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Sun Capital Advisers Trust
Sun Capital Money Market Fund
Sun Capital Investment Grade Bond Fund
Sun Capital Real Estate Fund
Statement of Additional Information
May 1, 1999
The statement of additional information is not a prospectus. The funds'
prospectus, dated May 1, 1999, may be obtained by contacting your agent or
the funds at:
Sun Capital Advisers Trust
One Sun Life Executive Park
Wellesley Hills, MA 02481
Telephone: 1-800-432-1102 x1780
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Table of Contents
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More Information about the Funds' Investments............ 1
Investment Strategy and Risks....................... 1
Investment Restrictions............................. 21
The Funds' Management.................................... 23
Trustees and Officers............................... 23
Trustee Compensation................................ 25
The Investment Adviser.............................. 26
Administrator....................................... 28
Transfer Agent...................................... 29
Custodian........................................... 29
Independent Auditors................................ 29
Information About The Trust's History And Organization... 30
More Information About How The Funds Value Their Shares.. 32
Taxes.................................................... 34
Brokerage Allocation..................................... 38
Calculation of Performance Information................... 40
Financial Statements..................................... 43
Appendix A............................................... A-1
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More Information about the Funds' Investments
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Investment Strategy and Risks. Each fund's principal investment strategies and
risks, as well as the securities in which each fund typically invests, are
described in the prospectus. Money Market Fund invests exclusively in high
quality U.S. dollar-denominated money market securities. Investment Grade Bond
Fund invests at least 80% of its total assets in investment grade bonds issued
by U.S. and foreign companies, the U.S. Government and its agencies and
instrumentalities, including those that issue mortgage-backed securities,
foreign governments, including those in emerging market countries, and
multinational organizations such as the World Bank. Real Estate Fund invests at
least 80% of its total assets in REITs and other real estate companies. More
information about those securities is provided below.
Investment Grade Bond Fund and Money Market Fund are diversified mutual funds.
This means that with respect to 75% of Investment Grade Bond Fund's total
assets, the fund may not invest more than 5% of its assets in the outstanding
securities of any one issuer, or own more than 10% of the voting securities of
any one issuer, except U.S. government securities or securities of other
investment companies. With respect to Money Market Fund, this means that the
fund may not invest more than 5% of its assets in any one issuer except U.S.
government securities and obligations of domestic banks. Real Estate Fund is not
diversified and may invest without regard to such limits. This means that Real
Estate Fund's net asset value may be more volatile because its portfolio may be
invested in fewer securities and it may be more sensitive to events affecting
the value of these securities. However, Real Estate Fund (and other funds) must
satisfy the diversification tests under Sections 851(b)(3) and 817(h) of the
Internal Revenue Code of 1986, as amended (Code), (see discussion under the
caption, Taxes). Meeting these diversification tests may limit Real Estate
Fund's volatility risk.
Securities in which the funds may invest.
Common Shares. (Real Estate Fund) Common shares represent an equity
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(ownership) interest in a company or other entity. This ownership interest
often gives a fund the right to vote on measures affecting the company's
organization and operations. Although common shares generally have a history of
long-term growth in value, their prices, particularly those of smaller
capitalization companies, are often volatile in the short-term.
Preferred Shares. (All funds) Preferred shares represent a limited equity
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interest in a company or other entity and frequently have debt-like features.
Preferred shares are often entitled only to dividends at a specified rate, and
have a preference over common shares with respect to dividends and on
liquidation of assets. Preferred shares generally have lesser voting rights
than common shares. Because their dividends are often fixed, the value of some
preferred shares fluctuates inversely with changes in interest rates. Money
Market Fund may invest in certain types of preferred shares having debt-like
features to the extent that the preferred shares meet the maturity, quality and
diversification requirements applicable to the fund.
Convertible Securities. (Real Estate Fund; Investment Grade Bond Fund)
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Convertible securities are bonds, preferred shares and other securities that pay
a fixed rate of interest or dividends. However, they offer the buyer the
additional option of converting the security into common stock. The value of
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convertible securities depends partially on interest rate changes and the credit
quality of the issuer. The value of convertible securities is also sensitive to
company, market and other economic news, and will change based on the price of
the underlying common stock. Convertible securities generally have less
potential for gain than common stock, but also less potential for loss, since
their income provides a cushion against the stock's price declines. However,
because the buyer is also exposed to the risk and reward potential of the
underlying stock, convertible securities generally pay less income than similar
non-convertible securities.
Warrants and Rights. (Real Estate Fund; Investment Grade Bond Fund) Warrants
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and rights are securities permitting, but not obligating, their holder to
purchase the underlying equity or fixed income securities at a predetermined
price. Generally, warrants and stock purchase rights do not carry with them the
right to receive dividends on or exercise voting rights concerning the
underlying equity securities. Further, they do not represent any rights in the
assets of the issuer. In addition, the value of warrants and rights does not
necessarily change with the value of the underlying securities, and they become
worthless if they are not exercised on or prior to their expiration date. As a
result, an investment in warrants and rights may entail greater investment risk
than certain other types of investments.
Real Estate Investment Trusts. (Real Estate Fund) REITs are pooled investment
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vehicles that invest primarily in income producing real estate or real estate
related loans or interests. REITs are generally classified as equity REITs,
mortgage REITs or a combination of equity and mortgage REITs. Equity REITs
invest most of their assets directly in real property and derive income
primarily from the collection of rents. Equity REITs can also realize capital
gains by selling properties that have appreciated in value. Mortgage REITs
invest most of their assets in real estate mortgages and derive income from
interest payments. Like regulated investment companies, such as Real Estate
Fund, REITs are not taxed on income distributed to shareholders if they comply
with several requirements of the Code. Real Estate Fund will indirectly bear its
proportionate share of any expenses (such as operating expenses and advisory
fees) paid by REITs in which it invests in addition to the expenses paid by the
Fund.
Risk Factors Associated with the Real Estate Industry. Although Real Estate
Fund does not invest directly in real estate, it does invest primarily in real
estate equity securities and does concentrate its investments in the real estate
industry, and, therefore, an investment in the fund may be subject to certain
risks associated with the direct ownership of real estate and with the real
estate industry in general. These risks include, among others: possible
declines in the value of real estate; risks related to general and local
economic conditions; possible lack of availability of mortgage funds;
overbuilding; extended vacancies of properties; increases in competition,
property taxes and operating expenses; changes in zoning or applicable tax law;
costs resulting from the clean-up of, and liability to third parties for damages
resulting from, environmental problems; casualty or condemnation losses;
uninsured damages from floods, earthquakes or other natural disasters;
limitations on and variations in rents; and changes in interest rates.
In addition, if the fund has rental income or income from the disposition of
real property acquired as a result of a default on securities the fund owns, the
receipt of such income may adversely affect its ability to retain its tax status
as a regulated investment company. Investments by the fund in securities of
companies providing mortgage servicing will be subject to the risks associated
with refinancings and their impact on servicing rights.
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Risk Factors Associated with Equity and Mortgage REITs. In addition to these
risks, equity REITs may be affected by changes in the value of the underlying
property owned by the trusts, while mortgage REITs may be affected by the
quality of any credit extended. Further, equity and mortgage REITs are dependent
upon management skills and generally may not be diversified. Equity and
mortgage REITs are also subject to heavy cash flow dependency, borrower default
and self-liquidation.
Mortgage REITs are also subject to different combinations of prepayment,
extension, interest rate and other market risks. The real estate mortgages
underlying mortgage REITs are generally subject to a faster rate of principal
repayments in a declining interest rate environment and to a slower rate of
principal repayments in an increasing interest rate environment.
Fixed Income Securities. (All funds) Bonds and other fixed-income instruments
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are used by issuers to borrow money from investors. The issuer pays the
investor a fixed or variable rate of interest, and must repay the amount
borrowed at maturity. Some fixed-income securities, such as zero coupon bonds,
do not pay current interest, but are purchased at a discount from their face
values. Fixed-income securities have varying degrees of quality and varying
levels of sensitivity to changes in interest rates. A decrease in interest
rates will generally result in an increase in the value of a fund's fixed-income
securities, and, conversely, during periods of rising interest rates, the value
of a fund's fixed-income securities will generally decline. Longer-term bonds
are generally more sensitive to interest rate changes than shorter-term bonds.
Changes by recognized agencies in the rating of any fixed-income security and in
the ability of an issuer to make payments of interest and principal will also
affect the value of these investments.
Maturity and Duration. The effective maturity of an individual portfolio
security in which a fund invests is defined as the period remaining until the
earliest date when the fund can recover the principal amount of such security
through mandatory redemption or prepayment by the issuer, the exercise by the
fund of a put option, demand feature or tender option granted by the issuer or a
third party or the payment of the principal on the stated maturity date. The
effective maturity of variable rate securities is calculated by reference to
their coupon reset dates. Thus, the effective maturity of a security may be
substantially shorter than its final stated maturity. Unscheduled prepayments
of principal have the effect of shortening the effective maturities of
securities in general and mortgage-backed securities in particular. Prepayment
rates are influenced by changes in current interest rates and a variety of
economic, geographic, social and other factors and cannot be predicted with
certainty. In general, securities, such as mortgage-backed securities, may be
subject to greater prepayment rates in a declining interest rate environment.
Conversely, in an increasing interest rate environment, the rate of prepayment
may be expected to decrease. A higher than anticipated rate of unscheduled
principal prepayments on securities purchased at a premium or a lower than
anticipated rate of unscheduled prepayments on securities purchased at a
discount may result in a lower yield (and total return) to a fund than was
anticipated at the time the securities were purchased. A fund's reinvestment of
unscheduled prepayments may be made at rates higher or lower than the rate
payable on the original prepaid security thus affecting positively or negatively
the return realized by the fund.
Duration of an individual portfolio security is a measure of the security's
price sensitivity taking into account expected cash flow and prepayments under a
wide range of interest rate scenarios. In computing the duration of its
portfolio, a fund will have to estimate the duration of obligations that are
subject to prepayment or redemption by the issuer taking into account the
influence of interest rates on prepayments and coupon flows. Each fund may use
various techniques to shorten or lengthen the option-adjusted duration of its
portfolio, including the acquisition of debt obligations at a premium or
discount, and the use of mortgage swaps and interest rate swaps, caps, floors
and collars.
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Ratings Criteria. In general, the ratings of Moody's Investors Service, Inc.
(Moody's), Standard & Poor's Ratings Group (S&P), FitchIBCA and Duff & Phelps
Credit Rating Co. (Duff) represent the opinions of these agencies as to the
credit quality of the securities which they rate. However, these ratings are
relative and subjective and are not absolute standards of quality.
After its purchase by a fund, an issue of securities may cease to be rated or
its rating may be reduced below the minimum required for purchase by the fund.
Neither of these events will necessarily require the adviser, on behalf of a
fund, to sell the securities.
Lower Rated High Yield Fixed Income Securities. (Real Estate Fund; Investment
Grade Bond Fund) Lower rated high yield fixed income securities are those rated
below Baa3 by Moody's, or below BBB-by S&P, FitchIBCA or Duff, or securities
which are unrated and determined by the adviser to be of comparable quality.
Investment Grade Bond Fund may invest in securities rated as low as B- by a
rating agency, which may indicate that the obligations are speculative with
respect to capacity to pay interest and repay principal in accordance with the
terms of the obligation. Lower rated securities are generally referred to as
high yield bonds or junk bonds. See the Appendix attached to this Statement of
Additional Information for a description of the characteristics of the
categories. A fund may invest in eligible unrated securities which, in the
opinion of the adviser, offer comparable risks to those securities which are
rated.
Debt obligations rated in the lower ratings categories, or which are unrated,
involve greater volatility of price and risk of loss of principal and income.
In addition, lower ratings reflect a greater possibility of an adverse change in
financial condition affecting the ability of the issuer to make payments of
interest and principal. The market price and liquidity of lower rated fixed
income securities generally respond to short-term economic, corporate and market
developments to a greater extent than do higher rated securities. These
developments are perceived to have a more direct relationship to the ability of
an issuer of lower rated securities to meet its ongoing debt obligations.
Reduced volume and liquidity in the high yield bond market, or the reduced
availability of market quotations, will make it more difficult to dispose of the
bonds and accurately value a fund's assets. The reduced availability of
reliable, objective data may increase a fund's reliance on management's judgment
in valuing the high yield bonds. To the extent that a fund invests in these
securities, the achievement of the fund's objective will depend more on the
adviser's judgment and analysis than it otherwise would. In addition, high
yield securities in a fund's portfolio may be susceptible to adverse publicity
and investor perceptions, whether or not the perceptions are justified by
fundamental factors. In the past, economic downturns and increases in interest
rates have caused a higher incidence of default by the issuers of lower-rated
securities and may do so in the future, particularly with respect to highly
leveraged issuers.
Credit Risk. Credit risk relates to the ability of the issuer to meet interest
or principal payments or both as they become due. Generally, lower quality,
higher yielding bonds are subject to credit risk to a greater extent than higher
quality, lower yielding bonds.
Interest Rate Risk. Interest rate risk refers to the fluctuations in value of
fixed-income securities resulting solely from the inverse relationship between
the market value of outstanding fixed-income securities and changes in interest
rates. An increase in interest rates will generally reduce the market value of
fixed-income investments, and a decline in interest rates will tend to increase
their value. In addition, debt securities with longer maturities, which tend to
produce higher yields, are subject to potentially greater capital appreciation
and depreciation than obligations with shorter maturities.
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Fluctuations in the market value of fixed-income securities subsequent to their
acquisition will not affect the interest payable on those securities, and thus
the cash income from such securities, but will be reflected in the valuations of
those securities used to compute a fund's net asset value.
Call Risk and Extension Risk. Call risk exists when the issuer may exercise its
right to pay principal on an obligation earlier than scheduled which would cause
cash flows to be returned earlier than expected. This typically results when
interest rates have declined, and a fund will suffer from having to reinvest in
lower yielding securities. Extension risk exists when the issuer may exercise
its right to pay principal on an obligation later than scheduled, which would
cause cash flows to be returned later than expected. This typically results when
interest rates have increased, and a fund will suffer from the inability to
invest in higher yield securities.
