in options transactions on
indices in much the same manner as the options on
securities discussed above, except the index options
may serve as a hedge against overall fluctuations in
the securities market in general.
The writing and purchasing of options is a highly
specialized activity that involves investment
techniques and risks different from those associated
with ordinary portfolio securities transactions.
Imperfect correlation between the options and
securities markets may detract from the effectiveness
of attempted hedging.
Spread Transactions. A Fund may use spread
transactions for any lawful purpose consistent with the
Fund's investment objective such as hedging or managing
risk, but not for speculation. A Fund may purchase
covered spread options from securities dealers. Such
covered spread options are not presently exchange-
listed or exchange-traded. The purchase of a spread
option gives a Fund the right to put, or sell, a
security that it owns at a fixed dollar spread or fixed
yield spread in relationship to another security that
the Fund does not own, but which is used as a
benchmark. The risk to a Fund in purchasing covered
spread options is the cost of the premium paid for the
spread option and any transaction costs. In addition,
there is no assurance that closing transactions will be
available. The purchase of spread options will be used
to protect a Fund against adverse changes in prevailing
credit quality spreads, i.e., the yield spread between
high quality and lower quality securities. Such
protection is only provided during the life of the
spread option.
Futures Contracts. A Fund may use futures
contracts for any lawful purpose consistent with the
Fund's investment objective such as hedging and
managing risk but not for speculation. A Fund may
enter into futures contracts, including interest rate,
index, and currency futures. Each Fund may also
purchase put and call options, and write covered put
and call options, on futures in which it is allowed to
invest. The purchase of futures or call options
thereon can serve as a long hedge, and the sale of
futures or the purchase of put options thereon can
serve as a short hedge. Writing covered call options
on futures contracts can serve as a limited short
hedge, and writing covered put options on futures
contracts can serve as a limited long hedge, using a
strategy similar to that used for writing covered
options in securities. The Funds' hedging may include
purchases of futures as an offset against the effect of
expected increases in currency exchange rates and
securities prices and sales of futures as an offset
against the effect of expected declines in currency
exchange rates and securities prices.
<PAGE>
To the extent required by regulatory authorities,
the Funds may enter into futures contracts that are
traded on national futures exchanges and are
standardized as to maturity date and underlying
financial instrument. Futures exchanges and trading
are regulated under the CEA by the CFTC. Although
techniques other than sales and purchases of futures
contracts could be used to reduce a Fund's exposure to
market, currency, or interest rate fluctuations, a Fund
may be able to hedge its exposure more effectively and
perhaps at a lower cost through using futures
contracts.
An interest rate futures contract provides for the
future sale by one party and purchase by another party
of a specified amount of a specific financial
instrument (e.g., debt security) or currency for a
specified price at a designated date, time, and place.
An index futures contract is an agreement pursuant to
which the parties agree to take or make delivery of an
amount of cash equal to the difference between the
value of the index at the close of the last trading day
of the contract and the price at which the index
futures contract was originally written. Transaction
costs are incurred when a futures contract is bought or
sold and margin deposits must be maintained. A futures
contract may be satisfied by delivery or purchase, as
the case may be, of the instrument or the currency or
by payment of the change in the cash value of the
index. More commonly, futures contracts are closed out
prior to delivery by entering into an offsetting
transaction in a matching futures contract. Although
the value of an index might be a function of the value
of certain specified securities, no physical delivery
of those securities is made. If the offsetting
purchase price is less than the original sale price, a
Fund realizes a gain; if it is more, a Fund realizes a
loss. Conversely, if the offsetting sale price is more
than the original purchase price, a Fund realizes a
gain; if it is less, a Fund realizes a loss. The
transaction costs must also be included in these
calculations. There can be no assurance, however, that
a Fund will be able to enter into an offsetting
transaction with respect to a particular futures
contract at a particular time. If a Fund is not able
to enter into an offsetting transaction, the Fund will
continue to be required to maintain the margin deposits
on the futures contract.
No price is paid by a Fund upon entering into a
futures contract. Instead, at the inception of a
futures contract, a Fund is required to deposit in a
segregated account with its custodian, in the name of
the futures broker through whom the transaction was
effected, "initial margin," consisting of cash, U.S.
government securities or other liquid, high-grade debt
obligations, in an amount generally equal to 10% or
less of the contract value. Margin must also be
deposited when writing a call or put option on a
futures contract, in accordance with applicable
exchange rules. Unlike margin in securities
transaction, initial margin on futures contracts does
not represent a borrowing, but rather is in the nature
of a performance bond or good-faith deposit that is
returned to a Fund at the termination of the
transaction if all contractual obligations have been
satisfied. Under certain circumstances, such as
periods of high volatility, a 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 a Fund's
obligations to or from a futures broker. When a Fund
purchases an option on a future, the premium paid plus
transaction costs is all that is at risk. In contrast,
when a Fund purchases or sells a futures contract or
writes a call or put option thereon, it is subject to
daily variation margin calls that could be substantial
in the event of adverse price movements. If a Fund has
insufficient cash to meet daily variation margin
requirements, it might need to sell securities at a
time when such sales are disadvantageous. Purchasers
and sellers of futures positions and options on futures
can enter into offsetting closing transactions 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 Funds intend to enter into futures
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 future or option on a futures contract 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.
<PAGE>
If a Fund were unable to liquidate a futures or
option on a futures contract 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 certain
liquid securities in a segregated account.
Certain characteristics of the futures market
might increase the risk that movements in the prices of
futures contracts or options on futures contracts might
not correlate perfectly with movements in the prices of
the investments being hedged. For example, all
participants in the futures and options on futures
contracts markets are subject to daily variation margin
calls and might be compelled to liquidate futures or
options on futures contracts positions whose prices are
moving unfavorably to avoid being subject to further
calls. These liquidations could increase the 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 markets are
less onerous than margin requirements in the securities
markets, there might be increased participation by
speculators in the future 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.
Foreign Currencies. The Funds may purchase and
sell foreign currency on a spot basis, and may use
currency-related derivatives instruments such as
options on foreign currencies, futures on foreign
currencies, options on futures on foreign currencies
and forward currency contracts (i.e., 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).
The Funds may use these instruments for hedging or any
other lawful purpose consistent with their respective
investment objectives, including transaction hedging,
anticipatory hedging, cross hedging, proxy hedging, and
position hedging. The Funds' use of currency-related
derivative instruments will be directly related to a
Fund's current or anticipated portfolio securities, and
the Funds may engage in transactions in currency-
related derivative instruments as a means to protect
against some or all of the effects of adverse changes
in foreign currency exchange rates on their portfolio
investments. In general, if the currency in which a
portfolio investment is denominated appreciates against
the U.S. dollar, the dollar value of the security will
increase. Conversely, a decline in the exchange rate
of the currency would adversely effect the value of the
portfolio investment expressed in U.S. dollars.
For example, a Fund might use currency-related
derivative instruments to "lock in" a U.S. dollar price
for a portfolio investment, thereby enabling the Fund
to protect itself against a possible loss resulting
from an adverse change in the relationship between the
U.S. dollar and the subject foreign currency during the
period between the date the security is purchased or
sold and the date on which payment is made or received.
A Fund also might use currency-related derivative
instruments when the Adviser believes that one currency
may experience a substantial movement against another
currency, including the U.S. dollar, and it may use
currency-related derivative instruments to sell or buy
the amount of the former foreign currency,
approximating the value of some or all of the Fund's
portfolio securities denominated in such foreign
currency. Alternatively, where appropriate, a Fund may
use currency-related derivative instruments to hedge
all or part of its foreign currency exposure through
the use of a basket of currencies or a proxy currency
where such currency or currencies act as an effective
proxy for other currencies. The use of this basket
hedging technique may be more efficient and economical
than using separate currency-related derivative
instruments for each currency exposure held by the
Fund. Furthermore, currency-related derivative
instruments may be used for short hedges -- for
example, a 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.
In addition, a Fund may use a currency-related
derivative instrument to shift exposure to foreign
currency fluctuations from one foreign country to
another foreign country where the Adviser believes that
the foreign currency exposure purchased will appreciate
relative to the U.S. dollar and thus better protect the
Fund against the expected decline in the foreign
currency exposure sold. For example, if a Fund owns
securities denominated in a foreign currency and the
Adviser believes that currency will decline, it might
enter into a forward contract to sell an appropriate
amount of the first foreign currency, with payment to
be made in a second foreign currency that the Adviser
believes would better protect the Fund against the
decline in the first security than would a U.S. dollar
exposure. Hedging
<PAGE>
transactions that use two foreign
currencies are sometimes referred to as "cross hedges."
The effective use of currency-related derivative
instruments by a Fund in a cross hedge is dependent
upon a correlation between price movements of the two
currency instruments and the underlying security
involved, and the use of two currencies magnifies the
risk that movements in the price of one instrument may
not correlate or may correlate unfavorably with the
foreign currency being hedged. Such a lack of
correlation might occur due to factors unrelated to the
value of the currency instruments used or investments
being hedged, such as speculative or other pressures on
the markets in which these instruments are traded.
A Fund also might seek to hedge against changes in
the value of a particular currency when no hedging
instruments on that currency are available or such
hedging instruments are more expensive than certain
other hedging instruments. In such cases, the Fund may
hedge against price movements in that currency by
entering into transactions using currency-related
derivative instruments on another foreign currency or a
basket of currencies, the values of which the Adviser
believes will have a high degree of positive
correlation to the value of the currency being hedged.
The risk that movements in the price of the hedging
instrument will not correlate perfectly with movements
in the price of the currency being hedged is magnified
when this strategy is used.
The use of currency-related derivative instruments
by a Fund involves a number of risks. The value of
currency-related derivative instruments 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, a 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
(generally consisting of transactions of greater than
$1 million).
There is no systematic reporting of last sale
information for 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 re-open.
Settlement of transactions in currency-related
derivative instruments might be required to take place
within the country issuing the underlying currency.
Thus, a 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.
When a Fund engages in a transaction in a currency-
related derivative instrument, it relies on the
counterparty to make or take delivery of the underlying
currency at the maturity of the contract or otherwise
complete the contract. In other words, the Fund will
be subject to the risk that it may sustain a loss as a
result of the failure of the counterparty to comply
with the terms of the transaction. The counterparty
risk for exchange-traded instruments is generally less
than for privately-negotiated or OTC currency
instruments, since generally a clearing agency, which
is the issuer or counterparty to each instrument,
provides a guarantee of performance. For privately-
negotiated instruments, there is no similar clearing
agency guarantee. In all transactions, the Fund will
bear the risk that the counterparty will default, and
this could result in a loss of the expected benefit of
the transaction and possibly other losses to the Fund.
The Funds will enter into transactions in currency-
related derivative instruments only with counterparties
that the Adviser reasonably believes are capable of
performing under the contract.
