Farmers Mutual Fund
Portfolios
o Income Portfolio
o Income with Growth Portfolio
o Balanced Portfolio
o Growth with Income Portfolio
o Growth Portfolio
Prospectus
September 1, 2000
Mutual funds:
o are not FDIC-insured
o have no bank guarantees
o may lose value
As with all mutual funds, the Securities and Exchange Commission (SEC) does
not approve or disapprove these shares or determine whether the information
in this prospectus is truthful or complete. It is a criminal offense for
anyone to inform you otherwise.
<PAGE>
Farmers Mutual Fund Portfolios
How the portfolios work
4 Income Portfolio
9 Income with Growth Portfolio
16 Balanced Portfolio
23 Growth with Income Portfolio
29 Growth Portfolio
34 Other Policies and Risks
35 Who Manages and Oversees the Portfolios
37 Financial Highlights
How to invest in the portfolios
48 Choosing a Share Class
53 How to Buy Shares
53 How to Exchange or Sell Shares
54 Policies You Should Know About
58 Understanding Distributions and Taxes
<PAGE>
How the portfolios work
These portfolios use an asset allocation strategy, dividing their
assets among different types of investments. All five portfolios
invest in a select group of underlying mutual funds that are either
affiliated with Scudder Kemper or are unaffiliated. Each portfolio
is designed for investors with a particular time horizon or risk
profile, and invests in a distinct mix of funds. Because the
underlying funds hold a range of securities, an investment in a
portfolio may offer exposure to thousands of individual securities.
Remember that mutual funds are investments, not bank deposits.
They're not insured or guaranteed by the FDIC or any other
government agency, and you could lose money by investing in them.
<PAGE>
--------------------------------------------------------------------------------
fund number | Class A 601
| Class B 701
Income Portfolio
--------------------------------------------------------------------------------
Investment Approach
The portfolio seeks a high level of current income. It does this by
investing mainly in a select group of underlying bond mutual funds,
including short- and long-term bond funds, government bond funds, high
yield bond funds and international bond funds.
The portfolio may at times concentrate in a particular underlying fund.
The portfolio has a target allocation, which the portfolio managers use
as a reference point in setting the portfolio's actual allocation.
While the actual allocation may vary, the managers expect that over the
long term it will average out to be similar to the target allocation.
The managers regularly review the actual allocation, and may adjust it
in seeking to take advantage of current or expected market conditions
or to manage risk. In making their allocation decisions, the managers
take a top-down approach, looking at the outlooks for various
securities markets and segments of those markets. Based on the desired
exposure to particular investments, the managers then decide which
funds to use as underlying funds and how much to invest in each fund.
The portfolio's underlying funds use a broad array of investment
styles, emphasizing high-grade bonds. These funds can buy many types of
income-producing securities, among them, corporate bonds of varying
credit qualities and maturities, U.S. government and agency bonds,
mortgage- and asset-backed securities, money market instruments, and
others. These securities are mainly from U.S. issuers but may be from
foreign issuers.
The managers of the underlying funds generally may adjust the duration
(a measure of sensitivity to interest rates) of a fund's bond
allocation depending on their outlook for interest rates, and the
portfolio's allocation among the underlying funds may similarly be
adjusted.
THE FOLLOWING SIDEBAR TEXT APPEARS NEXT TO THE PRECEDING PARAGRAPHS.
--------------------------------------------------------------------------------
ASSET ALLOCATION
The portfolio's target allocation is as follows:
THE ORIGINAL DOCUMENT CONTAINS A PIE CHART HERE
PIE CHART DATA:
Bond funds 97%
Money funds 3%
The managers have the flexibility to adjust this allocation within the following
ranges:
Bond funds 80%-100%
Money funds 0%-20%
4 | Income Portfolio
<PAGE>
--------------------------------------------------------------------------------
This portfolio may make sense for investors who have a time
horizon of one to three years or more and who are interested in
taking an asset allocation approach to income investing.
--------------------------------------------------------------------------------
Main Risks to Investors
There are several risk factors that could reduce the yield you get from
the portfolio, cause you to lose money or make the portfolio perform
less well than other investments.
As with most bond funds, the most important factor is market interest
rates. A rise in interest rates generally means a fall in bond prices
and, in turn, a fall in the value of your investment. (As a general
rule, a 1% rise in interest rates means a 1% fall in value for every
year of duration.) An increase in an underlying fund's duration would
make the portfolio more sensitive to this risk.
Certain underlying funds in which the portfolio invests may invest in
bonds that are not considered investment grade (i.e., grade BB/Ba and
below). Non-investment grade bonds, commonly known as "junk bonds," may
pay higher yields and have higher volatility and risk of default.
Other factors that could affect performance include:
o the managers of the portfolio or an underlying fund could be
wrong in their analysis of economic trends, issuers,
industries or other matters
o a bond could decline in credit quality or go into default;
this risk is greater with junk and foreign bonds
o some types of bonds could be paid off substantially earlier
than expected, which would hurt portfolio performance; with
mortgage- or asset-backed securities, any unexpected behavior
in interest rates could hurt performance, increasing the
volatility of the portfolio's share price and yield
o derivatives that the underlying funds may use could produce
disproportionate losses
o at times, it could be hard for an underlying fund to value
some investments or to get an attractive price for them
o foreign securities may be more volatile than their U.S.
counterparts, for reasons such as currency fluctuations and
political and economic uncertainty
5 | Income Portfolio
<PAGE>
The Fund's Track Record
Because this portfolio does not have a full calendar year of
performance to report as of the date of this prospectus, no bar chart
and performance table are provided.
6 | Income Portfolio
<PAGE>
How Much Investors Pay
This table describes the fees and expenses that you may pay if you buy
and hold shares of the portfolio. Each class of shares of the portfolio
has a single fee covering investment management and other operating
expenses, but not covering interest, taxes, and compensation and
expenses of the Trustees. This fee rate will not fluctuate. The
portfolio's shareholders will indirectly bear the pro rata share of
fees and expenses incurred by the underlying funds in which the
portfolio is invested.
-------------------------------------------------------------------
Fee Table Class A Class B
-------------------------------------------------------------------
Shareholder Fees (paid directly from your investment)
-------------------------------------------------------------------
Maximum sales charge (load) imposed on 5.00% None
purchases (as % of offering price)
-------------------------------------------------------------------
Maximum deferred sales charge (load) None* 4.00%
-------------------------------------------------------------------
Annual Operating Expenses (deducted from portfolio assets)
-------------------------------------------------------------------
Management Fee 0.75% 0.75%
-------------------------------------------------------------------
Distribution (12b-1) and Service Fees 0.25% 1.00%
-------------------------------------------------------------------
Other Expenses** 3.92% 3.92%
------------------------
-------------------------------------------------------------------
Total Annual Operating Expenses 4.92% 5.67%
-------------------------------------------------------------------
Expense Reimbursement*** 3.92% 3.92%
------------------------
-------------------------------------------------------------------
Net Expenses 1.00% 1.75%
-------------------------------------------------------------------
* The redemption of shares purchased at net asset value under
the Large Order NAV Purchase Privilege (see "Policies You
Should Know About -- Policies about transactions") may be
subject to a contingent deferred sales charge of 1% if
redeemed within one year of purchase and 0.50% if redeemed
during the second year following purchase.
** Includes compensation and expenses of the Trustees.
*** By contract, compensation and expenses of the Trustees are
reimbursed by the adviser until the portfolio's assets reach
$50,000,000.
The range for the average weighted expense ratio borne by the portfolio
in connection with its investments in the underlying funds is expected
to be 0.43% to 0.87%. The range has been restated to reflect new fixed
rate administrative fees for certain affiliated underlying funds. This
information is provided as a range since the average assets of the
portfolio invested in each of the underlying funds will fluctuate.
7 | Income Portfolio
<PAGE>
-----------------------------------------------------------------------
Expense Example
-----------------------------------------------------------------------
This example helps you compare each share class's expenses to those of
other portfolios. The example illustrates the impact of the total
estimated pro rata fees and expenses (including both portfolio and
underlying fund fees and expenses) on an account with an initial
investment of $10,000, based on the portfolio fees and operating
expenses and the midpoint of the range of expenses expected to be borne
by the portfolio in connection with its investments in the underlying
funds (discussed above). It assumes a 5% annual return, the
reinvestment of all dividends and distributions and "total annual
operating expenses" remaining the same each year, and includes one year
of reimbursed expenses in each period. This is only an example; your
actual expenses will be different.
-----------------------------------------------------------------------
1 Year 3 Years 5 Years 10 Years
-----------------------------------------------------------------------
Expenses, assuming you sold your shares at the end of each period
-----------------------------------------------------------------------
Class A shares $659 $1,747 $2,822 $5,457
-----------------------------------------------------------------------
Class B shares 643 1,823 2,969 4,057
-----------------------------------------------------------------------
Expenses, assuming you kept your shares
-----------------------------------------------------------------------
Class A shares $659 $1,747 $2,822 $5,457
-----------------------------------------------------------------------
Class B shares 243 1,523 2,769 4,057
-----------------------------------------------------------------------
8 | Income Portfolio
<PAGE>
--------------------------------------------------------------------------------
fund number | Class A 602
| Class B 702
Income with Growth Portfolio
--------------------------------------------------------------------------------
Investment Approach
The portfolio seeks current income and, as a secondary objective,
long-term growth of capital. It does this by investing substantially in
a select group of underlying bond mutual funds and, to a lesser extent,
equity mutual funds. The portfolio may at times concentrate in a
particular underlying fund.
The portfolio has a target allocation, which the portfolio managers use
as a reference point in setting the portfolio's actual allocation.
While the actual allocation may vary, the managers expect that over the
long term it will average out to be similar to the target allocation.
The managers regularly review the actual allocation, and may adjust it
in seeking to take advantage of current or expected market conditions
or to manage risk. In making their allocation decisions, the managers
take a top-down approach, looking at the outlooks for various
securities markets and segments of those markets. Based on the desired
exposure to particular investments, the managers then decide which
funds to use as underlying funds and how much to invest in each fund.
The portfolio's underlying funds use a broad array of investment
styles. These funds can buy many types of securities, among them common
stocks of companies of any size, corporate bonds of varying credit
qualities and maturities, U.S. government and agency bonds, mortgage-
and asset-backed securities, money market instruments, and others.
These securities are mainly from U.S. issuers but may be from foreign
issuers.
THE FOLLOWING SIDEBAR TEXT APPEARS NEXT TO THE PRECEDING PARAGRAPHS.
--------------------------------------------------------------------------------
ASSET ALLOCATION
The portfolio's target allocation is as follows:
THE ORIGINAL DOCUMENT CONTAINS A PIE CHART HERE
PIE CHART DATA:
Bond funds 69%
Equity funds 30%
Money funds 1%
The managers have the flexibility to adjust this allocation within the following
ranges:
Bond funds 60%-80%
Equity funds 20%-40%
Money funds 0%-15%
9 | Income with Growth Portfolio
<PAGE>
With respect to the equity portion of the portfolio, the portfolio
shifts assets between the growth and value components of its holdings
based on the portfolio managers' analysis of relevant market, financial
and economic conditions. If the portfolio managers believe that value
securities (those that are priced low in light of certain valuation
measures) may provide better yields than the returns then available or
expected on growth stocks (those that are selected primarily for their
growth potential), the portfolio will place a greater emphasis on the
value component of its holdings.
The managers of the underlying funds generally may adjust the duration
(a measure of sensitivity to interest rates) of a fund's bond
allocation depending on their outlook for interest rates, and the
portfolio's allocation among the underlying funds may similarly be
adjusted.
10 | Income with Growth Portfolio
<PAGE>
--------------------------------------------------------------------------------
This portfolio may make sense for investors who have a time horizon of
three to five years or more and who are interested in taking an asset
allocation approach to investing.
--------------------------------------------------------------------------------
Main Risks to Investors
There are several risk factors that could reduce the yield you get from
the portfolio, cause you to lose money or make the portfolio perform
less well than other investments.
As with most bond funds, the most important factor is market interest
rates. A rise in interest rates generally means a fall in bond prices
and, in turn, a fall in the value of your investment. (As a general
rule, a 1% rise in interest rates means a 1% fall in value for every
year of duration.) An increase in an underlying fund's duration would
make the portfolio more sensitive to this risk.
Certain underlying funds in which the portfolio invests may invest in
bonds that are not considered investment grade (i.e., grade BB/Ba and
below). Non-investment grade bonds, commonly known as "junk bonds," may
pay higher yields and have higher volatility and risk of default.
With the equity portion of the portfolio, one of the most important
factors is how stock markets perform. When stock prices fall, you
should expect the value of your investment to fall as well. Because a
stock represents ownership in its issuer, stock prices can be hurt by
poor management, shrinking product demand and other business risks.
These may affect single companies as well as groups of companies.
To the extent that the portfolio invests in an underlying fund that
invests in a given industry or a particular size of company, factors
affecting that industry or size of company could affect portfolio
securities. For example, a rise in unemployment could hurt
manufacturers of consumer goods, and large company stocks at times may
not perform as well as stocks of smaller companies.
11 | Income with Growth Portfolio
<PAGE>
Other factors that could affect performance include:
o the managers of the portfolio or an underlying fund could be
wrong in their analysis of economic trends, issuers,
industries or other matters
o a bond could decline in credit quality or go into default;
this risk is greater with junk and foreign bonds
o some types of bonds could be paid off substantially earlier
than expected, which would hurt portfolio performance; with
mortgage- or asset-backed securities, any unexpected behavior
in interest rates could hurt performance, increasing the
volatility of the portfolio's share price and yield
o derivatives that the underlying funds may use could produce
disproportionate losses
o at times, it could be hard for an underlying fund to value
some investments or to get an attractive price for them
o foreign securities may be more volatile than their U.S.
counterparts, for reasons such as currency fluctuations and
political and economic uncertainty
12 | Income with Growth Portfolio
<PAGE>
The Fund's Track Record
Because this portfolio does not have a full calendar year of
performance to report as of the date of this prospectus, no bar chart
and performance table are provided.
13 | Income with Growth Portfolio
<PAGE>
How Much Investors Pay
This table describes the fees and expenses that you may pay if you buy
and hold shares of the portfolio. Each class of shares of the portfolio
has a single fee covering investment management and other operating
expenses, but not covering interest, taxes, and compensation and
expenses of the Trustees. This fee rate will not fluctuate. The
portfolio's shareholders will indirectly bear the pro rata share of
fees and expenses incurred by the underlying funds in which the
portfolio is invested.
-----------------------------------------------------------------------
Fee Table Class A Class B
-----------------------------------------------------------------------
Shareholder Fees (paid directly from your investment)
-----------------------------------------------------------------------
Maximum sales charge (load) imposed on 5.25% None
purchases (as % of offering price)
-----------------------------------------------------------------------
Maximum deferred sales charge (load) None* 4.00%
-----------------------------------------------------------------------
Annual Operating Expenses (deducted from portfolio assets)
-----------------------------------------------------------------------
Management Fee 0.75% 0.75%
-----------------------------------------------------------------------
Distribution (12b-1) and Service Fees 0.25% 1.00%
-----------------------------------------------------------------------
Other Expenses** 1.41% 1.41%
----------------------------
-----------------------------------------------------------------------
Total Annual Operating Expenses 2.41% 3.16%
-----------------------------------------------------------------------
Expense Reimbursement*** 1.41% 1.41%
----------------------------
-----------------------------------------------------------------------
Net Expenses 1.00% 1.75%
-----------------------------------------------------------------------
* The redemption of shares purchased at net asset value under
the Large Order NAV Purchase Privilege (see "Policies You
Should Know About -- Policies about transactions") may be
subject to a contingent deferred sales charge of 1% if
redeemed within one year of purchase and 0.50% if redeemed
during the second year following purchase.
** Includes compensation and expenses of the Trustees.
*** By contract, compensation and expenses of the Trustees are
reimbursed by the adviser until the portfolio's assets reach
$50,000,000.
The range for the average weighted expense ratio borne by the portfolio
in connection with its investments in the underlying funds is expected
to be 0.54% to 0.88%. The range has been restated to reflect new fixed
rate administrative fees for certain affiliated underlying funds. This
information is provided as a range since the average assets of the
portfolio invested in each of the underlying funds will fluctuate.
14 | Income with Growth Portfolio
<PAGE>
-----------------------------------------------------------------------
Expense Example
-----------------------------------------------------------------------
This example helps you compare each share class's expenses to those of
other portfolios. The example illustrates the impact of the total
estimated pro rata fees and expenses (including both portfolio and
underlying fund fees and expenses) on an account with an initial
investment of $10,000, based on the portfolio fees and operating
expenses and the midpoint of the range of expenses expected to be borne
by the portfolio in connection with its investments in the underlying
funds (discussed above). It assumes a 5% annual return, the
reinvestment of all dividends and distributions and "total annual
operating expenses" remaining the same each year, and includes one year
of reimbursed expenses in each period. This is only an example; your
actual expenses will be different.
-----------------------------------------------------------------------
1 Year 3 Years 5 Years 10 Years
-----------------------------------------------------------------------
Expenses, assuming you sold your shares at the end of each period
-----------------------------------------------------------------------
Class A shares $690 $1,312 $1,958 $3,682
-----------------------------------------------------------------------
Class B shares 649 1,352 2,073 3,082
-----------------------------------------------------------------------
Expenses, assuming you kept your shares
-----------------------------------------------------------------------
Class A shares $690 $1,312 $1,958 $3,682
-----------------------------------------------------------------------
Class B shares 249 1,052 1,873 3,082
-----------------------------------------------------------------------
15 | Income with Growth Portfolio
<PAGE>
--------------------------------------------------------------------------------
fund number | Class A 603
| Class B 703
Balanced Portfolio
--------------------------------------------------------------------------------
Investment Approach
The portfolio seeks a balance of current income and long-term growth of
capital. It does this by investing mainly in a select mix of underlying
equity and bond mutual funds. The portfolio may at times concentrate in
a particular underlying fund.
The portfolio has a target allocation, which the portfolio managers use
as a reference point in setting the portfolio's actual allocation.
While the actual allocation may vary, the managers expect that over the
long term it will average out to be similar to the target allocation.
At all times the portfolio will indirectly be invested at least 25% in
fixed-income senior securities.
The managers regularly review the actual allocation, and may adjust it
in seeking to take advantage of current or expected market conditions
or to manage risk. In making their allocation decisions, the managers
take a top-down approach, looking at the outlooks for various
securities markets and segments of those markets. Based on the desired
exposure to particular investments, the managers then decide which
funds to use as underlying funds and how much to invest in each fund.
The portfolio's underlying funds use a broad array of investment
styles. These funds can buy many types of securities, among them common
stocks of companies of any size, corporate bonds of varying credit
qualities and maturities, U.S. government and agency bonds, mortgage-
and asset-backed securities, money market instruments, and others.
These securities are mainly from U.S. issuers but may be from foreign
issuers.
THE FOLLOWING SIDEBAR TEXT APPEARS NEXT TO THE PRECEDING PARAGRAPHS.
--------------------------------------------------------------------------------
ASSET ALLOCATION
The portfolio's target allocation is as follows:
THE ORIGINAL DOCUMENT CONTAINS A PIE CHART HERE
PIE CHART DATA:
Bond funds 49%
Equity funds 50%
Money funds 1%
The managers have the flexibility to adjust this allocation within the following
ranges:
Bond funds 40%-60%
Equity funds 40%-60%
Money funds 0%-10%
16 | Balanced Portfolio
<PAGE>
With respect to the equity portion of the portfolio, the portfolio
shifts assets between the growth and value components of its holdings
based on the portfolio managers' analysis of relevant market, financial
and economic conditions. If the portfolio managers believe that value
securities (those that are priced low in light of certain valuation
measures) may provide better yields than the returns then available or
expected on growth stocks (those that are selected primarily for their
growth potential), the portfolio will place a greater emphasis on the
value component of its holdings.
The managers of the underlying funds generally may adjust the duration
(a measure of sensitivity to interest rates) of a fund's bond
allocation depending on their outlook for interest rates, and the
portfolio's allocation among the underlying funds may similarly be
adjusted.
17 | Balanced Portfolio
<PAGE>
--------------------------------------------------------------------------------
Investors who have a time horizon of three to five years or more and
are seeking a balanced asset allocation investment may be interested in
this portfolio.
--------------------------------------------------------------------------------
Main Risks to Investors
There are several risk factors that could hurt the portfolio's
performance, cause you to lose money or make the portfolio perform less
well than other investments.
One of the most important factors with this portfolio is how stock
markets perform. When stock prices fall, you should expect the value of
your investment to fall as well. Large company stocks at times may not
perform as well as stocks of smaller or mid-size companies. Because a
stock represents ownership in its issuer, stock prices can be hurt by
poor management, shrinking product demand and other business risks.
These may affect single companies as well as groups of companies.
With the bond fund portion of the portfolio, the most important factor
is market interest rates. A rise in interest rates generally means a
fall in bond fund prices and, in turn, a fall in the value of your
investment. (As a general rule, a 1% rise in interest rates means a 1%
fall in value for every year of duration.) An increase in an underlying
fund's dollar-weighted average maturity could make the portfolio more
sensitive to this risk. To the extent that the portfolio invests in
underlying funds that invest in bonds from any given industry, it could
be hurt if that industry does not do well.
To the extent that the portfolio invests in an underlying fund that
invests in a given industry or a particular size of company, factors
affecting that industry or size of company could affect portfolio
securities. For example, a rise in unemployment could hurt
manufacturers of consumer goods, and large company stocks at times may
not perform as well as stocks of smaller companies.
18 | Balanced Portfolio
<PAGE>
Other factors that could affect performance include:
o the managers of the portfolio or an underlying fund could be
wrong in their analysis of economic trends, industries,
companies, the relative attractiveness of stocks and bonds or
other matters
o to the extent that the portfolio invests for income, it may
miss opportunities in faster-growing stocks
o a bond could decline in credit quality or go into default;
this risk is greater with lower-rated bonds
o derivatives that the underlying funds may use could produce
disproportionate losses
o at times, it could be hard for an underlying fund to value
some investments or to get an attractive price for them
o foreign securities may be more volatile than their U.S.
counterparts, for reasons such as currency fluctuations and
political and economic uncertainty
19 | Balanced Portfolio
<PAGE>
The Fund's Track Record
Because this portfolio does not have a full calendar year of
performance to report as of the date of this prospectus, no bar chart
and performance table are provided.