U.S. Government Securities. (All funds) U.S. government securities include:
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U.S. Treasury obligations and obligations issued or guaranteed by U.S.
government agencies, instrumentalities or sponsored enterprises which are
supported by (a) the full faith and credit of the U.S. Treasury (e.g.,
Government National Mortgage Association (GNMA)), (b) the right of the issuer to
borrow from the U.S. Treasury (e.g., Federal Home Loan Banks), (c) the
discretionary authority of the U.S. Government to purchase certain obligations
of the issuer (e.g., Federal National Mortgage Association (FNMA) and Federal
Home Loan Mortgage Corporation (FHLMC)), or (d) only the credit of the agency
and a perceived "moral obligation" of the U.S. government. No assurance can be
given that the U.S. government will provide financial support to U.S. government
agencies, instrumentalities or sponsored enterprises in the future.
U.S. government securities also include Treasury receipts, zero coupon bonds,
U.S. Treasury inflation-indexed bonds, deferred interest securities and other
stripped U.S. government securities. The interest and principal components of
stripped U.S. government securities are traded independently. The most widely
recognized trading program for such securities is the Separate Trading of
Registered Interest and Principal of Securities Program. U.S. Treasury
inflation-indexed obligations provide a measure of protection against inflation
by adjusting the principal amount for inflation. The semi-annual interest
payments on these obligations are equal to a fixed percentage of the inflation-
adjusted principal amount.
Mortgage-Backed Securities. (All funds) Mortgage-backed securities represent
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participation interests in pools of adjustable and fixed rate mortgage loans
secured by real property.
Unlike conventional debt obligations, mortgage-backed securities provide monthly
payments derived from the monthly interest and principal payments (including any
prepayments) made by the individual borrowers on the pooled mortgage loans. The
mortgage loans underlying mortgage-backed securities are generally subject to a
greater rate of principal prepayments in a declining interest rate environment
and to a lesser rate of principal prepayments in an increasing interest rate
environment. Under certain interest and prepayment scenarios, the fund may fail
to recover the full amount of its investment in mortgage-backed securities
notwithstanding any direct or indirect governmental or agency guarantee. Since
faster than expected prepayments must usually be invested in lower yielding
securities, mortgage-backed securities are less effective than conventional
bonds in "locking" in a specified interest rate. In a rising interest rate
environment, a declining prepayment rate may extend the average life of many
mortgage-backed securities. Extending the average life of a mortgage-backed
security reduces its value and increases the risk of depreciation due to future
increases in market interest rates.
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The fund's investments in mortgage-backed securities may include conventional
mortgage pass through securities and certain classes of multiple class
collateralized mortgage obligations ("CMOs"). Mortgage pass-through securities
are fixed or adjustable rate mortgage-backed securities that provide for monthly
payments that are a "pass-through" of the monthly interest and principal
payments (including any prepayments) made by the individual borrowers on the
pooled mortgage loans, net of any fees or other amounts paid to any guarantor,
administrator and/or servicer of the underlying mortgage loans. CMOs are issued
in multiple classes, each having different maturities, interest rates, payment
schedules and allocations of principal and interest on the underlying mortgages.
Senior CMO classes will typically have priority over residual CMO classes as to
the receipt of principal and/or interest payments on the underlying mortgages.
The CMO classes in which a fund may invest include but are not limited to
sequential and parallel pay CMOs, including planned amortization class ("PAC")
and target amortization class ("TAC") securities. Sequential pay CMOs apply
payments of principal, including any prepayments, to each class of CMO in the
order of the final distribution date. Thus, no payment of principal is made on
any class until all other classes having an earlier final distribution date have
been paid in full. Parallel pay CMOs apply principal payments and prepayments to
two or more classes concurrently on a proportionate or disproportionate basis.
The simultaneous payments are taken into account in calculating the final
distribution date of each class. Real Estate Fund and Investment Grade Bond Fund
may invest in the most junior class of CMO's (z-tranche) which involves risks
similar to those associated with investing in equity securities.
Different types of mortgage-backed securities are subject to different
combinations of prepayment, extension, interest rate and other market risks.
Conventional mortgage pass through securities and sequential pay CMOs are
subject to all of these risks, but are typically not leveraged. PACs, TACs and
other senior classes of sequential and parallel pay CMOs involve less exposure
to prepayment, extension and interest rate risk than other mortgage-backed
securities, provided that prepayment rates remain within expected prepayment
ranges or "collars." To the extent that the prepayment rates remain within
these prepayment ranges, the residual or support tranches of PAC and TAC CMOs
assume the extra prepayment, extension and interest rate risks associated with
the underlying mortgage assets.
Agency Mortgage Securities. (All funds) The funds may invest in mortgage-
backed securities issued or guaranteed by the U.S. government, foreign
governments or any of their agencies, instrumentalities or sponsored
enterprises. Agencies, instrumentalities or sponsored enterprises of the U.S.
government include but are not limited to GNMA, FNMA and FHLMC. GNMA securities
are backed by the full faith and credit of the U.S. government, which means that
the U.S. government guarantees that the interest and principal will be paid when
due. FNMA securities and FHLMC securities are not backed by the full faith and
credit of the U.S. government; however, these enterprises have the ability to
obtain financing from the U.S. Treasury. There are several types of agency
mortgage securities currently available, including, but not limited to,
guaranteed mortgage pass-through certificates and multiple class securities.
Privately-Issued Mortgage-Backed Securities. (All funds) Mortgage-backed
securities may also be issued by trusts or other entities formed or sponsored by
private originators of and institutional investors in mortgage loans and other
foreign or domestic non-governmental entities (or represent custodial
arrangements administered by such institutions). These private originators and
institutions include domestic and foreign savings and loan associations,
mortgage bankers, commercial banks, insurance companies, investment banks and
special purpose subsidiaries of the foregoing. Privately issued
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mortgage-backed securities are generally backed by pools of conventional (i.e.,
non-government guaranteed or insured) mortgage loans.
These mortgage-backed securities are not guaranteed by an entity having the
credit standing of GNMA, FNMA or FHLMC. In order to receive a high quality
rating, they normally are structured with one or more types of "credit
enhancement." These credit enhancements fall generally into two categories: (1)
liquidity protection and (2) protection against losses resulting after default
by a borrower and liquidation of the collateral. Liquidity protection refers to
the providing of cash advances to holders of mortgage-backed securities when a
borrower on an underlying mortgage fails to make its monthly payment on time.
Protection against losses resulting after default and liquidation is designed to
cover losses resulting when, for example, the proceeds of a foreclosure sale are
insufficient to cover the outstanding amount on the mortgage. This protection
may be provided through guarantees, insurance policies or letters of credit,
through various means of structuring the transaction or through a combination of
such approaches.
Asset-Backed Securities. (All funds) Asset-backed securities represent
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individual interests in pools of consumer loans, home equity loans, trade
receivables, credit card receivables, and other debt and are similar in
structure to mortgage-backed securities. The assets are securitized either in a
pass-through structure (similar to a mortgage pass-through structure) or in a
pay-through structure (similar to a CMO structure). Asset-backed securities may
be subject to more rapid repayment than their stated maturity date would
indicate as a result of the pass-through of prepayments of principal on the
underlying loans. During periods of declining interest rates, prepayment of
certain types of loans underlying asset-backed securities can be expected to
accelerate. Accordingly, a fund's ability to maintain positions in these
securities will be affected by reductions in the principal amount of the
securities resulting from prepayments, and the fund must reinvest the returned
principal at prevailing interest rates, which may be lower.
Asset-backed securities entail certain risks not presented by mortgage-backed
securities. The collateral underlying asset-backed securities may entail
features that make them less effective as security for payments than real estate
collateral. Debtors may have the right to set off certain amounts owed on the
credit cards or other obligations underlying the asset-backed security, or the
debt holder may not have a first (or proper) security interest in all of the
obligations backing the receivable because of the nature of the receivable or
state or federal laws granting protection to the debtor. Certain collateral may
be difficult to locate in the event of default, and recoveries on depreciated or
damaged collateral may not support payments on these securities. A fund may
invest in any type of asset-backed security if the adviser determines that the
security is consistent with the fund's investment objective and policies.
Structured Securities. (Real Estate Fund; Investment Grade Bond Fund)
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Structured securities include notes, bonds or debentures, the value of the
principal of and/or interest on which is determined by reference to changes in
the value of specific currencies, interest rates, commodities, indices or other
financial indicators (the Reference) or the relative change in two or more
References. The interest rate or the principal amount payable upon maturity or
redemption may be increased or decreased depending upon changes in the
applicable Reference. The terms of the structured securities may provide that
in certain circumstances no principal is due at maturity and, therefore, may
result in the loss of the fund's investment. Structured securities may be
positively or negatively indexed, so that appreciation of the Reference may
produce an increase or decrease in the interest rate or value of the security at
maturity. In addition, the change in interest rate or the value of the security
at maturity may be a multiple of the change in the value of the Reference.
Consequently, leveraged structured
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securities entail a greater degree of market risk than other types of debt
obligations. Structured securities may also be more volatile, less liquid and
more difficult to accurately price than less complex fixed income investments.
Pay-In-Kind, Delayed Payment and Zero Coupon Bonds. (Real Estate Fund;
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Investment Grade Bond Fund) These securities are generally issued at a discount
from their face value because actual interest payments are typically postponed
until maturity or after a stated period. The amount of the discount rate varies
depending on factors including the time remaining until maturity, prevailing
interest rates, the security's liquidity and the issuer's credit quality. These
securities also may take the form of debt securities that have been stripped of
their interest payments. The market prices of pay-in-kind, delayed payment and
zero coupon bonds generally are more volatile than the market prices of
securities that pay interest periodically and in cash, and are likely to respond
to a greater degree to changes in interest rates than interest-bearing
securities having similar maturities and credit quality. The fund generally
accrues income on securities that are issued at a discount and/or do not make
current cash payments of interest for tax and accounting purposes, which is
required to be distributed to shareholders. The fund's investments in pay-in-
kind, delayed payment and zero coupon bonds may require the fund to sell certain
of its portfolio securities to generate sufficient cash to satisfy certain
income distribution requirements.
Floating Rate/Variable Rate Notes. (All funds) Some notes a fund may purchase
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may have variable or floating interest rates. Variable rates are adjustable at
stated periodic intervals; floating rates are automatically adjusted according
to a specified market rate for such investments, such as the percentage of the
prime rate of a bank, or the 91-day U.S. Treasury Bill rate. These obligations
may be secured by bank letters of credit or other support arrangements. If a
security would not satisfy a fund's credit quality standards without such a
credit support, the entity providing a bank letter or line of credit, guarantee
or loan commitment must meet a fund's credit quality standards.
The absence of an active secondary market for certain variable and floating rate
notes could make it difficult for a fund to dispose of the instruments, and a
fund could suffer a loss if the issuer defaults or there are periods during
which the fund is not entitled to exercise its demand rights. Variable and
floating rate instruments held by a fund will be subject to the fund's
limitation on investments in illiquid securities if a reliable trading market
for the instruments does not exist and the fund cannot demand payment of the
principal amount of such instruments within seven days.
Foreign Securities. (All funds) Each fund may invest in the securities of
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corporate and governmental issuers located in or doing business in a foreign
country (foreign issuers). A company is considered to be located in or doing
business in a foreign country if it satisfies at least one of the following
criteria: (i) the equity securities of the company are traded principally on
stock exchanges in one or more foreign countries; (ii) it derives 50% or more of
its total revenue from goods produced, sales made or services performed in one
or more foreign countries; (iii) it maintains 50% or more of its assets in one
or more foreign countries; (iv) it is organized under the laws of a foreign
country; or (v) its principal executive offices are located in a foreign
country.
ADRs, EDRs, IDRs and GDRs. American Depository Receipts (ADRs) (sponsored or
unsponsored) are receipts typically issued by a U.S. bank, trust company or
other entity and evidence ownership of the underlying foreign securities. Most
ADRs are traded on a U.S. stock exchange. Issuers of unsponsored ADRs are not
contractually obligated to disclose material information in the U.S., so there
may not be a correlation between this information and the market value of the
unsponsored ADR. European Depository Receipts (EDRs) and International
Depository Receipts (IDRs) are receipts
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typically issued by a European bank or trust company evidencing ownership of the
underlying foreign securities. Global Depository Receipts (GDRs) are receipts
issued by either a U.S. or non-U.S. banking institution evidencing ownership of
the underlying foreign securities.
Brady Bonds. (Investment Grade Bond Fund) Brady bonds are securities created
through the exchange of existing commercial bank loans to sovereign entities for
new obligations in connection with debt restructurings under a debt
restructuring plan introduced by former U.S. Secretary of the Treasury, Nicholas
P. Brady. Brady bonds may be collateralized or uncollateralized, are issued in
various currencies (but primarily the U.S. dollar), and are actively traded in
the over-the-counter secondary market. Certain Brady bonds may be collateralized
as to principal due at maturity by U.S. Treasury zero coupon bonds with a
maturity equal to the final maturity of the bonds, although the collateral is
not available to investors until the final maturity of the bonds. Collateral
purchases are financed by the International Monetary Fund, the International
Bank for Reconstruction and Development (the World Bank) and the debtor nation's
reserves. Although Brady bonds may be collateralized by U.S. government
securities, repayment of principal and interest is not guaranteed by the U.S.
government. In light of the residual risk of Brady bonds and, among other
factors, the history of defaults with respect to commercial bank loans by public
and private entities in countries issuing Brady bonds, investments in Brady
bonds may be viewed as speculative. Brady bonds acquired by a fund might be
subject to restructuring arrangements or to requests for new credit, which may
reduce the value of the Brady bonds held by the fund.
Sovereign Debt Obligations. (All funds) Investment in sovereign debt
obligations involves special risks not present in domestic corporate debt
obligations. The issuer of the sovereign debt or the governmental authorities
that control the repayment of the debt may be unable or unwilling to repay
principal or interest when due, and a fund may have limited recourse in the
event of a default. During periods of economic uncertainty, the market prices of
sovereign debt, and a fund's net asset value, may be more volatile than prices
of U.S. debt obligations. In the past, certain emerging market countries have
encountered difficulties in servicing their debt obligations, withheld payments
of principal and interest and declared moratoria on the payment of principal and
interest on their sovereign debts.
A sovereign debtor's willingness or ability to repay principal and pay interest
in a timely manner may be affected by, among other factors, its cash flow
situation, the extent of its foreign currency reserves, the availability of
sufficient foreign exchange, the relative size of the debt service burden, the
sovereign debtor's policy toward principal international lenders and local
political constraints. Sovereign debtors may also be dependent on expected
disbursements from foreign governments, multilateral agencies and other entities
to reduce principal and interest arrearages on their debt. The failure of a
sovereign debtor to implement economic policies or repay principal or interest
when due may result in the cancellation of third-party commitments to lend funds
to the sovereign debtor, which may further impair such debtor's ability or
willingness to service its debts.