Purchasers and sellers of currency-related
derivative instruments may enter into offsetting
closing transactions by selling or purchasing,
respectively, an instrument identical to the instrument
purchased or sold. Secondary markets 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 a Fund will, in fact, be able to close out a
forward currency contract (or any other currency-
related derivative instrument) at a time and price
favorable to the Fund. In addition, in the event of
insolvency of the counterparty, a Fund might be unable
to close out a forward currency contract at any time
prior to maturity. In the case of an exchange-traded
<PAGE>
instrument, a Fund will be able to close the position
out only on an exchange which provides a market for the
instruments. The ability to establish and close out
positions on an exchange is subject to the maintenance
of a liquid market, and there can be no assurance that
a liquid market will exist for any instrument at any
specific time. In the case of a privately-negotiated
instrument, a Fund will be able to realize the value of
the instrument only by entering into a closing
transaction with the issuer or finding a third party
buyer for the instrument. While the Funds will enter
into privately-negotiated transactions only with
entities who are expected to be capable of entering
into a closing transaction, there can be no assurance
that the Funds will, in fact, be able to enter into
such closing transactions.
The precise matching of currency-related
derivative instrument amounts and the value of the
portfolio securities involved generally will not be
possible because the value of such securities, measured
in the foreign currency, will change after the currency-
related derivative instrument position has been
established. Thus, a Fund might need to purchase or
sell foreign currencies in the spot (cash) market. The
projection of short-term currency market movements is
extremely difficult, and the successful execution of a
short-term hedging strategy is highly uncertain.
Permissible foreign currency options will include
options traded primarily in the OTC market. Although
options on foreign currencies are traded primarily in
the OTC market, the Funds will normally purchase or
sell OTC options on foreign currency only when the
Adviser reasonably believes a liquid secondary market
will exist for a particular option at any specific
time.
There will be a cost to the Funds of engaging in
transactions in currency-related derivative instruments
that will vary with factors such as the contract or
currency involved, the length of the contract period
and the market conditions then prevailing. A Fund
using these instruments may have to pay a fee or
commission or, in cases where the instruments are
entered into on a principal basis, foreign exchange
dealers or other counterparties will realize a profit
based on the difference ("spread") between the prices
at which they are buying and selling various
currencies. Thus, for example, a dealer may offer to
sell a foreign currency to a Fund at one rate, while
offering a lesser rate of exchange should the Fund
desire to resell that currency to the dealer.
When required by the SEC guidelines, the Funds
will set aside permissible liquid assets in segregated
accounts or otherwise cover their respective potential
obligations under currency-related derivatives
instruments. To the extent a Fund's assets are so set
aside, they cannot be sold while the corresponding
currency position is open, unless they are replaced
with similar assets. As a result, if a large portion
of a Fund's assets are so set aside, this could impede
portfolio management or the Fund's ability to meet
redemption requests or other current obligations.
The Adviser's decision to engage in a transaction
in a particular currency-related derivative instrument
will reflect the Adviser's judgment that the
transaction will provide value to the Fund and its
shareholders and is consistent with the Fund's
objectives and policies. In making such a judgment,
the Adviser will analyze the benefits and risks of the
transaction and weigh them in the context of the Fund's
entire portfolio and objectives. The effectiveness of
any transaction in a currency-related derivative
instrument is dependent on a variety of factors,
including the Adviser's skill in analyzing and
predicting currency values and upon a correlation
between price movements of the currency instrument and
the underlying security. There might be imperfect
correlation, or even no correlation, between price
movements of an instrument and price movements of
investments being hedged. Such a lack of correlation
might occur due to factors unrelated to the value of
the investments being hedged, such as speculative or
other pressures on the markets in which these
instruments are traded. In addition, a Fund's use of
currency-related derivative instruments is always
subject to the risk that the currency in question could
be devalued by the foreign government. In such a case,
any long currency positions would decline in value and
could adversely affect any hedging position maintained
by the Fund.
The Funds' dealing in currency-related derivative
instruments will generally be limited to the
transactions described above. However, the Funds
reserve the right to use currency-related derivatives
instruments for different purposes and under different
circumstances. Of course, the Funds are not required
to use currency-related derivatives instruments and
will not do so unless deemed appropriate by the
Adviser. It should also be realized that use of these
instruments does not eliminate, or protect against,
price movements in the Funds' securities that are
attributable to other (i.e., non-currency related)
causes. Moreover, while the use of currency-related
derivatives instruments may reduce the risk of loss due
to a decline in the value of a hedged currency, at the
same time the use of these instruments tends to limit
any potential gain which may result from an increase in
the value of that currency.
<PAGE>
Swap Agreements. The Funds may enter into
interest rate, securities index, commodity, or security
and currency exchange rate swap agreements for any
lawful purpose consistent with each Fund's investment
objective, such as for the purpose of attempting to
obtain or preserve a particular desired return or
spread at a lower cost to the Fund than if the Fund had
invested directly in an instrument that yielded that
desired return or spread. The Funds may also enter
into swaps in order to protect against an increase in
the price of, or the currency exchange rate applicable
to, securities that the particular Fund anticipates
purchasing at a later date. Swap agreements are two-
party contracts entered into primarily by institutional
investors for periods ranging from a few weeks to
several years. In a standard "swap" transaction, two
parties agree to exchange the returns (or differentials
in rates of return) earned or realized on particular
predetermined investments or instruments. The gross
returns to be exchanged or "swapped" between the
parties are calculated with respect to a "notional
amount," i.e., the return on or increase in value of a
particular dollar amount invested at a particular
interest rate, in a particular foreign currency, or in
a "basket" of securities representing a particular
index. Swap agreements may include interest rate caps,
under which, in return for a premium, one party agrees
to make payments to the other to the extent that
interest rates exceed a specified rate, or "cap;"
interest rate floors, under which, in return for a
premium, one party agrees to make payments to the other
to the extent that interest rates fall below a
specified level, or "floor;" and interest rate collars,
under which a party sells a cap and purchases a floor,
or vice versa, in an attempt to protect itself against
interest rate movements exceeding given minimum or
maximum levels.
The "notional amount" of the swap agreement is the
agreed upon basis for calculating the obligations that
the parties to a swap agreement have agreed to
exchange. Under most swap agreements entered into by a
Fund, the obligations of the parties would be exchanged
on a "net basis." Consequently, a Fund's obligation
(or rights) under a swap agreement will generally be
equal only to the net amount to be paid or received
under the agreement based on the relative values of the
positions held by each party to the agreement (the "net
amount"). A Fund's obligation under a swap agreement
will be accrued daily (offset against amounts owed to
the Fund) and any accrued but unpaid net amounts owed
to a swap counterparty will be covered by the
maintenance of a segregated account generally
consisting of liquid assets.
Whether a Fund's use of swap agreements will be
successful in furthering its investment objective will
depend, in part, on the Adviser's ability to predict
correctly whether certain types of investments are
likely to produce greater returns than other
investments. Swap agreements may be considered to be
illiquid. Moreover, a Fund bears the risk of loss of
the amount expected to be received under a swap
agreement in the event of the default or bankruptcy of
a swap agreement counterparty. Certain restrictions
imposed on the Funds by the Internal Revenue Code may
limit the Funds' ability to use swap agreements. The
swaps market is largely unregulated.
The Funds will enter swap agreements only with
counterparties that the Adviser reasonably believes are
capable of performing under the swap agreements. If
there is a default by the other party to such a
transaction, a 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.
Additional Derivative Instruments and Strategies.
In addition to the derivative instruments and
strategies described above, the Adviser expects to
discover additional derivative instruments and other
hedging or risk management techniques. The Adviser may
utilize these new derivative instruments and techniques
to the extent that they are consistent with a Fund's
investment objective and permitted by the Fund's
investment limitations, operating policies, and
applicable regulatory authorities.
Depositary Receipts
Each Fund may invest up to 15% of its net assets
in foreign securities by purchasing depositary
receipts, including American Depositary Receipts
("ADRs") and European Depositary Receipts ("EDRs") or
other securities convertible into securities or issuers
based in foreign countries. These securities may not
necessarily be denominated in the same currency as the
securities into which they may be converted.
Generally, ADRs, in registered form, are denominated in
U.S. dollars and are designed for use in the U.S.
securities markets, while EDRs, in bearer form, may be
denominated in other currencies and are designed for
use in European securities markets. ADRs are receipts
typically issued by a U.S. Bank or trust company
evidencing ownership of the underlying securities.
EDRs are European receipts evidencing a similar
arrangement. For purposes of a Fund's investment
policies, ADRs and EDRs
<PAGE>
are deemed to have the same
classification as the underlying securities they
represent. Thus, an ADR or EDR representing ownership
of common stock will be treated as common stock.
ADR facilities may be established as either
"unsponsored" or "sponsored." While ADRs issued under
these two types of facilities are in some respects
similar, there are distinctions between them relating
to the rights and obligations of ADR holders and the
practices of market participants. For example, a non-
sponsored depositary may not provide the same
shareholder information that a sponsored depositary is
required to provide under its contractual arrangements
with the issuer, including reliable financial
statements. Under the terms of most sponsored
arrangements, depositories agree to distribute notices
of shareholder meetings and voting instructions, and to
provide shareholder communications and other
information to the ADR holders at the request of the
issuer of the deposited securities.
Investments in securities of foreign issuers
involve risks which are in addition to the usual risks
inherent in domestic investments. In many countries
there is less publicly available information about
issuers than is available in the reports and ratings
published about companies in the United States.
Additionally, foreign countries are not subject to
uniform accounting, auditing and financial reporting
standards. Other risks inherent in foreign investments
include expropriation; confiscatory taxation;
withholding taxes on dividends or interest; less
extensive regulation of foreign brokers, securities
markets, and issuers; costs incurred in conversions
between currencies; possible delays in settlement in
foreign securities markets; limitations on the use or
transfer of assets (including suspension of the ability
to transfer currency from a given country); the
difficulty of enforcing obligations in other countries;
diplomatic developments; and political or social
instability. Foreign economies may differ favorably or
unfavorably from the U.S. economy in various respects
and many foreign securities are less liquid and their
prices are more volatile than comparable U.S.
securities. From time to time foreign securities may
be difficult to liquidate rapidly without adverse price
effects. Certain costs attributable to foreign
investing, such as custody charges and brokerage costs,
may be higher than those attributable to domestic
investment. The value of a Fund's assets denominated
in foreign currencies will increase or decrease in
response to fluctuations in the value of those foreign
currencies relative to the U.S. dollar. Currency
exchange rates can be volatile at times in response to
supply and demand in the currency exchange markets,
international balances of payments, governmental
intervention, speculation and other political and
economic conditions.
Foreign Investment Companies
The Funds may invest, to a limited extent, in
foreign investment companies. Some of the countries in
which the Funds invest may not permit direct investment
by outside investors. Investments in such countries
may only be permitted through foreign government-
approved or -authorized investment vehicles, which may
include other investment companies. In addition, it
may be less expensive and more expedient for a Fund to
invest in a foreign investment company in a country
which permits direct foreign investment. Investing
through such vehicles may involve frequent or layered
fees or expenses and may also be subject to limitation
under the 1940 Act. Under the 1940 Act, a Fund may
invest up to 10% of its total assets in shares of other
investment companies and up to 5% of its total assets
in any one investment company as long as the investment
does not represent more than 3% of the voting stock of
the acquired investment company. The Funds do not
intend to invest in such investment companies unless,
in the judgment of the Adviser, the potential benefits
of such investments justify the payment of any
associated fees and expenses.