20 | Balanced Portfolio
<PAGE>
How Much Investors Pay
This table describes the fees and expenses that you may pay if you buy
and hold shares of the portfolio. Each class of shares of the portfolio
has a single fee covering investment management and other operating
expenses, but not covering interest, taxes, and compensation and
expenses of the Trustees. This fee rate will not fluctuate. The
portfolio's shareholders will indirectly bear the pro rata share of
fees and expenses incurred by the underlying funds in which the
portfolio is invested.
-----------------------------------------------------------------------
Fee Table Class A Class B
-----------------------------------------------------------------------
Shareholder Fees (paid directly from your investment)
-----------------------------------------------------------------------
Maximum sales charge (load) imposed on 5.75% None
purchases (as % of offering price)
-----------------------------------------------------------------------
Maximum deferred sales charge (load) None* 4.00%
-----------------------------------------------------------------------
Annual Operating Expenses (deducted from portfolio assets)
-----------------------------------------------------------------------
Management Fee 0.75% 0.75%
-----------------------------------------------------------------------
Distribution (12b-1) and Service Fees 0.25% 1.00%
-----------------------------------------------------------------------
Other Expenses** 0.95% 0.95%
----------------------------
-----------------------------------------------------------------------
Total Annual Operating Expenses 1.95% 2.70%
-----------------------------------------------------------------------
Expense Reimbursement*** 0.95% 0.95%
----------------------------
-----------------------------------------------------------------------
Net Expenses 1.00% 1.75%
-----------------------------------------------------------------------
* The redemption of shares purchased at net asset value under
the Large Order NAV Purchase Privilege (see "Policies You
Should Know About -- Policies about transactions") may be
subject to a contingent deferred sales charge of 1% if
redeemed within one year of purchase and 0.50% if redeemed
during the second year following purchase.
** Includes compensation and expenses of the Trustees.
*** By contract, compensation and expenses of the Trustees are
reimbursed by the adviser until the portfolio's assets reach
$50,000,000.
The range for the average weighted expense ratio borne by the portfolio
in connection with its investments in the underlying funds is expected
to be 0.59% to 0.88%. The range has been restated to reflect new fixed
rate administrative fees for certain affiliated underlying funds. This
information is provided as a range since the average assets of the
portfolio invested in each of the underlying funds will fluctuate.
21 | Balanced Portfolio
<PAGE>
-----------------------------------------------------------------------
Expense Example
-----------------------------------------------------------------------
This example helps you compare each share class's expenses to those of
other portfolios. The example illustrates the impact of the total
estimated pro rata fees and expenses (including both portfolio and
underlying fund fees and expenses) on an account with an initial
investment of $10,000, based on the portfolio fees and operating
expenses and the midpoint of the range of expenses expected to be borne
by the portfolio in connection with its investments in the underlying
funds (discussed above). It assumes a 5% annual return, the
reinvestment of all dividends and distributions and "total annual
operating expenses" remaining the same each year, and includes one year
of reimbursed expenses in each period. This is only an example; your
actual expenses will be different.
-----------------------------------------------------------------------
1 Year 3 Years 5 Years 10 Years
-----------------------------------------------------------------------
Expenses, assuming you sold your shares at the end of each period
-----------------------------------------------------------------------
Class A shares $742 $1,277 $1,838 $3,358
-----------------------------------------------------------------------
Class B shares 652 1,268 1,907 2,908
-----------------------------------------------------------------------
Expenses, assuming you kept your shares
-----------------------------------------------------------------------
Class A shares $742 $1,277 $1,838 $3,358
-----------------------------------------------------------------------
Class B shares 252 968 1,707 2,908
-----------------------------------------------------------------------
22 | Balanced Portfolio
<PAGE>
--------------------------------------------------------------------------------
fund number | Class A 604
| Class B 704
--------------------------------------------------------------------------------
Growth with Income Portfolio
Investment Approach
The portfolio seeks long-term growth of capital and modest income. It
does this by investing primarily in a select group of underlying equity
mutual funds and, to a lesser extent, bond mutual funds.
The portfolio may at times concentrate in a particular underlying fund.
The portfolio has a target allocation, which the portfolio managers use
as a reference point in setting the portfolio's actual allocation.
While the actual allocation may vary, the managers expect that over the
long term it will average out to be similar to the target allocation.
The managers regularly review the actual allocation, and may adjust it
in seeking to take advantage of current or expected market conditions
or to manage risk. In making their allocation decisions, the managers
take a top-down approach, looking at the outlooks for various
securities markets and segments of those markets. Based on the desired
exposure to particular investments, the managers then decide which
funds to use as underlying funds and how much to invest in each fund.
The portfolio's underlying funds use a broad array of investment
styles. These funds can buy many types of securities, among them common
stocks of companies of any size, corporate bonds of varying credit
qualities and maturities, U.S. government and agency bonds, mortgage-
and asset-backed securities, money market instruments, and others.
These securities are mainly from U.S. issuers but may be from foreign
issuers.
The managers of the underlying funds generally may adjust the duration
(a measure of sensitivity to interest rates) of a fund's bond
allocation depending on their outlook for interest rates, and the
portfolio's allocation among the underlying funds may similarly be
adjusted.
THE FOLLOWING SIDEBAR TEXT APPEARS NEXT TO THE PRECEDING PARAGRAPHS.
--------------------------------------------------------------------------------
ASSET ALLOCATION
The portfolio's target allocation is as follows:
THE ORIGINAL DOCUMENT CONTAINS A PIE CHART HERE
PIE CHART DATA:
Equity funds 70%
Bond funds 29%
Money funds 1%
The managers have the flexibility to adjust this allocation within the following
ranges:
Equity funds 60%-80%
Bond funds 20%-40%
Money funds 0%-10%
23 | Growth with Income Portfolio
<PAGE>
--------------------------------------------------------------------------------
This portfolio may make sense for investors who have a time horizon of
five years or more, and are seeking an asset allocation approach to
investing.
--------------------------------------------------------------------------------
Main Risks to Investors
There are several risk factors that could hurt the portfolio's
performance, cause you to lose money or make the portfolio perform less
well than other investments.
As with most stock funds, the most important factor with this portfolio
is how stock markets perform. When stock prices fall, you should expect
the value of your investment to fall as well. Large company stocks at
times may not perform as well as stocks of smaller or mid-size
companies. Because a stock represents ownership in its issuer, stock
prices can be hurt by poor management, shrinking product demand and
other business risks. These may affect single companies as well as
groups of companies.
With the bond portion of the portfolio, the most important factor is
market interest rates. A rise in interest rates generally means a fall
in bond prices and, in turn, a fall in the value of your investment.
(As a general rule, a 1% rise in interest rates means a 1% fall in
value for every year of duration.) An increase in an underlying fund's
dollar-weighted average maturity could make the portfolio more
sensitive to this risk. To the extent that the portfolio invests in
bonds from any given industry, it could be hurt if that industry does
not do well.
To the extent that the portfolio invests in an underlying fund that
invests in a given industry or a particular size of company, factors
affecting that industry or size of company could affect portfolio
securities. For example, a rise in unemployment could hurt
manufacturers of consumer goods, and large company stocks at times may
not perform as well as stocks of smaller companies.
24 | Growth with Income Portfolio
<PAGE>
Other factors that could affect performance include:
o the managers of the portfolio or an underlying fund could be
wrong in their analysis of economic trends, industries,
companies or other matters
o to the extent that the portfolio invests for income, it may
miss opportunities in faster-growing stocks
o a bond could decline in credit quality or go into default;
this risk is greater with lower-rated bonds
o derivatives that the underlying funds may use could produce
disproportionate losses
o at times, it could be hard for an underlying fund to value
some investments or to get an attractive price for them
o foreign securities may be more volatile than their U.S.
counterparts, for reasons such as currency fluctuations and
political and economic uncertainty
25 | Growth with Income Portfolio
<PAGE>
The Fund's Track Record
Because this portfolio does not have a full calendar year of
performance to report as of the date of this prospectus, no bar chart
and performance table are provided.
26 | Growth with Income Portfolio
<PAGE>
How Much Investors Pay
This table describes the fees and expenses that you may pay if you buy
and hold shares of the portfolio. Each class of shares of the portfolio
has a single fee covering investment management and other operating
expenses, but not covering interest, taxes, and compensation and
expenses of the Trustees. This fee rate will not fluctuate. The
portfolio's shareholders will indirectly bear the pro rata share of
fees and expenses incurred by the underlying funds in which the
portfolio is invested.
-----------------------------------------------------------------------
Fee Table Class A Class B
-----------------------------------------------------------------------
Shareholder Fees (paid directly from your investment)
-----------------------------------------------------------------------
Maximum sales charge (load) imposed on 5.75% None
purchases (as % of offering price)
-----------------------------------------------------------------------
Maximum deferred sales charge (load) None* 4.00%
-----------------------------------------------------------------------
Annual Operating Expenses (deducted from portfolio assets)
-----------------------------------------------------------------------
Management Fee 0.75% 0.75%
-----------------------------------------------------------------------
Distribution (12b-1) and Service Fees 0.25% 1.00%
-----------------------------------------------------------------------
Other Expenses** 1.18% 1.18%
----------------------------
-----------------------------------------------------------------------
Total Annual Operating Expenses 2.18% 2.93%
-----------------------------------------------------------------------
Expense Reimbursement*** 1.18% 1.18%
----------------------------
-----------------------------------------------------------------------
Net Expenses 1.00% 1.75%
-----------------------------------------------------------------------
* The redemption of shares purchased at net asset value under
the Large Order NAV Purchase Privilege (see "Policies You
Should Know About -- Policies about transactions") may be
subject to a contingent deferred sales charge of 1% if
redeemed within one year of purchase and 0.50% if redeemed
during the second year following purchase.
** Includes compensation and expenses of the Trustees.
*** By contract, compensation and expenses of the Trustees are
reimbursed by the adviser until the portfolio's assets reach
$50,000,000.
The range for the average weighted expense ratio borne by the portfolio
in connection with its investments in the underlying funds is expected
to be 0.66% to 1.00%. The range has been restated to reflect new fixed
rate administrative fees for certain affiliated underlying funds. This
information is provided as a range since the average assets of the
portfolio invested in each of the underlying funds will fluctuate.
27 | Growth with Income Portfolio
<PAGE>
-----------------------------------------------------------------------
Expense Example
-----------------------------------------------------------------------
This example helps you compare each share class's expenses to those of
other portfolios. The example illustrates the impact of the total
estimated pro rata fees and expenses (including both portfolio and
underlying fund fees and expenses) on an account with an initial
investment of $10,000, based on the portfolio fees and operating
expenses and the midpoint of the range of expenses expected to be borne
by the portfolio in connection with its investments in the underlying
funds (discussed above). It assumes a 5% annual return, the
reinvestment of all dividends and distributions and "total annual
operating expenses" remaining the same each year, and includes one year
of reimbursed expenses in each period. This is only an example; your
actual expenses will be different.
-----------------------------------------------------------------------
1 Year 3 Years 5 Years 10 Years
-----------------------------------------------------------------------
Expenses, assuming you sold your shares at the end of each period
-----------------------------------------------------------------------
Class A shares $750 $1,347 $1,968 $3,632
-----------------------------------------------------------------------
Class B shares 661 1,341 2,040 3,097
-----------------------------------------------------------------------
Expenses, assuming you kept your shares
-----------------------------------------------------------------------
Class A shares $750 $1,347 $1,968 $3,632
-----------------------------------------------------------------------
Class B shares 261 1,041 1,840 3,097
-----------------------------------------------------------------------
28 | Growth with Income Portfolio
<PAGE>
--------------------------------------------------------------------------------
fund number | Class A 605
| Class B 705
Growth Portfolio
--------------------------------------------------------------------------------
Investment Approach
The portfolio seeks long-term growth of capital. It does this by
investing mainly in a select group of primarily growth-oriented
underlying equity mutual funds. The portfolio may at times concentrate
in a particular underlying fund.
The portfolio has a target allocation, which the portfolio managers use
as a reference point in setting the portfolio's actual allocation.
While the actual allocation may vary, the managers expect that over the
long term it will average out to be similar to the target allocation.
The managers regularly review the actual allocation, and may adjust it
in seeking to take advantage of current or expected market conditions
or to manage risk. In making their allocation decisions, the managers
take a top-down approach, looking at the outlooks for various
securities markets and segments of those markets. Based on the desired
exposure to particular investments, the managers then decide which
funds to use as underlying funds and how much to invest in each fund.
The portfolio's underlying funds use a broad array of investment
styles, with an emphasis on the growth component of their holdings.
These funds can buy many types of securities, among them common stocks
of companies of any size, money market instruments, and others. These
securities are mainly from U.S. issuers but may be from foreign
issuers.
The portfolio shifts assets between the growth and value components of
its holdings based on the portfolio managers' analysis of relevant
market, financial and economic conditions. If the portfolio managers
believe that value securities (those that are priced low in light of
certain valuation measures) may provide better yields than the returns
then available or expected on growth stocks (those that are selected
primarily for their growth potential), the portfolio will place a
greater emphasis on the value component of its holdings.
THE FOLLOWING SIDEBAR TEXT APPEARS NEXT TO THE PRECEDING PARAGRAPHS.
--------------------------------------------------------------------------------
ASSET ALLOCATION
The portfolio's target allocation is as follows:
THE ORIGINAL DOCUMENT CONTAINS A PIE CHART HERE
PIE CHART DATA:
Equity funds 99%
Money funds 1%
The managers have the flexibility to adjust this allocation within the following
ranges:
Equity funds 95%-100%
Money funds 0%-5%
29 | Growth Portfolio
<PAGE>
--------------------------------------------------------------------------------
This portfolio may make sense for investors who have a time horizon of
five years or more and who are interested in taking an asset allocation
approach to growth investing.
--------------------------------------------------------------------------------
Main Risks to Investors
There are several risk factors that could hurt the portfolio's
performance, cause you to lose money or make the portfolio perform less
well than other investments.
As with most stock funds, the most important factor with this fund is
how stock markets perform. When stock prices fall, you should expect
the value of your investment to fall as well. Large company stocks at
times may not perform as well as stocks of smaller or mid-size
companies. Because a stock represents ownership in its issuer, stock
prices can be hurt by poor management, shrinking product demand and
other business risks. These may affect single companies as well as
groups of companies.
To the extent that the portfolio invests in an underlying fund that
invests in a given industry or a particular size of company, factors
affecting that industry or size of company could affect portfolio
securities. For example, a rise in unemployment could hurt
manufacturers of consumer goods, and large company stocks at times may
not perform as well as stocks of smaller companies.
Other factors that could affect performance include:
o the managers of the portfolio or an underlying fund could be
wrong in their analysis of companies, industries, risk factors
or other matters
o growth stocks may be out of favor for certain periods
o foreign securities may be more volatile than their U.S.
counterparts, for reasons such as currency fluctuations and
political and economic uncertainty
o derivatives that the underlying funds may use could produce
disproportionate losses
o at times, it might be hard for an underlying fund to value
some investments or to get an attractive price for them
30 | Growth Portfolio
<PAGE>
The Fund's Track Record
Because this portfolio does not have a full calendar year of
performance to report as of the date of this prospectus, no bar chart
and performance table are provided.
31 | Growth Portfolio
<PAGE>
How Much Investors Pay
This table describes the fees and expenses that you may pay if you buy
and hold shares of the portfolio. Each class of shares of the portfolio
has a single fee covering investment management and other operating
expenses, but not covering interest, taxes, and compensation and
expenses of the Trustees. This fee rate will not fluctuate. The
portfolio's shareholders will indirectly bear the pro rata share of
fees and expenses incurred by the underlying funds in which the
portfolio is invested.
-----------------------------------------------------------------------
Fee Table Class A Class B
-----------------------------------------------------------------------
Shareholder Fees (paid directly from your investment)
-----------------------------------------------------------------------
Maximum sales charge (load) imposed on 5.75% None
purchases (as % of offering price)
-----------------------------------------------------------------------
Maximum deferred sales charge (load) None* 4.00%
-----------------------------------------------------------------------
Annual Operating Expenses (deducted from portfolio assets)
-----------------------------------------------------------------------
Management Fee 0.75% 0.75%
-----------------------------------------------------------------------
Distribution (12b-1) and Service Fees 0.25% 1.00%
-----------------------------------------------------------------------
Other Expenses** 0.66% 0.66%
----------------------------
-----------------------------------------------------------------------
Total Annual Operating Expenses 1.66% 2.41%
-----------------------------------------------------------------------
Expense Reimbursement*** 0.66% 0.66%
----------------------------
-----------------------------------------------------------------------
Net Expenses 1.00% 1.75%
-----------------------------------------------------------------------
* The redemption of shares purchased at net asset value under
the Large Order NAV Purchase Privilege (see "Policies You
Should Know About -- Policies about transactions") may be
subject to a contingent deferred sales charge of 1% if
redeemed within one year of purchase and 0.50% if redeemed
during the second year following purchase.
** Includes compensation and expenses of the Trustees.
*** By contract, compensation and expenses of the Trustees are
reimbursed by the adviser until the portfolio's assets reach
$50,000,000.
The range for the average weighted expense ratio borne by the portfolio
in connection with its investments in the underlying funds is expected
to be 0.75% to 1.21%. The range has been restated to reflect new fixed
rate administrative fees for certain affiliated underlying funds. This
information is provided as a range since the average assets of the
portfolio invested in each of the underlying funds will fluctuate.
32 | Growth Portfolio
<PAGE>
-----------------------------------------------------------------------
Expense Example
-----------------------------------------------------------------------
This example helps you compare each share class's expenses to those of
other portfolios. The example illustrates the impact of the total
estimated pro rata fees and expenses (including both portfolio and
underlying fund fees and expenses) on an account with an initial
investment of $10,000, based on the portfolio fees and operating
expenses and the midpoint of the range of expenses expected to be borne
by the portfolio in connection with its investments in the underlying
funds (discussed above). It assumes a 5% annual return, the
reinvestment of all dividends and distributions and "total annual
operating expenses" remaining the same each year, and includes one year
of reimbursed expenses in each period. This is only an example; your
actual expenses will be different.
------------------------------------------------------------------------
1 Year 3 Years 5 Years 10 Years
------------------------------------------------------------------------
Expenses, assuming you sold your shares at the end of each period
------------------------------------------------------------------------
Class A shares $764 $1,289 $1,839 $3,332
------------------------------------------------------------------------
Class B shares 676 1,281 1,908 3,012
------------------------------------------------------------------------
Expenses, assuming you kept your shares
------------------------------------------------------------------------
Class A shares $764 $1,289 $1,839 $3,332
------------------------------------------------------------------------
Class B shares 276 981 1,708 3,012
------------------------------------------------------------------------
33 | Growth Portfolio
<PAGE>
Other Policies and Risks
While the portfolio-by-portfolio sections on the previous pages
describe the main points of each portfolio's strategy and risks, there
are a few other issues to know about:
o Although major changes tend to be infrequent, a portfolio's
Board could change that portfolio's investment goal without
seeking shareholder approval.
o As a temporary defensive measure, any of these portfolios
could shift up to 100% of its assets into investments such as
money market securities. This could prevent losses, but would
mean that the portfolio was not pursuing its goal.
o While certain underlying funds are permitted to use various
types of derivatives (contracts whose value is based on, for
example, indices, currencies or securities), the managers of
those funds don't intend to use them as principal investments,
and might not use them at all.
Euro conversion
Portfolios which invest in underlying funds which invest in foreign
securities could be affected by accounting differences, changes in tax
treatment or other issues related to the conversion of certain European
currencies into the euro, which is already underway. Scudder Kemper is
working to address euro-related issues as they occur and has been
notified that other key service providers are taking similar steps.
Still, there's some risk that this problem could materially affect a
portfolio's operation (including its ability to calculate net asset
value and to handle purchases and redemptions), the investments held by
underlying funds or securities markets in general.
For more information
This prospectus doesn't tell you about every policy or risk of
investing in the portfolios.
If you want more information on a portfolio's allowable securities and
investment practices and the characteristics and risks of each one, as
well as the list of underlying funds, you may want to request a copy of
the Statement of Additional Information (the back cover tells you how
to do this).
Keep in mind that there is no assurance that any mutual fund will
achieve its goal.
34 | Growth Portfolio
<PAGE>
--------------------------------------------------------------------------------
Scudder Kemper, the company with overall responsibility for managing the
portfolios, takes a team approach to asset management.
--------------------------------------------------------------------------------
Who Manages and Oversees the Portfolios
The investment adviser
The investment adviser for these portfolios is Scudder Kemper Investments, Inc.,
345 Park Avenue, New York, NY. Scudder Kemper has more than 80 years of
experience managing mutual funds, and currently has more than $290 billion in
assets under management.
Scudder Kemper's asset management teams include investment professionals,
economists, research analysts, traders and other investment specialists, located
in offices across the United States and around the world.
As payment for serving as investment adviser, Scudder Kemper receives a
management fee from each portfolio. For the twelve months through the most
recent fiscal year end, the actual amount each portfolio paid in management fees
was 0.75% of average daily net assets of that portfolio. Scudder Kemper also
receives management fees from managing the affiliated underlying funds in which
each portfolio invests. Each affiliated underlying fund pays Scudder Kemper a
management fee as determined by the Investment Management Agreement between that
fund and Scudder Kemper.
The portfolio managers
The following people handle the day-to-day management of each portfolio in this
prospectus.
Shahram Tajbakhsh Josephine W. K. Chu
Lead Portfolio Manager o Began investment career in 1997
o Began investment career in 1991 o Joined the adviser in 1997
o Joined the adviser in 1996 o Joined the fund team in 2000
o Joined the fund team in 1999
35
<PAGE>
The Board
A mutual fund's Board is responsible for the general oversight of the fund's
business. The individuals below serve concurrently on the board of all
portfolios in this prospectus. The majority of the board is not affiliated with
Scudder Kemper. These independent members have primary responsibility for
assuring that each portfolio is managed in the best interests of its
shareholders.