Obligations of Supranational Entities. (All funds) Each fund may invest in
obligations of supranational entities designated or supported by governmental
entities to promote economic reconstruction or development and of international
banking institutions and related government agencies. Examples include the World
Bank, the Asian Development Bank and the Inter-American Development Bank. Each
supranational entity's lending activities are limited to a percentage of its
total capital (including "callable capital" contributed by its governmental
members at the entity's call), reserves and net income. Participating
governments may not be able or willing to honor their commitments to make
capital contributions to a supranational entity.
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Risks of Foreign Securities. Investments in foreign securities may involve a
greater degree of risk than the risks of domestic securities. There is generally
less publicly available information about foreign companies in the form of
reports and ratings similar to those published about issuers in the United
States. Also, foreign issuers are generally not subject to uniform accounting,
auditing and financial reporting requirements comparable to those applicable to
United States issuers.
To the extent that a fund's foreign securities are denominated in currencies
other than the U.S. dollar, changes in foreign currency exchange rates will
affect the fund's net asset value, the value of dividends and interest earned,
gains and losses realized on the sale of securities, and any net investment
income and gains that the fund distributes to shareholders. Securities
transactions undertaken in some foreign markets may not be settled promptly so
that a fund's foreign investments may be less liquid and subject to the risk of
fluctuating currency exchange rates pending settlement.
Foreign securities may be purchased on over-the-counter markets or exchanges
located in the countries where an issuer's securities are principally traded.
Many foreign markets are not as developed or efficient as those in the United
States. While growing in volume, they usually have substantially less volume
than U.S. markets. Securities of some foreign issuers are less liquid and more
volatile than securities of comparable United States issuers. Fixed commissions
on foreign exchanges are generally higher than negotiated commissions on United
States exchanges, although a fund will endeavor to achieve the most favorable
net results on its portfolio transactions. There is generally less government
supervision and regulation of securities exchanges, brokers and listed issuers
than in the United States.
In certain foreign countries, there is the possibility of adverse changes in
investment or exchange control regulations, expropriation, nationalization or
confiscatory taxation, limitations on the removal of assets of a fund from a
country, political or social instability, or diplomatic developments. Moreover,
individual foreign economies may differ favorably or unfavorably from the United
States' economy in terms of growth of gross national product, rate of inflation,
capital reinvestment, resource self-sufficiency and balance of payments
position.
Dividends, interest, and, in some cases, capital gains earned by a fund on
certain foreign securities may be subject to foreign taxes, thus reducing the
net amount of income or gains available for distribution to the fund's
shareholders.
The above risks may be intensified for investments in emerging markets or
countries with limited or developing capital markets. These countries are
located in the Asia-Pacific region, Eastern Europe, Latin and South America and
Africa. Security prices in these markets can be significantly more volatile
than in more developed countries, reflecting the greater uncertainties of
investing in less established markets and economies. Political, legal and
economic structures in many of these emerging market countries may be undergoing
significant evolution and rapid development, and they may lack the social,
political, legal and economic stability characteristic of more developed
countries. Emerging market countries may have failed in the past to recognize
private property rights. They may have relatively unstable governments, present
the risk of nationalization of businesses, restrictions on foreign ownership, or
prohibitions on repatriation of assets, and may have less protection of property
rights than more developed countries. Their economies may be predominantly
based on only a few industries, may be highly vulnerable to changes in local or
global trade conditions, and may suffer from extreme and volatile debt burdens
or inflation rates. Local securities markets may trade a small number of
securities and may be unable to respond effectively to increases in trading
volume, potentially making prompt liquidation of substantial holdings difficult
or impossible at times. A fund may be required to establish special custodial or
other arrangements before making certain
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investments in those countries. Securities of issuers located in these countries
may have limited marketability and may be subject to more abrupt or erratic
price movements.
Bank and Corporate Obligations. (All funds) Commercial paper represents short-
- ------------------------------
term unsecured promissory notes issued in bearer form by banks or bank holding
companies, corporations and finance companies. The commercial paper purchased
by the funds consists of direct U.S. dollar denominated obligations of domestic
or foreign issuers. Bank obligations in which the funds may invest include
certificates of deposit, bankers' acceptances and fixed time deposits.
Certificates of deposit are negotiable certificates issued against funds
deposited in a commercial bank for a definite period of time and earning a
specified return. Bankers' acceptances are negotiable drafts or bills of
exchange, normally drawn by an importer or exporter to pay for specific
merchandise, which are "accepted" by a bank, meaning, in effect, that the bank
unconditionally agrees to pay the face value of the instrument on maturity.
Fixed time deposits are bank obligations payable at a stated maturity date and
bearing interest at a fixed rate. Fixed time deposits may be withdrawn on
demand by the investor, but may be subject to early withdrawal penalties which
vary depending upon market conditions and the remaining maturity of the
obligation. There are no contractual restrictions on the right to transfer a
beneficial interest in a fixed time deposit to a third party, although there is
no market for such deposits. Bank notes and bankers' acceptances rank junior to
domestic deposit liabilities of the bank and equal to other senior, unsecured
obligations of the bank. Bank notes are not insured by the Federal Deposit
Insurance Corporation or any other insurer. Deposit notes are insured by the
Federal Deposit Insurance Corporation only to the extent of $100,000 per
depositor per bank.
Repurchase Agreements. (All funds) In a repurchase agreement, a fund would buy
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a security for a relatively short period (usually not more than 7 days) subject
to the obligation to sell it back to the repurchase agreement counterparty at a
fixed time and price plus accrued interest. A fund will enter into repurchase
agreements only with member banks of the Federal Reserve System and with
"primary dealers" in U.S. government securities. Repurchase agreements that
mature in more than seven days will be treated as illiquid for purposes of each
fund's 15% limit (10% for Money Market Fund) in illiquid investments.
Securities serving as collateral for each repurchase agreement must be delivered
to the fund's custodian either physically or in book-entry form. The collateral
must be marked to market daily so that each repurchase agreement will be fully
collateralized at all times. In the event of bankruptcy or other default by a
seller of a repurchase agreement, a fund could experience delays in liquidating
the underlying securities while the fund is trying to enforce its rights to the
collateral, possible below normal levels of income, decline in value of the
underlying securities or lack of access to income during this period, as well as
the expense of enforcing its rights.
Reverse Repurchase Agreements. (Real Estate Fund; Investment Grade Bond Fund)
- -----------------------------
A fund may also enter into reverse purchase agreements, which involve the sale
of U.S. government securities held in its portfolio to a counterparty with an
agreement that the fund will buy back the securities at a fixed future date at a
fixed price plus an agreed amount of "interest," which may be reflected in the
repurchase price. Reverse repurchase agreements are considered to be borrowings
by a fund. Reverse repurchase agreements involve the risk that the market value
of securities purchased by a fund with proceeds of the initial sale transaction
may decline below the repurchase price of the securities sold by the fund which
it is obligated to repurchase. A fund will also continue to be subject to the
risk of a
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decline in the market value of the securities sold under the agreements because
it will reacquire those securities upon effecting their repurchase at a fixed
price agreed in advance. A fund will not enter into reverse repurchase
agreements or borrow money, except from banks as a temporary measure for
extraordinary emergency purposes in amounts not to exceed one-third of the
fund's total assets (including the amount borrowed) taken at market value. A
fund will not use leverage to attempt to enhance its return. A fund will not
purchase securities while outstanding borrowings exceed 5% of the fund's total
assets.
Mortgage "Dollar Roll" Transactions. (Investment Grade Bond Fund) The fund may
- -----------------------------------
enter into mortgage "dollar roll" transactions with selected banks and broker-
dealers. Under a dollar roll, the fund sells mortgage-backed securities and
simultaneously contracts to repurchase substantially similar (same type, coupon
and maturity) securities on a specified future date. The fund will only enter
into covered rolls. A "covered roll" is a specific type of dollar roll for
which there is an offsetting cash position or liquid security position. Covered
rolls are not treated as a borrowing or other senior security and will be
excluded from the calculation of a fund's borrowings and other senior
securities. For financial reporting purposes, a fund treats mortgage dollar
rolls as two separate transactions: one involving the purchase of a security
and a separate transaction involving a sale. The fund does not currently intend
to enter into mortgage dollar roll transactions that are accounted for as a
financing.
Restricted Securities. (All funds) A fund may purchase securities that are not
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registered (restricted securities) under the Securities Act of 1933 (1933 Act),
including commercial paper issued in reliance on Section 4(2) of the 1933 Act
and which are, therefore, restricted as to their resale. However, a fund will
not invest more than 15% of its net assets (10% for Money Market Fund) in
illiquid investments. The trustees may adopt guidelines and delegate to the
adviser the daily function of determining the monitoring and liquidity of
restricted securities. The trustees, however, will retain oversight as to, and
be ultimately responsible for, the determinations. If the adviser determines,
based upon a continuing review of the trading markets for specific Section 4(2)
paper or Rule 144A securities, that they are liquid, they will not be subject to
the 15% limit (10% for Money Market Fund) in illiquid investments. This
investment practice could have the effect of decreasing the level of liquidity
in the fund if sufficient numbers of qualified institutional buyers are not
interested in purchasing these restricted securities.
Other investment companies. (All funds) Each fund, together with any companies
- ---------------------------
controlled by the fund, may not acquire more than 3% of the total outstanding
securities of any other investment company. A fund may also not invest more
than 5% of its total assets in any one investment company and may not invest
more than 10% of its total assets in the securities of other investment
companies.
Forward Commitment and When-Issued Securities. (All funds) "When-issued"
- ---------------------------------------------
refers to securities whose terms are available and for which a market exists,
but which have not been issued. A fund will engage in when-issued purchases of
securities in order to obtain what is considered to be an advantageous price and
yield at the time of purchase. In when-issued transactions, frequently no
payment is made until delivery is due, often a month or more after the purchase.
In a forward commitment transaction, the fund contracts to purchase or sell
securities for a fixed price at a future date beyond customary settlement time.
When a fund engages in forward commitment and when-issued transactions, it
relies on the other party to consummate the transaction. The failure of the
issuer or other party to consummate the transaction may result in the fund's
losing the opportunity to obtain an advantageous price. The
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purchase of securities on a when-issued or forward commitment basis also
involves a risk of loss if the value of the security to be purchased declines
prior to the settlement date.
On the date a fund enters into an agreement to purchase securities on a when-
issued or forward commitment basis, the fund will segregate in a separate
account cash or liquid securities, of any type or maturity, equal in value to
the fund's commitment. These assets will be valued daily at market, and
additional cash or securities will be segregated in a separate account to the
extent that the total value of the assets in the account declines below the
amount of the when-issued commitments. Alternatively, a fund may enter into
offsetting contracts for the forward sale of other securities that it owns.
Options on Securities and Securities Indices. (Real Estate Fund; Investment
- --------------------------------------------
Grade Bond Fund) A fund may purchase and write (sell) call and put options on
any securities in which it may invest or on any securities index based on
securities in which it may invest. These options may be listed on securities
exchanges or traded in the over-the-counter market. A fund may write covered
put and call options and purchase put and call options to enhance total return,
as a substitute for the purchase or sale of securities, or to protect against
declines in the value of portfolio securities and against increases in the cost
of securities to be acquired.
Writing Covered Options. A call option on securities written by a fund
obligates the fund to sell specified securities to the holder of the option at a
specified price if the option is exercised at any time before the expiration
date. A put option on securities written by a fund obligates the fund to
purchase specified securities from the option holder at a specified price if the
option is exercised at any time before the expiration date. Options on
securities indices are similar to options on securities, except that the
exercise of securities index options requires cash settlement payments and does
not involve the actual purchase or sale of securities. In addition, securities
index options are designed to reflect price fluctuations in a group of
securities or segment of the securities market rather than price fluctuations in
a single security. Writing covered call options may deprive a fund of the
opportunity to profit from an increase in the market price of the securities in
its portfolio. Writing covered put options may deprive a fund of the
opportunity to profit from a decrease in the market price of the securities to
be acquired for its portfolio.
All call and put options written by a fund are covered. A written call option
or put option may be covered by (i) maintaining cash or liquid securities in a
segregated account with a value at least equal to a fund's obligation under the
option, (ii) entering into an offsetting forward commitment and/or (iii)
purchasing an offsetting option or any other option which, by virtue of its
exercise price or otherwise, reduces the fund's net exposure on its written
option position. A written call option on securities is typically covered by
maintaining the securities that are subject to the option in a segregated
account. A fund may cover call options on a securities index by owning
securities whose price changes are expected to be similar to those of the
underlying index.
A fund may terminate its obligations under an exchange traded call or put option
by purchasing an option identical to the one it has written. Obligations under
over-the-counter options may be terminated only by entering into an offsetting
transaction with the counterparty to the option. These purchases are referred
to as "closing purchase transactions."
Purchasing Options. A fund would normally purchase call options in anticipation
of an increase, or put options in anticipation of a decrease ("protective
puts"), in the market value of securities of the type in which it may invest. A
fund may also sell call and put options to close out its purchased options.
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The purchase of a call option would entitle a fund, in return for the premium
paid, to purchase specified securities at a specified price during the option
period. A fund would ordinarily realize a gain on the purchase of a call option
if, during the option period, the value of such securities exceeded the sum of
the exercise price, the premium paid and transaction costs; otherwise the fund
would realize either no gain or a loss on the purchase of the call option.
The purchase of a put option would entitle a fund, in exchange for the premium
paid, to sell specified securities at a specified price during the option
period. The purchase of protective puts is designed to offset or hedge against
a decline in the market value of a fund's portfolio securities. Put options may
also be purchased by a fund for the purpose of affirmatively benefiting from a
decline in the price of securities which it does not own. A fund would
ordinarily realize a gain if, during the option period, the value of the
underlying securities decreased below the exercise price sufficiently to cover
the premium and transaction costs; otherwise the fund would realize either no
gain or a loss on the purchase of the put option. Gains and losses on the
purchase of put options may be offset by countervailing changes in the value of
the fund's portfolio securities.