High-Yield (High-Risk) Securities
In General. The Balanced Fund will invest in
fixed income securities rated at the time of purchase
as at lease investment grade by at least one nationally
recognized statistical rating organization ("NRSROs"),
such as S&P or Moody's. If a security's rating falls
below the ratings criteria set forth in the Prospectus,
the Adviser will determine what action, if any, should
be taken to ensure compliance with the Balanced Fund's
investment objective and to ensure that the Balanced
Fund will at no time have 5% or more of its net assets
invested in non-investment grade debt securities. Non-
investment grade debt obligations ("lower-quality
securities") include (1) bonds rated as low as C by
S&P, Moody's and comparable ratings of other NRSROs;
(2) commercial paper rated as low as C by S&P, Not
Prime by Moody's and comparable ratings of other
NRSROs; and (3) unrated debt obligations of comparable
quality. Lower-quality securities, while generally
offering higher yields than investment grade securities
with similar maturities, involve greater risks,
including the possibility of default or bankruptcy.
They are regarded as predominantly speculative with
respect to the issuer's capacity to pay interest and
repay principal. The special risk considerations in
<PAGE>
connection with investments in these securities are
discussed below. Refer to the Appendix for a
description of the securities ratings.
Effect of Interest Rates and Economic Changes.
The lower-quality and comparable unrated security
market is relatively new and its growth has paralleled
a long economic expansion. As a result, it is not
clear how this market may withstand a prolonged
recession or economic downturn. Such conditions could
severely disrupt the market for and adversely affect
the value of such securities.
All interest-bearing securities typically
experience appreciation when interest rates decline and
depreciation when interest rates rise. The market
value of lower-quality and comparable unrated
securities tend to reflect individual corporate
developments to a greater extent than do higher rated
securities. As a result, they generally involve more
credit risks than securities in the higher-rated
categories. During an economic downturn or a sustained
period of rising interest rates, highly leveraged
issuers of lower-quality and comparable unrated
securities may experience financial stress and may not
have sufficient revenues to meet their payment
obligations. The issuer's ability to service its debt
obligations may also be adversely affected by specific
corporate developments, the issuer's inability to meet
specific projected business forecasts or the
unavailability of additional financing. The risk of
loss due to default by an issuer of these securities is
significantly greater than issuers of higher-rated
securities because such securities are generally
unsecured and are often subordinated to other
creditors. Further, if the issuer of a lower-quality
or comparable unrated security defaulted, the Balanced
Fund might incur additional expenses to seek recovery.
Periods of economic uncertainty and changes would also
generally result in increased volatility in the market
prices of these securities and thus in the Balanced
Fund's net asset value.
As previously stated, the value of a lower-quality
or comparable unrated security will decrease in a
rising interest rate market and accordingly, so will
the Balanced Fund's net asset value. If the Balanced
Fund experiences unexpected net redemptions in such a
market, it may be forced to liquidate a portion of its
portfolio securities without regard to their investment
merits. Due to the limited liquidity of lower-quality
and comparable unrated securities (discussed below),
the Balanced Fund may be forced to liquidate these
securities as a substantial discount. Any such
liquidation would force the Balanced Fund to sell the
more liquid portion of its portfolio.
Payment Expectations. Lower-quality and
comparable unrated securities typically contain
redemption, call or prepayment provisions which permit
the issuer of such securities containing such
provisions to, at its discretion, redeem the
securities. During periods of falling interest rates,
issuers of these securities are likely to redeem or
prepay the securities and refinance them with debt
securities with a lower interest rate. To the extent
an issuer is able to refinance the securities, or
otherwise redeem them, the Balanced Fund may have to
replace the securities with a lower yielding security,
which would result in a lower return for the Balanced
Fund.
Credit Ratings. Credit ratings issued by credit
rating agencies are designed to evaluate the safety of
principal and interest payments of rated securities.
They do not, however, evaluate the market value risk of
lower-quality securities and, therefore, may not fully
reflect the true risks of an investment. In addition,
credit rating agencies may or may not make timely
changes in a rating to reflect changes in the economy
or in the condition of the issuer that affect the
market value of the security. Consequently, credit
ratings are used only as a preliminary indicator of
investment quality. Investments in lower-quality and
comparable unrated obligations will be more dependent
on the Adviser's credit analysis than would be the case
with investments in investment-grade debt obligations.
The Adviser employs its own credit research and
analysis, which includes a study of existing debt,
capital structure, ability to service debt and to pay
dividends, the issuer's sensitivity to economic
conditions, its operating history and the current trend
of earnings. The Adviser continually monitors the
investments in the Balanced Fund's portfolio and
carefully evaluates whether to dispose of or to retain
lower-quality and comparable unrated securities whose
credit ratings or credit quality may have changed.
Liquidity and Valuation. The Balanced Fund may
have difficulty disposing of certain lower-quality and
comparable unrated securities because there may be a
thin trading market for such securities. Because not
all dealers maintain markets in all lower-quality and
comparable unrated securities, there is no established
retail secondary market for many of these securities.
The Balanced Fund anticipates that such securities
could be sold only to a limited number of dealers or
institutional investors. To the extent a secondary
trading market does exist, it is generally not as
liquid as the secondary market for higher-rated
securities. The lack of a liquid secondary market may
have an adverse impact on
<PAGE>
the market price of the
security. As a result, the Balanced Fund's asset value
and ability to dispose of particular securities, when
necessary to meet the Balanced Fund's liquidity needs
or in response to a specific economic event, may be
impacted. The lack of a liquid secondary market for
certain securities may also make it more difficult for
the Balanced Fund to obtain accurate market quotations
for purposes of valuing the Balanced Fund's portfolio.
Market quotations are generally available on many lower-
quality and comparable unrated issues only from a
limited number of dealers and may not necessarily
represent firm bids of such dealers or prices for
actual sales. During periods of thin trading, the
spread between bid and asked prices is likely to
increase significantly. In addition, adverse publicity
and investor perceptions, whether or not based on
fundamental analysis, may decrease the values and
liquidity of lower-quality and comparable unrated
securities, especially in a thinly traded market.
Legislation. Legislation may be adopted, from
time to time, designed to limit the use of certain
lower-quality and comparable unrated securities by
certain issuers. It is anticipated that if additional
legislation is enacted or proposed, it could have a
material affect on the value of these securities and
the existence of a secondary trading market for the
securities.
Warrants
Each Fund may invest in warrants, valued at the
lower of cost or market value, if, after giving effect
thereto, not more than 5% of its net assets will be
invested in warrants other than warrants acquired in
units or attached to other securities. Warrants are
options to purchase equity securities at a specific
price for a specific period of time. They do not
represent ownership of the securities but only the
right to buy them. Investing in warrants is purely
speculative in that they have no voting rights, pay no
dividends and have no rights with respect to the assets
of the corporation issuing them. In addition, the
value of a warrant does not necessarily change with the
value of the underlying securities, and a warrant
ceases to have value if it is not exercised prior to
its expiration date.
Short Sales Against the Box
Each Fund may sell securities short against the
box to hedge unrealized gains on portfolio securities.
Selling securities short against the box involves
selling a security that a Fund owns or has the right to
acquire, for delivery at a specified date in the
future. If a Fund sells securities short against the
box, it may protect unrealized gains, but will lose the
opportunity to profit on such securities if the price
rises.
DIRECTORS AND OFFICERS
Under the laws of the State of Maryland, the Board
of Directors of the Corporation is responsible for
managing its business and affairs. The directors and
officers of the Corporation, together with information
as to their principal business occupations during the
last five years, and other information, are shown
below. Each director who is deemed an "interested
person," as defined in the 1940 Act, is indicated by an
asterisk.
*J. Kevin Callaghan, a Director and Co-Chairman of
the Corporation.
Mr. Callaghan, 41 years old, received a Bachelor
of Arts degree in economics and finance from the
University of Puget Sound in 1981. Mr. Callaghan has
been with the Adviser since 1983 and is currently a
portfolio manager with the Adviser.
*Steven C. Phelps, a Director and Co-Chairman of
the Corporation.
Mr. Phelps, 38 years old, graduated magna cum
laude from Williams College in 1983 with a degree in
political economy and was awarded a Fulbright
Scholarship at the University of Frankfurt, Germany.
Mr. Phelps joined the Adviser in 1986 after working for
two years with PACCAR, Inc. as an analyst in the
treasury department of the finance subsidiary and as an
independent researcher in the field of transportation
economics. Mr. Phelps is a Chartered Financial Analyst
and a Chartered Investment Counselor.
<PAGE>
Frank S. Bayley, a Director of the Corporation
since June 1998.
Mr. Bayley, 60 years old, earned a Bachelor of
Arts degree and a law degree from Harvard University.
Mr. Bayley has been a partner with the law firm of
Baker & McKenzie since 1986. Mr. Bayley serves as
director and co-chairman of C. D. Stimson Company, a
private investment company. In addition, Mr. Bayley
has been a Trustee of AIM Global Mutual Funds (formerly
GT Global Mutual Funds) since 1985.
Madelyn B. Smith, a Director of the Corporation
since June 1998.
Ms. Smith, 68 years old, received a Bachelor of
Arts degree from the University of Puget Sound in 1970.
Prior to retiring, Ms. Smith worked as an analyst and
portfolio manager with the Frank Russell Company from
1971 to 1997.
Graham S. Anderson, a Director of the Corporation
since July 1999.
Mr. Anderson, 66 years old, received a Bachelor of
Arts from the University of Washington. Mr. Anderson
has served as a director of Tully's Coffee Co. since
1992. From 1987 until 1994, Mr. Anderson served as the
Chairman and Chief Executive Officer of Pettit-Morry
Co., an insurance broker, and prior thereto served as
President and Chief Executive Officer of Pettit-Morry
Co. In addition, Mr. Anderson served as a director of
Marker International, a ski equipment manufacturer,
from 1985 to 1999, director of Commerce Bank
Corporation from 1991 to 1999, director of Gray's
Harbor Paper Company from 1992 to 1998 and director of
Acordia Northwest, Inc., the successor to Pettit-Morry
Co., until 1998. Mr. Anderson was also the Chairman of
the National Association of Insurance Brokers and
Alberg Holding Co.
Scott R. Vokey, President of the Corporation.
Mr. Vokey, 45 years old, earned a B.A. from
Connecticut College in 1977 and a law degree from
University of Houston in 1984. Prior to joining the
Adviser as Manager of Private Capital Development and
General Counsel in 1999, Mr. Vokey worked as an
independent consultant for one year. From 1996 to
1998, Mr. Vokey was Associate General Counsel and
Director of Environmental Health and Safety of Westin
Hotels and Resorts/Starwood Hotels and Resorts. From
1986 to 1996, Mr. Vokey was an attorney with the law
firm of Preston, Gates & Ellis.
Lisa P. Guzman, Treasurer and Secretary of the
Corporation.
Ms. Guzman, 44 years old, graduated with honors
from the University of Washington in 1977 with a
Bachelor of Arts degree and from the University of
Puget Sound in 1983 with a Master's of Business
Administration. Prior to joining the Adviser in 1990,
Ms. Guzman worked for 12 years at PACCAR, Inc., the
last four years as cash manager of its finance
subsidiary.
The address for Messrs. Callaghan, Phelps and
Vokey and Ms. Guzman is Badgley, Phelps and Bell, Inc.,
1420 Fifth Avenue, Suite 4400, Seattle, Washington,
98101. The address for Mr. Bayley is Baker & McKenzie,
Two Embarcadero Center, 24th Floor, San Francisco,
California 94111. The address for Ms. Smith is 9
Forest Glen Drive SW, Tacoma, Washington 98498. The
address for Mr. Anderson is Graco Investments Inc., 520
Pike Street, 20th Floor, Seattle, Washington 98101.