Brian Cohen Dr. J.D. Hammond
o President of the Trust; o Trustee; Dean Emeritus, Smeal
President, Farmers Financial Solutions College of Business Administration,
Pennsylvania State University
Dr. Rosita P. Chang
o Trustee; Professor of Finance, Richard M. Hunt
University of Hawaii o Trustee; University Marshal and
Senior Lecturer, Harvard University
Edgar R. Fiedler
o Trustee; Senior Fellow and Kathryn L. Quirk
Economic Counsellor, o Trustee; Managing Director of
The Conference Board, Inc. Scudder Kemper Investments, Inc.
36
<PAGE>
Financial Highlights
These tables are designed to help you understand each portfolio's financial
performance in recent years. The figures in the first part of each table are for
a single share. The total return figures represent the percentage that an
investor in a particular portfolio would have earned (or lost), assuming all
dividends and distributions were reinvested. This information has been audited
by PricewaterhouseCoopers LLP, whose report, along with each portfolio's
financial statements, is included in the portfolios' annual report (see
"Shareholder reports" on the back cover).
Income Portfolio
<TABLE>
<CAPTION>
For the period
March 9, 1999
(commencement of
Year Ended operations) to
Class A April 30, 2000 April 30, 1999
-------------------------------------------------------------------------------------
----------------------------------
<S> <C> <C>
Net asset value, beginning of period $ 12.21 $ 12.00
----------------------------------
Income (loss) from investment operations:
Net investment income (loss) (a) .73 .11
Net realized and unrealized gain (loss) on
investment transactions (.84) .10
----------------------------------
Total from investment operations (.11) .21
----------------------------------
Less distributions from net investment income (.82) --
----------------------------------
Net asset value, end of period $ 11.28 $ 12.21
----------------------------------
-------------------------------------------------------------------------------------
Total Return (%) (b) (c) (.87) 1.75**
Ratios to Average Net Assets and Supplemental Data
Net assets, end of period ($ thousands) 54 103
Ratio of expenses before expense reductions (%) 4.92 1.00*
Ratio of expenses after expense reductions (%) 1.00 1.00*
Ratio of net investment income (loss) (%) 6.24 .93**
Portfolio turnover rate (%) 59 --
</TABLE>
(a) Based on daily average shares outstanding during the period.
(b) Total return would have been lower if the investment adviser to this
Portfolio and the investment adviser to some of the Underlying Funds had
not maintained some of the expenses.
(c) Total return does not reflect the effect of any sales charge.
* Annualized
** Not annualized
37
<PAGE>
Income Portfolio
<TABLE>
<CAPTION>
For the period
March 9, 1999
(commencement of
Year Ended operations) to
Class B April 30, 2000 April 30, 1999
-------------------------------------------------------------------------------------
<S> <C> <C>
----------------------------------
Net asset value, beginning of period $ 12.19 $ 12.00
----------------------------------
Income (loss) from investment operations:
Net investment income (loss) (a) .64 .12
Net realized and unrealized gain (loss) on
investment transactions (.83) .07
----------------------------------
Total from investment operations (.19) .19
----------------------------------
Less distributions from net investment income (.73) --
----------------------------------
Net asset value, end of period $ 11.27 $ 12.19
----------------------------------
-------------------------------------------------------------------------------------
Total Return (%) (b) (c) (1.56) 1.58**
Ratios to Average Net Assets and Supplemental Data
Net assets, end of period ($ thousands) 52 51
Ratio of expenses before expense reductions (%) 5.67 1.75*
Ratio of expenses after expense reductions (%) 1.75 1.75*
Ratio of net investment income (loss) (%) 5.53 1.01**
Portfolio turnover rate (%) 59 --
</TABLE>
(a) Based on daily average shares outstanding during the period.
(b) Total return would have been lower if the investment adviser to this
Portfolio and the investment adviser to some of the Underlying Funds had
not maintained some of the expenses.
(c) Total return does not reflect the effect of any sales charge.
* Annualized
** Not annualized
38
<PAGE>
Income with Growth Portfolio
<TABLE>
<CAPTION>
For the period
March 9, 1999
(commencement of
Year Ended operations) to
Class A April 30, 2000 April 30, 1999
-------------------------------------------------------------------------------------
<S> <C> <C>
----------------------------------
Net asset value, beginning of period $ 12.33 $ 12.00
----------------------------------
Income (loss) from investment operations:
Net investment income (loss) (a) .51 .07
Net realized and unrealized gain (loss) on
investment transactions .40 .26
----------------------------------
Total from investment operations .91 .33
----------------------------------
Less distributions from net investment income (.45) --
----------------------------------
Net asset value, end of period $ 12.79 $ 12.33
----------------------------------
-------------------------------------------------------------------------------------
Total Return (%) (b) (c) 7.54 2.75**
Ratios to Average Net Assets and Supplemental Data
Net assets, end of period ($ thousands) 543 52
Ratio of expenses before expense reductions (%) 2.41 1.00*
Ratio of expenses after expense reductions (%) 1.00 1.00*
Ratio of net investment income (loss) (%) 4.16 .55**
Portfolio turnover rate (%) 38 --
</TABLE>
(a) Based on daily average shares outstanding during the period.
(b) Total return would have been lower if the investment adviser to this
Portfolio and the investment adviser to some of the Underlying Funds had
not maintained some of the expenses.
(c) Total return does not reflect the effect of any sales charge.
* Annualized
** Not annualized
39
<PAGE>
Income with Growth Portfolio
<TABLE>
<CAPTION>
For the period
March 9, 1999
(commencement of
Year Ended operations) to
Class B April 30, 2000 April 30, 1999
-------------------------------------------------------------------------------------
<S> <C> <C>
----------------------------------
Net asset value, beginning of period $ 12.32 $ 12.00
----------------------------------
Income (loss) from investment operations:
Net investment income (loss) (a) .39 .05
Net realized and unrealized gain (loss) on
investment transactions .42 .27
----------------------------------
Total from investment operations .81 .32
----------------------------------
Less distributions from net investment income (.37) --
----------------------------------
Net asset value, end of period $ 12.76 $ 12.32
----------------------------------
-------------------------------------------------------------------------------------
Total Return (%) (b) (c) 6.67 2.67**
Ratios to Average Net Assets and Supplemental Data
Net assets, end of period ($ thousands) 327 58
Ratio of expenses before expense reductions (%) 3.16 1.75*
Ratio of expenses after expense reductions (%) 1.75 1.75*
Ratio of net investment income (loss) (%) 3.14 .44**
Portfolio turnover rate (%) 38 --
</TABLE>
(a) Based on daily average shares outstanding during the period.
(b) Total return would have been lower if the investment adviser to this
Portfolio and the investment adviser to some of the Underlying Funds had
not maintained some of the expenses.
(c) Total return does not reflect the effect of any sales charge.
* Annualized
** Not annualized
40
<PAGE>
Balanced Portfolio
<TABLE>
<CAPTION>
For the period
March 9, 1999
(commencement of
Year Ended operations) to
Class A April 30, 2000 April 30, 1999
-------------------------------------------------------------------------------------
<S> <C> <C>
----------------------------------
Net asset value, beginning of period $ 12.45 $ 12.00
----------------------------------
Income (loss) from investment operations:
Net investment income (loss) (a) .39 .06
Net realized and unrealized gain (loss) on
investment transactions .22 .39
----------------------------------
Total from investment operations .61 .45
----------------------------------
Less distributions from net investment income (.36) --
----------------------------------
Net asset value, end of period $ 12.70 $ 12.45
----------------------------------
-------------------------------------------------------------------------------------
Total Return (%) (b) (c) 4.95 3.75**
Ratios to Average Net Assets and Supplemental Data
Net assets, end of period ($ thousands) 757 64
Ratio of expenses before expense reductions (%) 1.95 1.00*
Ratio of expenses after expense reductions (%) 1.00 1.00*
Ratio of net investment income (loss) (%) 3.17 .52**
Portfolio turnover rate (%) 20 --
</TABLE>
(a) Based on daily average shares outstanding during the period.
(b) Total return would have been lower if the investment adviser to this
Portfolio and the investment adviser to some of the Underlying Funds had
not maintained some of the expenses.
(c) Total return does not reflect the effect of any sales charge.
* Annualized
** Not annualized
41
<PAGE>
Balanced Portfolio
<TABLE>
<CAPTION>
For the period
March 9, 1999
(commencement of
Year Ended operations) to
Class B April 30, 2000 April 30, 1999
-------------------------------------------------------------------------------------
<S> <C> <C>
----------------------------------
Net asset value, beginning of period $ 12.43 $ 12.00
----------------------------------
Income (loss) from investment operations:
Net investment income (loss) (a) .27 .05
Net realized and unrealized gain (loss) on
investment transactions .24 .38
Total from investment operations .51 .43
Less distributions from net investment income (.26) --
----------------------------------
Net asset value, end of period $ 12.68 $ 12.43
----------------------------------
-------------------------------------------------------------------------------------
Total Return (%) (b) (c) 4.06 3.58**
Ratios to Average Net Assets and Supplemental Data
Net assets, end of period ($ thousands) 607 68
Ratio of expenses before expense reductions (%) 2.70 1.75*
Ratio of expenses after expense reductions (%) 1.75 1.75*
Ratio of net investment income (loss) (%) 2.15 .40**
Portfolio turnover rate (%) 20 --
</TABLE>
(a) Based on daily average shares outstanding during the period.
(b) Total return would have been lower if the investment adviser to this
Portfolio and the investment adviser to some of the Underlying Funds had
not maintained some of the expenses.
(c) Total return does not reflect the effect of any sales charge.
* Annualized
** Not annualized
42
<PAGE>
Growth with Income Portfolio
<TABLE>
<CAPTION>
For the period
March 9, 1999
(commencement of
Year Ended operations) to
Class A April 30, 2000 April 30, 1999
-------------------------------------------------------------------------------------
<S> <C> <C>
----------------------------------
Net asset value, beginning of period $ 12.63 $ 12.00
----------------------------------
Income (loss) from investment operations:
Net investment income (loss) (a) .25 .04
Net realized and unrealized gain (loss) on
investment transactions (.08) .59
----------------------------------
Total from investment operations .17 .63
----------------------------------
Less distributions from net investment income (.28) --
----------------------------------
Net asset value, end of period $ 12.52 $ 12.63
----------------------------------
-------------------------------------------------------------------------------------
Total Return (%) (b) (c) 1.30 5.25**
Ratios to Average Net Assets and Supplemental Data
Net assets, end of period ($ thousands) 487 298
Ratio of expenses before expense reductions (%) 2.18 1.00*
Ratio of expenses after expense reductions (%) 1.00 1.00*
Ratio of net investment income (loss) (%) 1.98 .37**
Portfolio turnover rate (%) 56 --
</TABLE>
(a) Based on daily average shares outstanding during the period.
(b) Total return would have been lower if the investment adviser to this
Portfolio and the investment adviser to some of the Underlying Funds had
not maintained some of the expenses.
(c) Total return does not reflect the effect of any sales charge.
* Annualized
** Not annualized
43
<PAGE>
Growth with Income Portfolio
<TABLE>
<CAPTION>
For the period
March 9, 1999
(commencement of
Year Ended operations) to
Class B April 30, 2000 April 30, 1999
-------------------------------------------------------------------------------------
<S> <C> <C>
----------------------------------
Net asset value, beginning of period $ 12.61 $ 12.00
----------------------------------
Income (loss) from investment operations:
Net investment income (loss) (a) .18 .04
Net realized and unrealized gain (loss) on
investment transactions (.09) .57
----------------------------------
Total from investment operations .09 .61
----------------------------------
Less distributions from net investment income (.18) --
----------------------------------
Net asset value, end of period $ 12.52 $ 12.61
----------------------------------
-------------------------------------------------------------------------------------
Total Return (%) (b) (c) .62 5.08**
Ratios to Average Net Assets and Supplemental Data
Net assets, end of period ($ thousands) 597 55
Ratio of expenses before expense reductions (%) 2.93 1.75*
Ratio of expenses after expense reductions (%) 1.75 1.75*
Ratio of net investment income (loss) (%) 1.46 .31**
Portfolio turnover rate (%) 56 --
</TABLE>
(a) Based on daily average shares outstanding during the period.
(b) Total return would have been lower if the investment adviser to this
Portfolio and the investment adviser to some of the Underlying Funds had
not maintained some of the expenses.
(c) Total return does not reflect the effect of any sales charge.
* Annualized
** Not annualized
44
<PAGE>
Growth Portfolio
<TABLE>
<CAPTION>
For the period
March 9, 1999
(commencement of
Year Ended operations) to
Class A April 30, 2000 April 30, 1999
-------------------------------------------------------------------------------------
<S> <C> <C>
----------------------------------
Net asset value, beginning of period $ 12.80 $ 12.00
Income (loss) from investment operations:
Net investment (loss) income (a) .05 .01
Net realized and unrealized gain (loss) on
investment transactions .35 .79
----------------------------------
Total from investment operations .40 .80
----------------------------------
Less distributions from:
Net investment income (.17) --
Net realized gains on investment transactions (.04) --
----------------------------------
Net asset value, end of period $ 12.99 $ 12.80
----------------------------------
-------------------------------------------------------------------------------------
Total Return (%) (b) (c) 3.02 6.67**
Ratios to Average Net Assets and Supplemental Data
Net assets, end of period ($ thousands) 1,562 92
Ratio of expenses before expense reductions (%) 1.66 1.00*
Ratio of expenses after expense reductions (%) 1.00 1.00*
Ratio of net investment income (loss) (%) .41 .12**
Portfolio turnover rate (%) 31 --
</TABLE>
(a) Based on daily average shares outstanding during the period.
(b) Total return would have been lower if the investment adviser to this
Portfolio and the investment adviser to some of the Underlying Funds had
not maintained some of the expenses.
(c) Total return does not reflect the effect of any sales charge.
* Annualized
** Not annualized
45
<PAGE>
Growth Portfolio
<TABLE>
<CAPTION>
For the period
March 9, 1999
(commencement of
Year Ended operations) to
Class B April 30, 2000 April 30, 1999
-------------------------------------------------------------------------------------
<S> <C> <C>
----------------------------------
Net asset value, beginning of period $ 12.79 $ 12.00
----------------------------------
Income (loss) from investment operations:
Net investment income (loss) (a) (.05) .01
Net realized and unrealized gain (loss) on
investment transactions .33 .78
----------------------------------
Total from investment operations .28 .79
----------------------------------
Less distributions from:
Net investment income (.07) --
Net realized gains on investment transactions (.04) --
----------------------------------
Net asset value, end of period $ 12.96 $ 12.79
----------------------------------
-------------------------------------------------------------------------------------
Total Return (%) (b) (c) 2.09 6.58**
Ratios to Average Net Assets and Supplemental Data
Net assets, end of period ($ thousands) 902 55
Ratio of expenses before expense reductions (%) 2.41 1.75*
Ratio of expenses after expense reductions (%) 1.75 1.75*
Ratio of net investment income (loss) (%) (.39) .06**
Portfolio turnover rate (%) 31 --
</TABLE>
(a) Based on daily average shares outstanding during the period.
(b) Total return would have been lower if the investment adviser to this
Portfolio and the investment adviser to some of the Underlying Funds had
not maintained some of the expenses.
(c) Total return does not reflect the effect of any sales charge.
* Annualized
** Not annualized
46
<PAGE>
How to invest in the portfolios
The following pages tell you how to invest in these portfolios and what to
expect as a shareholder. If you're investing directly with Farmers, all of this
information applies to you.
If you're investing through a "third party provider" -- for example, a workplace
retirement plan, financial supermarket, or financial adviser -- your provider
may have its own policies or instructions, and you should follow those.
<PAGE>
Choosing a Share Class
Offered in this prospectus are two share classes for each portfolio. Each class
has its own fees and expenses, offering you a choice of cost structures. Class A
and Class B shares are intended for investors seeking the advice and assistance
of a financial representative, who may receive compensation for those services
through sales commissions, service fees and/or distribution fees.
Before you invest, take a moment to look over the characteristics of each share
class, so that you can be sure to choose the class that's right for you. You may
want to ask your financial representative to help you with this decision.
We describe each share class in detail on the following pages. But first, you
may want to look at the table below, which gives you a brief comparison of the
main features of each class.
<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------
Classes and features Points to help you compare
---------------------------------------------------------------------------------------
<S> <C> <C>
Class A o Sales charges with a range of o Some investors may be
up to 5.75%, charged when you able to reduce or eliminate
buy shares their sales charges; see page 50
o In most cases, no charges o Total annual operating
when you sell shares expenses are lower than those
for Class B
o No distribution fee
---------------------------------------------------------------------------------------
Class B o No charges when you buy o The deferred sales
shares charge rate falls to zero
after six years
o Deferred sales charge of up o Shares automatically convert
to 4.00%, charged when you sell to Class A after six years,
shares you bought within the which means lower annual
last six years expenses going forward
o 0.75% distribution fee
---------------------------------------------------------------------------------------
</TABLE>
48
<PAGE>
--------------------------------------------------------------------------------
Class A shares may make sense for long-term investors, especially those who are
eligible for reduced or eliminated sales charges.
--------------------------------------------------------------------------------
Class A Shares
Class A shares have a sales charge that varies with the amount you invest:
Income Portfolio
Sales
charge as a
% of Sales charge Sales charge allowed
offering as % of your to dealers as a % of
Your investment price net investment offering price*
--------------------------------------------------------------------------------
Up to $50,000 5.00% 5.26% 3.30%
--------------------------------------------------------------------------------
$50,000-$99,999 4.50% 4.71% 2.93%
--------------------------------------------------------------------------------
$100,000-$249,999 3.50% 3.63% 2.20%
--------------------------------------------------------------------------------
$250,000-$499,999 2.60% 2.67% 1.65%
--------------------------------------------------------------------------------
$500,000-$999,999 2.00% 2.04% 1.28%
--------------------------------------------------------------------------------
$1 million or more See page 51
--------------------------------------------------------------------------------
* Rounded to the nearest one hundredth percent.
The offering price includes the sales charge.
Income with Growth Portfolio
Sales
charge as a
% of Sales charge Sales charge allowed
offering as % of your to dealers as a % of
Your investment price net investment offering price*
--------------------------------------------------------------------------------
Up to $50,000 5.25% 5.54% 3.42%
--------------------------------------------------------------------------------
$50,000-$99,999 4.50% 4.71% 2.93%
--------------------------------------------------------------------------------
$100,000-$249,999 3.50% 3.63% 2.20%
--------------------------------------------------------------------------------
$250,000-$499,999 2.60% 2.67% 1.65%
--------------------------------------------------------------------------------
$500,000-$999,999 2.00% 2.04% 1.28%
--------------------------------------------------------------------------------
$1 million or more See page 51
--------------------------------------------------------------------------------
* Rounded to the nearest one hundredth percent.
The offering price includes the sales charge.
49
<PAGE>
Balanced Portfolio, Growth with Income Portfolio, and Growth Portfolio
Sales
charge as a
% of Sales charge Sales charge allowed
offering as % of your to dealers as a % of
Your investment price net investment offering price*
--------------------------------------------------------------------------------
Up to $50,000 5.75% 6.10% 3.79%
--------------------------------------------------------------------------------
$50,000-$99,999 4.50% 4.71% 2.93%
--------------------------------------------------------------------------------
$100,000-$249,999 3.50% 3.63% 2.20%
--------------------------------------------------------------------------------
$250,000-$499,999 2.60% 2.67% 1.65%
--------------------------------------------------------------------------------
$500,000-$999,999 2.00% 2.04% 1.28%
--------------------------------------------------------------------------------
$1 million or more See page 51
--------------------------------------------------------------------------------
* Rounded to the nearest one hundredth percent.
The offering price includes the sales charge.
You may be able to lower your Class A sales charges if:
o you plan to invest at least $50,000 over the next 24 months ("letter of
intent")
o the amount of shares you already own (including shares in certain other
portfolios) plus the amount you're investing now is at least $50,000
("cumulative discount")
o you are investing a total of $50,000 or more in several portfolios at once
("combined purchases")
The point of these three features is to let you count investments made at other
times for purposes of calculating your present sales charge. Any time you can
use the privileges to "move" your investment into a lower sales charge category
in the table above, it's generally beneficial for you to do so. You can take
advantage of these methods by filling in the appropriate sections of your
application or by speaking with your financial representative.
50
<PAGE>
You may be able to buy Class A shares without sales charges when you are:
o investing through certain workplace retirement plans
o participating in an investment advisory program under which you pay a fee
to an investment adviser or other firm for portfolio management services
o buying shares with reinvested dividends or distributions
There are a number of additional provisions that apply in order to be eligible
for a sales charge waiver. The portfolios may waive the sales charges for
investors in other situations as well. Your financial representative or Farmers
Customer Support can answer your questions and help you determine if you are
eligible.
If you're investing $1 million or more, either as a lump sum or through one of
the sales charge reduction features described on the previous page, you may be
eligible to buy Class A shares without sales charges. However, you may be
charged a contingent deferred sales charge (CDSC) of 1.00% on any shares you
sell within the first year of owning them, and a similar charge of 0.50% on
shares you sell within the second year of owning them. This CDSC is waived under
certain circumstances (see "Policies You Should Know About"). Your financial
representative or Farmers Customer Support can answer your questions and help
you determine if you're eligible.
51
<PAGE>
--------------------------------------------------------------------------------
Class B shares can be a logical choice for long-term investors who would prefer
to see all of their investment go to work right away, and can accept somewhat
higher annual expenses in exchange.
--------------------------------------------------------------------------------
Class B Shares
With Class B shares, you pay no up-front sales charges to the portfolio. Class B
shares do have a 12b-1 plan, under which a distribution fee of 0.75% is deducted
from portfolio assets each year. This means the annual expenses for Class B
shares are somewhat higher (and their performance correspondingly lower)
compared to Class A shares, which don't have a 12b-1 fee. After six years, Class
B shares automatically convert to Class A shares, which has the net effect of
lowering the annual expenses from the seventh year on.