A fund's options transactions will be subject to limitations established by each
of the exchanges, boards of trade or other trading facilities on which such
options are traded. These limitations govern the maximum number of options in
each class which may be written or purchased by a single investor or group of
investors acting in concert, regardless of whether the options are written or
purchased on the same or different exchanges, boards of trade or other trading
facilities or are held or written in one or more accounts or through one or more
brokers. Thus, the number of options which a fund may write or purchase may be
affected by options written or purchased by other investment advisory clients of
the adviser. An exchange, board of trade or other trading facility may order
the liquidation of positions found to be in excess of these limits, and it may
impose certain other sanctions.
Risks Associated with Options Transactions. There is no assurance that a liquid
secondary market on a domestic or foreign options exchange will exist for any
particular exchange-traded option or at any particular time. If a fund is
unable to effect a closing purchase transaction with respect to covered options
it has written, the fund will not be able to sell the underlying securities or
dispose of assets held in a segregated account until the options expire or are
exercised. Similarly, if a fund is unable to effect a closing sale transaction
with respect to options it has purchased, it would have to exercise the options
in order to realize any profit and will incur transaction costs upon the
purchase or sale of underlying securities.
Reasons for the absence of a liquid secondary market on an exchange include the
following: (i) there may be insufficient trading interest in certain options;
(ii) restrictions may be imposed by an exchange on opening transactions or
closing transactions or both; (iii) trading halts, suspensions or other
restrictions may be imposed with respect to particular classes or series of
options; (iv) unusual or unforeseen circumstances may interrupt normal
operations on an exchange; (v) the facilities of an exchange or the Options
Clearing Corporation may not at all times be adequate to handle current trading
volume; or (vi) one or more exchanges could, for economic or other reasons,
decide or be compelled at some future date to discontinue the trading of options
(or a particular class or series of options). If trading were discontinued, the
secondary market on that exchange (or in that class or series of options) would
cease to exist. However, outstanding options on that exchange that had been
issued by the Options Clearing Corporation as a result of trades on that
exchange would continue to be exercisable in accordance with their terms.
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A fund's ability to terminate over-the-counter options is more limited than with
exchange-traded options and may involve the risk that broker-dealers
participating in such transactions will not fulfill their obligations. The
adviser will determine the liquidity of each over-the-counter option in
accordance with guidelines adopted by the trustees.
The writing and purchase of options is a highly specialized activity which
involves investment techniques and risks different from those associated with
ordinary portfolio securities transactions. The successful use of options
depends in part on the adviser's ability to predict future price fluctuations
and, for hedging transactions, the degree of correlation between the options and
securities markets.
Futures Contracts and Options on Futures Contracts. (Real Estate Fund;
- --------------------------------------------------
Investment Grade Bond Fund) To seek to increase total return or hedge against
changes in interest rates or securities prices, a fund may purchase and sell
futures contracts, and purchase and write call and put options on these futures
contracts. A fund may also enter into closing purchase and sale transactions
with respect to any of these contracts and options. The futures contracts may
be based on various securities (such as U.S. government securities), securities
indices and any other financial instruments and indices. All futures contracts
entered into by the fund are traded on U.S. exchanges or boards of trade that
are licensed, regulated or approved by the Commodity Futures Trading Commission
("CFTC").
Futures Contracts. A futures contract may generally be described as an
agreement between two parties to buy and sell particular financial instruments
for an agreed price during a designated month (or to deliver the final cash
settlement price, in the case of a contract relating to an index or otherwise
not calling for physical delivery at the end of trading in the contract).
Positions taken in the futures markets are not normally held to maturity but are
instead liquidated through offsetting transactions which may result in a profit
or a loss. While futures contracts on securities will usually be liquidated in
this manner, a fund may instead make, or take, delivery of the underlying
securities whenever it appears economically advantageous to do so. A clearing
corporation associated with the exchange on which futures contracts are traded
guarantees that, if still open, the sale or purchase will be performed on the
settlement date.
Hedging and Other Strategies. Hedging is an attempt to establish with more
certainty than would otherwise be possible the effective price or rate of return
on portfolio securities or securities that a fund proposes to acquire. When
interest rates are rising or securities prices are falling, a fund can seek to
offset a decline in the value of its current portfolio securities through the
sale of futures contracts. When interest rates are falling or securities prices
are rising, a fund, through the purchase of futures contracts, can attempt to
secure better rates or prices than might later be available in the market when
it effects anticipated purchases.
A fund may, for example, take a "short" position in the futures market by
selling futures contracts in an attempt to hedge against an anticipated rise in
interest rates or a decline in market prices that would adversely affect the
value of the fund's portfolio securities. These futures contracts may include
contracts for the future delivery of securities held by the fund or securities
with characteristics similar to those of the fund's portfolio securities.
If, in the opinion of the adviser, there is a sufficient degree of correlation
between price trends for a fund's portfolio securities and futures contracts
based on other financial instruments, securities indices
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or other indices, the fund may also enter into such futures contracts as part of
its hedging strategy. Although under some circumstances prices of securities in
a fund's portfolio may be more or less volatile than prices of these futures
contracts, the adviser will attempt to estimate the extent of this volatility
difference based on historical patterns and compensate for any differential by
having the fund enter into a greater or lesser number of futures contracts or by
attempting to achieve only a partial hedge against price changes affecting the
fund's portfolio securities.
When a short hedging position is successful, any depreciation in the value of
portfolio securities will be substantially offset by appreciation in the value
of the futures position. On the other hand, any unanticipated appreciation in
the value of a fund's portfolio securities would be substantially offset by a
decline in the value of the futures position.
On other occasions, a fund may take a "long" position by purchasing futures
contracts. This would be done, for example, when the fund anticipates the
subsequent purchase of particular securities when it has the necessary cash, but
expects the prices then available in the applicable market to be less favorable
than prices that are currently available. The fund may also purchase futures
contracts as a substitute for transactions in securities, to alter the
investment characteristics of portfolio securities or to gain or increase its
exposure to a particular securities market.
Options on Futures Contracts. A fund may purchase and write options on futures
for the same purposes as its transactions in futures contracts. The purchase of
put and call options on futures contracts will give a fund the right (but not
the obligation) for a specified price to sell or to purchase, respectively, the
underlying futures contract at any time during the option period. As the
purchaser of an option on a futures contract, the fund obtains the benefit of
the futures position if prices move in a favorable direction but limits its risk
of loss in the event of an unfavorable price movement to the loss of the premium
and transaction costs.
The writing of a call option on a futures contract generates a premium which may
partially offset a decline in the value of a fund's assets. By writing a call
option, a fund becomes obligated, in exchange for the premium (upon exercise of
the option) to sell a futures contract if the option is exercised, which may
have a value higher than the exercise price. Conversely, the writing of a put
option on a futures contract generates a premium which may partially offset an
increase in the price of securities that a fund intends to purchase. However,
the fund becomes obligated (upon exercise of the option) to purchase a futures
contract if the option is exercised, which may have a value lower than the
exercise price. The loss incurred by the fund in writing options on futures is
potentially unlimited and may exceed the amount of the premium received.
The holder or writer of an option on a futures contract may terminate its
position by selling or purchasing an offsetting option of the same series.
There is no guarantee that such closing transactions can be effected. A fund's
ability to establish and close out positions on such options will be subject to
the development and maintenance of a liquid market.
Other Considerations. A fund will engage in futures and related options
transactions either for bona fide hedging purposes or to seek to increase total
return as permitted by the CFTC. To the extent that a fund is using futures and
related options for hedging purposes, futures contracts will be sold to protect
against a decline in the price of securities that the fund owns or futures
contracts will be purchased to protect the fund against an increase in the price
of securities it intends to purchase. The adviser will determine that the price
fluctuations in the futures contracts and options on futures used
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for hedging purposes are substantially related to price fluctuations in
securities held by the fund or securities or instruments which it expects to
purchase. As evidence of its hedging intent, a fund expects that on 75% or more
of the occasions on which it takes a long futures or option position (involving
the purchase of futures contracts), the fund will have purchased, or will be in
the process of purchasing, equivalent amounts of related securities in the cash
market at the time when the futures or option position is closed out. However,
in particular cases, when it is economically advantageous for the fund to do so,
a long futures position may be terminated or an option may expire without the
corresponding purchase of securities or other assets.
To the extent that a fund engages in nonhedging transactions in futures
contracts and options on futures, the aggregate initial margin and premiums
required to establish these nonhedging positions will not exceed 5% of the net
asset value of the fund's portfolio, after taking into account unrealized
profits and losses on any such positions and excluding the amount by which such
options were in-the-money at the time of purchase.
Transactions in futures contracts and options on futures involve brokerage
costs, require margin deposits and, in the case of contracts and options
obligating the fund to purchase securities, require the fund to establish a
segregated account consisting of cash or liquid securities in an amount equal to
the underlying value of such contracts and options.
While transactions in futures contracts and options on futures may reduce
certain risks, these transactions themselves entail certain other risks. For
example, unanticipated changes in interest rates or securities prices may result
in a poorer overall performance for a fund than if it had not entered into any
futures contracts or options transactions.
Perfect correlation between a fund's futures positions and portfolio positions
will be impossible to achieve. There are no futures contracts based upon
individual securities, except certain U.S. government securities. In the event
of an imperfect correlation between a futures position and a portfolio position
which is intended to be protected, the desired protection may not be obtained
and the fund may be exposed to risk of loss.
Some futures contracts or options on futures may become illiquid under adverse
market conditions. In addition, during periods of market volatility, a commodity
exchange may suspend or limit trading in a futures contract or related option,
which may make the instrument temporarily illiquid and difficult to price.
Commodity exchanges may also establish daily limits on the amount that the price
of a futures contract or related option can vary from the previous day's
settlement price. Once the daily limit is reached, no trades may be made that
day at a price beyond the limit. This may prevent the fund from closing out
positions and limiting its losses.
Foreign Currency Transactions. (Real Estate Fund; Investment Grade Bond Fund)
- -----------------------------
A fund's foreign currency exchange transactions may be conducted on a spot
(i.e., cash) basis at the spot rate for purchasing or selling currency
prevailing in the foreign exchange market. A fund may also enter into
forward foreign currency exchange contracts to enhance return, to hedge against
fluctuations in currency exchange rates affecting a particular transaction or
portfolio position, or as a substitute for the purchase or sale of a currency or
assets denominated in that currency. Forward contracts are agreements to
purchase or sell a specified currency at a specified future date and price set
at the time of the contract. Transaction hedging is the purchase or sale of
forward foreign currency contracts with respect to specific receivables or
payables of a fund accruing in connection with the purchase and sale of its
portfolio securities quoted or denominated in the same or related foreign
currencies. Portfolio
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hedging is the use of forward foreign currency contracts to offset portfolio
security positions denominated or quoted in the same or related foreign
currencies. A fund may elect to hedge less than all of its foreign portfolio
positions if deemed appropriate by the adviser.
If a fund purchases a forward contract or sells a forward contract for non-
hedging purposes, it will segregate cash or liquid securities, of any type or
maturity, in a separate account in an amount equal to the value of the fund's
total assets committed to the consummation of the forward contract. The assets
in the segregated account will be valued at market daily and if the value of the
securities in the separate account declines, additional cash or securities will
be placed in the account so that the value of the account will be equal to the
amount of the fund's commitment with respect to such contracts.
Hedging against a decline in the value of a currency does not eliminate
fluctuations in the prices of portfolio securities or prevent losses if the
prices of such securities decline. These transactions also preclude the
opportunity for gain if the value of the hedged currency rises. Moreover, it
may not be possible for the fund to hedge against a devaluation that is so
generally anticipated that the fund is not able to contract to sell the currency
at a price above the devaluation level it anticipates.
The cost to a fund of engaging in foreign currency transactions varies with such
factors as the currency involved, the length of the contract period and the
market conditions then prevailing. Since transactions in foreign currency are
usually conducted on a principal basis, no fees or commissions are involved.
Foreign Currency Options. A foreign currency option provides the option buyer
with the right to buy or sell a stated amount of foreign currency at the
exercise price on a specified date or during the option period. The owner of a
call option has the right, but not the obligation, to buy the currency.
Conversely, the owner of a put option has the right, but not the obligation, to
sell the currency. When the option is exercised, the seller (i.e., writer) of
the option is obligated to fulfill the terms of the sold option. However,
either the seller or the buyer may, in the secondary market, close its position
during the option period at any time prior to expiration.
A call option on a foreign currency generally rises in value if the underlying
currency appreciates in value, and a put option on a foreign currency generally
rises in value if the underlying currency depreciates in value. Although
purchasing a foreign currency option can protect the fund against an adverse
movement in the value of a foreign currency, the option will not limit the
movement in the value of such currency. For example, if a fund was holding
securities denominated in a foreign currency that was appreciating and had
purchased a foreign currency put to hedge against a decline in the value of the
currency, the fund would not have to exercise its put option. Likewise, if a
fund were to enter into a contract to purchase a security denominated in foreign
currency and, in conjunction with that purchase, were to purchase a foreign
currency call option to hedge against a rise in value of the currency, and if
the value of the currency instead depreciated between the date of purchase and
the settlement date, the fund would not have to exercise its call. Instead, the
fund could acquire in the spot market the amount of foreign currency needed for
settlement.
Special Risks Associated with Foreign Currency Options. Buyers and sellers of
foreign currency options are subject to the same risks that apply to options
generally. In addition, there are certain additional risks associated with
foreign currency options. The markets in foreign currency options are
relatively new, and a fund's ability to establish and close out positions on
such options is subject to the maintenance of a liquid secondary market.
Although a fund will not purchase or write such options
================================================================================
-18-
<PAGE>
================================================================================
unless and until, in the opinion of the adviser, the market for them has
developed sufficiently to ensure that the risks in connection with such options
are not greater than the risks in connection with the underlying currency, there
can be no assurance that a liquid secondary market will exist for a particular
option at any specific time. In addition, options on foreign currencies are
affected by most of the same factors that influence foreign exchange rates and
investments generally.
The value of a foreign currency option depends upon the value of the underlying
currency relative to the U.S. dollar. As a result, the price of the option
position may vary with changes in the value of either or both currencies and may
have no relationship to the investment merits of a foreign security. Because
foreign currency transactions occurring in the interbank market involve
substantially larger amounts than those that may be involved in the use of
foreign currency options, investors may be disadvantaged by having to deal in an
odd lot market (generally consisting of transactions of less than $1 million)
for the underlying foreign currencies at prices that are less favorable than for
round lots.