As of August 31, 1999, officers and directors of
the Corporation beneficially owned 9.9% of the Growth
Fund's then outstanding shares and 3.5% of the Balanced
Fund's then outstanding shares. Directors and officers
of the Corporation who are also officers, directors,
employees, or shareholders of the Adviser do not
receive any compensation from any of the Funds for
serving as directors or officers.
The following table provides information relating
to compensation paid to directors of the Corporation
for their services as such for the period June 25, 1998
to May 31, 1999:
<PAGE>
Cash Other
Name Compensation(1) Compensation Total
J. Kevin Callaghan $ 0 $0 $ 0
Steven C. Phelps $ 0 $0 $ 0
Frank S. Bayley $1,000 $0 $1,000
Madelyn B. Smith $1,000 $0 $1,000
Graham S. Anderson (2) $ 0 $0 $ 0
All directors as a $2,000 $0 $2,000
group (5 persons)
____________________
(1) Each director who is not deemed an "interested
person" as defined in the 1940 Act, receives $250 for
each Board of Directors meeting attended by such person
and reasonable expenses incurred in connection
therewith. The Board held four meetings during fiscal
1999.
(2) Mr. Anderson was elected to the Board of Directors
in July 1999. Accordingly, he did not receive any
compensation from any of the Funds during fiscal 1999.
PRINCIPAL SHAREHOLDERS
As of August 31, 1999, the following persons owned
of record or are known by the Corporation to own of
record or beneficially 5% or more of the outstanding
shares of each Fund:
Name and Address Fund No. Shares Percentage
Charles Schwab & Co. Growth 172,882 25.4%
Special Custody Account for the Balanced 772,801 45.0%
Exclusive Benefit of Customers
101 Montgomery Street
San Francisco, CA 94104-4122
Montevilla Farm Limited Partnership Growth 34,695 5.1%
P.O. Box 1863
Bellevue, WA 98009-1863
Based on the foregoing, as of August 31, 1999, the
Corporation was not aware of any one security holder
beneficially owning 25% or more of a Fund's voting
securities.
INVESTMENT ADVISER
Badgley, Phelps and Bell, Inc. (the "Adviser") is
the investment adviser to the Funds. The Adviser is
controlled by several of its officers and directors.
The investment advisory agreement between the
Corporation and the Adviser dated as of June 23, 1998
(the "Advisory Agreement") has an initial term of two
years and thereafter is required to be approved
annually by the Board of Directors of the Corporation
or by vote of a majority of each of the Fund's
outstanding voting securities (as defined in the 1940
Act). Each annual renewal must also be approved by the
vote of a majority of the Corporation's directors who
are not parties to the Advisory Agreement or interested
persons of any such party, cast in person at a meeting
called for the purpose of voting on such approval. The
Advisory Agreement was approved by the Board of
Directors, including a majority of the disinterested
directors on June 23, 1998 and by the initial
shareholders of each Fund on
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June 23, 1998. The
Advisory Agreement is terminable without penalty, on 60
days' written notice by the Board of Directors of the
Corporation, by vote of a majority of each of the
Fund's outstanding voting securities or by the Adviser,
and will terminate automatically in the event of its
assignment.
Under the terms of the Advisory Agreement, the
Adviser manages the Funds' investments and business
affairs, subject to the supervision of the
Corporation's Board of Directors. At its expense, the
Adviser provides office space and all necessary office
facilities, equipment and personnel for managing the
investments of the Funds. As compensation for its
services, the Growth Fund pays the Adviser an annual
management fee of 1.00% of its average daily net
assets, and the Balanced Fund pays the Adviser an
annual management fee of 0.90% of its average daily net
assets. The advisory fee is accrued daily and paid
monthly. The organizational expenses of each Fund were
advanced by the Adviser and will be reimbursed by the
Funds over a period of not more than 60 months.
For the fiscal year ended May 31, 1999, the
Adviser waived its management fee and reimbursed the
Funds' other expenses so that the Growth Fund's total
operating expenses (on an annual basis) did not exceed
1.50% of its average daily net assets and that the
Balanced Fund's total operating expenses (on an annual
basis) did not exceed 1.30% of its average daily net
assets. The Adviser has contractually agreed that until
September 30, 2000, the Adviser will continue to waive
its management fee and/or reimburse the Fund's
operating expenses to the extent necessary to ensure
that (i) the total operating expenses (on an annual
basis) for the Growth Fund do not exceed 1.50% of
average daily net assets, and (ii) the total operating
expenses (on an annual basis) for the Balanced Fund do
not exceed 1.30% of the average daily net assets.
After such date, the Adviser may from time to time
voluntarily waive all or a portion of its fee and/or
absorb expenses for the Funds. Any waiver of fees or
absorption of expenses will be made on a monthly basis
and, with respect to the latter, will be paid to the
Funds by reduction of the Adviser's fee. Any such
waiver/absorption is subject to later adjustment during
the term of the Advisory Agreement to allow Adviser to
recoup amounts waived/absorbed to the extend actual
fees and expenses for a period are less than the
expense limitation caps, provided, however, that, the
Adviser shall only be entitled to recoup such amounts
for a maximum period of three years from the date such
amount was waived or reimbursed. For the period June
25, 1998 to May 31, 1999, the Funds did not pay a
management fee to the Adviser because the Adviser
waived its entire management fee. If the Adviser had
not agreed to waive its management fee, the Adviser
would have received $31,437 and $53,223 from the Growth
Fund and Balanced Fund, respectively, for its
investment advisory services.
For more information on the Adviser, see the
Adviser's website at http://www.badgley.com.
Information contained in the Adviser's website is not
deemed to be a part of the Funds' Prospectus or this
Statement of Additional Information.
FUND TRANSACTIONS AND BROKERAGE
Under the Advisory Agreement, the Adviser, in its
capacity as portfolio manager, is responsible for
decisions to buy and sell securities for the Funds and
for the placement of the Funds' securities business,
the negotiation of the commissions to be paid on such
transactions and the allocation of portfolio brokerage
business. The Adviser seeks to obtain the best
execution at the best security price available with
respect to each transaction. The best price to the
Funds means the best net price without regard to the
mix between purchase or sale price and commission, if
any. While the Adviser seeks reasonably competitive
commission rates, the Funds do not necessarily pay the
lowest available commission. Brokerage will not be
allocated based on the sale of a Fund's shares.
The Adviser has adopted procedures that provide
generally for the Adviser to seek to batch orders for
the purchase or sale of the same security for the Funds
and other advisory accounts (collectively, "accounts").
The Adviser will batch orders when it deems it to be
appropriate and in the best interest of the accounts.
When a batched order is filled in its entirety, each
participating account will participate at the average
share price for the batched order on the same business
day, and transaction costs will be shared pro rata
based on each account's participation in the batched
order. When a batched order is only partially filled,
the securities purchased will be allocated on a pro
rata basis to each account participating in the batched
order based upon the initial amount requested for the
account, subject to certain exceptions, and each
participating account will participate at the average
share price for the batched order on the same business
day. With respect to that portion of the order not
filled, the Adviser will reevaluate whether to place
another order and on what terms for the same securities
or whether an order should be placed for different
securities.
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Section 28(e) of the Securities Exchange Act of
1934, as amended, ("Section 28(e)"), permits an
investment adviser, under certain circumstances, to
cause an account to pay a broker or dealer who supplies
brokerage and research services a commission for
effecting a transaction in excess of the amount of
commission another broker or dealer would have charged
for effecting the transaction. Brokerage and research
services include (a) furnishing advice as to the value
of securities, the advisability of investing,
purchasing or selling securities and the availability
of securities or purchasers or sellers of securities;
(b) furnishing analyses and reports concerning issuers,
industries, securities, economic factors and trends,
portfolio strategy and the performance of accounts; and
(c) effecting securities transactions and performing
functions incidental thereto (such as clearance,
settlement, and custody).
In selecting brokers or dealers, the Adviser
considers investment and market information and other
research, such as economic, securities and performance
measurement research provided by such brokers or
dealers and the quality and reliability of brokerage
services, including execution capability, performance
and financial responsibility. Accordingly, the
commissions charged by any such broker or dealer may be
greater than the amount another firm might charge if
the Adviser determines in good faith that the amount of
such commissions is reasonable in relation to the value
of the research information and brokerage services
provided by such broker or dealer to the Funds. The
Adviser believes that the research information received
in this manner provides the Funds with benefits by
supplementing the research otherwise available to the
Funds. Such higher commissions will not be paid by the
Funds unless (a) the Adviser determines in good faith
that the amount is reasonable in relation to the
services in terms of the particular transaction or in
terms of the Adviser's overall responsibilities with
respect to the accounts, including the Funds, as to
which it exercises investment discretion; (b) such
payment is made in compliance with the provisions of
Section 28(e) and other applicable state and federal
laws; and (c) in the opinion of the Adviser, the total
commissions paid by the Funds will be reasonable in
relation to the benefits to the Funds over the long
term.
The aggregate amount of brokerage commissions paid
by the Growth Fund and the Balanced Fund for the period
June 25, 1998 to May 31, 1999 were $8,180 and $10,395,
respectively. For the period June 25, 1998 to May 31,
1999, the Funds did not pay brokerage commissions with
respect to transactions for which research services
were provided. During the period June 25, 1998 to May
31, 1999, the Funds did not acquire any stock of their
regular brokers or dealers.
The Adviser places portfolio transactions for
other advisory accounts managed by the Adviser.
Research services furnished by firms through which the
Funds effect their securities transactions may be used
by the Adviser in servicing all of its accounts; not
all of such services may be used by the Adviser in
connection with the Funds. The Adviser believes it is
not possible to measure separately the benefits from
research services to each of the accounts (including
the Funds) managed by it. Because the volume and
nature of the trading activities of the accounts are
not uniform, the amount of commissions in excess of
those charged by another broker paid by each account
for brokerage and research services will vary.
However, the Adviser believes such costs to the Funds
will not be disproportionate to the benefits received
by the Funds on a continuing basis. The Adviser seeks
to allocate portfolio transactions equitably whenever
concurrent decisions are made to purchase or sell
securities by the Funds and another advisory account.
In some cases, this procedure could have an adverse
effect on the price or the amount of securities
available to the Funds. In making such allocations
between a Fund and other advisory accounts, the main
factors considered by the Adviser are the respective
investment objectives, the relative size of portfolio
holdings of the same or comparable securities, the
availability of cash for investment and the size of
investment commitments generally held.
CUSTODIAN
As custodian of the Funds' assets, Firstar Bank
Milwaukee, N.A. ("Firstar Bank"), 777 East Wisconsin
Avenue, Milwaukee, Wisconsin 53202, has custody of all
securities and cash of each Fund, delivers and receives
payment for portfolio securities sold, receives and
pays for portfolio securities purchased, collects
income from investments and performs other duties, all
as directed by the officers of the Corporation.
TRANSFER AGENT AND DIVIDEND-DISBURSING AGENT
Firstar Mutual Fund Services, LLC ("Firstar"),
Third Floor, 615 East Michigan Street, Milwaukee,
Wisconsin 53202, acts as transfer agent and dividend-
disbursing agent for the Funds. Firstar is compensated
based on an annual fee per open account of $14 (subject
to a minimum annual fee of $16,250 per Fund) plus out-
of-pocket expenses, such
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as postage and printing
expenses in connection with shareholder communications.