Class B shares have a contingent deferred sales charge (CDSC). This charge
declines over the years you own shares, and disappears completely after six
years of ownership. But for any shares you sell within those six years, you may
be charged as follows:
Year after you bought shares CDSC on shares you sell
--------------------------------------------------------------------------------
First year 4.00%
--------------------------------------------------------------------------------
Second year or third 3.00
--------------------------------------------------------------------------------
Fourth or fifth year 2.00
--------------------------------------------------------------------------------
Sixth year 1.00
--------------------------------------------------------------------------------
Seventh year and later None (automatic conversion to Class A)
--------------------------------------------------------------------------------
This CDSC is waived under certain circumstances (see "Policies You Should Know
About"). Your financial representative or Farmers Customer Support can answer
your questions and help you determine if you're eligible.
While Class B shares don't have any front-end sales charges, their higher annual
expenses mean that over the years you could end up paying more than the
equivalent of the maximum allowable front-end sales charge.
52
<PAGE>
How to Buy Shares
For information on how to buy shares, call your agent or Farmers Customer
Support toll free at 1-877-327-8899.
How to Exchange or Sell Shares
Any shareholder may require a portfolio to redeem his or her shares. When shares
are held for the account of a shareholder by the portfolios' transfer agent, the
shareholder may redeem them by sending a written request with signatures
guaranteed to Kemper Service Company, P.O. Box 419453, Kansas City, Missouri
64141. Contact your agent or call toll-free 1-877-327-8899 for more information.
53
<PAGE>
--------------------------------------------------------------------------------
Questions? You can speak to your agent or call toll free 1-877-327-8899.
--------------------------------------------------------------------------------
Policies You Should Know About
Along with the instructions on the previous pages, the policies below may affect
you as a shareholder. Some of this information, such as the section on dividends
and taxes, applies to all investors, including those investing through
investment providers.
If you are investing through an investment provider, check the materials you got
from them. As a general rule, you should follow the information in those
materials wherever it contradicts the information given here. Please note that
an investment provider may charge its own fees.
Policies about transactions
The portfolios are open for business each day the New York Stock Exchange is
open. Each portfolio calculates its share price every business day, as of the
close of regular trading on the Exchange (typically 4 p.m. Eastern time, but
sometimes earlier, as in the case of scheduled half-day trading or unscheduled
suspensions of trading).
You can place an order to buy or sell shares at any time. Once your order is
received by Kemper Distributors, Inc. and they have determined that it is a
"good order," it will be processed at the next share price calculated.
Because orders placed through investment providers must be forwarded to Kemper
Distributors, Inc. before they can be processed, you'll need to allow extra
time. A representative of your investment provider should be able to tell you
when your order will be processed.
When you call us to sell shares, we may record the call, ask you for certain
information or take other steps designed to prevent fraudulent orders. It's
important to understand that, with respect to certain pre-authorized privileges,
as long as we take reasonable steps to ensure that an order appears genuine, we
are not responsible for any losses that may occur.
Exchanges are a shareholder privilege, not a right: we may reject any exchange
order, particularly when there appears to be a pattern of "market timing" or
other frequent purchases and sales. We may also reject or limit purchase orders,
for these or other reasons.
54
<PAGE>
When you want to sell more than $100,000 worth of shares, or send the proceeds
to a third party or to a new address, you'll usually need to place your order in
writing and include a signature guarantee. The only exception is if you want
money wired to a bank account that is already on file with us; in that case, you
don't need a signature guarantee. Also, you don't need a signature guarantee for
an exchange, although we may require one in certain other circumstances.
A signature guarantee is simply a certification of your signature -- a valuable
safeguard against fraud. You can get a signature guarantee from most brokers,
banks, savings institutions and credit unions. Note that you can't get a
signature guarantee from a notary public.
When you sell shares that have a contingent deferred sales charge (CDSC), we
calculate the CDSC as a percentage of what you paid for the shares or what you
are selling them for -- whichever results in the lowest charge to you. In
processing orders to sell shares, we turn to the shares with the lowest CDSC
first. Exchanges from one portfolio into another don't affect CDSCs: for each
investment you make, the date you first bought shares is the date we use to
calculate a CDSC on that particular investment.
There are certain cases in which you may be exempt from a CDSC. These include:
o the death or disability of an account owner (including a joint owner)
o withdrawals made through a systematic withdrawal plan
o withdrawals related to certain retirement or benefit plans
o redemptions for certain loan advances, hardship provisions or returns of
excess contributions from retirement plans
o For Class A shares purchased through the Large Order NAV Purchase
Privilege, redemption of shares whose dealer of record at the time of the
investment notifies Kemper Distributors that the dealer is waiving the
applicable commission
In each of these cases, there are a number of additional provisions that apply
in order to be eligible for a CDSC waiver. Your financial representative or
Farmers Customer Support can answer your questions and help you determine if you
are eligible.
There is also an option that lets investors who sold Class B shares buy Class A
shares with no sales charge, although they won't be reimbursed for any CDSC they
paid. You can only use the reinstatement feature once for any given group of
shares. To take advantage of this feature, contact Farmers Customer Support or
your financial representative.
55
<PAGE>
--------------------------------------------------------------------------------
If you ever have difficulty placing an order by phone or fax, you can always
send us your order in writing.
--------------------------------------------------------------------------------
Money from shares you sell is normally sent out within one business day of when
your order is processed (not when it is received), although it could be delayed
for up to seven days. There are also two circumstances when it could be longer:
when you are selling shares you bought recently by check and that check hasn't
cleared yet (maximum delay: 10 days) or when unusual circumstances prompt the
SEC to allow further delays.
Minimum balances The minimum initial investment for each portfolio is $1,000 and
the minimum subsequent investment is $100. The minimum initial investment for an
Individual Retirement Account is $500 and the minimum subsequent investment is
$100. Under an automatic investment plan, the initial investment is $100. These
minimum amounts may be changed at any time.
How the portfolios calculate share prices
For each portfolio in this prospectus, the price at which you buy shares is as
follows:
Class A shares -- net asset value per share, or NAV, adjusted to allow for any
applicable sales charges (see "Choosing a Share Class")
Class B shares-- net asset value per share, or NAV
To calculate NAV, each share class of each portfolio uses the following
equation:
TOTAL ASSETS - TOTAL LIABILITIES
---------------------------------- = NAV
TOTAL NUMBER OF SHARES OUTSTANDING
For each portfolio and each share class, the price at which you sell shares is
also the NAV, although a contingent deferred sales charge may be taken out of
the proceeds (see "Choosing a Share Class").
The assets of each portfolio consist primarily of shares of the underlying
mutual funds, which are valued at their respective net asset values at the time
of computation.
56
<PAGE>
The underlying funds typically use market prices to value securities. However,
when a market price isn't available, or when there is reason to believe it
doesn't represent market realities, the underlying funds may use fair value
methods approved by a their fund's Board. In such a case, the underlying fund's
value for a security is likely to be different from quoted market prices.
To the extent that an underlying fund invests in securities that are traded
primarily in foreign markets, the value of their holdings could change at a time
when you aren't able to buy or sell portfolio shares. This is because some
foreign markets are open on days when the portfolios don't price their shares.
Other rights we reserve
For each portfolio in this prospectus, you should be aware that we may do any of
the following:
o withhold 31% of your distributions as federal income tax if you have been
notified by the IRS that you are subject to backup withholding, or if you
fail to provide us with a correct taxpayer ID number or certification that
you are exempt from backup withholding
o reject a new account application if you don't provide a correct Social
Security or other tax ID number; if the account has already been opened, we
may give you 30 days' notice to provide the correct number
o charge you $9 each calendar quarter if your account balance is below $1,000
for the entire quarter (this policy doesn't apply to most retirement
accounts or if you have an automatic investment plan)
o pay you for shares you sell by "redeeming in kind," that is, by giving you
marketable securities (which typically will involve brokerage costs for you
to liquidate) rather than cash
o change, add or withdraw various services, fees and account policies (for
example, we may change or terminate the exchange privilege at any time)
57
<PAGE>
--------------------------------------------------------------------------------
Because each shareholder's tax situation is unique, it's always a good idea to
ask your tax professional about the tax consequences of your investments,
including any state and local tax consequences.
--------------------------------------------------------------------------------
Understanding Distributions and Taxes
By law, a mutual fund is required to pass through to its shareholders virtually
all of its net earnings. A portfolio can earn money in two ways: by receiving
interest, dividends or other income from securities it holds, and by selling
securities for more than it paid for them. (A portfolio's earnings are separate
from any gains or losses stemming from your own purchase of shares.) A portfolio
may not always pay a distribution for a given period.
The portfolios have regular schedules for paying out any earnings to
shareholders:
o Income: paid annually in November or December for the Growth with Income
Portfolio and the Growth Portfolio; paid quarterly in March, June,
September and December for the Income, Income with Growth, and Balanced
Portfolios.
o Long-term and short-term capital gains: annually in November or December,
or otherwise as needed.
You can choose how to receive your dividends and distributions. You can have
them all automatically reinvested in fund shares or all sent to you by check.
Tell us your preference on your application. If you don't indicate a preference,
your dividends and distributions will all be reinvested. For retirement plans,
reinvestment is the only option.
Buying and selling portfolio shares will usually have tax consequences for you
(except in an IRA or other tax-advantaged account, or in the case of money
market funds). Your sales of shares may result in a capital gain or loss for
you; whether long-term or short-term depends on how long you owned the shares.
For tax purposes, an exchange is the same as a sale.
58
<PAGE>
The tax status of the portfolio earnings you receive, and your own portfolio
transactions, generally depends on their type:
Generally taxed at ordinary income rates
--------------------------------------------------------------------------------
o short-term capital gains from selling portfolio shares
--------------------------------------------------------------------------------
o taxable income dividends you receive from a portfolio
--------------------------------------------------------------------------------
o short-term capital gains distributions you receive from a portfolio
--------------------------------------------------------------------------------
Generally taxed at capital gains rates
--------------------------------------------------------------------------------
o long-term capital gains from selling portfolio shares
--------------------------------------------------------------------------------
o long-term capital gains distributions you receive from a portfolio
--------------------------------------------------------------------------------
Each portfolio will send you detailed tax information every January. These
statements tell you the amount and the tax category of any dividends or
distributions you received. They also have certain details on your purchases and
sales of shares. The tax status of dividends and distributions is the same
whether you reinvest them or not. Dividends or distributions declared in the
last quarter of a given year are taxed in that year, even though you may not
receive the money until the following January.
If you invest right before the portfolio pays a dividend, you'll be getting some
of your investment back as a taxable dividend. You can avoid this, if you want,
by investing after the portfolio declares a dividend. In tax-advantaged
retirement accounts you don't need to worry about this.
Corporations may be able to take a dividends-received deduction for a portion of
income dividends they receive from portfolios other than the Income Portfolio.
59
<PAGE>
To Get More Information
Shareholder reports -- These include commentary from the portfolio's management
team about recent market conditions and the effects of the portfolio's
strategies on its performance. For each portfolio, they also have detailed
performance figures, a list of everything the portfolio owns, and the
portfolio's financial statements. Shareholders get the reports automatically. To
reduce costs, we mail one copy per household. For more copies, call
1-877-327-8899.
Statements of Additional Information (SAI) -- This tells you more about the
portfolios' features and policies, including additional risk information. The
SAI is incorporated by reference into this document (meaning that it's legally
part of this prospectus).
If you'd like to ask for copies of these documents, please contact Farmers or
the SEC. If you're a shareholder and have questions, please contact Farmers (see
below). Materials you get from Farmers are free; those from the SEC involve a
copying fee. If you like, you can look over these materials at the SEC's Public
Reference Room in Washington, DC or request them electronically at
[email protected].
Farmers Mutual Fund Portfolios SEC
222 Riverside Plaza 24th Fl 450 Fifth Street, N.W.
Chicago, IL 60606 Washington, DC 20549-0102
(202) 942-8090
www.sec.gov
<PAGE>
FARMERS MUTUAL FUND PORTFOLIOS
Two International Place
Boston, Massachusetts 02110
Farmers Investment Trust is a professionally managed, open-end
investment company that offers five investment portfolios.
INCOME PORTFOLIO
INCOME WITH GROWTH PORTFOLIO
BALANCED PORTFOLIO
GROWTH WITH INCOME PORTFOLIO
GROWTH PORTFOLIO
--------------------------------------------------------------------------------
STATEMENT OF ADDITIONAL INFORMATION
September 1, 2000
--------------------------------------------------------------------------------
This Statement of Additional Information is not a prospectus and should
be read in conjunction with the prospectus of Income Portfolio, Income with
Growth Portfolio, Balanced Portfolio, Growth with Income Portfolio, and Growth
Portfolio dated September 1, 2000. The prospectus may be obtained without charge
by writing to Farmers Customer Support, 222 South Riverside Plaza, 24th Floor,
Chicago, IL 60606 or calling toll-free 1-877-327-8899 and is also available
along with other related materials on the SEC's Internet web site
(http://www.sec.gov).
The Annual Report to Shareholders of the Portfolios dated April 30,
2000 is incorporated by reference and is hereby deemed to be part of this
Statement of Additional Information. The Annual Report to Shareholders may be
obtained without charge by calling 1-877-327-8899.
<PAGE>
<TABLE>
<CAPTION>
TABLE OF CONTENTS
Page
<S> <C>
FARMERS MUTUAL FUND PORTFOLIOS INVESTMENT OBJECTIVES AND POLICIES........................................1
General Investment Objectives and Policies......................................................1
Master/Feeder Structure.........................................................................2
The Underlying Funds............................................................................3
Risk Factors of the Underlying Funds............................................................7
Investment Restrictions of the Portfolios.......................................................7
PURCHASE OF SHARES.......................................................................................8
ADDITIONAL TRANSACTION INFORMATION......................................................................17
Share Certificates.............................................................................18
Other Information..............................................................................18
FEATURES AND SERVICES OFFERED BY THE TRUST..............................................................19
Internet access................................................................................19
Reports to Shareholders........................................................................19
Transaction Summaries..........................................................................20
DIVIDENDS AND CAPITAL GAINS DISTRIBUTIONS...............................................................20
PERFORMANCE INFORMATION.................................................................................20
Average Annual Total Return....................................................................20
Cumulative Total Return........................................................................21
SEC Yield of Income Portfolio..................................................................22
Total Return...................................................................................22
TRUST ORGANIZATION......................................................................................22
INVESTMENT ADVISER......................................................................................24
Investment Management Fees.....................................................................26
Personal Investments by Employees of the Adviser...............................................27
TRUSTEES AND OFFICERS...................................................................................27
REMUNERATION............................................................................................29
Responsibilities of the Board-- Board and Committee Meetings...................................29
Compensation of Officers and Trustees..........................................................29
PRINCIPAL UNDERWRITER...................................................................................30
SHAREHOLDER SERVICES....................................................................................31
CUSTODIAN, TRANSFER AGENT AND SHAREHOLDER SERVICE AGENT.................................................32
FUND ACCOUNTING AGENT...................................................................................32
TAXES...................................................................................................32
Taxation of the Portfolios and Their Shareholders..............................................32
Taxation of the Underlying Funds...............................................................35
PORTFOLIO TRANSACTIONS..................................................................................35
Portfolio Turnover.............................................................................35
NET ASSET VALUE.........................................................................................36
ADDITIONAL INFORMATION..................................................................................37
Experts........................................................................................37
Shareholder Indemnification....................................................................37
Other Information..............................................................................37
FINANCIAL STATEMENTS....................................................................................38
GLOSSARY
</TABLE>
I
<PAGE>
FARMERS MUTUAL FUND PORTFOLIOS INVESTMENT OBJECTIVES AND POLICIES
General Investment Objectives and Policies
Farmers Investment Trust (the "Trust") is an open-end management
investment company composed of five separate diversified portfolios, the Farmers
Mutual Fund Portfolios (each a "Portfolio," collectively the "Portfolios"),
which invest primarily in existing mutual funds (the "Underlying Funds")
according to well-defined investment objectives.
Each Portfolio offers a professionally managed, long-term investment
program that can serve as a complete investment program or as a core part of a
larger portfolio. The Portfolios may invest in money market instruments to
provide for redemptions and for temporary or defensive purposes. The Portfolios
may each also enter into reverse repurchase agreements. The Portfolios may also
each borrow money for temporary, emergency or other purposes, including
investment leverage purposes, as determined by the Board of Trustees of the
Portfolios (the "Board"). While the Trustees do not currently anticipate that an
Underlying Fund will borrow for investment leveraging purposes, if such a
strategy were implemented in the future it would increase a Portfolio's
volatility and the risk of loss in a declining market. The Investment Company
Act of 1940 (the "1940 Act") requires borrowings to have 300% asset coverage. It
is impossible to accurately predict how long such alternate strategies may be
utilized. Achievement of each Portfolio's objective cannot be assured.
Descriptions in this Statement of Additional Information of a
particular investment practice or technique in which an Underlying Fund
affiliated with Scudder Kemper Investments, Inc. (the "Adviser") may engage
(such as short selling, hedging, etc.) or a financial instrument which the
affiliated Underlying Fund may purchase (such as options, forward foreign
currency contracts, etc.) are meant to describe the spectrum of investments that
the Adviser, in its discretion, might, but is not required to, use in managing
an affiliated Underlying Fund's portfolio assets. The Adviser may, in its
discretion, at any time employ such practice, technique or instrument for one or
more funds but not for all funds advised by it. Furthermore, it is possible that
certain types of financial instruments or investment techniques described herein
may not be available, permissible, economically feasible or effective for their
intended purposes in all markets. Certain practices, techniques, or instruments
may not be principal activities of an affiliated Underlying Fund but, to the
extent employed, could from time to time have a material impact on that
affiliated Underlying Fund's performance.
The Portfolios are professionally managed portfolios which allocate
their investments among select Underlying Funds. The Portfolios represent a
range of investment approaches: a conservative investment approach ("Income
Portfolio" and "Income with Growth Portfolio"), a balance of growth and income
("Balanced Portfolio" and "Growth with Income Portfolio") or growth of capital
("Growth Portfolio"). The Portfolios have been created in response to increasing
demand by mutual fund investors for a simple and effective means of structuring
a diversified mutual fund investment program suited to their general needs. As
has been well documented in the financial press, the proliferation of mutual
funds over the last several years has left many investors confused and in search
of a simpler means to manage their investments. Many mutual fund investors
realize the value of diversifying their investments in a number of mutual funds
(e.g., a money market fund for liquidity and price stability, a growth fund for
long-term appreciation, an income fund for current income and relative safety of
principal), but need professional management to decide such questions as which
mutual funds to select, how much of their assets to commit to each fund and when
to reallocate their selections. The Portfolios will allow investors to rely on
the Adviser to determine (within clearly explained parameters) the amount to
invest in each of several Underlying Funds and the timing of such investments.
The investment objectives of the five Portfolios are as follows:
Income Portfolio
The Income Portfolio seeks a high level of current income. The
Portfolio invests primarily in bond funds, including short- and long-term bond
funds, government bond funds, high yield bond funds and international bond
funds. The Portfolio may be suitable for investors with an investment time
horizon of 1-3 years or more.
Income with Growth Portfolio
<PAGE>
The Income with Growth Portfolio seeks current income and, as a
secondary objective, long-term growth of capital, by investing substantially in
bond funds and, to a lesser extent, equity funds. The Portfolio may be suitable
for investors with an investment time horizon of 3-5 years or more.
Balanced Portfolio
The Balanced Portfolio seeks a balance of current income and long-term
growth of capital by investing predominantly in a mix of equity and bond funds.
The Portfolio may be suitable for investors with an investment time horizon of
3-5 years or more. At all times the portfolio will indirectly (through
investments in Underlying Funds) be invested at least 25% in fixed-income senior
securities.
Growth with Income Portfolio
The Growth with Income Portfolio seeks long-term growth of capital and
modest income by investing primarily in equity funds and, to a lesser extent,
bond funds. The Portfolio may be suitable for investors with an investment time
horizon of 5 years or more.
Growth Portfolio
The Growth Portfolio seeks long-term growth of capital through
investment primarily in growth-oriented equity funds. The Portfolio may be
suitable for investors with an investment time horizon of 5 years or more.
Except as otherwise indicated, each Portfolio's investment objective
and policies may be changed without a vote of shareholders.
Master/Feeder Structure
The Board of Trustees has the discretion to retain the current
distribution arrangement for each Portfolio while investing in a master fund in
a master/feeder fund structure as described below.
A master/feeder fund structure is one in which a fund (a "feeder
fund"), instead of investing directly in a portfolio of securities, invests most
or all of its investment assets in a separate registered investment company (the
"master fund") with substantially the same investment objective and policies as
the feeder fund. Such a structure permits the pooling of assets of two or more
feeder funds, preserving separate identities or distribution channels at the
feeder fund level. Based on the premise that certain of the expenses of
operating an investment portfolio are relatively fixed, a larger investment
portfolio may eventually achieve a lower ratio of operating expenses to average
net assets. An existing investment company is able to convert to a feeder fund
by selling all of its investments, which involves brokerage and other
transaction costs and realization of a taxable gain or loss, or by contributing
its assets to the master fund and avoiding transaction costs and, if proper
procedures are followed, the realization of taxable gain or loss.
Additional Information
Each Portfolio will purchase or sell securities to: (a) accommodate
purchases and sales of the Portfolio's shares, (b) change the percentages of the
Portfolio's assets invested in each applicable Underlying Funds in response to
changing market conditions, and (c) maintain or modify the allocation of the
Portfolio's assets in accordance with the investment mixes described below.