There is no systematic reporting of last sale information for foreign currencies
or any regulatory requirement that quotations available through dealers or other
market sources be firm or revised on a timely basis. Available quotation
information is generally representative of very large transactions in the
interbank market and thus may not reflect relatively smaller transactions (i.e.,
less than $1 million) where rates may be less favorable. The interbank market
in foreign currencies is a global, around-the-clock market. To the extent that
the U.S. option markets are closed while the markets for the underlying
currencies remain open, significant price and rate movements may take place in
the underlying markets that cannot be reflected in the options markets until
they reopen.
Foreign Currency Futures Transactions. By using foreign currency futures
contracts and options on such contracts, the fund may be able to achieve many of
the same objectives as it would through the use of forward foreign currency
exchange contracts. The fund may be able to achieve these objectives possibly
more effectively and at a lower cost by using futures transactions instead of
forward foreign currency exchange contracts.
A foreign currency futures contract sale creates an obligation by the fund, as
seller, to deliver the amount of currency called for in the contract at a
specified future time for a specified price. A currency futures contract
purchase creates an obligation by the fund, as purchaser, to take delivery of an
amount of currency at a specified future time at a specified price. Although
the terms of currency futures contracts specify actual delivery or receipt, in
most instances the contracts are closed out before the settlement date without
the making or taking of delivery of the currency. Closing out of currency
futures contracts is effected by entering into an offsetting purchase or sale
transaction. An offsetting transaction for a currency futures contract sale is
effected by the fund entering into a currency futures contract purchase for the
same aggregate amount of currency and same delivery date. If the price of the
sale exceeds the price of the offsetting purchase, the fund is immediately paid
the difference and realizes a gain, and if the price of the sale is less than
the price of the offsetting purchase, the fund pays the difference and realizes
a loss. Similarly, the closing out of a currency futures contract purchase is
effected by the fund entering into a currency futures contract sale. If the
offsetting sale price exceeds the purchase price, the fund realizes a gain, and
if the offsetting sale price is less than the purchase price, the fund realizes
a loss.
Special Risks Associated with Foreign Currency Futures Contracts and Related
Options. Buyers and sellers of foreign currency futures contracts and related
options are subject to the same risks that apply to the use of futures
generally. In addition, the risks associated with foreign currency futures
contracts and
================================================================================
-19-
<PAGE>
================================================================================
options on futures are similar to those associated with options on foreign
currencies, as described above.
Swaps, Caps, Floors and Collars. (Real Estate Fund; Investment Grade Bond Fund)
- -------------------------------
As one way of managing its exposure to different types of investments, a fund
may enter into interest rate swaps, currency swaps, and other types of swap
agreements such as caps, collars and floors. In a typical interest rate swap,
one party agrees to make regular payments equal to a floating interest rate
times a "notional principal amount," in return for payments equal to a fixed
rate times the same notional amount, for a specified period of time. If a swap
agreement provides for payment in different currencies, the parties might agree
to exchange the notional principal amount as well. Swaps may also depend on
other prices or rates, such as the value of an index or mortgage prepayment
rates.
In a typical cap or floor agreement, one party agrees to make payments only
under specified circumstances, usually in return for payment of a fee by the
other party. For example, the buyer of an interest rate cap obtains the right
to receive payments to the extent that a specified interest rate exceeds an
agreed-upon level, while the seller of an interest rate floor is obligated to
make payments to the extent that a specified interest rate falls below an
agreed-upon level. An interest rate collar combines elements of buying a cap
and selling a floor.
Swap agreements will tend to shift a fund's investment exposure from one type of
investment to another. For example, if the fund agreed to exchange payments in
dollars for payments in a foreign currency, the swap agreement would tend to
decrease the fund's exposure to U.S. interest rates and increase its exposure to
foreign currency and interest rates. Caps and floors have an effect similar to
buying or writing options. Depending on how they are used, swap agreements may
increase or decrease the overall volatility of a fund's investments and its
share price and yield.
Swap agreements are sophisticated hedging instruments that typically involve a
small investment of cash relative to the magnitude of risks assumed. As a
result, swaps can be highly volatile and may have a considerable impact on a
fund's performance. Swap agreements are subject to risks related to the
counterparty's ability to perform, and may decline in value if the
counterparty's creditworthiness deteriorates. A fund may also suffer losses if
it is unable to terminate outstanding swap agreements or reduce its exposure
through offsetting transactions. A fund will maintain in a segregated account,
cash or liquid securities equal to the net amount, if any, of the excess of the
fund's obligations over its entitlements with respect to swap, cap, collar or
floor transactions.
Temporary Investments. (Real Estate Fund; Investment Grade Bond Fund) For
- ---------------------
temporary and defensive purposes, a fund may invest up to 100% of its total
assets in investment grade short-term fixed income securities, including short-
term U.S. government securities, money market instruments, including negotiable
certificates of deposit, non-negotiable fixed time deposits, bankers'
acceptances, commercial paper, floating rate notes, and repurchase agreements. A
fund may also hold significant amounts of its assets in cash.
Lending of Securities. (All funds) A fund may lend portfolio securities to
- ---------------------
brokers, dealers, and financial institutions if the loan is secured by cash,
U.S. government securities or other collateral according to applicable
regulatory requirements. A fund may reinvest any cash collateral in short-term
securities and money market funds. When a fund lends portfolio securities,
there is a risk that the borrower may fail to return the securities. As a
result, a fund may incur a loss or, in the
================================================================================
-20-
<PAGE>
================================================================================
event of the borrower's bankruptcy, may be delayed in or prevented from
liquidating the collateral. A fund may not lend portfolio securities having a
total value exceeding one-third of its total assets.
Short-Term Trading and Portfolio Turnover. (All funds) Short-term trading
- -----------------------------------------
means the purchase and subsequent sale of a security after it has been held for
a relatively brief period of time. A fund may engage in short-term trading in
response to stock market conditions, changes in interest rates or other economic
trends and developments, or to take advantage of yield disparities between
various fixed income securities in order to realize capital gains or improve
income. Short-term trading may have the effect of increasing portfolio turnover
rate. A high rate of portfolio turnover (100% or more) involves correspondingly
higher brokerage costs that must be borne directly by the fund and thus
indirectly by the shareholders, reducing the shareholder's return.
Investment Restrictions. Each fund has adopted fundamental investment
restrictions. These restrictions cannot be changed unless the change is
approved by the lesser of (1) 67% or more of the voting securities present at a
meeting, if the holders of more than 50% of the outstanding voting securities of
the affected fund are present or represented by proxy, or (2) more than 50% of
the outstanding voting securities of the affected fund.
These fundamental restrictions provide that a fund may not:
1. Invest 25% or more of its total assets in securities of issuers in any one
industry, except that Real Estate Fund invests 25% or more of its total assets
in the real estate group of industries. The United States government, its
agencies or instrumentalities are not considered industries for this purpose.
2. Borrow money or issue senior securities except to the extent permitted by the
1940 Act.
3. Make loans of securities to other persons, except loans of securities not
exceeding one-third of the fund's total assets, investments in debt obligations
and transactions in repurchase agreements.
4. Underwrite securities of other issuers, except insofar as the fund may be
deemed an underwriter under the Securities Act of 1933, as amended (the "1933
Act") in selling portfolio securities.
5. Purchase, sell or invest in real estate, but each fund subject to its other
investment policies and restrictions may invest in securities of companies that
deal in real estate or are engaged in the real estate business, including real
estate investment trusts, and securities secured by real estate or interests
therein and may hold and sell real estate acquired through default, liquidation
or other distributions of an interest in real estate as a result of the fund's
ownership of such securities.
6. Invest in commodities or commodity futures contracts, excluding transactions
in financial derivative contracts, such as forward currency contracts; financial
futures contracts and options on financial futures contracts; options on
securities, currencies and financial indices; and swaps, caps, floors, collars
and swaptions, as permitted by the fund's prospectus and this statement of
additional information.
7. Make investments that are inconsistent with the status of Investment Grade
Bond Fund and Money Market Fund as diversified funds.
The 1940 Act currently prohibits the funds from issuing senior securities or
borrowing money, except that Real Estate Fund and Investment Grade Bond Fund may
borrow from banks or pursuant to
================================================================================
-21-
<PAGE>
================================================================================
reverse repurchase agreements in an amount not exceeding one-third of total
assets (including the amount borrowed). Each fund is required to reduce the
amount of its borrowings to not more than one-third of total assets within three
days after such borrowings first exceed this one-third limitation.
Additional investment restrictions adopted by the funds, which may be changed by
the trustees, provide that a fund may not:
1. a. Investment Grade Bond Fund Only. With respect to 75% of the fund's
-------------------------------
assets, invest more than 5% of the fund's assets (taken at a market value at the
time of purchase) in the outstanding securities of any single issuer or own more
than 10% of the outstanding voting securities of any one issuer, in each case
other than (1) securities issued or guaranteed by the U.S. Government, its
agencies or instrumentalities, or (2) securities of other investment companies.
b. Money Market Fund Only. Except with respect to investments in
----------------------
obligations of (a) the U.S. Government, its agencies, authorities or
instrumentalities and (b) domestic banks, purchase any security if, as a result
(i) more than 5% of its assets would be invested in the securities of any one
issuer, or (ii) more than 25% of its assets would be invested in a particular
industry.
2. Invest more than 15% (10% for Money Market Fund) of its net assets (taken at
market value at the time of purchase) in illiquid securities.
3. Make investments for the purpose of exercising control or management.
4. Invest in other investment companies except as permitted under the 1940 Act.
================================================================================
-22-
<PAGE>
The Funds' Management
================================================================================
Trustees and Officers. Each fund's business is managed by the trustees. The
trustees elect each fund's officers who are responsible for the day-to-day
operations of the fund and who execute the investment policies approved by the
trustees. Several of the funds' trustees and officers are also directors and
officers of Sun Life Assurance Company of Canada or the adviser. The table below
provides more information about the funds' trustees and officers.
- --------------------------------------------------------------------------------
Principal occupation
Name, address and age Position with the trust past 5 years
- --------------------------------------------------------------------------------
C. James Prieur* Chairman, Executive President and chief
One Sun Life Executive Park Vice President and operating officer, Sun
Wellesley Hills, MA 02481 Trustee Life Assurance Company
Date of birth: April 21, of Canada since 1999.
1951 Prior to that, senior
vice president and
general manager, U.S.
operations, Sun Life
Assurance Company of
Canada, since 1997, and
vice president,
Investments, U.S.
operations, Sun Life
Assurance Company of
Canada. Chairman, since
1998 and director, Sun
Capital Advisers, Inc.
since 1992.
- --------------------------------------------------------------------------------
Graham E. Jones Trustee Senior vice president,
330 Garfield Street BGK Properties, Inc.,
Santa Fe, NM 87501 since 1994. Chief
Date of birth: January Financial Officer and
21, 1933 Principal, Practice
Management Systems, Inc.
from 1988-95.
- --------------------------------------------------------------------------------
Anthony C. Paddock Trustee Managing Director,
350 Fifth Street, Suite 5713 Empire Valuation
New York, NY 10118 Consultants, Inc., since
Date of birth: July 9, 1996. President, AC
1935 Paddock & Associates,
since 1996. Prior to
that, principal, KPMG
Peat Marwick from
1987-96.
- --------------------------------------------------------------------------------
William N. Searcy Trustee Pension and savings
2330 Shawnee Mission trust officer, Sprint
Parkway Corp., since 1989.
Westwood, KS 66205
Date of birth: September
3, 1946
- --------------------------------------------------------------------------------
================================================================================
-23-
<PAGE>
================================================================================
- --------------------------------------------------------------------------------
Principal occupation
Name, address and age Position with the trust past 5 years
- --------------------------------------------------------------------------------
James M.A. Anderson* President, Chief Vice president,
One Sun Life Executive Park Executive Officer and Investments, U.S.
Wellesley Hills, MA 02481 Trustee operations, Sun Life
Date of birth: September Assurance Company of
14, 1949 Canada, since 1998.
Prior to that, vice
president, Securities
Investments, Canada
operations, Sun Life
Assurance Company of
Canada, 1995-98. Prior
to that, vice president,
Mortgage Investments,
Canada operations, Sun
Life Assurance Company
of Canada, 1993-95.
President and director,
Sun Capital Advisers,
Inc. since 1998.
- --------------------------------------------------------------------------------
James F. Alban* Chief Financial Officer Assistant vice president,
One Sun Life Executive Park and Treasurer Sun Capital Advisers,
Wellesley Hills, MA 02481 Inc. since 1998. Audit
Date of birth: January 23, senior manager,
1962 PricewaterhouseCoopers
LLP, 1996-1998. Assistant
vice president, Eaton
Vance Management, 1991-
1996.
- --------------------------------------------------------------------------------
Robert P. Vrolyk* Assistant Treasurer Vice president, Finance,
One Sun Life Executive Park U.S. operations, Sun
Wellesley Hills, MA 02481 Life Assurance Company
Date of birth: April 15, of Canada, since 1993.
1953 Vice president,
treasurer and director,
Sun Capital Advisers,
Inc. since 1998.
- --------------------------------------------------------------------------------
Richard Gordon, CFA* Vice President Vice president, Sun
One Sun Life Executive Park Capital Advisers, Inc.,
Wellesley Hills, MA 02481 since 1992. Vice
Date of birth: July 10, president, U.S. Public
1945 Bonds, Sun Life
Assurance Company of
Canada, since 1994.
Prior to that, assistant
vice president.
- --------------------------------------------------------------------------------
Howard C. Greene, CFA* Vice President Vice president, Sun
One Sun Life Executive Park Capital Advisers, Inc.,
Wellesley Hills, MA 02481 since 1998. Assistant
Date of birth: July 22, vice president, U.S.
1957 Public Bonds, Sun Life
Assurance Company of
Canada, since 1996.
Prior to that, senior
investment officer.
- --------------------------------------------------------------------------------
John T. Donnelly, CFA* Vice President Vice president, Sun
One Sun Life Executive Park Capital Advisers, Inc.,
Wellesley Hills, MA 02481 since 1998. Vice
Date of birth: October president, U.S.
28, 1958 Equities, Sun Life
Assurance Company of
Canada, since 1999.
Prior to that,
assistant vice president,
U.S. Equities, Sun Life
Assurance Company of
Canada, since 1997,
senior investment officer
U.S. Public Bonds (1994-
1997), and investment
officer, portfolio
management (1991-1994).
- --------------------------------------------------------------------------------
================================================================================
-24-
<PAGE>
================================================================================
- --------------------------------------------------------------------------------
Principal occupation
Name, address and age Position with the trust past 5 years
- --------------------------------------------------------------------------------
Maura A. Murphy, Esq.* Secretary Senior counsel, U.S.