Firstar also receives an annual fee per closed account
of $14.
From time to time, the Corporation, on behalf of
the Funds, directly or indirectly through arrangements
with the Adviser, the Distributor (as defined below) or
Firstar, may pay amounts to third parties that provide
transfer agent type services and other administrative
services relating to the Funds to persons who
beneficially have interests in a Fund, such as
participants in 401(k) plans. These services may
include, among other things, sub-accounting services,
transfer agent type activities, answering inquiries
relating to the Funds, transmitting proxy statements,
annual reports, updated prospectuses, other
communications regarding the Funds and related services
as Funds or beneficial owners may reasonably request.
In such cases, the Funds will not pay fees based on the
number of beneficial owners at a rate that is greater
than the rate the Funds are currently paying Firstar
for providing these services to the Funds' shareholders
(i.e., $14 per account plus expenses).
ADMINISTRATOR
Pursuant to a Fund Administration Servicing
Agreement and a Fund Accounting Servicing Agreement,
Firstar also performs accounting and certain compliance
and tax reporting functions for the Corporation. For
these services, Firstar receives from the Corporation
out-of-pocket expenses plus the following aggregate
annual fees, computed daily and payable monthly, based
on each Fund's aggregate average net assets:
Administrative Services Fees
First $200 million of average net assets .06 of 1%*
Next $500 million of average net assets .05 of 1%
Average net assets in excess of $700 million .03 of 1%
_____________________________
* Subject to a minimum fee of $30,000 per Fund.
Accounting Services Fees
Growth Fund Balanced Fund
First $40 million of average net assets $22,000 $23,500
Next $200 million of average net assets .01 of 1% .015 of 1%
Average net assets in excess of $240 million .005 of 1% .01 of 1%
For the period June 25, 1998 to May 31, 1999,
Firstar received $27,501 and $27,501 from the Growth
Fund and the Balanced Fund, respectively, under the
Fund Administration Servicing Agreement, and $21,996
and $23,382 from the Growth Fund and the Balanced Fund,
respectively, under the Fund Accounting Servicing
Agreement.
DISTRIBUTOR AND PLAN OF DISTRIBUTION
Distributor
Under a distribution agreement dated June 23, 1998
(the "Distribution Agreement"), Rafferty Capital
Markets, Inc. (the "Distributor"), 1311 Mamaroneck
Avenue, White Plains, New York 10605, acts as principal
distributor of the Funds' shares. The Distribution
Agreement provides that the Distributor will use its
best efforts to distribute the Funds' shares, which
shares are offered for sale by the Funds continuously
at net asset value per share without the imposition of
a sales charge. Pursuant to the terms of the
Distribution Agreement, the Distributor receives from
the Corporation out-of-pocket expenses plus an annual
fee equal to the greater of (i) $18,000 or (ii) .01% of
each Fund's net assets, computed daily and payable
monthly. All or a portion of the distribution and
shareholder servicing fee may be used by the
Distributor to pay such expenses under the distribution
and shareholder servicing plan discussed below.
<PAGE>
Distribution and Shareholder Servicing Plan
The Corporation, on behalf of the Funds, has
adopted a plan pursuant to Rule 12b-1 under the 1940
Act (the "12b-1 Plan"), which requires it to pay the
Distributor, in its capacity as the principal
distributor of Fund shares, a distribution and
shareholder servicing fee of 0.25% per annum of each
Fund's average daily net assets. Under the terms of
the 12b-1 Plan, the Distributor is authorized to, in
turn, pay all or a portion of this fee to any
securities dealer, financial institution or any other
person (the "Recipient") who renders assistance in
distributing or promoting the sale of Fund shares, or
who provides certain shareholder services to Fund
shareholders, pursuant to a written agreement (the
"Related Agreement"). Payments under the 12b-1 Plan
are based upon a percentage of average daily net assets
attributable to each Fund regardless of the amounts
actually paid or expenses actually incurred by the
Distributor, however, in no event, may such payments
exceed the maximum allowable fee. It is, therefore,
possible that the Distributor may realize a profit in a
particular year as a result of these payments. The 12b-
1 Plan has the effect of increasing the Fund's expenses
from what they would otherwise be. The Board of
Directors reviews each Fund's distribution and
shareholder servicing fee payments in connection with
their determination as to the continuance of the 12b-1
Plan.
The 12b-1 Plan, including a form of the Related
Agreement, has been unanimously approved by a majority
of the Board of Directors of the Corporation, and of
the members of the Board who are not "interested
persons" of the Corporation as defined in the 1940 Act
and who have no direct or indirect financial interest
in the operation of the 12b-1 Plan or any related
agreements (the "Disinterested Directors") voting
separately. The 12b-1 Plan, and any Related Agreement
which is entered into, will continue in effect for a
period of more than one year only so long as its
continuance is specifically approved at least annually
by a vote of a majority of the Corporation's Board of
Directors and of the Disinterested Directors, cast in
person at a meeting called for the purpose of voting on
the 12b-1 Plan or the Related Agreement, as applicable.
In addition, the 12b-1 Plan and any Related Agreement
may be terminated with respect to either or both Funds
at any time, without penalty, by vote of a majority of
the outstanding voting securities of the applicable
Fund, or by vote of a majority of Disinterested
Directors (on not more than 60 days' written notice in
the case of the Related Agreement only). Payment of the
distribution and shareholder servicing fee is to be
made monthly. The Distributor will provide reports to
the Board of Directors of the Corporation of all
recipients of payments made (and the purposes for which
amounts were paid) pursuant to the 12b-1 Plan.
Interests of Certain Persons
With the exception of the Adviser, in its capacity
as the Funds' investment adviser, and the Distributor,
in its capacity as principal underwriter of Fund
shares, no "interested person" of the Funds, as defined
in the 1940 Act, and no director of the Corporation who
is not an "interested person" has or had a direct or
indirect financial interest in the 12b-1 Plan or any
Related Agreement.
Anticipated Benefits to the Funds
The Board of Directors considered various factors
in connection with its decision to approve the 12b-1
Plan, including: (a) the nature and causes of the
circumstances which make implementation of the 12b-1
Plan necessary and appropriate; (b) the way in which
the 12b-1 Plan would address those circumstances,
including the nature and potential amount of
expenditures; (c) the nature of the anticipated
benefits; (d) the merits of possible alternative plans
or pricing structures; (e) the relationship of the
12b-1 Plan to other distribution efforts of the Funds;
and (f) the possible benefits of the 12b-1 Plan to any
other person relative to those of the Funds.
Based upon its review of the foregoing factors and
the material presented to it, and in light of its
fiduciary duties under relevant state law and the 1940
Act, the Board of Directors determined, in the exercise
of its business judgment, that the 12b-1 Plan was
reasonably likely to benefit the Funds and their
respective shareholders in at least one or several
potential ways. Specifically, the Board concluded that
the Distributor and any Recipients operating under
Related Agreements would have little or no incentive to
incur promotional expenses on behalf of a Fund if a
12b-1 Plan were not in place to reimburse them, thus
making the adoption of such 12b-1 Plan important to the
initial success and thereafter, continued viability of
the Funds. In addition, the Board determined that the
payment of distribution fees to these persons should
motivate them to provide an enhanced level of service
to Fund shareholders, which would, of course, benefit
such shareholders. Finally, the adoption of the 12b-1
Plan would help to increase net
<PAGE>
assets under management in a relatively short amount
of time, given the marketing efforts on the part of the
Distributor and Recipients to sell Fund shares, which
should result in certain economies of scale.
While there is no assurance that the expenditure
of Fund assets to finance distribution of Fund shares
will have the anticipated results, the Board of
Directors believes there is a reasonable likelihood
that one or more of such benefits will result, and
since the Board will be in a position to monitor the
distribution and shareholder servicing expenses of the
Funds, it will be able to evaluate the benefit of such
expenditures in deciding whether to continue the 12b-1
Plan.
Amounts Incurred Under the Plan
For the period June 25, 1998 to May 31, 1999,
pursuant to the terms of the 12b-1 Plan, the Growth
Fund expensed $7,859, representing 0.25% per annum of
its average daily net assets. Of this amount, $704.32
was spent on advertising, $84.58 on printing and
mailing prospectuses to other than current shareholders
and $5,589.82 was spent on compensation to broker-
dealers. The Distributor received $5,147.16 of the
amounts incurred under the 12b-1 Plan with respect to
the Growth Fund. For the same period, pursuant to the
terms of the 12b-1 Plan, the Balanced Fund expensed
$14,784, representing 0.25% per annum of its average
daily net assets. Of this amount, $1,721.87 was spent
on advertising, $69.66 on printing and mailing to other
than current shareholders and $6,067.27 was spent on
compensation to broker-dealers. The Distributor
received $11,040.84 of the amounts incurred under the
12b-1 Plan with respect to the Balanced Fund.
PURCHASE, REDEMPTION, EXCHANGE AND PRICING OF SHARES
Financial Intermediaries
If you purchase or redeem shares of a Fund through
a financial intermediary (such as a broker-dealer),
certain features of the Fund relating to such
transactions may not be available or may be modified.
In addition, certain operational policies of a Fund,
including those related to settlement and dividend
accrual, may vary from those applicable to direct
shareholders of a Fund and may vary among
intermediaries. You should consult your financial
intermediary for more information regarding these
matters. Refer to "Transfer Agent and Dividend-
Disbursing Agent" for information regarding certain
fees paid by the Corporation to financial
intermediaries. In addition, financial intermediaries
may receive compensation pursuant to the 12b-1 Plan
under a Related Agreement and may receive additional
compensation in excess of such amounts from the
Adviser. Certain financial intermediaries may charge
you an advisory, transaction or other fee for their
services. You will not be charged for such fees if you
purchase or redeem your Fund shares directly from a
Fund without the intervention of a financial
intermediary.
Automatic Investment Plan
The Automatic Investment Plan ("AIP") allows you
to make regular systematic investments in one or more
of the Funds from your bank checking or NOW account.
The minimum initial investment for investors using the
AIP is $1,000 with a monthly minimum investment of
$100. To establish the AIP, complete the appropriate
section in the shareholder application. Under certain
circumstances (such as discontinuation of the AIP
before a Fund's minimum initial investment is reached),
the Corporation reserves the right to close the
investor's account. Prior to closing any account for
failure to reach the minimum initial investment, the
Corporation will give the investor written notice and
60 days in which to reinstate the AIP or otherwise
reach the minimum initial investment. You should
consider your financial ability to continue in the AIP
until the minimum initial investment amount is met
because the Corporation has the right to close an
investor's account for failure to reach the minimum
initial investment. Such closing may occur in periods
of declining share prices.
Under the AIP, you may choose to make monthly
investments on the days of your choosing (or the next
business day thereafter) from your financial
institution in amounts of $100 or more. There is no
service fee for participating in the AIP. However, a
service fee of $20 will be deducted from your Fund
account for any AIP purchase that does not clear due to
insufficient funds or, if prior to notifying the
Corporation in writing or by telephone of your
intention to terminate the plan, you close your bank
account or in any manner prevent withdrawal of funds
from the designated checking or NOW account. You can
set up the AIP with any financial institution that is a
member of ACH.