The portfolio management team for each Portfolio will allocate
Portfolio assets among the Underlying Funds in accordance with predetermined
percentage ranges, based on the Adviser's outlook for the financial markets, the
world's economies and the relative performance potential of the Underlying
Funds. The Underlying Fund have been selected to represent a broad spectrum of
investment options for the Portfolios, subject to the following investment
ranges:
o Income Portfolio: 80-100% in bond funds, 0% in equity funds
and 0-20% in a money market fund, cash or cash equivalents;
o Income with Growth Portfolio: 60-80% in bond funds, 20-40% in
equity funds and 0-15% in a money market fund, cash or cash
equivalents;
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o Balanced Portfolio: 40-60% in equity funds, 40-60% in bond
funds and 0-10% in a money market fund, cash or cash
equivalents;
o Growth with Income Portfolio: 60-80% in equity funds, 20-40%
in bond funds and 0-10% in a money market fund, cash or cash
equivalents;
o Growth Portfolio: 95-100% in equity funds, 0% in bond funds
and 0-5% in a money market fund, cash or cash equivalents.
Rather than investing in individual securities like a traditional
mutual fund, each Portfolio seeks to achieve its particular objective by
investing in a carefully selected combination of established, open-end mutual
funds that in turn invest in a wide range of securities. Therefore, an
investment in one of the Portfolios may be diversified over hundreds, or even
thousands, of individual securities. The Portfolio management team for each
Portfolio allocates investments, using a disciplined approach, based on a
proprietary model for asset allocation that incorporates fundamental and
quantitative data. This investment approach incorporates measures of relative
valuation and performance potential as well as the correlation of returns of the
Underlying Funds. In developing these measures, the portfolio management team
will consider the outlook of the Adviser for the financial markets and the world
economies. Each of the Farmers Mutual Fund Portfolios seeks to provide the
investor with long-term returns superior to a comparable risk benchmark,
although there can be no guarantee that these returns will be achieved.
The Underlying Funds
Each Portfolio may invest in Underlying Funds that are affiliated or
unaffiliated with the Adviser. The Portfolios may invest in, but are not limited
to, the following Underlying Funds:
Zurich Money Market Fund,
Kemper High Yield Fund,
Kemper U.S. Government Securities Fund,
PIMCO Low Duration Fund,
PIMCO Foreign Bond Fund,
Scudder Income Fund,
Janus Twenty Fund,
Kemper-Dreman High Return Equity Fund,
Scudder Growth and Income Fund,
Scudder International Fund,
Scudder Small Company Value Fund; and
Templeton Developing Markets Trust.
The Portfolios invest in Underlying Fund shares that, with respect to
the Farmers Mutual Funds Portfolios, do not charge any sales, service or
distribution fees. The following is a description of the investment objectives
and strategies for each of the Underlying Funds:
Zurich Money Market Fund seeks maximum current income to the extent
consistent with stability of principal. The Fund pursues its objective by
investing exclusively in the following types of U.S. Dollar denominated money
market instruments that mature in 12 months or less:
o Obligations of, or guaranteed by, the U.S. Government, its
agencies or instrumentalities.
o Bank certificates of deposit (including time deposits) or
bankers' acceptances limited to domestic banks (including
their foreign branches) and Canadian chartered banks having
total assets in excess of $1 billion.
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o Commercial paper obligations rated A-1 or A-2 by Standard &
Poor's Corporation ("S&P") or Prime-1 or Prime-2 by Moody's
Investors Service, Inc. ("Moody's") or issued by companies
with an unsecured debt issue outstanding currently rated Aa by
Moody's or AA by S&P or higher and investments in other
corporate obligations such as publicly traded bonds,
debentures and notes rated Aa by Moody's or AA by S&P or
higher.
o Repurchase agreements of obligations that are suitable for
investment under the categories set forth above.
The Fund may concentrate more than 25% of its assets in bank
certificates of deposit or bankers' acceptances of United States banks in
accordance with its written objective and policies. For temporary defensive
purposes, the Fund may invest up to 100% of its assets in short-term high-grade
debt securities, cash and cash equivalents. Because this defensive policy
differs from the Fund's investment objective, the Fund may not achieve its goals
during a defensive period. Temporary defensive investments may also be taxable.
Kemper High Yield Fund seeks the highest level of current income
obtainable from a diversified portfolio of fixed income securities which the
fund's investment manager considers consistent with reasonable risk. As a
secondary objective, the fund will seek capital gain where consistent with its
primary objective. The fund invests predominantly in high yield, fixed income
securities and foreign securities. The fund anticipates that under normal
circumstances 90% to 100% of its assets will be invested in fixed income
securities. The high yield, fixed income securities in which the fund intends to
invest (commonly referred to as "junk bonds") normally offer a current yield or
yield to maturity that is significantly higher than the yield available from
investment-grade securities (those rated in the four highest categories assigned
by a nationally recognized statistical rating service such as S&P or Moody's.
The characteristics of the securities in the Fund's portfolio, such as the
maturity and the type of issuer, will affect yields and yield differentials,
which vary over time. In seeking to achieve its investment objectives, the Fund
will invest in fixed income securities based on the Fund's investment manager's
analysis without relying on published ratings. The Fund will invest in a
particular security if in the view of the Fund's investment manager the
increased yield offered, regardless of published ratings, is sufficient to
compensate for a reasonable element of assumed risk. Such investments will be
based upon the investment manager's analysis rather than upon published ratings,
achievement of the Fund's goals may depend more upon the abilities of the Fund's
investment manager than would otherwise be the case. For temporary defensive
purposes, the Fund may invest up to 100% of its assets in short-term high-grade
debt securities, cash and cash equivalents. Because this defensive policy
differs from the Fund's investment objective, the Fund may not achieve its goals
during a defensive period.
Kemper U.S. Government Securities Fund seeks high current income,
liquidity and security of principal. The Fund invests in a portfolio of U.S.
Government Securities, and predominantly in Government National Mortgage
Association ("GNMA") securities. The Fund's investment manager focuses on
managing the fund's duration and selecting mortgage securities that are
undervalued in comparison with other sectors of the market. The Fund is designed
for the investor who seeks a higher yield than a money market fund or an insured
bank certificate of deposit and less fluctuation in net asset value than a
longer-term bond fund; unlike money market funds, however, the Fund does not
seek to maintain a stable net asset value and, unlike an insured bank
certificate of deposit, the Fund's shares are not insured. The fund invests up
to 100% in GNMA Certificates of the modified pass-through type. These GNMA
Certificates are debt securities issued by a mortgage banker or other mortgagee
and represent an interest in one or a pool of mortgages insured by the Federal
Housing Administration or guaranteed by the Veterans Administration. GNMA
guarantees the timely payment of monthly installments of principal and interest
on modified pass-through Certificates at the time such payments are due, whether
or not such amounts are collected by the issuer of these Certificates on the
underlying mortgages. The Fund may also invest in other U.S. Government
Securities. There are two broad categories of U.S. Government-related debt
instruments:
o Direct obligations of the U.S. Treasury, including agency
mortgage-backed securities
o Securities issued or guaranteed by U.S. Government agencies or
Government sponsored entities.
These instruments differ primarily in interest rates, the length of
maturities, the nature of the government obligation and the dates of issuance.
U.S. Treasury obligations are backed by the "full faith and credit" of the
United States. In the case of U.S. Government agency obligations, some are
backed by the full faith and credit of the United States and others are backed
only by the rights of the issuer to borrow from the U.S. Government. For
temporary
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defensive purposes, the Fund may invest up to 100% of its assets in short-term
high-grade debt securities, cash and cash equivalents. Because this defensive
policy differs from the Fund's investment objective, the Fund may not achieve
its goals during a defensive period.
PIMCO Foreign Bond Fund seeks to maximize total return, consistent with
preservation of capital and prudent investment management. The fund seeks to
achieve its investment objective by investing under normal circumstances at
least 85% of its assets in fixed income instruments of issuers located outside
the United States, representing at least three foreign countries, which may be
represented by futures contracts (including related options) with respect to
such securities, and options on such securities. Such securities normally are
denominated in major foreign currencies or baskets of foreign currencies (such
as the euro). The fund will normally hedge at least 75% of its exposure to
foreign currency to reduce the risk of loss due to fluctuations in currency
exchange rates.
The fund's investment adviser selects the fund's foreign country and currency
compositions based on an evaluation of various factors, including, but not
limited to, relative interest rates, exchange rates, monetary and fiscal
policies, trade and current account balances. The average portfolio duration of
this fund normally varies within a three- to seven-year time frame. The fund
invests primarily in investment grade debt securities, but may invest up to 10%
of its assets in high yield securities rated B or higher by Moody's or S&P, or,
if unrated, determined by the fund's investment adviser to be of comparable
quality. The fund is non-diversified, which means that it may concentrate its
assets in a smaller number of issuers than a diversified fund.
The fund may invest all of its assets in derivative instruments, such as
options, futures contracts or swap agreements, or in mortgage- or asset-backed
securities. The fund may lend its portfolio securities to brokers, dealers and
other financial institutions to earn income. The fund may seek to obtain market
exposure to the securities in which it primarily invests by entering into a
series of purchase and sale contracts or by using other investment techniques
(such as buy backs or dollar rolls). The total return sought by the fund
consists of income earned on the fund's investments, plus capital appreciation,
if any, which generally arises from decreases in interest rates or improving
credit fundamentals for a particular sector or security.
PIMCO Low Duration Fund seeks to maximize total return, consistent with
preservation of capital and prudent investment management. The fund seeks to
achieve its investment objective by investing under normal circumstances at
least 65% of its assets in a diversified portfolio of fixed income instruments
of varying maturities. The average portfolio duration of this fund normally
varies within a one- to three-year time frame based on the fund's investment
adviser's forecast for interest rates.
The fund invest primarily in investment grade debt securities, but may invest up
to 10% of its assets in high yield securities rated B or higher by Moody's or
S&P, or, if unrated, determined by the fund's investment adviser to be
comparable quality. The fund may invest up to 20% of it assets in securities
denominated in foreign currencies, and may invest beyond this limit in U.S.
dollar-denominated securities of foreign issuers. The fund will normally hedge
at least 75% of its exposure to foreign currency to reduce the risk of loss due
to fluctuations in currency exchange rates.
The fund may invest all of its assets in derivative instruments, such
as options, futures contracts or swap agreements, or in mortgage- or
asset-backed securities. The fund may lend its portfolio securities to brokers,
dealers and other financial institutions to earn income. The fund may seek to
obtain market exposure to the securities in which it primarily invests by
entering into a series of purchase and sale contracts or by using other
investment techniques (such as buy backs or dollar rolls). The total return
sought by the fund consists of income earned on the fund's investments, plus
capital appreciation, if any, which generally arises from decreases in interest
rates or improving credit fundamentals for a particular sector or security.
Scudder Income Fund seeks a high level of income, consistent with the
prudent investment of capital, through a flexible investment program emphasizing
high-grade bonds. The Fund invests primarily in a broad range of high-grade,
income-producing securities such as corporate bonds and government securities.
Under normal market conditions, the Fund will invest at least 65% of its assets
in securities rated within the three highest quality rating categories of
Moody's (Aaa, Aa and A) or S&P (AAA, AA and A), or if unrated, in bonds judged
by the Adviser, to be of comparable quality at the time of purchase. The Fund
may invest up to 20% of its assets in debt securities rated lower than Baa or
BBB or, if unrated, of equivalent quality as determined by the Adviser, but will
not purchase bonds rated below B by Moody's or S&P or their equivalent. The Fund
may invest in bonds, notes, zero coupon securities, adjustable rate
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bonds, convertible bonds, preferred and convertible preferred securities, U.S.
Government securities, commercial paper, debt securities issued by real estate
investment trusts ("REITs"), mortgage and asset-backed securities and other
money market instruments and illiquid securities such as certain securities
issued in private placements, foreign securities and certificates of deposit
issued by foreign and domestic branches of U.S. banks. It may also invest in
warrants, when-issued or forward delivery securities, indexed securities,
repurchase agreements, reverse repurchase agreements, and may engage in
dollar-roll transactions, securities lending and strategic transactions
including derivatives.
Janus Twenty Fund is a nondiversified fund that seeks long-term growth
of capital by normally concentrating its investments in a core position of 20-30
common stocks. The fund invests in primarily in common stocks of foreign and
domestic companies and may invest to a lesser degree in other types of
securities including preferred stock, warrants, convertible securities and debt
securities. The percentage of the fund's assets invested in common stocks will
vary and the fund may at times hold substantial positions in cash equivalents or
interest bearing securities.
Kemper-Dreman High Return Equity Fund seeks to achieve a high rate of
total return. The fund invests primarily in common stocks of larger, listed
companies with a record of earnings and dividends, low price-earnings ratios,
reasonable returns on equity, and sound finances which appear to have intrinsic
value. The fund generally invests in common stocks that pay relatively high
dividends, i.e. comparable to the dividend yield of Standard & Poor's 500
Composite Stock Price Index. In order to enhance its investment return, the Fund
may sell covered call options, and sell put options on securities it may
acquire. The Fund will earn premium income on the sale of these options. Under
normal market conditions, the Fund will invest at least 65% of its total assets
in equity securities. Equity securities include common stocks, preferred stocks,
securities convertible into or exchangeable for common or preferred stocks,
equity investments in partnerships, joint ventures and other forms of
non-corporate investment and warrants and rights exercisable for equity
securities and equity equivalents. Although the Fund will not invest 25% or more
of its total assets in any one industry, it may, from time to time, invest a
significant percentage of its total assets in one or more market sectors, such
as the financial services sector. The Fund's investment manager considers a
market sector to be comprised of a group of industries. If the Fund invests a
significant percentage of its assets in a market sector, financial, economic,
business and other developments affecting issuers in that sector may have a
greater effect on the Fund than if it had not invested a significant percentage
of its assets in that sector.
Scudder Growth and Income Fund seeks long-term growth of capital,
current income and growth of income. The Fund attempts to achieve its investment
objective by investing at least 65% of total assets in dividend-paying common
stocks, preferred stocks and securities convertible into common stocks of
companies with long-standing records of earnings growth. Although the Fund can
invest in companies of any size and from any country, it invests primarily in
large U.S. companies. The Fund may also purchase securities which do not pay
current dividends but which offer prospects for growth of capital and future
income. Convertible securities (which may be current coupon or zero coupon
securities) are bonds, notes, debentures, preferred stocks and other securities
which may be converted or exchanged at a stated or determinable exchange ratio
into underlying shares of common stock. The Fund may also invest in
nonconvertible preferred stocks consistent with its objective. The Fund may for
temporary defensive purposes invest without limit in cash and cash equivalents.
It is impossible to accurately predict how long such alternative strategies may
be utilized. In addition, the Fund may invest in warrants, foreign securities,
real estate investment trusts, illiquid securities, reverse repurchase
agreements, repurchase agreements and may engage in securities lending and
strategic transactions including derivatives.
Scudder International Fund seeks long-term growth of capital primarily
through a diversified portfolio of marketable foreign equity securities. The
Fund invests in companies, wherever organized, which do business primarily
outside the United States. Under normal market conditions, the Fund will invest
at least 65% of total assets in foreign equities (equities issued by
foreign-based companies and listed in foreign exchanges). The Fund intends to
diversify investments among several countries and to have represented in the
portfolio, in substantial proportions, business activities in not less than
three different countries other than the U.S. The Fund does not intend to
concentrate investments in any particular industry. The Fund's investments are
generally denominated in foreign currencies. The strength or weakness of the
U.S. dollar against these currencies is responsible for part of the Fund's
investment performance. The Fund may invest up to 20% of its total assets in
investment-grade debt securities except that the Fund may invest up to 5% of its
total assets in debt securities which are rated below investment-grade. The Fund
may for temporary defensive purposes invest without limits in Canadian or U.S.
Government obligations or currencies, or securities of companies incorporated in
and having their principal activities in Canada or the U.S. It is impossible to
accurately predict how long such alternative strategies may be utilized. In
addition, the Fund may invest in warrants,
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trust preferred securities, fixed-income securities, illiquid securities,
reverse repurchase agreements, repurchase agreements and may engage in
securities lending and strategic transactions including derivatives.
Scudder Small Company Value Fund pursues long-term growth of capital by
seeking out undervalued stocks of small U.S. companies. The Fund's investment
adviser uses a systematic, proprietary investment approach to identify small,
domestic companies that, in the opinion of the Fund's investment adviser, are
selling at prices that do not reflect adequately their long-term investment
potential. These companies are often out of favor or not closely followed by
investors and, as a result, may offer substantial appreciation potential over
time.
In pursuit of long-term growth of capital, the Fund invests, under
normal circumstances, at least 90% of its assets in the common stock of small
U.S. companies. The Fund will invest in securities of companies that are similar
in size to those in the Russell 2000 Index of small stocks. The Fund will
normally sell securities of companies that have grown in market capitalization
above the maximum of the Russell 2000 Index, as necessary to keep the Fund
focused on smaller companies. The Fund takes a diversified approach to investing
in small capitalization issues. The Fund will typically invest in more than one
hundred and fifty small companies, representing a variety of U.S. industries.
While the Fund invests predominately in common stocks, it can purchase
other types of equity securities including preferred stocks (convertible
securities), rights, warrants and illiquid securities. Securities may be listed
on national exchanges or traded over-the-counter. The Fund may invest up to 20%
of its assets in U.S. Treasury, agency and instrumentality obligations on a
temporary basis, may enter into repurchase agreements and reverse repurchase
agreements and may engage in strategic transactions, using such derivatives
contracts as index options and futures, to increase stock market participation,
enhance liquidity and manage transaction costs. The Fund currently intends to
borrow only for temporary or emergency purposes, such as providing for
redemptions or distributions, and not for investment leverage purposes. For
temporary defensive purposes, the Fund may invest without limit in cash and cash
equivalents when the Fund's Adviser deems such a position advisable in light of
economic or market conditions. It is impossible to accurately predict how long
such alternative strategies may be utilized.
Templeton Development Markets Trust seeks long-term capital
appreciation. The fund tries to achieve its investment goal by investing, under
normal market conditions, at least 65% of its total assets in equity securities
of developing market issuers. The fund will normally invest in at least three
developing market countries. For purposes of the fund's investments, developing
or emerging market countries include those considered such by the World Bank,
the International Finance Corporation, or the United Nations. In addition,
developing market equity securities means those issued by: companies with their
principal securities trading market within a developing market country, as
defined above; or companies that derive 50% or more of their total revenue from
either goods or services produced or sales made in developing market countries;
or companies organized under the laws of, and with a principal office in, a
developing market country.
Risk Factors of the Underlying Funds
In pursuing its investment objectives, each of the Underlying Funds has
adopted a wide range of investment strategies and policies. The Underlying
Funds' risks are determined by the nature of the securities held and the
portfolio management strategies used by their particular investment adviser.
Certain of these policies, with respect to the affiliated Underlying Funds, are
described in the "Glossary" and further information about the Underlying Funds
is contained in the prospectuses of such funds. Because each Portfolio invests
in certain of the Underlying Funds, shareholders of each Portfolio will be
affected by these investment policies in direct proportion to the amount of
assets each Portfolio allocates to the Underlying Funds pursuing such policies.
Investment Restrictions of the Portfolios
The policies set forth below are fundamental policies of each Portfolio
and may not be changed with respect to each of the Portfolios without the
approval of a majority of the outstanding voting securities of the Portfolio. As
used in this Statement of Additional Information, a "majority of the outstanding
voting securities of a Portfolio" means the lesser of (1) 67% or more of the
voting securities present at such meeting, if the holders of more than 50% of
the outstanding voting securities of such Portfolio are present or represented
by proxy; or (2) more than 50% of the outstanding voting securities of such
Portfolio.
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Each Portfolio has elected to be classified as a diversified series of
an open-end investment company. In addition, as a matter of fundamental policy,
each Portfolio will not:
(1) borrow money, except as permitted under the 1940 Act, as
amended, and as interpreted or modified by regulatory
authority having jurisdiction, from time to time;
(2) issue senior securities, except as permitted under the 1940
Act, as amended, and as interpreted or modified by regulatory
authority having jurisdiction, from time to time;
(3) engage in the business of underwriting securities issued by
others, except to the extent that a Portfolio may be deemed to
be an underwriter in connection with the disposition of
portfolio securities;
(4) concentrate its investments in investment companies, as the
term "concentrate" is used in the 1940 Act, as amended and
interpreted by regulatory authority having jurisdiction from
time to time, except that each Portfolio may concentrate in an
Underlying Fund. However, each Underlying Fund in which each
Portfolio will invest may concentrate its investments in a
particular industry;
(5) purchase or sell real estate, which term does not include
securities of companies which deal in real estate or mortgages
or investments secured by real estate or interests therein,
except that the Portfolio reserves freedom of action to hold
and to sell real estate acquired as a result of the
Portfolio's ownership of securities;
(6) purchase physical commodities or contracts relating to
physical commodities; or
(7) make loans except as permitted under the Investment Company
Act of 1940, as amended, and as interpreted or modified by
regulatory authority having jurisdiction, from time to time.
With respect to fundamental policy (4) above, each Portfolio has
reserved the freedom of action to concentrate its investments in a
particular Underlying Fund .
Nonfundamental policies may be changed by the Board without shareholder
approval. As a matter of nonfundamental policy, each Portfolio does not
currently intend to:
(a) invest in companies for the purpose of exercising management
or control; or
(b) borrow money in an amount greater than 5% of its total assets,
except for (i) temporary or emergency purposes; and (ii) by
engaging in reverse repurchase agreements, entering into
dollar rolls, or making other investments or engaging in other
transactions which may be deemed to be borrowings but are
consistent with each Portfolio's investment objective.
Any investment restrictions in this Statement of Additional Information
which involve a maximum percentage of securities or assets shall not be
considered to be violated unless an excess over the percentage occurs
immediately after, and is caused by, an acquisition or encumbrance of securities
or assets of, or borrowings by, the Portfolios.
PURCHASE OF SHARES
As described in the Portfolios' prospectus, shares of a Portfolio are
sold at their public offering price, which is the net asset value per share of
the Portfolio next determined after an order is received in proper form plus,
with respect to certain purchases of Class A shares, an initial sales charge. An
order for the purchase of shares that is accompanied by a check drawn on a
foreign bank (other than a check drawn on a Canadian bank in U.S. Dollars) will
not be considered in proper form and will not be processed unless and until the
Portfolio determines that it has received payment of the proceeds of the check.