One Sun Life Executive Park operations, Sun Life
Wellesley Hills, MA 02481 Assurance Company of
Date of birth: February Canada, since 1998.
12, 1960 Prior to that,
securities counsel, New
England Life Insurance
Company, 1994-98. Prior
to that, attorney,
Division of Investment
Management, U.S.
Securities and Exchange
Commission, 1990-94.
- --------------------------------------------------------------------------------
Peter F. Demuth, Esq.* Assistant Secretary Vice president and chief
One Sun Life Executive Park counsel, U.S.
Wellesley Hills, MA 02481 operations, Sun Life
Date of birth: June 4, Assurance Company of
1958 Canada, since 1998.
Prior to that, partner
at the Boston law firm
of Mintz, Levin, Cohn,
Ferris, Glovsky and
Popeo, P.C.
- --------------------------------------------------------------------------------
Christopher P. Harvey, Assistant Secretary Partner, Hale and Dorr
Esq.* LLP, since 1991, counsel
60 State Street to the Trust.
Boston, MA 02109
Date of birth: June 27,
1961
- --------------------------------------------------------------------------------
* An interested person of the funds for purposes of the 1940 Act.
Trustee Compensation. The trust pays the trustees who are not interested
persons of the trust or the adviser for their service as trustees. The
following table sets forth all compensation paid to the trustees as of the
funds' fiscal year ended December 31, 1998. The trustees who are officers or
employees of Sun Life or the adviser are not paid by the trust for their service
as trustees.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------
Name and position Aggregate Pension or Estimated annual Total
with compensation retirement benefits upon compensation
the trust from the trust benefits accrued retirement from the trust
as part of funds' paid to trustees*
expenses
- ------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Graham B. Jones $ 1,750 0 0 $ 1,750
- ------------------------------------------------------------------------------------------------
Anthony C. Paddock 1,750 0 0 1,750
- ------------------------------------------------------------------------------------------------
William N. Searcy 2,000 0 0 2,000
- ------------------------------------------------------------------------------------------------
</TABLE>
* The trust is the only registered investment company managed by the
adviser.
As of April 21, 1999, the trustees and officers of Sun Capital Advisers Trust
as a group owned less than 1% of the outstanding shares of beneficial interest
in each of the funds.
================================================================================
-25-
<PAGE>
================================================================================
The Investment Adviser. Sun Capital Advisers, Inc., the funds' investment
adviser, is located at One Sun Life Executive Park, Wellesley Hills,
Massachusetts 02481. The adviser is a wholly-owned subsidiary of Sun Life
Assurance Company of Canada (U.S.), which is an indirect wholly-owned subsidiary
of Sun Life Assurance Company of Canada (Sun Life of Canada). Sun Life of Canada
is a mutual life insurance company incorporated pursuant to an Act of Parliament
of Canada in 1865. Sun Life of Canada and its affiliates currently transact
business in Canada, the United States, the United Kingdom, Asia Pacific and
South America. Sun Life of Canada has established a record of financial strength
that has resulted in consistently outstanding ratings from A.M. Best (A++ for
financial strength (highest rating level)), Duff & Phelps (AAA for claims-paying
ability (highest rating level)), Moody's Investors' Service, Inc. (Aa1 for
Canadian currency financial strength (second highest of 21 rating levels) and
Aa2 for foreign currency financial strength (third highest of 21 rating levels)
and Standard & Poor's Ratings Group (AAA for financial strength (highest rating
level)).
The adviser is a Delaware corporation and a registered investment adviser. The
adviser provides investment management and supervisory services to pension and
profit-sharing accounts of Sun Life of Canada. Each fund will offer its shares
to separate accounts that are funding vehicles for variable contracts offered by
Sun Life of Canada and its affiliates and other insurance companies. It is also
expected that the adviser, through certain asset allocation programs offered to
holders of variable contracts offered by Sun Life of Canada and its affiliates,
will have discretion to allocate assets to the funds.
Restrictions on Personal Trading. In order to avoid conflicts with portfolio
trades for the funds, the adviser and the funds have adopted restrictions on
personal securities trading by personnel of the adviser and its affiliates. Some
of the adviser's restrictions include pre-clearance for all personal trades and
a ban on the purchase of initial public offerings by certain personnel. These
restrictions reflect the basic principle that the interests of the funds and
their shareholders come before the interests of personnel of the adviser and its
affiliates.
Terms of Advisory Agreement. Each fund has entered into an investment advisory
agreement with the adviser which was approved by the fund's trustees. Under the
terms of the advisory agreement, the adviser furnishes an investment program for
the fund and determines, subject to the overall supervision and review of the
trustees, which investments should be purchased, held, sold or exchanged and
provides supervision over all aspects of the fund's operations, except those
which are delegated to a custodian, transfer agent or other agent. The adviser
may enter into agreements with Sun Life of Canada to utilize the resources and
personnel of the company.
Each fund bears the cost of its operations not expressly assumed by the adviser
or another service provider. These costs may include, but are not limited to,
(i) charges and expenses for fund accounting, pricing and appraisal services and
related overhead, including, to the extent such services are performed by
personnel of the Adviser, or its affiliates, office space and facilities and
personnel compensation, training and benefits; (ii) charges and expenses of
auditors; (iii) charges and expenses of any custodian, administrator, transfer
agent, plan agent, dividend disbursing agent and registrar appointed by the
Trust; (iv) issue and transfer taxes chargeable to the Trust in connection with
securities transactions to which the Trust is a party; (v) insurance premiums,
interest charges, dues and fees for membership in trade associations and all
taxes and corporate fees payable by the Trust to federal, state or other
governmental agencies; (vi) fees and expenses involved in registering and
maintaining registrations of the Trust and/or its shares with the Commission,
state securities agencies and foreign jurisdictions, including the preparation
of prospectuses and statements of additional information for filing with such
regulatory agencies; (vii) all expenses of shareholders' and Trustees'
================================================================================
-26-
<PAGE>
================================================================================
meetings and of preparing, printing and distributing prospectuses, notices,
proxy statements and all reports to shareholders and to governmental agencies;
(viii) charges and expenses of legal counsel to the Trust and the Trustees; (ix)
if applicable, any distribution fees paid by the Trust in accordance with Rule
12b-1 promulgated by the Commission pursuant to the 1940 Act; (x) compensation
of those Trustees of the Trust who are not affiliated with or interested persons
of the adviser or the Trust (other than as Trustees); (xi) the cost of preparing
and printing share certificates; and (xii) interest on borrowed money, if any.
Each fund pays a fee monthly to the adviser for its advisory services based on a
stated percentage of the average daily net assets of the fund as follows:
-----------------------------------
Money Market Fund 0.50%
-----------------------------------
Investment Grade Bond Fund 0.60%
-----------------------------------
Real Estate Fund 0.95%
-----------------------------------
From time to time, the adviser may reduce its fee or make other arrangements to
limit a fund's expenses to a specified percentage of average daily net assets.
To the extent that a fund's total expense ratio falls below its expense limit,
the adviser reserves the right to be reimbursed for management fees waived and
fund expenses paid by it during the prior two fiscal years. The adviser may
modify or eliminate this voluntary expense at any time. The adviser has
voluntarily agreed to limit its advisory fee and to reimburse each fund's other
expenses for an indefinite period to reduce each fund's total annual operating
expenses to the amounts set forth below.
Fund Total Operating Expenses
---- ------------------------
Money Market Fund 0.65%
Investment Grade Bond Fund 0.75%
Real Estate Fund 1.25%
The adviser may modify or terminate this voluntary expense limit at any time.
For the period ended December 31, 1998, the adviser waived all of the advisory
fees due to it for the period. Absent this fee waiver, the advisory fees would
have been $857, $4,096 and $3,200 for Money Market Fund, Investment Grade Bond
Fund and Real Estate Fund.
Securities held by a fund may also be held by other funds or investment advisory
clients for which the adviser or any of its affiliates provides investment
advice. Because of different investment objectives or other factors, a
particular security may be bought for one or more funds or clients when one or
more are selling the same security. If opportunities for purchase or sale of
securities by the adviser or for other funds or investment advisory clients
arise at or about the same time, transactions in the securities will be made,
insofar as feasible, for the respective funds or clients in a manner deemed
equitable to all of them. To the extent that transactions on behalf of more than
one client of the adviser or its affiliates may increase the demand for
securities being purchased or the supply of securities being sold, there may be
an adverse effect on the price obtained by a fund.
Pursuant to the advisory agreement, the adviser is not liable for any error of
judgment or mistake of law or for any loss suffered by the funds in connection
with the matters to which its respective contract relates, except a loss
resulting from willful misfeasance, bad faith or gross negligence on the part of
the adviser in the performance of its duties or from its reckless disregard of
the obligations and duties under the applicable agreement.
================================================================================
-27-
<PAGE>
================================================================================
Under the advisory agreement, each fund may use the name "Sun Capital" or any
name derived from or similar to this name only for as long as the advisory
agreement or any extension, renewal or amendment of the agreement remains in
effect. If a fund's advisory agreement is no longer in effect, the fund will
cease to use such name or any other name indicating that it is advised by or
otherwise connected with the adviser. In addition, the adviser may grant the
non-exclusive right to use the name "Sun Capital" or any similar name to any
other corporation or entity, including but not limited to any investment company
of which Sun Life of Canada or any subsidiary or affiliate of the company or any
successor to the business of the company or any subsidiary or affiliate of the
company is the investment adviser.
The advisory agreement initially expires on October 31, 2000, and will continue
in effect from year to year for each fund if approved by either the vote of the
fund's shareholders (if a shareholder vote is required) or the trustees,
including a vote of a majority of the trustees who are not parties to the
agreement or "interested persons" of any such party, cast at a meeting called
for such purposes. The advisory agreement may be terminated on 60 days' written
notice by any party or by a vote of a majority of the outstanding voting
securities of the affected fund and will terminate automatically if assigned.
Administrator. State Street Bank & Trust Company, 1776 Heritage Drive, North
Quincy, Massachusetts, 02171, is the funds' administrator. State Street is
responsible for managing the funds' business affairs. State Street's services
include recordkeeping, preparation and filing of documents required to comply
with federal and state securities laws, preparation and filing of tax returns,
supervising the activities of the custodian and transfer and shareholder
servicing agent and other administrative services necessary to conduct the
funds' business. For its services, State Street receives an asset based fee with
breakpoints not to exceed 0.08% of the average net assets of each fund subject
to a minimum fee of $57,500 per fund.
For the period ended December 31, 1998, each of the funds accrued fees, to be
paid in 1999, to the administrator as follows:
<TABLE>
<CAPTION>
Money Market Investment Grade Real Estate
Fund Bond Fund Fund
---- --------- ----
<S> <C> <C> <C>
$399 $399 $399
</TABLE>
Transfer Agent. State Street Bank & Trust Company is the transfer agent for the
funds.
Custodian. Each fund's portfolio securities are held pursuant to a master
custodian agreement between the trust and State Street Bank & Trust Company.
Under the custodian agreement, the custodian performs custody, portfolio and
fund accounting services.
Independent Auditors. The trustees have selected Deloitte & Touche LLP as the
funds' independent auditor. Deloitte & Touche LLP audits and renders opinions on
the funds' annual financial statements and reviews the funds' annual federal
income tax returns.
================================================================================
-28-
<PAGE>
Information About The Trust's History And Organization
================================================================================
Description of the Trust's Shares. The trust is a business trust organized
under Delaware law. The trustees are responsible for the management and
supervision of the funds. The declaration of trust, dated July 13, 1998, permits
the trustees to issue an unlimited number of full and fractional shares of
beneficial interest of the funds, without par value. Under the declaration of
trust, the trustees have the authority to create and classify shares of
beneficial interest in separate series, without further action by shareholders.
As of the date of this statement of additional information, the trustees have
authorized shares only of the funds. Additional series may be added in the
future. The declaration of trust also authorizes the trustees to classify and
reclassify the shares of the funds, or any other series of the trust, into one
or more classes. As of the date of this statement of additional information, the
trustees have not authorized the issuance of additional classes of shares of the
funds.
Each share of a fund represents an equal proportionate interest in the assets
belonging to that fund. When issued, shares are fully paid and nonassessable.
In the event of liquidation of a fund, shareholders are entitled to share pro
rata in the net assets of the fund available for distribution to such
shareholders. Shares of a fund are freely transferable and have no preemptive,
subscription or conversion rights.
In accordance with the provisions of the declaration of trust, the trustees have
initially determined that shares entitle their holders to one vote per share on
any matter on which such shares are entitled to vote. The trustees may determine
in the future, without the vote or consent of shareholders, that each dollar of
net asset value (number of shares owned times net asset value per share) will be
entitled to one vote on any matter on which such shares are entitled to vote.
The rights, if any, of variable contract holders to vote the shares of a fund
are governed by the participating insurance company's variable contract. For
information on the voting rights under a particular variable contract, see the
prospectus offering that variable contract.
Unless otherwise required by the 1940 Act or the declaration of trust, the funds
have no intention of holding annual meetings of shareholders. Shareholders may
remove a trustee by the affirmative vote of at least two-thirds of the trust's
outstanding shares. At any time that less than a majority of the trustees
holding office were elected by the shareholders, the trustees will call a
special meeting of shareholders for the purpose of electing trustees.
Under Delaware law, shareholders of a Delaware business trust are protected from
liability for acts or obligations of the trust to the same extent as
shareholders of a private, for-profit Delaware corporation. In addition, the
declaration of trust expressly provides that the trust has been organized under
Delaware law and that the declaration of trust will be governed by Delaware law.
It is possible that the trust might become a party to an action in another state
whose courts refuse to apply Delaware law, in which case the trust's
shareholders could be subject to personal liability.
To guard against this risk, the declaration of trust (i) contains an express
disclaimer of shareholder liability for acts or obligations of the trust and
provides that notice of this disclaimer may be given in each agreement,
obligation and instrument entered into or executed by the trust or its trustees,
(ii) provides for the indemnification out of trust or fund property of any
shareholders held personally liable for any obligations of the trust or of the
fund and (iii) provides that the trust shall, upon request, assume the defense
of any claim made against any shareholder for any act or obligation of the
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================================================================================
trust and satisfy any judgment thereon. Thus, the risk of a shareholder
incurring financial loss beyond his or her investment because of shareholder
liability with respect to a fund is limited to circumstances in which all of the
following factors are present: (1) a court refused to apply Delaware law; (2)
the liability arose under tort law or, if not, no contractual limitation of
liability was in effect; and (3) the fund itself would be unable to meet its
obligations. In the light of Delaware law, the nature of the trust business and
the nature of its assets, the risk of personal liability to a shareholder is
remote.