<PAGE>
The AIP is a method of using dollar cost averaging
which is an investment strategy that involves investing
a fixed amount of money at a regular time interval.
However, a program of regular investment cannot ensure
a profit or protect against a loss from declining
markets. By always investing the same amount, you will
be purchasing more shares when the price is low and
fewer shares when the price is high. Since such a
program involves continuous investment regardless of
fluctuating share values, you should consider your
financial ability to continue the program through
periods of low share price levels.
Individual Retirement Accounts
In addition to purchasing Fund shares as described
in the Prospectus under "How to Purchase Shares,"
individuals may establish their own tax-sheltered IRAs.
The Funds offer two types of IRAs, including the
Traditional IRA, that can be adopted by executing the
appropriate Internal Revenue Service ("IRS") Form.
Traditional IRA. In a Traditional IRA, amounts
contributed to the IRA may be tax deductible at the
time of contribution depending on whether the investor
is an "active participant" in an employer-sponsored
retirement plan and the investor's income.
Distributions from a Traditional IRA will be taxed at
distribution except to the extent that the distribution
represents a return of the investor's own contributions
for which the investor did not claim (or was not
eligible to claim) a deduction. Distributions prior to
age 59-1/2 may be subject to an additional 10% tax
applicable to certain premature distributions.
Distributions must commence by April 1 following the
calendar year in which the investor attains age 70-1/2.
Failure to begin distributions by this date (or
distributions that do not equal certain minimum
thresholds) may result in adverse tax consequences.
Roth IRA. In a Roth IRA (sometimes known as the
American Dream IRA), amounts contributed to the IRA are
taxed at the time of contribution, but distributions
from the IRA are not subject to tax if the investor has
held the IRA for certain minimum periods of time
(generally, until age 59-1/2). Investors whose income
exceeds certain limits are ineligible to contribute to
a Roth IRA. Distributions that do not satisfy the
requirements for tax-free withdrawal are subject to
income taxes (and possibly penalty taxes) to the extent
that the distribution exceeds the investor's
contributions to the IRA. The minimum distribution
rules applicable to Traditional IRAs do not apply
during the lifetime of the investor. Following the
death of the investor, certain minimum distribution
rules apply.
For Traditional and Roth IRAs, the maximum annual
contribution generally is equal to the lesser of $2,000
or 100% of the investor's compensation (earned income).
An individual may also contribute to a Traditional IRA
or Roth IRA on behalf of his or her spouse provided
that the individual has sufficient compensation (earned
income). Contributions to a Traditional IRA reduce the
allowable contributions under a Roth IRA, and
contributions to a Roth IRA reduce the allowable
contribution to a Traditional IRA.
Simplified Employee Pension Plan. A Traditional
IRA may also be used in conjunction with a Simplified
Employee Pension Plan ("SEP-IRA"). A SEP-IRA is
established through execution of Form 5305-SEP together
with a Traditional IRA established for each eligible
employee. Generally, a SEP-IRA allows an employer
(including a self-employed individual) to purchase
shares with tax deductible contributions not exceeding
annually for any one participant 15% of compensation
(disregarding for this purpose compensation in excess
of $160,000 per year). The $160,000 compensation limit
applies for 1999 and is adjusted periodically for cost
of living increases. A number of special rules apply
to SEP Plans, including a requirement that
contributions generally be made on behalf of all
employees of the employer (including for this purpose a
sole proprietorship or partnership) who satisfy certain
minimum participation requirements.
SIMPLE IRA. An IRA may also be used in connection
with a SIMPLE Plan established by the investor's
employer (or by a self-employed individual). When this
is done, the IRA is known as a SIMPLE IRA, although it
is similar to a Traditional IRA with the exceptions
described below. Under a SIMPLE Plan, the investor may
elect to have his or her employer make salary reduction
contributions of up to $6,000 per year to the SIMPLE
IRA. The $6,000 limit applies for 1999 and is adjusted
periodically for cost of living increases. In
addition, the employer will contribute certain amounts
to the investor's SIMPLE IRA, either as a matching
contribution to those participants who make salary
reduction contributions or as a non-elective
contribution to all eligible participants whether or
not making salary reduction contributions. A number of
special rules apply to SIMPLE Plans, including (1) a
SIMPLE
<PAGE>
Plan generally is available only to employers
with fewer than 100 employees; (2) contributions must
be made on behalf of all employees of the employer
(other than bargaining unit employees) who satisfy
certain minimum participation requirements; (3)
contributions are made to a special SIMPLE IRA that is
separate and apart from the other IRAs of employees;
(4) the distribution excise tax (if otherwise
applicable) is increased to 25% on withdrawals during
the first two years of participation in a SIMPLE IRA;
and (5) amounts withdrawn during the first two years of
participation may be rolled over tax-free only into
another SIMPLE IRA (and not to a Traditional IRA or to
a Roth IRA). A SIMPLE IRA is established by executing
Form 5304-SIMPLE together with an IRA established for
each eligible employee.
Under current IRS regulations, all IRA applicants
must be furnished a disclosure statement containing
information specified by the IRS. Applicants generally
have the right to revoke their account within seven
days after receiving the disclosure statement and
obtain a full refund of their contributions. The
custodian may, in its discretion, hold the initial
contribution uninvested until the expiration of the
seven-day revocation period. The Custodian does not
anticipate that it will exercise its discretion but
reserves the right to do so.
Systematic Withdrawal Plan
You may set up automatic withdrawals from your
account at regular intervals. To begin distributions,
you must have an initial balance of $1,000 in your
account and withdraw at least $100 per payment. To
establish the systematic withdrawal plan ("SWP"), you
must complete the appropriate section in the
shareholder application. Redemptions will take place
on a monthly, quarterly, semi-annual or annual basis
(or the following business day) as indicated on your
shareholder application. You may vary the amount or
frequency of withdrawal payments or temporarily
discontinue them by calling 1-877-BADGLEY (1-877-223-
4539). Depending upon the size of the account and the
withdrawals requested (and fluctuations in the net
asset value of the shares redeemed), redemptions for
the purpose of satisfying such withdrawals may reduce
or even exhaust your account. If the amount remaining
in your account is not sufficient to meet a plan
payment, the remaining amount will be redeemed and the
SWP will be terminated.
Exchange Privilege
Fund to Fund Exchange. You may exchange your
shares in a Fund for shares in any other Fund of the
Corporation at any time by written request or by
telephone exchange if you have authorized this
privilege in the shareholder application. Exchange
requests are available for exchanges of $1,000 or more.
The value of the shares to be exchanged and the price
of the shares being purchased will be the net asset
value next determined after receipt of instructions for
exchange. No sales charge is imposed on exchanges
between Funds; however, a $5 service fee will be
charged for each telephone exchange request (no charge
is imposed with respect to written exchange requests).
Exchange requests should be directed to the following
address:
By Mail In Person or By Overnight Mail
Firstar Mutual Fund Services, LLC Firstar Mutual Fund Services, LLC
P.O. Box 701 Third Floor
Milwaukee, Wisconsin 53201-0701 615 East Michigan Street
Milwaukee, Wisconsin 53202
To effect a telephone exchange, you may call
1-877-BADGLEY (1-877-223-4539). Exchange requests may
be subject to limitations, including those relating to
frequency, that may be established from time to time to
ensure that such exchanges are not disadvantageous to
the Funds or their investors. The Corporation reserves
the right to modify or terminate the exchange privilege
upon 60 days' written notice to each shareholder prior
to the modification or termination taking effect. The
exchange privilege is only available in states where
the securities are registered.
Money Market Exchange. As a service to our
shareholders, the Corporation has established a program
whereby our shareholders can exchange shares of any one
of the Funds for shares of the Firstar Money Market
Funds (the "Firstar Funds"). Exchange requests are
available for exchanges of $1,000 or more. The Firstar
Funds are no-load money market funds managed by an
affiliate of Firstar. The Firstar Funds are unrelated
to the Corporation or any of the
<PAGE>
Funds. However, the
Distributor may be compensated by the Firstar Funds for
servicing and related services provided in connection
with exchanges made by shareholders of the Funds. This
exchange privilege is a convenient way to buy shares in
money market funds in order to respond to changes in
your goals or in market conditions. Before exchanging
into the Firstar Funds, please read the applicable
prospectus, which may be obtained by calling 1-877-
BADGLEY (1-877-223-4539). As noted above, there is no
charge for written exchange requests. Firstar will,
however, charge a $5.00 fee for each exchange
transaction that is executed via the telephone.
An exchange from one Fund to another, including
the Firstar Funds, is treated the same as an ordinary
sale and purchase for federal income tax purposes and
you will realize a capital gain or loss. An exchange
is not a tax-free transaction.
Pricing of Shares
Shares of the Funds are sold on a continual basis
at the net asset value per share next computed
following receipt of an order in proper form by a
dealer, the Distributor or Firstar, the Funds' transfer
agent.
The net asset value per share is determined as of
the close of trading (generally 4:00 p.m. Eastern
Standard Time) on each day the New York Stock Exchange
(the "NYSE") is open for business. Purchase orders
received or shares tendered for redemption on a day the
NYSE is open for trading, prior to the close of trading
on that day, will be valued as of the close of trading
on that day. Applications for purchase of shares and
requests for redemption of shares received after the
close of trading on the NYSE will be valued as of the
close of trading on the next day the NYSE is open. The
net asset value is calculated by taking the value of a
Fund's total assets, including interest or dividends
accrued, but not yet collected, less all liabilities,
and dividing by the total number of shares outstanding.
The result, rounded to the nearest cent, is the net
asset value per share.
In determining the net asset value, expenses are
accrued and applied daily and securities and other
assets for which market quotations are available are
valued at market value. Common stocks and other equity-
type securities are valued at the last sales price on
the national securities exchange or NASDAQ on which
such securities are primarily traded; however,
securities traded on a national securities exchange or
NASDAQ for which there were no transactions on a given
day, and securities not listed on a national securities
exchange or NASDAQ, are valued at the average of the
most recent bid and asked prices. Fixed income
securities are valued by a pricing service that
utilizes electronic data processing techniques to
determine values for normal institutional-sized trading
units of fixed income securities without regard to sale
or bid prices when such values are believed to more
accurately reflect the fair market value of such
securities; otherwise, actual sale or bid prices are
used. The Board of Directors may approve the use of
pricing services to assist the Funds in the
determination of net asset value. Fixed income
securities having remaining maturities of 60 days or
less when purchased are generally valued by the
amortized cost method. Under this method of valuation,
a security is initially valued at its acquisition cost
and, thereafter, amortization of any discount or
premium is assumed each day, regardless of the impact
of fluctuating interest rates on the market value of
the security.
TAXATION OF THE FUNDS
Each Fund intends to qualify annually as a
"regulated investment company" under Subchapter M of
the Code, and, if so qualified, will not be liable for
federal income taxes to the extent earnings are
distributed to shareholders on a timely basis. In the
event a Fund fails to qualify as a "regulated
investment company," it will be treated as a regular
corporation for federal income tax purposes.
Accordingly, the Fund would be subject to federal
income taxes and any distributions that it makes would
be taxable and non-deductible by the Fund. This would
increase the cost of investing in the Fund for
shareholders and would make it more economical for
shareholders to invest directly in securities held by
the Fund instead of investing indirectly in such
securities through the Fund.