The time required for such a determination will vary and cannot be determined in
advance.
Scheduled variations in or the elimination of the initial sales charge
for purchases of Class A shares or the contingent deferred sales charge for
redemptions of Class B shares by certain classes of persons or through certain
types
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of transactions as described in the prospectus are provided because of
anticipated economies in sales and sales related efforts.
The conversion of Class B shares to Class A shares may be subject to
the continuing availability of an opinion of counsel or ruling by the Internal
Revenue Service or other assurance acceptable to each Portfolio to the effect
that (a) the assessment of the distribution services fee with respect to Class B
shares and not Class A shares and the assessment of the shareholder services fee
with respect to each Class does not result in the Portfolio's dividends
constituting "preferential dividends" under the Internal Revenue Code, and (b)
that the conversion of Class B shares to Class A shares does not constitute a
taxable event under the Internal Revenue Code. The conversion of Class B shares
to Class A shares may be suspended if such assurance is not available. In that
event, no further conversions of Class B shares would occur, and shares might
continue to be subject to the distribution services fee for an indefinite period
that may extend beyond the proposed conversion date as described in the
prospectus.
Each Portfolio has authorized certain members of the National
Association of Securities Dealers, Inc. ("NASD"), other than Kemper
Distributors, Inc. ("KDI," the "Distributor" or the "principal underwriter") to
accept purchase and redemption orders for the Portfolio's shares. Those brokers
may also designate other parties to accept purchase and redemption orders on the
Portfolio's behalf. Orders for purchase or redemption will be deemed to have
been received by the Portfolio when received by Kemper Service Company ("KSvC,"
the "Shareholder Service Agent" or the "Transfer Agent") in good order. Further,
if purchases or redemptions of the Portfolio's shares are arranged and
settlement is made at an investor's election through any other authorized NASD
member, that member may, at its discretion, charge a fee for that service. The
Board and KDI each has the right to limit the amount of purchases by, and to
refuse to sell to, any person. The Board and KDI may suspend or terminate the
offering of shares of the Portfolio at any time for any reason.
Checks. A certified check is not necessary, but checks are only accepted subject
to collection at full face value in U.S. funds and must be drawn on, or payable
through, a U.S. bank.
If shares of a Portfolio are purchased by a check which proves to be
uncollectible, the Portfolio reserves the right to cancel the purchase
immediately and the purchaser will be responsible for any loss incurred by the
Portfolio or the principal underwriter by reason of such cancellation. If the
purchaser is a shareholder, the Portfolio shall have the authority, as agent of
the shareholder, to redeem shares in the shareholder's account in order to
reimburse the Portfolio or the principal underwriter for the loss incurred.
Investors whose orders have been canceled may be prohibited or restricted from
placing future orders in any of the Portfolios and their affiliated Underlying
Funds.
Wire Transfer of Federal Funds. To obtain the net asset value determined as of
the close of regular trading on the New York Stock Exchange (the "Exchange") on
a selected day for a Portfolio, your bank must forward federal funds by wire
transfer and provide the required account information so as to be available to a
Portfolio prior to the regular close of trading on the Exchange (normally 4 p.m.
eastern time). The bank sending an investor's federal funds by bank wire may
charge for the service. Presently, the Distributor pays a fee for receipt by the
custodian of "wired funds," but the right to charge investors for this service
is reserved. Banks are closed on certain holidays although the Exchange may be
open. These holidays include: Columbus Day (the 2nd Monday in October) and
Veterans Day (November 11). Investors are not able to purchase shares by wiring
federal funds on such holidays because the custodian is not open to receive such
federal funds on behalf of a Portfolio.
Share Price. Purchases will be filled at the net asset value next computed after
receipt of the application by KSvC in good order plus, with respect to certain
purchases of Class A shares, an initial sales charge. Net asset value per share
normally will be computed as of the close of regular trading on each day the
Exchange is open for trading. Orders received after the close of regular trading
on the Exchange will be executed at the next business day's net asset value. If
the order has been placed by a member of the NASD, other than KDI, it is the
responsibility of that member broker, rather than a Portfolio, to forward the
purchase order to KSvC by the close of regular trading on the Exchange.
Alternative Purchase Arrangements. Class A shares of each Portfolio are sold to
investors subject to an initial sales charge. Class B shares are sold without an
initial sales charge but are subject to higher ongoing expenses than Class A
shares and a contingent deferred sales charge payable upon certain redemptions.
Class B shares automatically convert to Class A shares six years after issuance.
When placing purchase orders, investors must specify whether the order is for
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Class A or Class B shares. If a class of shares is not specified on the account
application, Class A shares will be purchased for an investor.
The primary distinctions among the classes of each Portfolio's shares
lie in their initial and contingent deferred sales charge structures and in
their ongoing expenses, including asset-based sales charges in the form of Rule
12b-1 distribution fees. These differences are summarized in the table below.
Each class has distinct advantages and disadvantages for different investors,
and investors may choose the class that best suits their circumstances and
objectives.
<TABLE>
<CAPTION>
Discount Allowed to
-------------------
Annual 12b-1 Dealers
Fees -------
Sales Charge (as a % of (as a % of public offering
------------ average daily --------------------------
(as a % of public offering price) net assets) price) Other Information
--------------------------------- ------ -----------------
<S> <C> <C> <C> <C>
Class A Maximum initial sales charge of 5.00% of 0.00% Maximum initial sales charge Initial sales charge
for Income Portfolio, 5.25% for Income of 3.30% for Income waived or reduced for
with Growth Portfolio and 5.75% for Portfolio, 3.42% for Income certain purchases
Balanced, Growth with Income, and Growth with Growth Portfolio and
Portfolios 3.79% for Balanced, Growth
with Income, and Growth
Portfolios
Class B Maximum contingent deferred sales charge 0.75% __ Shares automatically
of 4% of redemption proceeds; declines to convert to Class A
zero on certain redemptions made within shares six years
six years after issuance
</TABLE>
The minimum initial investment for each Portfolio is $1,000 and the
minimum subsequent investment is $100. The minimum initial investment for an
Individual Retirement Account is $500 and the minimum subsequent investment is
$50. Under an automatic investment plan, such as Auto Buy, Payroll Direct
Deposit or Government Direct Deposit, the minimum initial and subsequent
investment is $100. These minimum amounts may be changed at any time at
management's discretion.
Each Portfolio receives the entire net asset value of all its Class A
shares sold. KDI, the Portfolios' principal underwriter, retains the sales
charge on sales of Class A shares from which it allows discounts from the
applicable public offering price to investment dealers, which discounts are
uniform for all dealers in the United States and its territories. The normal
discount allowed to dealers is set forth in the above table. Upon notice to all
dealers with whom it has sales agreements, KDI may reallow up to the full
applicable sales charge, as shown in the above table, during periods and for
transactions specified in such notice and such reallowances may be based upon
attainment of minimum sales levels. During periods when 90% or more of the sales
charge is reallowed, such dealers may be deemed to be underwriters as that term
is defined in the Securities Act of 1933.
Class A shares of a Portfolio may be purchased at net asset value by:
(a) shareholders in connection with the investment or reinvestment of income and
capital gains dividends; (b) a participant-directed qualified retirement plan or
a participant-directed non-qualified deferred compensation plan or a
participant-directed qualified retirement plan, providing that the Portfolios
are accepting such orders; (c) any purchaser with Portfolio investment provided
that the amount invested in such Portfolio totals at least $1,000,000 (the
"Large Order NAV Purchase Privilege") including purchases of Class A shares
pursuant to the "Combined Purchases," "Letter of Intent" and "Cumulative
Discount" features described under "Special Features" in the Portfolios'
prospectus, or (d) officers, Trustees, directors, employees (including
retirees), certain independent contractors and sales representatives of a
Portfolio, its investment adviser, its principal underwriter or certain
affiliated companies, for themselves or members of their families or any trust,
pension, profit-sharing or other benefit plan for such persons; (e) registered
representatives and employees of broker-dealers having selling group agreements
with the Distributor or any trust, pension, profit-sharing or other benefit plan
for such persons; (f) in connection with the acquisition of the assets of or
merger on consolidation with another investment company.
10
<PAGE>
KDI may in its discretion compensate investment dealers or other
financial services firms in connection with the sale of Class A shares of a
Portfolio at net asset value in accordance with the Large Order NAV Purchase
Privilege up to the following amounts: 1.00% of the net asset value of shares
sold on amounts up to $5 million, 0.50% on the next $45 million and 0.25% on
amounts over $50 million. The commission schedule will be reset on a calendar
year basis for sales of shares pursuant to the Large Order NAV Purchase
Privilege to employer sponsored employee benefit plans using the subaccount
record keeping system made available through KSvC. For purposes of determining
the appropriate commission percentage to be applied to a particular sale, KDI
will consider the cumulative amount invested by the purchaser in the Portfolios
as noted under
"Special Features -- Class A Shares -- Combined Purchases" in the
Portfolios' prospectus, including purchases pursuant to the "Combined
Purchases," "Letter of Intent" and "Cumulative Discount" features. The privilege
of purchasing Class A shares of a Portfolio at net asset value under the Large
Order NAV Purchase Privilege is not available if another net asset value
purchase privilege also applies.
The sales charge scale is applicable to purchases made at one time by
any "purchaser" which includes: an individual; or an individual, his or her
spouse and children under the age of 21; or a trustee or other fiduciary of a
single trust estate or single fiduciary account; or an organization exempt from
federal income tax under Section 501(c)(3) or (13) of the Code; or a pension,
profit-sharing or other employee benefit plan whether or not qualified under
Section 401 of the Code; or other organized group of persons whether
incorporated or not, provided the organization has been in existence for at
least six months and has some purpose other than the purchase of redeemable
securities of a registered investment company at a discount. In order to qualify
for a lower sales charge, all orders from an organized group will have to be
placed through a single investment dealer or other firm and identified as
originating from a qualifying purchaser.
Deferred Sales Charge Alternative -- Class B Shares. Investors choosing the
deferred sales charge alternative may purchase Class B shares at net asset value
per share without any sales charge at the time of purchase. Since Class B shares
are being sold without an initial sales charge, the full amount of the
investor's purchase payment will be invested in Class B shares for his or her
account. A contingent deferred sales charge may be imposed upon redemption of
Class B shares.
KDI compensates firms for sales of Class B shares at the time of sale
at a commission rate of up to 2.93% of the amount of Class B shares sold. KDI is
compensated by each Fund for services as distributor and principal underwriter
for Class B shares.
Class B shares of a Fund will automatically convert to Class A shares
of the same Fund six years after issuance on the basis of the relative net asset
value per share. The purpose of the conversion feature is to relieve holders of
Class B shares from the distribution services fee when they have been
outstanding long enough for KDI to have been compensated for distribution
related expenses. For purposes of conversion to Class A shares, shares purchased
through the reinvestment of dividends and other distributions paid with respect
to Class B shares in a shareholder's Fund account will be converted to Class A
shares on a pro rata basis.
REDEMPTION OR REPURCHASE OF SHARES
General. Any shareholder may require a Portfolio to redeem his or her shares.
Upon receipt by KSvC of a request for redemption, shares of a Portfolio will be
redeemed by the Portfolio at the applicable net asset value per share of such
Portfolio as described in the Portfolios' prospectus. When shares are held for
the account of a shareholder by the Portfolios' transfer agent, the shareholder
may redeem them by sending a written request with signatures guaranteed to
Kemper Service Company, P.O. Box 419453, Kansas City, Missouri 64141. Redemption
requests must be endorsed by the account holder with signatures guaranteed by a
commercial bank, trust company, savings and loan association, federal savings
bank, member firm of a national securities exchange or other eligible financial
institution. The redemption request must be signed exactly as the account is
registered including any special capacity of the registered owner. Additional
documentation may be requested, and a signature guarantee is normally required,
from institutional and fiduciary account holders, such as corporations,
custodians (e.g., under the Uniform Transfers to Minors Act), executors,
administrators, Trustees or guardians.
11
<PAGE>
The redemption price for shares of a Portfolio will be the net asset
value per share of that Portfolio next determined following receipt by KSvC of a
properly executed request with any required documents as described above.
Payment for shares redeemed will be made in cash as promptly as practicable but
in no event later than seven days after receipt of a properly executed request,
unless unusual circumstances prompt the SEC to allow further delays. When a
Portfolio is asked to redeem shares for which it may not have yet received good
payment (i.e., purchases by check, AutoBuy or Bank Direct Deposit), it may delay
transmittal of redemption proceeds until it has determined that collected funds
have been received for the purchase of such shares, which will be up to 10 days
from receipt by a Portfolio of the purchase amount. The redemption within two
years of Class A shares purchased at net asset value under the Large Order NAV
Purchase Privilege may be subject to a contingent deferred sales charge (see
"Purchase of Shares"). The redemption of Class B shares within six years may be
subject to a contingent deferred sales charge (see "Contingent Deferred Sales
Charge -- Class B Shares" below).
Because of the high cost of maintaining small accounts, the Portfolios
may assess a quarterly fee of $9 on an account with a balance below $1,000 for
the quarter. The fee will not apply to accounts enrolled in an automatic
investment program, Individual Retirement Accounts or employer sponsored
employee benefit plans using the subaccount record keeping system made available
through the Shareholder Service Agent.
Shareholders can request the following telephone privileges: expedited
wire transfer redemptions and AutoBuy and exchange transactions for individual
and institutional accounts and pre-authorized telephone redemption transactions
for certain institutional accounts. Shareholders may choose these privileges on
the account application or by contacting KSvC for appropriate instructions.
Please note that the telephone exchange privilege is automatic unless the
shareholder refuses it on the account application. A Portfolio or its agents may
be liable for any losses, expenses or costs arising out of fraudulent or
unauthorized telephone requests pursuant to these privileges unless the
Portfolio or its agents reasonably believe, based upon reasonable verification
procedures, that the telephonic instructions are genuine. The shareholder will
bear the risk of loss, including loss resulting from fraudulent or unauthorized
transactions, as long as the reasonable verification procedures are followed.
The verification procedures include recording instructions, requiring certain
identifying information before acting upon instructions and sending written
confirmations.
Telephone Redemptions. If the proceeds of the redemption (prior to the
imposition of any contingent deferred sales charge) are $50,000 or less and the
proceeds are payable to the shareholder of record at the address of record,
normally a telephone request or a written request by any one account holder
without a signature guarantee is sufficient for redemptions by individual or
joint account holders, and trust, executor and guardian account holders
(excluding custodial accounts for gifts and transfers to minors), provided the
trustee, executor or guardian is named in the account registration. Other
institutional account holders and guardian account holders of custodial accounts
for gifts and transfers to minors may exercise this special privilege of
redeeming shares by telephone request or written request without signature
guarantee subject to the same conditions as individual account holders and
subject to the limitations on liability described under "General" above,
provided that this privilege has been pre-authorized by the institutional
account holder or guardian account holder by written instruction to KSvC with
signatures guaranteed. Telephone requests may be made by calling 1-877-327-8899.
Shares purchased by check or through AutoBuy or Bank Direct Deposit may not be
redeemed under this privilege of redeeming shares by telephone request until
such shares have been owned for at least 10 days. This privilege of redeeming
shares by telephone request or by written request without a signature guarantee
may not be used if the shareholder's account has had an address change within 30
days of the redemption request. During periods when it is difficult to contact
the Shareholder Service Agent by telephone, it may be difficult to use the
telephone redemption privilege, although investors can still redeem by mail. The
Funds reserve the right to terminate or modify this privilege at any time.
Repurchases (Confirmed Redemptions). A request for repurchase may be
communicated by a shareholder through a securities dealer or other financial
services firm to KDI, which each Portfolio has authorized to act as its agent.
There is no charge by KDI with respect to repurchases; however, dealers or other
firms may charge customary commissions for their services. Dealers and other
financial services firms are obligated to transmit orders promptly. The
repurchase price will be the net asset value of the Portfolio next determined
after receipt of a request by KDI. However, requests for repurchases received by
dealers or other firms prior to the determination of net asset value (see "Net
Asset Value") and received by KDI prior to the close of KDI's business day will
be confirmed at the net asset value effective on that day. The offer to
repurchase may be suspended at any time. Requirements as to stock powers,
payments and delay of payments are the same as for redemptions.
12
<PAGE>
Expedited Wire Transfer Redemptions. If the account holder has given
authorization for expedited wire redemption to the account holder's brokerage or
bank account, shares of a Portfolio can be redeemed and proceeds sent by federal
wire transfer to a single previously designated account. Requests received by
KSvC prior to the determination of net asset value will result in shares being
redeemed that day at the net asset value of the Portfolio effective on that day
and normally the proceeds will be sent to the designated account the following
business day. Delivery of the proceeds of a wire redemption request of $250,000
or more may be delayed by the Portfolio for up to seven days if the Adviser
deems it appropriate under then current market conditions. Once authorization is
on file, KSvC will honor requests by telephone at 1-877-327-8899 or in writing,
subject to the limitations on liability described under "General" above. The
Portfolios are not responsible for the efficiency of the federal wire system or
the account holder's financial services firm or bank. The Portfolios currently
do not charge the account holder for wire transfers. The account holder is
responsible for any charges imposed by the account holder's firm or bank. There
is a $1,000 wire redemption minimum (including any contingent deferred sales
charge). To change the designated account to receive wire redemption proceeds,
send a written request to KSvC with signatures guaranteed as described above or
contact the firm through which shares of the Portfolio were purchased. Shares
purchased by check or through AutoBuy or Bank Direct Deposit may not be redeemed
by wire transfer until such shares have been owned for at least 10 days. During
periods when it is difficult to contact the KSvC by telephone, it may be
difficult to use the expedited redemption privilege. The Portfolios reserve the
right to terminate or modify this privilege at any time.
Contingent Deferred Sales Charge -- Large Order NAV Purchase Privilege. A
contingent deferred sales charge may be imposed upon redemption of Class A
shares that are purchased under the Large Order NAV Purchase Privilege as
follows: 1.00% if they are redeemed within one year of purchase and 0.50% if
they are redeemed during the second year following purchase. The charge will not
be imposed upon redemption of reinvested dividends or share appreciation. The
charge is applied to the value of the shares redeemed excluding amounts not
subject to the charge. The contingent deferred sales charge will be waived in
the event of: (a) redemptions by a participant-directed qualified retirement
plan described in Code Section 401(a) or a participant-directed non-qualified
deferred compensation plan described in Code Section 457 or a
participant-directed qualified retirement plan described in Code Section
403(b)(7) which is not sponsored by a K-12 school district; (b) redemptions by
employer sponsored employee benefit plans using the subaccount record keeping
system made available through the Shareholder Service Agent; (c) redemption of
shares of a shareholder (including a registered joint owner) who has died; (d)
redemption of shares of a shareholder (including a registered joint owner) who
after purchase of the shares being redeemed becomes totally disabled (as
evidenced by a determination by the federal Social Security Administration); (e)
redemptions under a Fund's Systematic Withdrawal Plan at a maximum of 10% per
year of the net asset value of the account; and (f) redemptions of shares whose
dealer of record at the time of the investment notifies KDI that the dealer
waives the commission applicable to such Large Order NAV Purchase.
Contingent Deferred Sales Charge -- Class B Shares. A contingent deferred sales
charge may be imposed upon redemption of Class B shares. There is no such charge
upon redemption of any share appreciation or reinvested dividends on Class B
shares. The charge is computed at the following rates applied to the value of
the shares redeemed excluding amounts not subject to the charge.
Year of Redemption after Purchase Contingent Deferred Sales Charge
--------------------------------- --------------------------------
First 4%
Second 3%
Third 3%
Fourth 2%
Fifth 2%
Sixth 1%
The contingent deferred sales charge will be waived: (a) in the event
of the total disability (as evidenced by a determination by the federal Social
Security Administration) of the shareholder (including a registered joint owner)
occurring after the purchase of the shares being redeemed, (b) in the event of
the death of the shareholder (including a registered joint owner), (c) for
redemptions made pursuant to a systematic withdrawal plan (see "Special Features
-- Systematic Withdrawal Plan" below) and (d) for redemptions made pursuant to
any IRA systematic withdrawal based on the shareholder's life expectancy
including, but not limited to, substantially equal periodic payments described
in
13
<PAGE>
Internal Revenue Code Section 72(t)(2)(A)(iv) prior to age 59 1/2; and (e) for
redemptions to satisfy required minimum distributions after age 70 1/2 from an
IRA account (with the maximum amount subject to this waiver being based only
upon the shareholder's IRA accounts). The contingent deferred sales charge will
also be waived in connection with the following redemptions of shares held by
employer sponsored employee benefit plans maintained on the subaccount record
keeping system made available by KSvC: (a) redemptions to satisfy participant
loan advances (note that loan repayments constitute new purchases for purposes
of the contingent deferred sales charge and the conversion privilege), (b)
redemptions in connection with retirement distributions (limited at any one time
to 10% of the total value of plan assets invested in a Portfolio), (c)
redemptions in connection with distributions qualifying under the hardship
provisions of the Internal Revenue Code and (d) redemptions representing returns
of excess contributions to such plans.
Contingent Deferred Sales Charge -- General. The following example will
illustrate the operation of the contingent deferred sales charge. Assume that an
investor makes a single purchase of $10,000 of a Portfolio's Class B shares and
that 16 months later the value of the shares has grown by $1,000 through
reinvested dividends and by an additional $1,000 in appreciation to a total of
$12,000. If the investor were then to redeem the entire $12,000 in share value,
the contingent deferred sales charge would be payable only with respect to
$10,000 because neither the $1,000 of reinvested dividends nor the $1,000 of
share appreciation is subject to the charge. The charge would be at the rate of
3% ($300) because it was in the second year after the purchase was made.
The rate of the contingent deferred sales charge is determined by the
length of the period of ownership. Investments are tracked on a monthly basis.
The period of ownership for this purpose begins the first day of the month in
which the order for the investment is received. For example, an investment made
in January, 2000 will be eligible for the second year's charge if redeemed on or
after January 1, 2001. In the event no specific order is requested, the
redemption will be made first from shares representing reinvested dividends and
then from the earliest purchase of shares. KDI receives any contingent deferred
sales charge directly.