The declaration of trust further provides that the trust shall indemnify each of
its trustees and officers against liabilities and expenses reasonably incurred
by them, in connection with, or arising out of, any action, suit or proceeding,
threatened against or otherwise involving the trustee or officer, directly or
indirectly, by reason of being or having been a trustee or officer of the trust.
The declaration of trust does not authorize the trust or any fund to indemnify
any trustee or officer against any liability to which he or she would otherwise
be subject by reason of or for willful misfeasance, bad faith, gross negligence
or reckless disregard of such person's duties.
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<PAGE>
More Information About How The Funds Value Their Shares
================================================================================
For purposes of calculating the net asset value (NAV) of the shares of the
funds, the funds use the following procedures.
The funds generally value equity securities traded on a principal exchange or
NASDAQ National Market issues at their last sale price on the day of valuation.
The funds generally value equity securities for which no sales are reported on a
valuation day, and other securities traded over-the-counter, at the last
available bid price.
The funds value debt securities on the basis of valuations furnished by a
principal market maker or a pricing service, both of which generally use
electronic data processing techniques (matrix pricing) to value normal
institutional size trading units of debt securities without exclusive reliance
upon quoted prices.
The funds value short-term debt instruments that have a remaining maturity of 60
days or less at the time of purchase at amortized cost, which approximates
market value.
If market quotations are not readily available or if in the opinion of the
adviser any quotation or market price is not representative of true market
value, the funds may determine the fair value of any security in good faith in
accordance with procedures approved by the trustees.
Money Market Fund utilizes the amortized cost valuation method of valuing
portfolio instruments in the absence of extraordinary or unusual circumstances.
Under the amortized cost method, assets are valued by constantly amortizing over
the remaining life of an instrument the difference between the principal amount
due at maturity and the cost of the instrument to the fund. The trustees will
from time to time review the extent of any deviation of the net asset value, as
determined on the basis of the amortized cost method, from net asset value as
determined on the basis of available market quotations. If any deviation occurs
that may result in unfairness either to new investors or existing shareholders,
the trustees will take such actions as they deem appropriate to eliminate or
reduce this unfairness to the extent reasonably practicable. These actions may
include selling portfolio instruments prior to maturity to realize gains or
losses or to shorten the fund's average portfolio maturity, withholding
dividends, splitting, combining or otherwise recapitalizing outstanding shares
or using available market quotations to determine net asset value per share.
The funds value foreign securities, if any, on the basis of quotations from the
primary market in which they are traded. The fund's custodian translates assets
or liabilities expressed in foreign currencies into U.S. dollars as of the close
of the London exchange (5:00 p.m., London time; 12:00 noon, New York time) on
the date of determining a fund's NAV. If quotations are not readily available,
or the value has been materially affected by events occurring after the closing
of a foreign market, the funds may value their assets by a method that the
trustees believe accurately reflects fair value.
Each fund determines its NAV each business day at the close of regular trading
on the New York Stock Exchange (typically 4:00 p.m. eastern time) by dividing
the fund's net assets by the number of its shares outstanding. On any day an
international market is closed and the New York Stock Exchange is open, any
foreign securities will be valued at the prior day's close with the current
day's exchange rate. Trading of foreign securities may take place on Saturdays
and U.S. business holidays on which a
================================================================================
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<PAGE>
================================================================================
fund's NAV is not calculated. Consequently, a fund's portfolio securities may
trade and the NAV of that fund's shares may be significantly affected on days
when a shareholder has no access to that fund.
Each participating insurance company receives orders from its variable
annuity contract and variable life insurance policy owners to purchase or redeem
shares of the funds each business day. That night, all orders received by that
insurance company on that business day are aggregated, and the insurance company
places a net purchase or redemption order for shares of one or more funds the
morning of the next business day. These orders are normally executed at the NAV
that was computed at the close of the previous business day in order to provide
a match between the variable contract and policy owners' orders to the insurance
companies and the insurance companies' orders to a fund. In some cases, an
insurance company's orders for fund shares may be executed at the NAV next
computed after the order is actually transmitted to a fund.
Redemptions in Kind. Although the funds would not normally do so, each fund has
the right to pay the redemption price of shares of the fund in whole or in part
in portfolio securities as prescribed by the trustees. When the shareholder
sells portfolio securities received in this fashion, a brokerage charge would be
incurred. The fund will value securities for the purpose of making a redemption
payment at the same value used in determining NAV.
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<PAGE>
Taxes
================================================================================
Each fund is treated as a separate entity for federal income tax purposes. Each
fund has elected or intends to elect to be treated, and intends to qualify for
each taxable year, as a separate "regulated investment company" under Subchapter
M of the Internal Revenue Code of 1986, as amended (the "Code"). As such and by
complying with the applicable provisions of the Code regarding the sources of
its income, the timing of its distributions, and the diversification of its
assets, each fund will not be subject to Federal income tax on taxable income
(including net realized capital gains) which is distributed to shareholders in
accordance with the timing and other requirements of the Code.
Qualification of a fund for treatment as a regulated investment company under
the Code requires, among other things, that (a) at least 90% of a fund's gross
income for its taxable year, without offset for losses from the sale or other
disposition of stock or securities or other transactions, be derived from
interest, dividends, payments with respect to securities loans and gains from
the sale or other disposition of stock or securities or foreign currencies, or
other income (including but not limited to gains from options, futures, or
forward contracts) derived with respect to its business of investing in such
stock, securities or currencies; (b) each fund distribute to its shareholders
for each taxable year (in compliance with certain timing requirements) as
dividends at least 90% of the sum of its taxable and any tax-exempt net
investment income, the excess of net short-term capital gain over net long-term
capital loss and any other net income for that year (except for the excess, if
any, of net long-term capital gain over net short-term capital loss, which need
not be distributed in order for the fund to qualify as a regulated investment
company but is taxed to the fund if it is not distributed); and (c) each fund
diversify its assets so that, at the close of each quarter of its taxable year,
(i) at least 50% of the fair market value of its total (gross) assets is
comprised of cash, cash items, U.S. Government securities, securities of other
regulated investment companies and other securities limited in respect of any
one issuer to no more than 5% of the fair market value of the fund's total
assets and 10% of the outstanding voting securities of such issuer and (ii) no
more than 25% of the fair market value of its total assets is invested in the
securities of any one issuer (other than U.S. Government securities and
securities of other regulated investment companies) or of two or more issuers
controlled by the fund and engaged in the same, similar, or related trades or
businesses.
Each fund also intends to comply with the separate diversification requirements
imposed by Section 817(h) of the Code and the regulations thereunder on certain
insurance company separate accounts. These requirements, which are in addition
to the diversification requirements imposed on a fund by the 1940 Act and
Subchapter M of the Code, place certain limitations on assets of each insurance
company separate account used to fund variable contracts. Because Section 817(h)
and those regulations treat the assets of the fund as assets of the related
separate account, these regulations are imposed on the assets of a fund unless a
one year start up period exception is available to each separate account
investing in the fund. Specifically, the regulations provide that, except as
permitted by the "safe harbor" described below, as of the end of each calendar
quarter or within 30 days thereafter no more than 55% of the total assets of a
fund may be represented by any one investment, no more than 70% by any two
investments, no more than 80% by any three investments and no more than 90% by
any four investments. For this purpose, all securities of the same issuer are
considered a single investment, and each U.S. Government agency and
instrumentality is considered a separate issuer. Section 817(h) provides, as a
safe harbor, that a separate account will be treated as being adequately
diversified if the diversification requirements under Subchapter M are satisfied
and no more than 55% of the value of the account's total assets is attributable
to cash and cash items (including receivables), U.S. Government securities and
securities of other regulated investment
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================================================================================
companies. Failure by a fund to both qualify as a regulated investment company
and satisfy the Section 817(h) requirements would generally cause the variable
contracts to lose their favorable tax status and require a contract holder to
include in ordinary income any income accrued under the contracts for the
current and all prior taxable years. Under certain circumstances described in
the applicable Treasury regulations, inadvertent failure to satisfy the
applicable diversification requirements may be corrected, but such a correction
would require a payment to the Internal Revenue Service based on the tax
contract holders would have incurred if they were treated as receiving the
income on the contract for the period during which the diversification
requirements were not satisfied. Any such failure may also result in adverse tax
consequences for the insurance company issuing the contracts. Failure by a fund
to qualify as a regulated investment company would also subject the fund to
federal and state income taxation of all of its taxable income and gain, whether
or not distributed to shareholders.
If "seed money" contributed to any fund in connection with its organization
exceeds $250,000 or under certain other circumstances, the fund will be subject
to a 4% nondeductible federal excise tax on any amounts required to be but not
distributed under a prescribed formula. The formula requires that a fund
distribute (or be deemed to have distributed) to its shareholders during each
calendar year at least 98% of the fund's ordinary income for the calendar year,
at least 98% of the excess of its capital gains over its capital losses realized
during the one-year period ending on October 31 of such year, and any income or
gain (as so computed) from the prior calendar year that was not distributed for
such year and on which the fund paid no income tax. Each fund intends generally
to seek to avoid liability for this tax.
Dividends from net capital gain are classified as long-term capital gain and
dividends from investment company taxable income are classified as ordinary
income for federal income tax purposes. Redemptions of fund shares are also
potentially taxable transactions. An insurance company should consult its own
tax adviser regarding whether these dividends and share redemption proceeds
received by separate accounts result in federal income tax liability for the
insurance company if they are allocated to reserves for, or used to pay
distributions on, the applicable variable contracts.
Any dividend declared by a fund in October, November or December as of a record
date in such a month and paid the following January will be treated for federal
income tax purposes as received by shareholders on December 31 of the year in
which it is declared.
Any dividend (except a daily dividend) paid by a fund shortly after a
shareholder's purchase of shares will have the effect of reducing the net asset
value per share by the amount of the dividend distribution. Although such
dividends are, in effect, a partial return of the shareholder's purchase price,
they may be characterized as ordinary income or capital gain as described above.
If a fund acquires any equity interest in certain foreign corporations that
receive at least 75% of their annual gross income from passive sources (such as
interest, dividends, certain rents and royalties, or capital gains) or hold at
least 50% of their assets in investments producing such passive income ("passive
foreign investment companies"), that fund could be subject to Federal income tax
and additional interest charges on "excess distributions" received from such
companies or gain from the sale of stock in such companies, even if all income
or gain actually received by the fund is timely distributed to its shareholders.
The fund would not be able to pass through to its shareholders any credit or
deduction for such a tax. Certain elections may ameliorate these adverse tax
consequences, but any such election could require the applicable fund to
recognize taxable income or gain (subject to tax distribution requirements)
without the concurrent receipt of cash. These investments could also result in
the treatment of associated capital gains as ordinary income. Any fund that is
permitted to invest in foreign corporations may limit and/or manage its holdings
in passive foreign investment companies to minimize its tax liability or
maximize its return from these investments.
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================================================================================
Foreign exchange gains and losses realized by a fund in connection with certain
transactions involving foreign currency-denominated debt securities, certain
foreign currency futures and options, foreign currency forward contracts,
foreign currencies, or payables or receivables denominated in a foreign currency
are subject to Section 988 of the Code, which generally causes such gains and
losses to be treated as ordinary income and losses and may affect the amount,
timing and character of distributions to shareholders. Any such transactions
that are not directly related to a fund's investment in stock or securities,
possibly including speculative currency positions or currency derivatives not
used for hedging purposes, could under future Treasury regulations produce
income not among the types of "qualifying income" from which the fund must
derive at least 90% of its annual gross income. Income from investments in
commodities, such as gold and certain related derivative instruments, is also
not treated as qualifying income under this test. If the net foreign exchange
loss for a year treated as ordinary loss under Section 988 were to exceed a
fund's investment company taxable income computed without regard to such loss,
the resulting overall ordinary loss for such year would not be deductible by the
fund or its shareholders in future years.
A fund may be subject to withholding and other taxes imposed by foreign
countries with respect to its investments in foreign securities. Tax conventions
between certain countries and the U.S. may reduce or eliminate such taxes in
some cases.
Investments in debt obligations that are at risk of default may present special
tax issues for Investment Grade Bond Fund or Real Estate Fund. Tax rules may not
be entirely clear about issues such as when a fund may cease to accrue interest,
original issue discount, or market discount, when and to what extent deductions
may be taken for bad debts or worthless securities, how payments received on
obligations in default should be allocated between principal and income, and
whether exchanges of debt obligations in a workout context are taxable. These
and any other issues will be addressed by a fund, in the event it invests in
such securities, in order to seek to ensure that it distributes sufficient
income to preserve its status as a regulated investment company and does not
become subject to federal income or excise tax.
Each fund that invests in certain pay in-kind securities ("PIKs") (debt
securities whose interest payments may be made either in cash or in-kind), zero
coupon securities, deferred payment securities, or certain increasing rate
securities (and, in general, any other securities with original issue discount
or with market discount if the fund elects to include market discount in income
currently) must accrue income on such investments prior to the receipt of the
corresponding cash payments. However, each fund must distribute, at least
annually, all or substantially all of its net income, including such accrued
income, to shareholders to qualify as a regulated investment company under the
Code and avoid Federal income tax. Therefore, a fund may have to dispose of its
portfolio securities under disadvantageous circumstances to generate cash, or
may have to leverage itself by borrowing the cash, to satisfy distribution
requirements.
Redemptions and exchanges of fund shares (except, generally, shares of the Money
Market Fund) are potentially taxable transactions for shareholders that are
subject to tax. Shareholders should consult their own tax advisers to determine
whether any particular transaction in fund shares is properly treated as a sale
for tax purposes, as the following discussion assumes, and to ascertain its tax
consequences in their particular circumstances. Any loss realized by a
shareholder upon the redemption, exchange or other disposition of shares with a
tax holding period of six months or less will be treated as a long-term capital
loss to the extent of any amounts treated as distributions of long-term capital
gain with respect to such shares. Losses on redemptions or other dispositions of
shares may be disallowed under wash sale rules in the event of other investments
in the same fund
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(including through automatic reinvestment of dividends and distributions) within
a period of 61 days beginning 30 days before and ending 30 days after a
redemption or other disposition of shares. In such a case, the disallowed
portion of any loss would be included in the federal tax basis of the shares
acquired in the other investments.