PERFORMANCE INFORMATION
The Funds' historical performance or return may be
shown in the form of various performance figures. The
Funds' performance figures are based upon historical
results and are not necessarily representative of
future performance. Factors affecting the Funds'
performance include general market conditions,
operating expenses, and investment management.
<PAGE>
Total Return
The average annual total return of each Fund is
computed by finding the average annual compounded rates
of return over the periods that would equate the
initial amount invested to the ending redeemable value,
according to the following formula:
P(1+T)n = ERV
P = a hypothetical initial payment of $1,000.
T = average annual total return.
n = number of years.
ERV = ending redeemable value of a
hypothetical $1,000 payment made at
the beginning of the stated periods
at the end of the stated periods.
Performance for a specific period is calculated by
first taking an investment (assumed to be $1,000)
("initial investment") in a Fund's shares on the first
day of the period and computing the "ending value" of
that investment at the end of the period. The total
return percentage is then determined by subtracting the
initial investment from the ending value and dividing
the remainder by the initial investment and expressing
the result as a percentage. The calculation assumes
that all income and capital gains dividends paid by a
Fund have been reinvested at the net asset value of the
Fund on the reinvestment dates during the period.
Total return may also be shown as the increased dollar
value of the hypothetical investment over the period.
Cumulative total return represents the simple
change in value of an investment over a stated period
and may be quoted as a percentage or as a dollar
amount. Total returns may be broken down into their
components of income and capital (including capital
gains and changes in share price) in order to
illustrate the relationship between these factors and
their contributions to total return.
The total returns for the Growth Fund and the
Balanced Fund for the period June 25, 1998 to May 31,
1999 were 14.65% and 8.66%, respectively.
Yield
Yield is computed in accordance with a
standardized method prescribed by rules of the SEC.
Under that method, the current yield quotation for a
Fund is based on a one-month or 30-day period. The
yield is computed by dividing the net investment income
per share earned during the 30-day or one-month period
by the maximum offering price per share on the last day
of the period, according to the following formula:
YIELD = 2[(ab/cd + 1)6 - 1]
Where: a = dividends and interest earned
during the period.
b = expenses accrued for the period
(net of reimbursements).
c = the average daily number of
shares outstanding during the period that
were entitled to receive dividends.
d = the maximum offering price per
share on the last day of the period.
Comparisons
From time to time, in marketing and other Fund
literature, the Funds' performance may be compared to
the performance of other mutual funds in general or to
the performance of particular types of mutual funds
with similar investment goals, as tracked by
independent organizations. Among these organizations,
Lipper Analytical Services, Inc. ("Lipper"), a widely
used independent research firm which ranks mutual funds
by overall performance, investment objectives, and
assets, may be cited. Lipper performance figures are
based on changes in net asset value, with all
<PAGE>
income and capital gains dividends reinvested. Such
calculations do not include the effect of any sales
charges imposed by other funds. The Funds will be
compared to Lipper's appropriate fund category, that
is, by fund objective and portfolio holdings.
The Funds' performance may also be compared to the
performance of other mutual funds by Morningstar, Inc.
("Morningstar"), which ranks funds on the basis of
historical risk and total return. Morningstar's
rankings range from five stars (highest) to one star
(lowest) and represent Morningstar's assessment of the
historical risk level and total return of a fund as a
weighted average for 3, 5 and 10 year periods.
Rankings are not absolute or necessarily predictive of
future performance.
Evaluations of Fund performance made by
independent sources may also be used in advertisements
concerning the Funds, including reprints of or
selections from, editorials or articles about the
Funds. Sources for Fund performance and articles about
the Funds may include publications such as Money,
Forbes, Kiplinger's, Financial World, Business Week,
U.S. News and World Report, the Wall Street Journal,
Barron's and a variety of investment newsletters.
The Funds may compare their performance to a wide
variety of indices and measures of inflation including
the Standard & Poor's Index of 500 Stocks, the NASDAQ
Over-the-Counter Composite Index, the Russell 2500
Index and the Lehman Aggregate Bond Index. There are
differences and similarities between the investments
that the Funds may purchase for their respective
portfolios and the investments measured by these
indices.
ADDITIONAL INFORMATION
From time to time, in marketing and other Fund
literature, the Funds may quote founders, officers,
directors and other employees of the Adviser, such as a
quote from Charles H. Badgley who said, "Success in any
endeavor is best achieved when goals are defined and
strategy is well planned. This is especially true with
money management." In addition, the Funds may state
that they have been selected as an option for purchase
through Charles Schwab's Institutional "One Source"
service, which allows Charles Schwab institutional
investors, including financial planners and investment
advisers, to access information concerning and to
purchase shares in the Funds.
INDEPENDENT ACCOUNTANTS
PricewaterhouseCoopers LLP, 100 East Wisconsin
Avenue, Suite 1500, Milwaukee, Wisconsin 53202,
independent accountants for the Funds, audit and report
on the Funds' financial statements.
FINANCIAL STATEMENTS
The following audited financial statements of each
of the Funds are incorporated herein by reference to
the Funds' Annual Report for the period June 25, 1998
to May 31, 1999, as filed with the Securities and
Exchange Commission on August 3, 1999:
(a) Report of Independent Accountants.
(b) Schedule of Investments as of May 31, 1999.
(c) Statement of Assets and Liabilities as of May 31, 1999.
(d) Statement of Operations for the period June 25, 1998 to
May 31, 1999.
(e) Statement of Changes in Net Assets for the period
June 25, 1998 to May 31, 1999.
(f) Financial Highlights for the period June 25, 1998
to May 31, 1999.
(g) Notes to the Financial Statements.
<PAGE>
APPENDIX
SHORT-TERM RATINGS
Standard & Poor's Short-Term Debt Credit Ratings
A Standard & Poor's credit rating is a current
opinion of the creditworthiness of an obligor with
respect to a specific financial obligation, a specific
class of financial obligations or a specific financial
program. It takes into consideration the
creditworthiness of guarantors, insurers or other forms
of credit enhancement on the obligation and takes into
account the currency in which the obligation is
denominated. The credit rating is not a recommendation
to purchase, sell or hold a financial obligation,
inasmuch as it does not comment as to market price or
suitability for a particular investor.
Credit ratings are based on current information
furnished by the obligors or obtained by Standard &
Poor's from other sources it considers reliable.
Standard & Poor's does not perform an audit in
connection with any credit rating and may, on occasion,
rely on unaudited financial information. Credit
ratings may be changed, suspended or withdrawn as a
result of changes in, or unavailability of, such
information, or based on other circumstances.
Short-term ratings are generally assigned to those
obligations considered short-term in the relevant
market. In the U.S., for example, that means
obligations with an original maturity of no more than
365 days-including commercial paper. Short-term
ratings are also used to indicate the creditworthiness
of an obligor with respect to put features on long-term
obligations. The result is a dual rating, in which the
short-term rating addresses the put feature, in
addition to the usual long-term rating.
Ratings are graded into several categories,
ranging from `A-1' for the highest quality obligations
to `D' for the lowest. These categories are as
follows:
A-1 A short-term obligation rated `A-1' is rated
in the highest category by Standard & Poor's.
The obligor's capacity to meet its financial
commitment on the obligation is strong.
Within this category, certain obligations are
designated with a plus sign (+). This
indicates that the obligor's capacity to meet
its financial commitment on these obligations
is extremely strong.
A-2 A short-term obligation rated `A-2' is
somewhat more susceptible to the adverse
effects of changes in circumstances and
economic conditions than obligations in
higher rating categories. However, the
obligor's capacity to meet its financial
commitment on the obligation is satisfactory.
A-3 A short-term obligation rated `A-3' 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.
B A short-term obligation rated `B' is regarded
as having significant speculative
characteristics. The obligor currently has
the capacity to meet its financial commitment
on the obligation; however, it faces major
ongoing uncertainties which could lead to the
obligor's inadequate capacity to meet its
financial commitment on the obligation.
C A short-term obligation rated `C' 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.
D A short-term 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 Standard
& Poor's 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.
<PAGE>
Moody's Short-Term Debt Ratings
Moody's short-term debt ratings are opinions of
the ability of issuers to repay punctually senior debt
obligations. These obligations have an original
maturity not exceeding one year, unless explicitly
noted. Moody's ratings are opinions, not
recommendations to buy or sell, and their accuracy is
not guaranteed.
Moody's employs the following three designations,
all judged to be investment grade, to indicate the
relative repayment ability of rated issuers:
PRIME-1 Issuers rated `Prime-1' (or supporting
institutions) have a superior ability for
repayment of senior short-term debt
obligations. Prime-1 repaying ability will
often be evidenced by many of the following
characteristics:
* Leading market positions in well-established
industries.
* High rates of return on funds employed.
* Conservative capitalization structure with
moderate reliance on debt and ample asset protection.
* Broad margins in earnings coverage of fixed
financial charges and high internal cash generation.
* Well-established access to a range of financial
markets and assured sources of alternate liquidity.
PRIME-2 Issuers rated `Prime-2' (or supporting
institutions) have a strong ability for
repayment of senior short-term debt
obligations. This will normally be evidenced
by many of the characteristics cited above,
but to a lesser degree. Earnings trends and
coverage ratios, while sound, may be more
subject to variation. Capitalization
characteristics, while still appropriate, may
be more affected by external conditions.
Ample alternate liquidity is maintained.
PRIME-3 Issuers rated `Prime-3' (or supporting
institutions) have an acceptable ability for
repayment of senior short-term obligations.
The effect of industry characteristics and
market compositions may be more pronounced.
Variability in earnings and profitability may
result in changes in the level of debt
protection measurements and may require
relatively high financial leverage. Adequate
alternate liquidity is maintained.
NOT PRIME Issuers rated `Not Prime' do not fall within
any of the Prime rating categories.
Fitch IBCA International Short-Term Debt Credit Ratings
Fitch IBCA's international debt credit ratings are
applied to the spectrum of corporate, structured and
public finance. They cover sovereign (including
supranational and subnational), financial, bank,
insurance and other corporate entities and the
securities they issue, as well as municipal and other
public finance entities, securities backed by
receivables or other financial assets and
counterparties. When applied to an entity, these short-
term ratings assess its general creditworthiness on a
senior basis. When applied to specific issues and
programs, these ratings take into account the relative
preferential position of the holder of the security and
reflect the terms, conditions and covenants attaching
to that security.
International credit ratings assess the capacity
to meet foreign currency or local currency commitments.
Both "foreign currency" and "local currency" ratings
are internationally comparable assessments. The local
currency rating measures the probability of payment
within the relevant sovereign state's currency and
jurisdiction and therefore, unlike the foreign currency
rating, does not take account of the possibility of
foreign exchange controls limiting transfer into
foreign currency.
A short-term rating has a time horizon of less
than 12 months for most obligations, or up to three
years for U.S. public finance securities, and thus
places greater emphasis on the liquidity necessary to
meet financial commitments in a timely manner.
<PAGE>
F-1 Highest credit quality. Indicates the
strongest capacity for timely payment of
financial commitments; may have an added "+"
to denote any exceptionally strong credit
feature.
F-2 Good credit quality. A satisfactory capacity
for timely payment of financial commitments,
but the margin of safety is not as great as
in the case of the higher ratings.
F-3 Fair credit quality. The capacity for timely
payment of financial commitments is adequate;
however, near term adverse changes could
result in a reduction to non-investment
grade.