Redemption by Mail or Fax. In order to ensure proper authorization before
redeeming shares, the Transfer Agent may request additional documents such as,
but not restricted to, stock powers, trust instruments, certificates of death,
appointments as executor/executrix, certificates of corporate authority and
waivers of tax (required in some states when settling estates).
It is suggested that shareholders holding shares registered in other
than individual names contact the Transfer Agent prior to any redemptions to
ensure that all necessary documents accompany the request. When shares are held
in the name of a corporation, trust, fiduciary agent, attorney or partnership,
the Transfer Agent requires, in addition to the stock power, certified evidence
of authority to sign. These procedures are for the protection of shareholders
and should be followed to ensure prompt payment. Redemption requests must not be
conditional as to date or price of the redemption. Proceeds of a redemption will
be sent within seven (7) days after receipt by the Transfer Agent of a request
for redemption that complies with the above requirements. Delays of more than
seven (7) days of payment for shares tendered for repurchase or redemption may
result, but only until the purchase check has cleared.
The requirements for IRA redemptions are different from those for
regular accounts. For more information, please call Farmers Customer Support
toll-free at 1-877-327-8899.
Reinvestment Privilege. A shareholder who has redeemed Class A shares of a
Portfolio may reinvest up to the full amount redeemed at net asset value at the
time of the reinvestment in Class A shares of another Portfolio. A shareholder
of a Portfolio who redeems Class A shares purchased under the Large Order NAV
Purchase Privilege (see "Purchase of Shares") or Class B shares and incurs a
contingent deferred sales charge may reinvest up to the full amount redeemed at
net asset value at the time of the reinvestment in Class A shares or Class B
shares, as the case may be, of a Portfolio. The amount of any contingent
deferred sales charge also will be reinvested. These reinvested shares will
retain their original cost and purchase date for purposes of the contingent
deferred sales charge. Also, a holder of Class B shares who has redeemed shares
may reinvest up to the full amount redeemed, less any applicable contingent
deferred sales charge that may have been imposed upon the redemption of such
shares, at net asset value in Class A shares of a Portfolio. Purchases through
the reinvestment privilege are subject to the minimum investment requirements
applicable to the shares being purchased. The reinvestment privilege can be used
only once as to any specific shares and reinvestment must be effected within six
months of the redemption. In certain circumstances, shareholders will be
ineligible to take sales charges into account in computing taxable gain or loss
on a redemption if the reinvestment privilege is exercised. (See "Taxes") If a
loss is realized on the redemption of a Portfolio's shares, the reinvestment in
the same Portfolio may
14
<PAGE>
be subject to the "wash sale" rules if made within 30 days of the redemption,
resulting in a postponement of the recognition of such loss for federal income
tax purposes. The reinvestment privilege may be terminated or modified at any
time.
SPECIAL FEATURES
Class A Shares -- Combined Purchases. Each Portfolio's Class A shares may be
purchased at the rate applicable to the discount bracket attained by combining
concurrent investments in Class A shares of the Portfolios.
Class A Shares -- Letter of Intent. A written Letter of Intent (the "Letter"),
which imposes no obligation to purchase or sell additional Class A shares,
provides for a price adjustment depending upon the actual amount purchased
within a 24-month period. The Letter provides that the first purchase following
execution of the Letter must be at least 5% of the amount of the intended
purchase, and that 5% of the amount of the intended purchase normally will be
held in escrow in the form of shares pending completion of the intended
purchase. If the total investments under the Letter are less than the intended
amount and thereby qualify only for a higher sales charge than actually paid,
the appropriate number of escrowed shares are redeemed and the proceeds used
toward satisfaction of the obligation to pay the increased sales charge. The
Letter for an employer sponsored employee benefit plan maintained on the
subaccount record keeping system available through KSvC may have special
provisions regarding payment of any increased sales charge resulting from a
failure to complete the intended purchase under the Letter. A shareholder may
include the value (at the maximum offering price) of all shares of such
Portfolios held of record as of the initial purchase date under the Letter as an
"accumulation credit" toward the completion of the Letter, but no price
adjustment will be made on such shares. Only investments in Class A shares of a
Portfolio are included for this privilege.
Class A Shares -- Cumulative Discount. Class A shares of a Portfolio may also be
purchased at the rate applicable to the discount bracket attained by adding to
the cost of shares of a Portfolio being purchased, the value of all Class A
shares of Farmers Mutual Fund Portfolios (computed at the maximum offering price
at the time of the purchase for which the discount is applicable) already owned
by the investor.
Class A Shares -- Availability of Quantity Discounts. An investor or the
investor's agent must notify KSvC or KDI whenever a quantity discount or reduced
sales charge is applicable to a purchase. Upon such notification, the investor
will receive the lowest applicable sales charge. Quantity discounts described
above may be modified or terminated at any time.
Exchange Privilege. Shareholders of Class A or Class B shares may exchange their
shares for shares of the corresponding class of other Portfolios, or shares of
Farmers Money Market Portfolio - Retail Shares, in accordance with the
provisions below.
Class A Shares. Class A shares of the Portfolios may be exchanged for each other
at their relative net asset values. Class A shares of a Fund purchased under the
Large Order NAV Purchase Privilege may be exchanged for Class A shares of
another Portfolio under the exchange privilege described above without paying
any contingent deferred sales charge at the time of exchange. If the Class A
shares received on exchange are redeemed thereafter, a contingent deferred sales
charge may be imposed in accordance with the foregoing requirements provided
that the shares redeemed will retain their original cost and purchase date for
purposes of the contingent deferred sales charge. In the case of an exchange of
Class A shares of a Portfolio for Farmers Money Market Portfolio - Retail
Shares, the period during which the Retail Shares are held is not considered for
purposes of calculating any contingent deferred sales charge applicable to the
Class A shares exchanged.
Class B Shares. Class B shares of the Portfolios may be exchanged for each other
at their relative net asset values. Class B shares may be exchanged without any
contingent deferred sales charge being imposed at the time of exchange. For
purposes of the contingent deferred sales charge that may be imposed upon the
redemption of the Class B shares received on exchange, amounts exchanged retain
their original cost and purchase date. In the case of an exchange of Class B
shares of a Portfolio for Farmers Money Market Portfolio - Retail Shares, the
period during which the Retail Shares are held is not considered for purposes of
calculating the contingent deferred sales charge applicable to the Class B
shares exchanged.
15
<PAGE>
General. Shares of a Portfolio with a value in excess of $1,000,000 acquired by
exchange from another Portfolio may not be exchanged thereafter until they have
been owned for 15 days (the "15 Day Hold Policy"). For purposes of determining
whether the 15 Day Hold Policy applies to a particular exchange, the value of
the shares to be exchanged shall be computed by aggregating the value of shares
being exchanged for all accounts under common control, direction, or advice,
including without limitation, accounts administered by a financial services firm
offering market timing, asset allocation or similar services. The total value of
shares being exchanged must at least equal the minimum investment requirement of
the Portfolio into which they are being exchanged. Exchanges are made based on
relative dollar values of the shares involved in the exchange. For federal
income tax purposes, any such exchange constitutes a sale upon which a gain or
loss may be realized, depending upon whether the value of the shares being
exchanged is more or less than the shareholder's adjusted cost basis of such
shares. Exchanges may be accomplished by a written request to Kemper Service
Company, P.O. Box 419453, Kansas City, Missouri 64141, or by telephone if the
shareholder has given authorization (1-877-327-8899). Once the authorization is
on file, KSvC will honor requests by telephone at 1-877-327-8899, subject to the
limitations on liability under "Redemption or Repurchase of Shares -- General."
During periods when it is difficult to contact the Shareholder Service Agent by
telephone, it may be difficult to use the telephone exchange privilege. The
exchange privilege is not a right and may be suspended, terminated or modified
at any time. Except as otherwise permitted by applicable regulations, 60 days'
prior written notice of any termination or material change will be provided.
Systematic Exchange Privilege. The owner of $1,000 or more of any class of the
shares of a Portfolio may authorize the automatic exchange of a specified amount
($100 minimum) of such shares for shares of the same class of another Portfolio.
If selected, exchanges will be made automatically until the privilege is
terminated by the shareholder or the other Portfolio, although shareholders of
either class of a Portfolio may automatically exchange their shares for shares
of Farmers Money Market Portfolio - Retail Shares. Exchanges are subject to the
terms and conditions described above under "Exchange Privilege" except that the
$100 minimum investment requirement for the Portfolio acquired on exchange is
not applicable.
AutoBuy/AutoSell. AutoBuy permits the transfer of money via the Automated
Clearing House System (minimum $100 and maximum $50,000) from a shareholder's
bank, savings and loan, or credit union account to purchase shares in a Fund. By
utilizing AutoSell, shareholders can redeem shares (minimum $100 and maximum
$50,000) from their Portfolio account and transfer the proceeds to their bank,
savings and loan, or credit union checking account. Shares purchased by check or
through AutoBuy or Bank Direct Deposit may not be redeemed under this privilege
until such shares have been owned for at least 10 days. By enrolling in
AutoBuy/AutoSell, the shareholder authorizes the Shareholder Service Agent to
rely upon telephone instructions from any person to transfer the specified
amounts between the shareholder's Portfolio account and the predesignated bank,
savings and loan or credit union account, subject to the limitations on
liability under "Redemption or Repurchase of Shares - General." Once enrolled in
AutoBuy/AutoSell, a shareholder can initiate a transaction by calling Kemper
Service Company toll free at 1-877-327-8899 Monday through Friday, 8:00 a.m. to
3:00 p.m. Chicago time. Shareholders may terminate this privilege by sending
written notice to Kemper Service Company, P.O. Box 419453, Kansas City, Missouri
64141. Termination will become effective as soon as the Shareholder Service
Agent has had a reasonable time to act upon the request. AutoBuy/AutoSell cannot
be used with passbook savings accounts or for tax-deferred plans such as
Individual Retirement Accounts.
Bank Direct Deposit. A shareholder may purchase additional shares of a Portfolio
through an automatic investment program. With the Bank Direct Deposit Purchase
Plan, investments are made automatically (maximum $50,000) from the
shareholder's account at a bank, savings and loan or credit union into the
shareholder's Portfolio account. By enrolling in Bank Direct Deposit, the
shareholder authorizes the Portfolio and its agents to either draw checks or
initiate Automated Clearing House debits against the designated account at a
bank or other financial institution. This privilege may be selected by
completing the appropriate section on the Account Application or by contacting
KSvC for appropriate forms. A shareholder may terminate his or her Plan by
sending written notice to Kemper Service Company, P.O. Box 419453, Kansas City,
Missouri 64141. Termination by a shareholder will become effective within thirty
days after the KSvC has received the request. A Portfolio may immediately
terminate a shareholder's Plan in the event that any item is unpaid by the
shareholder's financial institution. The Portfolios may terminate or modify this
privilege at any time.
Payroll Direct Deposit and Government Direct Deposit. A shareholder may invest
in a Portfolio through Payroll Direct Deposit or Government Direct Deposit.
Under these programs, all or a portion of a shareholder's net pay or
16
<PAGE>
government check is automatically invested in a Portfolio account each payment
period. A shareholder may terminate participation in these programs by giving
written notice to the shareholder's employer or government agency, as
appropriate. (A reasonable time to act is required.) A Portfolio is not
responsible for the efficiency of the employer or government agency making the
payment or any financial institutions transmitting payments.
Systematic Withdrawal Plan. The owner of $50,000 or more of a class of a
Portfolio's shares at the offering price (net asset value plus, in the case of
Class A shares, the initial sales charge) may provide for the payment from the
owner's account of any requested dollar amount to be paid to the owner or a
designated payee monthly, quarterly, semiannually or annually. The $50,000
minimum account size is not applicable to Individual Retirement Accounts. The
minimum periodic payment is $100. The maximum annual rate at which Class B
shares (and Class A shares purchased under the Large Order NAV Purchase
Privilege) may be redeemed under a systematic withdrawal plan is 10% of the net
asset value of the account. Shares are redeemed so that the payee will receive
payment approximately the first of the month. Any income and capital gain
dividends will be automatically reinvested at net asset value. A sufficient
number of full and fractional shares will be redeemed to make the designated
payment. Depending upon the size of the payments requested and fluctuations in
the net asset value of the shares redeemed, redemptions for the purpose of
making such payments may reduce or even exhaust the account.
The purchase of Class A shares while participating in a systematic
withdrawal plan will ordinarily be disadvantageous to the investor because the
investor will be paying a sales charge on the purchase of shares at the same
time that the investor is redeeming shares upon which a sales charge may have
already been paid. Therefore, a Portfolio will not knowingly permit additional
investments of less than $2,000 if the investor is at the same time making
systematic withdrawals. KDI will waive the contingent deferred sales charge on
redemptions of Class A shares purchased under the Large Order NAV Purchase
Privilege and Class B shares made pursuant to a systematic withdrawal plan. The
right is reserved to amend the systematic withdrawal plan on 30 days' notice.
The plan may be terminated at any time by the investor or the Portfolios.
Tax-Sheltered Retirement Plans. The Shareholder Service Agent provides
retirement plan services and documents and KDI can establish investor accounts
in any of the following types of retirement plans:
Individual Retirement Accounts ("IRAs") with Investors Fiduciary Trust
Company ("IFTC"), 801 Pennsylvania Avenue, Kansas City, Missouri 64105 as
custodian. This includes Savings Incentive Match Plan for Employees of Small
Employers ("SIMPLE"), IRA accounts and Simplified Employee Pension Plan ("SEP")
IRA accounts and prototype documents.
403(b)(7) Custodial Accounts also with IFTC as custodian. This type of
plan is available to employees of most non-profit organizations.
Prototype money purchase pension and profit-sharing plans may be
adopted by employers. The maximum annual contribution per participant is the
lesser of 25% of compensation or $30,000.
Brochures describing the above plans as well as model defined benefit
plans, target benefit plans, 457 plans, 401(k) plans, SIMPLE 401(k) plans and
materials for establishing them are available from the Shareholder Service Agent
upon request. The brochures for plans with IFTC as custodian describe the
current fees payable to State Street Bank and Trust for its services as
custodian. Investors should consult with their own tax advisers before
establishing a retirement plan.
ADDITIONAL TRANSACTION INFORMATION
General. Banks and other financial services firms may provide administrative
services related to order placement and payment to facilitate transactions in
shares of a Portfolio for their clients, and KDI may pay them a transaction fee
up to the level of the discount or commission allowable or payable to dealers,
as described above. Banks may be prohibited from providing certain underwriting
or distribution services. Banks or other financial services firms may be subject
to various state laws regarding the services described above and may be required
to register as dealers pursuant to state law. If banking firms were prohibited
from acting in any capacity or providing any of the described services,
management would consider what action, if any, would be appropriate. KDI does
not believe that termination of a relationship with a bank would result in any
material adverse consequences to a Portfolio.
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In addition to the payments and allowances KDI may make to firms
described above, KDI may, from time to time, pay or allow to firms a 1%
commission on the amount of shares of a Portfolio sold by the firm under the
following conditions: (i) the purchased shares are held in a IRA account, (ii)
the shares are purchased as a direct "roll over" of a distribution from a
qualified retirement plan account maintained on a participant subaccount record
keeping system provided by KSvC, (iii) the registered representative placing the
trade is a member of ProStar, a group of persons designated by KSvC in
acknowledgment of their dedication to the employee benefit plan area and (iv)
the purchase is not otherwise subject to a commission.
In addition to the discounts or commissions described above, KDI will,
from time to time, pay or allow additional discounts, commissions or promotional
incentives, in the form of cash or other compensation, to firms that sell shares
of the Portfolios. Non-cash compensation includes luxury merchandise and trips
to luxury resorts. In some instances, such discounts, commissions or other
incentives will be offered only to certain firms that sell or are expected to
sell during specified time periods certain minimum amounts of shares of the
Portfolios or other funds underwritten by KDI.
Orders for the purchase of shares of a Portfolio will be confirmed at a
price based on the net asset value of that Portfolio next determined after
receipt by KDI of the order accompanied by payment. However, orders received by
dealers or other financial services firms prior to the determination of net
asset value (see "Net Asset Value") and received by KDI prior to the close of
its business day will be confirmed at a price based on the net asset value
effective on that day ("trade date"). The Portfolios reserve the right to
determine the net asset value more frequently than once a day if deemed
desirable. Dealers and other financial services firms are obligated to transmit
orders promptly. Collection may take significantly longer for a check drawn on a
foreign bank than for a check drawn on a domestic bank. Therefore, if an order
is accompanied by a check drawn on a foreign bank, funds must normally be
collected before shares will be purchased. See "Purchase and Redemption of
Shares."
The Portfolios reserve the right to withdraw all or any part of the
offering made by this Statement of Additional Information and to reject purchase
orders. Also, from time to time, each Portfolio may temporarily suspend the
offering of any class of its shares to new investors. During the period of such
suspension, persons who are already shareholders of such class of the Portfolio
normally are permitted to continue to purchase additional shares of such class
and to have dividends reinvested.
Shareholders should direct their inquiries to Farmers Customer Support,
222 South Riverside Plaza, 24th Floor, Chicago, IL 60606-5808, 1-877-327-8899 or
to the Farmers' agent from whom they received this Statement of Additional
Information.
Share Certificates
Due to the desire of the Portfolios' management to afford ease of
redemption, certificates will not be issued to indicate ownership in a
Portfolio.
Other Information
The "Tax Identification Number" section of the application must be
completed when opening an account. Applications and purchase orders without a
correct certified tax identification number and certain other certified
information (e.g. from exempt organizations, certification of exempt status)
will be returned to the investor.
The Trust may issue shares of each Portfolio at net asset value in
connection with any merger or consolidation with, or acquisition of the assets
of, any investment company (or series thereof) or personal holding company,
subject to the requirements of the 1940 Act.
Clients, officers or employees of the Adviser or of an affiliated
organization, and members of such clients', officers' or employees' immediate
families, banks and members of the NASD may direct repurchase requests to a
Portfolio through Kemper Distributors, Inc. at 222 South Riverside Plaza,
Chicago, IL 60606-5808 by letter, telegram, TWX, or telephone. A two-part
confirmation will be mailed out promptly after receipt of the repurchase
request. A written request in good order should be sent with a copy of the
invoice to Kemper Service Company, P.O. Box 419453, Kansas City, Missouri 64141.
Failure to deliver shares or required documents (see above) by the settlement
date may
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result in cancellation of the trade and the shareholder will be responsible for
any loss incurred by a Portfolio or the principal underwriter by reason of such
cancellation. Net losses on such transactions which are not recovered from the
shareholder will be absorbed by the principal underwriter. Any net gains so
resulting will accrue to the Portfolio. For this group, repurchases will be
carried out at the net asset value next computed after such repurchase requests
have been received. The arrangements described in this paragraph for
repurchasing shares are discretionary and may be discontinued at any time.
If a shareholder redeems all shares in the account after the record
date of a dividend, the shareholder receives, in addition to the net asset value
thereof, all declared but unpaid dividends thereon. The value of shares redeemed
or repurchased may be more or less than the shareholder's cost depending on the
net asset value at the time of redemption or repurchase. The Trust does not
impose a redemption or repurchase charge, although a wire charge may be
applicable for redemption proceeds wired to an investor's bank account.
Redemption of shares, including redemptions undertaken to effect an exchange for
shares of another Portfolio, may result in tax consequences (gain or loss) to
the shareholder and the proceeds of such redemptions may be subject to backup
withholding. (See "Taxes.")
The determination of net asset value and a shareholder's right to
redeem shares and to receive payment may be suspended at times (a) during which
the Exchange is closed, other than customary weekend and holiday closings, (b)
during which trading on the Exchange is restricted for any reason, (c) during
which an emergency exists as a result of which disposal by the Fund of
securities owned by it is not reasonably practicable or it is not reasonably
practicable for the Fund fairly to determine the value of its net assets, or (d)
during which the SEC by order permits a suspension of the right of redemption or
a postponement of the date of payment or of redemption; provided that applicable
rules and regulations of the SEC (or any succeeding governmental authority)
shall govern as to whether the conditions prescribed in (b), (c) or (d) exist.
FEATURES AND SERVICES OFFERED BY THE TRUST
Internet access
World Wide Web Site -- The address for the Underlying Scudder Funds is
http://investments.scudder.com. The site offers guidance on global investing and
developing strategies to help meet financial goals and provides access to the
Scudder investor relations department via e-mail. The site also enables users to
access or view fund prospectuses and profiles with links between summary
information in Profiles and details in the Prospectus. Users can fill out new
account forms on-line, order free software, and request literature on funds.
Account Access -- Scudder is among the first mutual fund families to allow
shareholders to manage their fund accounts through the World Wide Web. Scudder
Fund shareholders can view a snapshot of current holdings, review account
activity and move assets between Scudder Fund accounts.
Scudder's personal portfolio capabilities -- known as SEAS (Scudder
Electronic Account Services) -- are accessible only by current Scudder Fund
shareholders who have set up a Personal Page on Scudder's Web site. By setting
up a Personal page, users are able to customize the Scudder website to meet
their personal preferences. Using a secure Web browser, shareholders sign on to
their account with their Social Security number and their SAIL password. As an
additional security measure, users can change their current password or disable
access to their portfolio through the World Wide Web.
The "your portfolio" section of the Scudder website allows access to
Account Activity such as the financial history of transactions for an account,
with trade dates, type and amount of transaction, share price and number of
shares traded. For users who wish to trade shares between Scudder Funds, the
Fund Exchange option provides a step-by-step procedure to exchange shares among
existing fund accounts or to new Scudder Fund accounts. Registered and account
access enabled shareholders may also conduct purchase transactions on the
Scudder website. To do this the shareholder must also have a bank account on
file for their Scudder account.
Reports to Shareholders
The Trust issues shareholders unaudited semiannual financial statements
and annual financial statements audited by independent accountants, including a
list of investments held and statements of assets and liabilities,
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operations, changes in net assets and financial highlights. The Trust presently
intends to distribute to shareholders informal quarterly reports during the
intervening quarters, containing a statement of the investments of the
portfolios.