Limitations imposed by the Code on regulated investment companies like the funds
may restrict a fund's ability to enter into futures, options and currency
forward transactions.
Certain options, futures and forward foreign currency transactions undertaken by
a fund may cause the fund to recognize gains or losses from marking to market
even though its securities or other positions have not been sold or terminated
and affect the character as long-term or short-term (or, in the case of certain
currency forwards, options and futures, as ordinary income or loss) and timing
of some capital gains and losses realized by the fund. Also, certain of a fund's
losses on its transactions involving options, futures and forward foreign
currency contracts and/or offsetting or successor portfolio positions may be
deferred rather than being taken into account currently in calculating the
fund's taxable income or gains. These transactions may therefore affect the
amount, timing and character of a fund's distributions to shareholders. Certain
of the applicable tax rules may be modified if the fund is eligible and chooses
to make one or more of certain tax elections that may be available. The funds
will take into account the special tax rules (including consideration of
available elections) applicable to options, futures or forward contracts in
order to minimize any potential adverse tax consequences.
The tax rules applicable to dollar rolls, currency swaps and interest rate
swaps, caps, floors and collars may be unclear in some respects, and the funds
may be required to limit participation in such transactions in order to qualify
as regulated investment companies. Additionally, a fund may be required to
recognize gain, but not loss, if an option, collar, futures contract, swap,
short sale or other transaction that is not subject to the market-to-market
rules is treated as a constructive sale of an appreciated financial position in
the fund's portfolio under Section 1259 of the Code. The funds may have to sell
portfolio securities under disadvantageous circumstances to generate cash, or
borrow cash, to satisfy the distribution requirements described above as a
result of participation in some of these transactions and derivatives.
If, as anticipated, each fund qualifies as a regulated investment company under
the Code, it will not be required to pay any Massachusetts income, corporate
excise or franchise taxes or any Delaware corporation income tax.
The foregoing discussion relates solely to U.S. federal income tax law as
applicable to the funds and certain aspects of their distributions. The
discussion does not address special tax rules applicable to insurance companies.
Shareholders should consult their own tax advisers as to the Federal, state or
local tax consequences of ownership or redemption of shares of, and receipt of
distributions from, a fund in their particular circumstances.
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<PAGE>
Brokerage Allocation
================================================================================
Decisions concerning the purchase and sale of portfolio securities and the
allocation of brokerage commissions are made by the adviser and the officers of
the trust pursuant to recommendations made by the portfolio managers. Orders for
purchases and sales of securities are placed in a manner which, in the opinion
of the adviser, will offer the best price and market for the execution of each
transaction. Purchases of portfolio securities from underwriters may include a
commission or commissions paid by the issuer, and transactions with dealers
serving as market makers reflect a "spread."
In the U.S. and some other countries, debt securities are generally traded on a
net basis through dealers acting for their own account as principals and not as
brokers; no brokerage commissions are payable on these transactions. In other
countries, both debt and equity securities are traded on exchanges at fixed
commission rates. Commissions on foreign transactions are generally higher than
the negotiated commission rates available in the U.S. There is generally less
government supervision and regulation of foreign stock exchanges and broker-
dealers than in the U.S.
Purchases and sales of exchange-traded options and futures will be effected
through brokers who charge a commission for their services.
Each fund's primary policy is to execute all purchases and sales of portfolio
instruments at the most favorable prices consistent with best execution,
considering all of the costs of the transaction including brokerage commissions.
This policy governs the selection of brokers and dealers and the market in which
a transaction is executed.
To the extent consistent with the foregoing, each fund will be governed in the
selection of brokers and dealers, and the negotiation of brokerage commission
rates and dealer spreads, by the reliability and quality of the services,
including primarily the availability and value of research information and to a
lesser extent statistical assistance furnished to the adviser, and their value
and expected contribution to the performance of the fund. It is not possible to
place a dollar value on information and services to be received from brokers and
dealers, since it is only supplementary to the research efforts of the adviser.
The receipt of research information is not expected to reduce significantly the
expenses of the adviser. The research information and statistical assistance
furnished by brokers and dealers may benefit Sun Life of Canada or other
advisory clients of the adviser, and conversely, brokerage commissions and
spreads paid by other advisory clients of the adviser may result in research
information and statistical assistance beneficial to the funds. The funds will
not make commitments to allocate portfolio transactions on any prescribed basis.
While the adviser's officers will be primarily responsible for the allocation of
each fund's brokerage business, the policies and practices of the adviser in
this regard must be consistent with the foregoing, and will at all times be
subject to review by the trustees.
As permitted by Section 28(e) of the Securities Exchange Act of 1934, a fund may
pay to a broker which provides brokerage and research services to the fund an
amount of disclosed commission in excess of the commission which another broker
would have charged for effecting that transaction. This practice is subject to a
good faith determination by the adviser that the price is reasonable in light of
the services provided viewed either in terms of the specific transaction
involved in the adviser's overall duties to the accounts or the policies that
the trustees may adopt from time to time.
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Other investment advisory clients advised by the adviser may also invest in the
same securities as the funds. When these clients buy or sell the same securities
at substantially the same time, the adviser may average the transactions as to
price and allocate the amount of available investments in a manner which the
adviser believes to be equitable to each client, including the funds. In
individual instances, this investment procedure may adversely affect the price
to be paid or received by a fund or the size of the position attainable for it.
On the other hand, to the extent permitted by law, the adviser may aggregate
securities to be sold or purchased for the funds with those to be sold or
purchased for other clients managed by it in order to obtain overall best
execution for its participating clients.
For the period ended December 31, 1998, each of the funds paid brokerage
commissions as follows:
<TABLE>
<CAPTION>
Money Market Investment Grade Real Estate
Fund Bond Fund Fund
---- --------- ----
<S> <C> <C> <C>
$ 0 $ 0 $6,262
</TABLE>
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Calculation of Performance Information
================================================================================
Yield (except for Money Market Fund). The yield of each fund (except for Money
Market Fund) is computed by dividing net investment income per share determined
for a 30-day period by the net asset value per share on the last day of the
period, according to the following standard formula:
a - b
Yield = 2 ([ ( ------- ) +1]/6/ -1)
cd
Where:
a = dividends and interest earned during the period.
b = net expenses accrued during the period.
c = the average daily number of fund shares outstanding during the
period that would be entitled to receive dividends.
d = the net asset value per share on the last day of the period.
Money Market Fund Yield. For the purposes of calculating yield for the Money
Market Fund, daily income per share consists of interest and discount earned on
the fund's investments less provision for amortization of premiums and
applicable expenses, divided by the number of shares outstanding, but does not
include realized or unrealized appreciation or depreciation.
Yield calculations are based on the value of a hypothetical preexisting account
with exactly one share at the beginning of the seven day period. Yield is
computed by determining the net change in the value of the account during the
base period and dividing the net change by the value of the account at the
beginning of the base period to obtain the base period return. Base period is
multiplied by 365/7 and the resulting figure is carried to the nearest 100th of
a percent. Net change in account value during the base period includes dividends
declared on the original share, dividends declared on any shares purchased with
dividends of that share and any account or sales charges that would affect an
account of average size, but excludes any capital changes. The yield of Money
Market Fund for the seven-day period ended December 31, 1998 was 4.48%.
Effective yield is computed by determining the net change, exclusive of capital
changes, in the value of a hypothetical preexisting account having a balance of
one share at the beginning of the period, subtracting a hypothetical charge
reflecting deductions from shareholder accounts, and dividing the difference by
the value of the account at the beginning of the base period to obtain the base
period return, and then compounding the base period return by adding 1, raising
the sum to a power equal to 365 divided by 7, and subtracting 1 from the result,
according to the following formula:
Effective Yield = [(Base Period Return + 1)/365/7/]-1
The effective yield of Money Market Fund for the seven-day period ended December
31, 1998 was 4.57%.
Total Return. Each fund's total return is computed by finding the average
annual compounded rate of return over the indicated period that would equate the
initial amount invested to the ending redeemable value according to the
following formula:
T = /N/(SQUARE ROOT) ERV/P - 1
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Where:
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 investment made
at the beginning of the indicated period.
This calculation assumes that all dividends and distributions are reinvested at
net asset value on the reinvestment dates during the period. The "distribution
rate" is determined by annualizing the result of dividing the declared dividends
of a fund during the period stated by the net asset value at the end of the
period.
The average annual total return for each fund for the one-year period, five-year
period and ten-year period since inception to December 31, 1998 was as
follows:
<TABLE>
<CAPTION>
Period 5-Year Period 10-Year Period
Ended Ended Ended Inception to
Fund 12/31/98(1) 12/31/98 12/31/98 12/31/98 (1)
---- ---------- -------- -------- ------------
<S> <C> <C> <C> <C>
Money Market Fund 4.48% N/A N/A 4.48%
Investment Grade Bond Fund 0.61% N/A N/A 0.61%
Real Estate Fund (10.30)% N/A N/A (10.30)%
</TABLE>
(1) Inception of each fund was December 7, 1998.
In addition to average annual total returns, a fund may quote unaveraged or
cumulative total returns reflecting the simple change in value of an investment
over a stated period. Cumulative total returns may be quoted as a percentage or
as a dollar amount, and may be calculated for a single investment, a series of
investments, and/or a series of redemptions, over any time period.
Total returns and yields quoted for the funds include each fund's expenses, but
may not include charges and expenses attributable to any particular insurance
product. Since shares of the funds may be purchased only through variable
annuity contracts and variable life insurance policies, you should carefully
review the prospectus of the insurance product you have chosen for information
on relevant charges and expenses. Excluding these charges from quotations of
each fund's performance has the effect of increasing the performance quoted. You
should bear in mind the effect of these charges when comparing a fund's
performance to that of other mutual funds.
From time to time, in reports and promotional literature, a fund's yield and
total return will be compared to indices of mutual funds and other relevant
broad based indices.
Performance rankings and ratings reported periodically in national financial
publications such as Money Magazine, Forbes, Business Week, The Wall Street
Journal, Micropal, Inc., Morningstar, Stanger's and Barron's, etc. will also be
utilized. A fund's promotional and sales literature may make reference to the
fund's "beta." Beta reflects the market-related risk of the fund by showing how
responsive the fund is to the market.
The performance of a fund is not fixed or guaranteed. Performance quotations
should not be considered to be representations of performance of a fund for any
period in the future. The performance of a fund is a function of many factors
including its earnings, expenses and number of outstanding shares. Fluctuating
market conditions; purchases, sales and maturities of portfolio securities;
sales and redemptions of shares of beneficial interest; and changes in operating
expenses are all examples of items that can increase or decrease a fund's
performance.
Financial Statements
Each fund's audited financial statements for the fiscal year ended
December 31, 1998 from the funds' annual reports filed with the SEC on February
26, 1999 are incorporated by reference into this statement of additional
information. Those financial statements, including the financial highlights in
the prospectuses, have been audited by Deloitte & Touche LLP, independent public
accountants, as indicated in their report with respect to the financial
statements and are included in reliance upon the authority of Deloitte & Touche
LLP as experts in accounting and auditing in giving their report.
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Appendix A
MOODY'S INVESTORS SERVICE, INC.
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 edge." 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 fluctuations of protective elements
may be of greater amplitude or there may be other elements present which make
the long-term risks appear somewhat larger than in Aaa securities.
A: Bonds which are rated A possess many favorable investment attributes and are
to be considered as upper medium grade obligations. Factors giving security to
principal and interest are considered adequate but elements may be present which
suggest a susceptibility to impairment at 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 the characteristics of 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.
STANDARD & POOR'S RATINGS GROUP
AAA: Debt rated AAA has the highest rating assigned by Standard & Poor's.
Capacity to pay interest and repay principal is extremely strong.
AA: Debt rated AA has a very strong capacity to pay interest and repay
principal and differs from the highest rated issues only in small degree.
A: Debt rated A has a strong capacity to pay interest and repay principal,
although it is somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions than debt in higher rated categories.
A-1
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BBB: Debt rated BBB is regarded as having an adequate capacity to pay interest
and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead a weakened capacity to pay interest and repay principal for debt
in this category than in higher rated categories.
BB, B: Debt rated BB and B is regarded, on balance, as predominantly
speculative with respect to capacity to pay interest and repay principal in
accordance with the terms of the obligation. BB indicates the lowest degree of
speculation and CC the highest degree of speculation. While such debt will
likely have some quality and protective characteristics, these are outweighed by
large uncertainties or major risk exposures to adverse conditions.
DUFF & PHELPS CREDIT RATING CO.
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 strong. Risk is modest but
may vary slightly from time to time because of economic conditions.
A: Protection factors are average but adequate. However, risk factors are more
variable and greater in periods of economic stress.
BBB: Below average protection factors but still considered sufficient for
prudent investment. Considerable variability in risk during economic cycles.
BB: Below investment grade but deemed likely to meet obligations when due.
Present or prospective financial protection factors fluctuate according to
industry conditions or company fortunes. Overall quality may move up or down
frequently within this category.
FitchIBCA
AAA: Bonds considered to be investment grade and of the highest credit quality.
The obligor has an exceptionally strong ability to pay interest and repay
principal, which is unlikely to be affected by reasonably foreseeable events.
AA: Bonds considered to be investment grade and of very high credit quality.
The obligor's ability to pay interest and repay principal is very strong,
although not quite as strong as bonds rated AAA. Because bonds rated in the AAA
and AA categories are not significantly vulnerable to foreseeable future
development, short-term debt of these issuers is generally rated F-1+.
A: Bonds considered to be investment grade and of high credit quality. The
obligor's ability to pay interest and repay principal is considered to be
strong, but may be more vulnerable to adverse changes in economic conditions and
circumstances than bonds with higher ratings.
BBB: Bonds considered to be investment grade and of satisfactory credit
quality. The obligor's ability to pay interest and repay principal is
considered to be adequate. Adverse changes in economic conditions and
circumstances, however, are more likely to have adverse impact on these bonds,
and
A-2
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therefore impair timely payment. The likelihood that the ratings of these bonds
will fall below investment grade is higher than for bonds with higher ratings.
BB: Bonds are considered speculative. The obligor's ability to pay interest
and repay principal may be affected over time by adverse economic changes.
however, business and financial alternatives can be identified which could
assist the obligor satisfying its debt service requirements.
B: Bonds are considered highly speculative, 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 development.
A-3