B Speculative. Minimal capacity for timely
payment of financial commitments, plus
vulnerability to near term adverse changes in
financial and economic conditions.
C High default risk. Default is a real
possibility. Capacity for meeting financial
commitments is solely reliant upon a
sustained, favorable business and economic
environment.
D Default. Denotes actual or imminent payment
default.
Duff & Phelps, Inc. Short-Term Debt Ratings
Duff & Phelps Credit Ratings' short-term debt
ratings are consistent with the rating criteria used by
money market participants. The ratings apply to all
obligations with maturities of under one year,
including commercial paper, the uninsured portion of
certificates of deposit, unsecured bank loans, master
notes, bankers acceptances, irrevocable letters of
credit and current maturities of long-term debt. Asset-
backed commercial paper is also rated according to this
scale.
Emphasis is placed on liquidity which is defined
as not only cash from operations, but also access to
alternative sources of funds including trade credit,
bank lines and the capital markets. An important
consideration is the level of an obligor's reliance on
short-term funds on an ongoing basis.
The distinguishing feature of Duff & Phelps Credit
Ratings' short-term debt ratings is the refinement of
the traditional `1' category. The majority of short-
term debt issuers carry the highest rating, yet quality
differences exist within that tier. As a consequence,
Duff & Phelps Credit Rating has incorporated gradations
of `1+' (one plus) and `1-` (one minus) to assist
investors in recognizing those differences.
These ratings are recognized by the SEC for broker-
dealer requirements, specifically capital computation
guidelines. These ratings meet Department of Labor
ERISA guidelines governing pension and profit sharing
investments. State regulators also recognize the
ratings of Duff & Phelps Credit Rating for insurance
company investment portfolios.
Rating Scale: Definition
High Grade
D-1+ Highest certainty of timely payment. Short-
term liquidity, including internal operating
factors and/or access to alternative sources
of funds, is outstanding, and safety is just
below risk-free U.S. Treasury short-term
obligations.
D-1 Very high certainty of timely payment.
Liquidity factors are excellent and supported
by good fundamental protection factors. Risk
factors are minor.
D-1- High certainty of timely payment. Liquidity
factors are strong and supported by good
fundamental protection factors. Risk factors
are very small.
<PAGE>
Good Grade
D-2 Good certainty of timely payment. Liquidity
factors and company fundamentals are sound.
Although ongoing funding needs may enlarge
total financing requirements, access to
capital markets is good. Risk factors are
small.
Satisfactory Grade
D-3 Satisfactory liquidity and other protection
factors qualify issue as to investment grade.
Risk factors are larger and subject to more
variation. Nevertheless, timely payment is
expected.
Non-investment Grade
D-4 Speculative investment characteristics.
Liquidity is not sufficient to insure against
disruption in debt service. Operating
factors and market access may be subject to a
high degree of variation.
Default
D-5 Issuer failed to meet scheduled principal
and/or interest payments.
LONG-TERM RATINGS
Standard & Poor's Long-Term Debt Credit Ratings
A Standard & Poor's credit rating is a current
opinion of the creditworthiness of an obligor with
respect to a specific financial obligation, a specific
class of financial obligations or a specific financial
program. It takes into consideration the
creditworthiness of guarantors, insurers or other forms
of credit enhancement on the obligation and takes into
account the currency in which the obligation is
denominated. The credit rating is not a recommendation
to purchase, sell or hold a financial obligation,
inasmuch as it does not comment as to market price or
suitability for a particular investor.
Credit ratings are based on current information
furnished by the obligors or obtained by Standard &
Poor's from other sources it considers reliable.
Standard & Poor's does not perform an audit in
connection with any credit rating and may, on occasion,
rely on unaudited financial information. Credit
ratings may be changed, suspended or withdrawn as a
result of changes in, or unavailability of, such
information, or based on other circumstances.
Credit ratings are based, in varying degrees, on
the following considerations: (1) likelihood of
payment-capacity and willingness of the obligor to meet
its financial commitment on an obligation in accordance
with the terms of the obligation; (2) nature of and
provisions of the obligation; and (3) protection
afforded by, and relative position of, the obligation
in the event of bankruptcy, reorganization or other
arrangement under the laws of bankruptcy and other laws
affecting creditors' rights.
The rating definitions are expressed in terms of
default risk. As such, they pertain to senior
obligations of an entity. Junior obligations are
typically rated lower than senior obligations, to
reflect the lower priority in bankruptcy. (Such
differentiation applies when an entity has both senior
and subordinated obligations, secured and unsecured
obligations, or operating company and holding company
obligations.) Accordingly, in the case of junior debt,
the rating may not conform exactly with the category
definition.
AAA An obligation rated `AAA' has the highest
rating assigned by Standard & Poor's. 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.
<PAGE>
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 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.
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 Standard &
Poor's 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.
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.
Moody's Long-Term Debt Ratings
Aaa Bonds which are rated `Aaa' are judged to be
of the best quality. They carry the smallest
degree of investment risk and are generally
referred to as "gilt edged." Interest
payments are protected by a large or by an
exceptionally stable margin and principal is
secure. While the various protective
elements are likely to change, such changes
as can be visualized are most unlikely to
impair the fundamentally strong position of
such issues.
Aa Bonds which are rated `Aa' are judged to be
of high quality by all standards. Together
with the Aaa group they comprise what are
generally known as high-grade bonds. They
are rated lower than the best bonds because
margins of protection may not be as large as
in Aaa securities or fluctuation 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 Aaa securities.
<PAGE>
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.
Moody's applies numerical modifiers 1, 2 and 3 in
each generic rating classification from `Aa' through
`B.' 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.
Fitch IBCA International Long-Term Debt Credit Ratings
Fitch IBCA's international debt credit ratings are
applied to the spectrum of corporate, structured and
public finance. They cover sovereign (including
supranational and subnational), financial, bank,
insurance and other corporate entities and the
securities they issue, as well as municipal and other
public finance entities, securities backed by
receivables or other financial assets and
counterparties. When applied to an entity, these long-
term ratings assess its general creditworthiness on a
senior basis. When applied to specific issues and
programs, these ratings take into account the relative
preferential position of the holder of the security and
reflect the terms, conditions and covenants attaching
to that security.
International credit ratings assess the capacity
to meet foreign currency or local currency commitments.
Both "foreign currency" and "local currency" ratings
are internationally comparable assessments. The local
currency rating measures the probability of payment
within the relevant sovereign state's currency and
jurisdiction and therefore, unlike the foreign currency
rating, does not take account of the possibility of
foreign exchange controls limiting transfer into
foreign currency.
Investment Grade
AAA Highest credit quality. `AAA' ratings
denote the lowest expectation of credit
risk. They are assigned only in case of
exceptionally strong capacity for timely
payment of financial commitments. This
capacity is highly unlikely to be
adversely affected by foreseeable
events.
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AA Very high credit quality. `AA' ratings
denote a very low expectation of credit
risk. They indicate very strong
capacity for timely payment of financial
commitments. This capacity is not
significantly vulnerable to foreseeable
events.
A High credit quality. `A' ratings denote
a low expectation of credit risk. The
capacity for timely payment of financial
commitments is considered strong. This
capacity may, nevertheless, be more
vulnerable to changes in circumstances
or in economic conditions than is the
case for higher ratings.
BBB Good credit quality. `BBB' ratings
indicate that there is currently a low
expectation of credit risk. The
capacity for timely payment of financial
commitments is considered adequate, but
adverse changes in circumstances and in
economic conditions are more likely to
impair this capacity. This is the
lowest investment grade category.
Speculative Grade
BB Speculative. `BB' ratings indicate that
there is a possibility of credit risk
developing, particularly as the result
of adverse economic change over time;
however, business or financial
alternatives may be available to allow
financial commitments to be met.
B Highly speculative. `B' ratings
indicate that significant credit risk is
present, but a limited margin of safety
remains. Financial commitments are
currently being met; however, capacity
for continued payment is contingent upon
a sustained, favorable business and
economic environment.
CCC, CC, C High default risk. Default is a
real possibility. Capacity for meeting
financial commitments is solely reliant
upon sustained, favorable business or
economic developments. A `CC' rating
indicates that default of some kind
appears probable. `C' ratings signal
imminent default.
DDD, DD and D Default. Securities are not
meeting current obligations and are
extremely speculative. `DDD' designates
the highest potential for recovery of
amounts outstanding on any securities
involved. For U.S. corporates, for
example, `DD' indicates expected
recovery of 50% - 90% of such
outstandings, and `D' the lowest
recovery potential, i.e. below 50%.
Duff & Phelps, Inc. Long-Term Debt Ratings
These ratings represent a summary opinion of the
issuer's long-term fundamental quality. Rating
determination is based on qualitative and quantitative
factors which may vary according to the basic economic
and financial characteristics of each industry and each
issuer. Important considerations are vulnerability to
economic cycles as well as risks related to such
factors as competition, government action, regulation,
technological obsolescence, demand shifts, cost
structure and management depth and expertise. The
projected viability of the obligor at the trough of the
cycle is a critical determination.
Each rating also takes into account the legal form
of the security (e.g., first mortgage bonds,
subordinated debt, preferred stock, etc.). The extent
of rating dispersion among the various classes of
securities is determined by several factors including
relative weightings of the different security classes
in the capital structure, the overall credit strength
of the issuer and the nature of covenant protection.
The Credit Rating Committee formally reviews all
ratings once per quarter (more frequently, if
necessary). Ratings of `BBB-` and higher fall within
the definition of investment grade securities, as
defined by bank and insurance supervisory authorities.
Structured finance issues, including real estate, asset-
backed and mortgage-backed financings, use this same
rating scale. Duff & Phelps Credit Rating claims
paying ability ratings of insurance companies use the
same scale with minor modification in the definitions.
Thus, an investor can compare the credit quality of
investment alternatives across industries and
structural types. A "Cash Flow Rating" (as noted for
specific ratings) addresses the
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likelihood that aggregate principal and interest will equal
or exceed the rated amount under appropriate stress conditions.
Rating Scale Definition
AAA Highest credit quality. The risk factors are
negligible, being only slightly more
than for risk-free U.S. Treasury debt.
AA+ High credit quality. Protection factors are
AA strong. Risk is modest but may
AA- vary slightly from time to time because of
economic conditions.
A+ Protection factors are average but adequate.
A However, risk factors are more
A- variable and greater in periods of economic stress.
BBB+ Below-average protection factors but still
BBB considered sufficient for prudent
BBB- investment. Considerable variability in risk
during economic cycles.
BB+ Below investment grade but deemed likely to
BB meet obligations when due.
BB- Present or prospective financial protection
factors fluctuate according to
industry conditions or company fortunes.
Overall quality may move up or
down frequently within this category.
B+ Below investment grade and possessing risk
B that obligations will not be met
B- when due. Financial protection factors will
fluctuate widely according to
economic cycles, industry conditions and/or
company fortunes. Potential
exists for frequent changes in the rating
within this category or into a higher
or lower rating grade.
CCC Well below investment grade securities.
Considerable uncertainty exists as to
timely payment of principal, interest or
preferred dividends.
Protection factors are narrow and risk can be
substantial with unfavorable
economic/industry conditions, and/or with
unfavorable company developments.
DD Defaulted debt obligations. Issuer failed to
meet scheduled principal and/or interest payments.
DP Preferred stock with dividend arrearages.