Transaction Summaries
Annual summaries of all transactions in each Portfolio account are
available to shareholders. The summaries may be obtained by calling
1-877-327-8899.
DIVIDENDS AND CAPITAL GAINS DISTRIBUTIONS
Each Portfolio intends to follow the practice of distributing all of
its investment company taxable income, which includes any excess of net realized
short-term capital gains over net realized long-term capital losses. Each
Portfolio may follow the practice of distributing the entire excess of net
realized long-term capital gains over net realized short-term capital losses.
However, a Portfolio may retain all or part of such gain for reinvestment after
paying the related federal income taxes for which the shareholders may then be
asked to claim a credit against their federal income tax liability. (See
"Taxes.")
If a Portfolio does not distribute the amount of capital gain and/or
ordinary income required to be distributed by an excise tax provision of the
Code, the Portfolio may be subject to that excise tax. (See "Taxes.") In certain
circumstances, a Portfolio may determine that it is in the interest of
shareholders to distribute less than the required amount.
Earnings and profits distributed to shareholders on redemptions of
Portfolio shares may be utilized by a Portfolio, to the extent permissible, as
part of that Portfolio's dividends paid deduction on its federal tax return.
The Income, Income with Growth, and Balanced Portfolios each intend to
distribute investment company taxable income, exclusive of net short-term
capital gains in excess of net long-term capital losses, on a quarterly basis,
and distributions of net short-term and long-term capital gains realized during
the fiscal year will be made in November or December to avoid federal excise
tax, although an additional distribution may be made within three months of its
fiscal year end, if necessary. The Growth with Income Portfolio, and Growth
Portfolio each intend to distribute their investment company taxable income and
any net realized capital gains in November or December to avoid federal excise
tax, although an additional distribution may be made within three months of the
Portfolios' fiscal year end, if necessary.
Both types of distributions will be made in Portfolio shares and
confirmations will be mailed to each shareholder unless a shareholder has
elected to receive cash, in which case a check will be sent. Distributions of
investment company taxable income and net realized capital gains are taxable
(See "Taxes"), whether made in shares or cash.
Each distribution is accompanied by a brief explanation of the form and
character of the distribution. The characterization of distributions on such
correspondence may differ from the characterization for federal tax purposes. In
January of each year each Portfolio issues to each shareholder a statement of
the federal income tax status of all distributions in the prior calendar year.
PERFORMANCE INFORMATION
From time to time, quotations of a Portfolio's performance may be
included in advertisements, sales literature or reports to shareholders or
prospective investors. These performance figures will be calculated in the
following manner:
Average Annual Total Return
Average Annual Total Return is the average annual compound rate of
return for the periods of one year, five years, ten years or for the life of the
Portfolio, all ended on the last day of a recent calendar quarter. Average
annual total return quotations reflect changes in the price of a Portfolio's
shares and assume that all dividends and capital gains distributions during the
respective periods were reinvested in Portfolio shares. Average annual total
return is calculated
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by finding the average annual compound rates of return of a hypothetical
investment over such periods, according to the following formula (average annual
total return is then expressed as a percentage):
T = (ERV/P)^1/n - 1
Where:
P = a hypothetical initial payment of $1,000
T = Average Annual Total Return
N = Number of years
ERV = Ending redeemable value: ERV is the
value, at the end of the applicable
period, of a hypothetical $1,000
investment made at the beginning of
the applicable period.
Average Annual Total Return for period ended April 30, 2000 - Class A shares
One Year Life of Portfolio^(1)
Income Portfolio -5.81% -3.64%
Income with Growth Portfolio 1.92% 4.12%
Balanced Portfolio -1.08% 2.30%
Growth with Income Portfolio -4.52% 0.44%
Growth Portfolio -2.90% 3.12%
^(1) For the period beginning March 9, 1999 (commencement of operations)
Total returns would have been lower if the Adviser to the
Portfolios and the Adviser to certain of the Underlying Funds had
not maintained some of the expenses.
Average Annual Total Return for period ended April 30, 2000 - Class B shares
One Year Life of Portfolio^(1)
Income Portfolio -4.33% -2.39%
Income with Growth Portfolio 3.67 5.65
Balanced Portfolio 1.06 4.24
Growth with Income Portfolio -2.36 2.45
Growth Portfolio -0.91 5.05
^(1) For the period beginning March 9, 1999 (commencement of operations)
Total returns would have been lower if the Adviser to the Portfolios
and the Adviser to certain of the Underlying Funds had not maintained
some of the expenses.
Cumulative Total Return
Cumulative Total Return is the compound rate of return on a
hypothetical initial investment of $1,000 for a specified period. Cumulative
Total Return quotations reflect changes in the price of a Portfolio's shares and
assume that all dividends and capital gains distributions during the period were
reinvested in Portfolio shares. Cumulative Total Return is calculated by finding
the cumulative rates of return of a hypothetical investment over such periods,
according to the following formula (Cumulative Total Return is then expressed as
a percentage):
C = (ERV/P)-1
Where:
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C = Cumulative Total Return
P = a hypothetical initial investment of $1,000
ERV = Ending redeemable value: ERV is the value,
at the end of the applicable period, of a
hypothetical $1,000 investment made at the
beginning of the applicable period.
Cumulative Total Return for period ended April 30, 2000 - Class A shares
One Year Life of Portfolio^(1)
Income Portfolio -5.81% -4.17%
Income with Growth Portfolio 1.92 4.74
Balanced Portfolio -1.08 2.65
Growth with Income Portfolio -4.52 0.51
Growth Portfolio -2.90 3.58
^(1) For the period beginning March 9, 1999 (commencement of operations)
Cumulative Total Return for period ended April 30, 2000 - Class B shares
One Year Life of Portfolio^(1)
Income Portfolio -4.33% -2.74%
Income with Growth Portfolio 3.67 6.51
Balanced Portfolio 1.06 4.87
Growth with Income Portfolio -2.36 2.82
Growth Portfolio -0.91 5.81
^(1) For the period beginning March 9, 1999 (commencement of operations)
Total Return
Total Return is the rate of return on an investment for a specified
period of time calculated in the same manner as Cumulative Total Return.
TRUST ORGANIZATION
The Portfolios are portfolios of Farmers Investment Trust (the
"Trust"), a Massachusetts business trust established under a Declaration of
Trust dated October 26, 1998. The Trust offers five portfolios: Income
Portfolio, Income with Growth Portfolio, Balanced Portfolio, Growth with Income
Portfolio, and Growth Portfolio.
The Trust may issue an unlimited number of shares of beneficial
interest in the Portfolios, all having $.01 par value, which may be divided by
the Board of Trustees into classes of shares. The Board of Trustees of the Trust
may authorize the issuance of additional classes and additional Portfolios if
deemed desirable, each with its own investment objective, policies and
restrictions. Since the Trust offers multiple Portfolios, it is known as a
"series company." Shares of a Portfolio have equal noncumulative voting rights
and equal rights with respect to dividends, assets and liquidation of such
Portfolio and are subject to any preferences, rights or privileges of any
classes of shares of the Portfolio. Currently, each Portfolio offers two classes
of shares: Class A and Class B shares. Shares of each Portfolio have equal
noncumulative voting rights except that each Portfolio's Class A and Class B
shares have separate and exclusive voting rights with respect to the Portfolios'
Class A and Class B Rule 12b-1 Plans, respectively. Shares of each class also
have equal rights with respect to dividends, assets and liquidation subject to
any preferences (such as those resulting from different Rule 12b-1 distribution
fees), rights or privileges of any classes of shares of a Portfolio. Shares of
each Portfolio are fully paid and nonassessable when issued, are transferable
without restriction and have no preemptive or
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conversion rights. The Trust is not required to hold annual shareholder meetings
and does not intend to do so. However, the Trust will hold shareholder meetings
as required or deemed desirable in connection with the following matters: (a)
the election or removal of Trustees if a meeting is called for such purpose; (b)
the adoption of any contract for which shareholder approval is required by the
1940 Act; (c) any termination of a Portfolio to the extent and as provided in
the Declaration of Trust; (d) any amendment of the Declaration of Trust (other
than amendments changing the name of the Trust, establishing a fund, supplying
any omission, curing any ambiguity or curing, correcting or supplementing any
defective or inconsistent provision thereof); and (e) such additional matters as
may be required by law, the Declaration of Trust, the By-laws of the Trust, or
any registration of the Trust with the Securities and Exchange Commission (the
"SEC") or any state, or as the Trustees may consider necessary or desirable. The
shareholders also would vote upon changes in fundamental investment objectives,
policies or restrictions. Subject to the Declaration of Trust, shareholders may
remove Trustees. If shares of more than one Portfolio are outstanding,
shareholders will vote by Portfolio and not in the aggregate or by class except
when voting in the aggregate is required under the 1940 Act, such as for the
election of Trustees, or when voting by class is appropriate.
Each Trustee serves until the next meeting of shareholders, if any,
called for the purpose of electing Trustees and until the election and
qualification of a successor or until such trustee sooner dies, resigns, retires
or is removed by a majority vote of the shares entitled to vote (as described
below) or a majority of the Trustees. In accordance with the 1940 Act (a) each
Fund will hold a shareholder meeting for the election of Trustees at such time
as less than a majority of the Trustees have been elected by shareholders, and
(b) if, as a result of a vacancy on the Board of Trustees, less than two-thirds
of the Trustees have been elected by the shareholders, that vacancy will be
filled only by a vote of the shareholders.
Trustees may be removed from office by a vote of the holders of
two-thirds of the outstanding shares at a meeting called for that purpose, which
meeting shall be held upon the written request of the holders of not less than
10% of the outstanding shares. Upon the written request of ten or more
shareholders who have been such for at least six months and who hold shares
constituting at least 1% of the outstanding shares of a Portfolio stating that
such shareholders wish to communicate with the other shareholders for the
purpose of obtaining the signatures necessary to demand a meeting to consider
removal of a trustee, each Portfolio has undertaken to disseminate appropriate
materials at the expense of the requesting shareholders.
The Trust's Declaration of Trust provides that the presence at a
shareholder meeting in person or by proxy of at least 30% of the shares entitled
to vote on a matter shall constitute a quorum. Thus, a meeting of shareholders
of a Portfolio could take place even if less than a majority of the shareholders
were represented on its scheduled date. Shareholders would in such a case be
permitted to take action which does not require a larger vote than a majority of
a quorum, such as the election of Trustees and ratification of the selection of
auditors. Some matters requiring a larger vote under the Declaration of Trust,
such as termination or reorganization of a Portfolio and certain amendments of
the Declaration of Trust, would not be effected by this provision; nor would
matters which under the 1940 Act require the vote of a "majority of the
outstanding voting securities" as defined in the 1940 Act.
The Trust's Declaration of Trust specifically authorizes the Board of
Trustees to terminate any Portfolio or class by notice to the shareholders
without shareholder approval.
Under Massachusetts law, shareholders of a Massachusetts business trust
could, under certain circumstances, be held personally liable for obligations of
a Portfolio. The Declaration of Trust, however, disclaims shareholder liability
for acts or obligations of each Portfolio and requires that notice of such
disclaimer be given in each agreement, obligation, or instrument entered into or
executed by a Portfolio or the Trust's Trustees. Moreover, the Declaration of
Trust provides for indemnification out of Portfolio property for all losses and
expenses of any shareholder held personally liable for the obligations of a
Portfolio and each Portfolio will be covered by insurance which the Trustees
consider adequate to cover foreseeable tort claims. Thus, the risk of a
shareholder incurring financial loss on account of shareholder liability is
considered by the Adviser remote and not material, since it is limited to
circumstances in which a disclaimer is inoperative and such Portfolio itself is
unable to meet its obligations. The Trust will vote its shares in each
Underlying Fund in proportion to the vote of all other shareholders of each
respective Underlying Fund.
The Declaration of Trust provides that obligations of the Trust are not
binding upon the Trustees individually but only upon the property of the Trust,
that the Trustees and officers will not be liable for errors of judgment or
mistakes of fact or law, and that the Trust, will indemnify its Trustees and
officers against liabilities and expenses incurred in connection with litigation
in which they may be involved because of their offices with the Trust, except if
it is determined in the manner provided in the Declaration of Trust that they
have not acted in good faith in the reasonable belief that their actions were in
the best interests of the Trust. However, nothing in the Declaration of Trust
protects or
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indemnifies a Trustee or officer against any liability to which he or she would
otherwise be subject by reason of willful misfeasance, bad faith, gross
negligence, of reckless disregard of duties involved in the conduct of his or
her office.
INVESTMENT ADVISER
Scudder Kemper Investments, Inc., an investment counsel firm, acts as
investment adviser to the Portfolios. This organization, the predecessor of
which is Scudder, Stevens & Clark, Inc., is one of the most experienced
investment counsel firms in the U. S. It was established as a partnership in
1919 and pioneered the practice of providing investment counsel to individual
clients on a fee basis. In 1928 it introduced the first no-load mutual fund to
the public. In 1953 the Adviser introduced Scudder International Fund, Inc., the
first mutual fund available in the U.S. investing internationally in securities
of issuers in several foreign countries. The predecessor firm reorganized from a
partnership to a corporation on June 28, 1985. On December 31, 1997, Zurich
Insurance Company ("Zurich") acquired a majority interest in the Adviser, and
Zurich Kemper Investments, Inc., a Zurich subsidiary, became part of the
Adviser. The Adviser's name changed to Scudder Kemper Investments, Inc. On
September 7, 1998, the businesses of Zurich (including Zurich's 70% interest in
Scudder Kemper) and the financial services businesses of B.A.T Industries p.l.c.
("B.A.T") were combined to form a new global insurance and financial services
company known as Zurich Financial Services Group. By way of a dual holding
company structure, former Zurich shareholders initially owned approximately 57%
of Zurich Financial Services Group, with the balance initially owned by former
B.A.T shareholders.
Founded in 1872, Zurich is a multinational, public corporation
organized under the laws of Switzerland. Its home office is located at
Mythenquai 2, 8002 Zurich, Switzerland. Historically, Zurich's earnings have
resulted from its operations as an insurer as well as from its ownership of its
subsidiaries and affiliated companies (the "Zurich Insurance Group"). Zurich and
the Zurich Insurance Group provide an extensive range of insurance products and
services and have branch offices and subsidiaries in more than 40 countries
throughout the world.
The Adviser maintains a large research department, which conducts
continuous studies of the factors that affect the position of various
industries, companies and individual securities. The Adviser receives published
reports and statistical compilations from issuers and other sources, as well as
analyses from brokers and dealers who may execute portfolio transactions for the
Adviser's clients. However, the Adviser regards this information and material as
an adjunct to its own research activities. The Adviser's international
investment management team travels the world, researching hundreds of companies.
In selecting the securities in which each Portfolio may invest, the conclusions
and investment decisions of the Adviser with respect to the Portfolios are based
primarily on the analyses of its own research department.
Certain investments may be appropriate for the affiliated Underlying
Funds held by each Portfolio and also for other clients advised by the Adviser.
Investment decisions for the Underlying Funds and other clients are made with a
view to achieving their respective investment objectives and after consideration
of such factors as their current holdings, availability of cash for investment
and the size of their investments generally. Frequently, a particular security
may be bought or sold for only one client or in different amounts and at
different times for more than one but less than all clients. Likewise, a
particular security may be bought for one or more clients when one or more other
clients are selling the security. In addition, purchases or sales of the same
security may be made for two or more clients on the same day. In such event,
such transactions will be allocated among the clients in a manner believed by
the Adviser to be equitable to each. In some cases, this procedure could have an
adverse effect on the price or amount of the securities purchased or sold by the
Underlying Fund. Purchase and sale orders for the Underlying Fund may be
combined with those of other clients of the Adviser in the interest of achieving
the most favorable net results to the Underlying Fund.
For each of the Portfolios, the present investment management
agreements (the "Agreements") became effective February 16, 1999, and were
approved by the initial shareholder of each Portfolio on February 12, 1999, and
by the Trustees of the Trust on February 12, 1999. Each Agreement will continue
in effect from year to year thereafter only if its continuance is approved
annually by the vote of a majority of those Trustees who are not parties to such
Agreement or interested persons of the Adviser or the Trust, cast in person at a
meeting called for the purpose of voting on such approval, and either by a vote
of the Trustees or of a majority of the outstanding voting securities of the
Trust. The Agreements may be terminated at any time without payment of penalty
by either party on sixty days' written notice and automatically terminates in
the event of its assignment.
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In certain cases, the investments for the Portfolios are managed by the
same individuals who manage one or more other Underlying Funds advised by the
Adviser that have similar names, objectives and investment styles as the
Portfolios. You should be aware that the Portfolios are likely to differ from
these affiliated Underlying Funds in size, cash flow pattern and tax matters.
Accordingly, the holdings and performance of the Portfolios can be expected to
vary from those of the affiliated Underlying Funds.
The Adviser regularly provides the Trust with continuing investment
management for the Portfolios consistent with the Portfolios' investment
objectives, policies and restrictions and determines what Underlying Funds shall
be purchased, held or sold and what portion of each Portfolio's assets shall be
held uninvested, subject to the Declaration of Trust, the 1940 Act, the Code,
the Order and to the Portfolios' investment objectives, policies and
restrictions, and subject, further, to such policies and instructions as the
Board of Trustees may from time to time establish.
The Adviser provides each Portfolio with discretionary investment
services. Specifically, the Adviser is responsible for supervising and directing
the investments of each Portfolio in accordance with each Portfolio's investment
objectives, program, and restrictions as provided in the prospectus and this
Statement of Additional Information. The Adviser is also responsible for
effecting all security transactions on behalf of each Portfolio, including the
negotiation of commissions and the allocation of principal business and
portfolio brokerage. However, it should be understood that each Portfolio will
invest its assets almost exclusively in the shares of the Underlying Funds and
such investments will be made without the payment of any commission or other
sales charges. In addition to these services, the Adviser provides the Trust
with certain corporate administrative services, including: maintaining the
corporate existence, corporate records, and registering and qualifying Portfolio
shares under federal and state laws; monitoring the financial accounting, and
administrative functions of each Portfolio; maintaining liaison with the agents
employed by the Trust such as the custodian and transfer agent; assisting the
Trust in the coordination of such agents' activities; and permitting the
Adviser's employees to serve as officers, Trustees, and committee members of the
Trust without cost to the Trust.
The Adviser also renders significant administrative services (not
otherwise provided by third parties) necessary for the Portfolios' operations as
an open-end investment company including, but not limited to, preparing reports
and notices to the Trustees and shareholders; supervising, negotiating
contractual arrangements with, and monitoring various third-party service
providers to the Trust (such as the Portfolios' transfer agent, pricing agents,
custodian, fund accounting agent and others); preparing and making filings with
the SEC and other regulatory agencies; assisting in the preparation and filing
of the Portfolios' federal, state and local tax returns; preparing and filing
the Portfolios' federal excise tax returns; assisting with investor and public
relations matters; monitoring the valuation of securities and the calculation of
net asset value; monitoring the registration of shares of each Portfolio under
applicable federal and state securities laws; maintaining the Portfolios' books
and records to the extent not otherwise maintained by a third party; assisting
in establishing accounting policies of the Portfolios; assisting in the
resolution of accounting and legal issues; establishing and monitoring the
Portfolios' operating budget; processing the payment of the Portfolios' bills;
assisting each Portfolio in, and otherwise arranging for, the payment of
distributions and dividends and otherwise assisting the Portfolios in the
conduct of their business, subject to the direction and control of the Trustees.
The Adviser pays the compensation and expenses (except those of
attending Board and committee meetings outside New York, New York or Boston,
Massachusetts) of all Trustees, officers and executive employees of the Trust
affiliated with the Adviser and makes available, without expense to the Trust,
the services of such Trustees, officers and employees of the Adviser as may duly
be elected officers of the Trust, subject to their individual consent to serve
and to any limitations imposed by law, and provides the Trust's office space and
facilities.
In reviewing the terms of the Agreements and in discussions with the
Adviser concerning such Agreements, the Trustees of the Fund who are not
"interested persons" of the Adviser are represented by independent counsel. The
Agreements provide that the Adviser shall not be liable for any error of
judgment or mistake of law or for any loss suffered by the Trust in connection
with matters to which the Agreements relate, 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 reckless disregard by the Adviser of its
obligations and duties under the Agreements.
A Portfolio's shareholders will also indirectly bear the Portfolio's
pro rata share of fees and expenses charged by the Underlying Funds in which a
Portfolio is invested. The ranges of the average weighted pro rata share of
expenses borne by each Portfolio in connection with its investments in the
Underlying Funds are expected to be as follows:
25
<PAGE>
Income Portfolio: 0.43% to 0.87%, Income with Growth Portfolio: 0.54% to 0.88%,
Balanced Portfolio: 0.59% to 0.88%, Growth with Income Portfolio: 0.66% to 1.00%
and Growth Portfolio: 0.75% to 1.21%. This information is provided in ranges
since the average assets of a Portfolio invested in each of the Underlying Funds
will fluctuate.
The Agreements identify the Adviser as the exclusive licensee of the
rights to use and sublicense the names "Scudder," "Scudder Kemper Investments,
Inc." and "Scudder Stevens and Clark, Inc." (together, the "Scudder Marks").
Under this license, the Trust, with respect to the Portfolios, has the
non-exclusive right to use and sublicense the Scudder name and marks as part of
its name, and to use the Scudder Marks in the Trust's investment products and
services.
Investment Management Fees
Each class of shares of a Portfolio has a single (exclusive of
interest, taxes and compensation and expenses of Trustees) fee covering
investment management and other operating expenses. This fee rate will not
fluctuate. In contrast, most mutual funds pay a fixed management fee and absorb
operating expenses that vary according to a number of factors. Each Portfolio
pays the Adviser an annual all-inclusive fee of 0.75% of the average daily net
assets of that Portfolio.
The investment management fees paid by each Portfolio for its last two
fiscal periods are shown in the table below:
Portfolio Year Management Fee
--------- ---- --------------
Income 2000 $1,082
1999* 140
Income with Growth 2000 3,062
1999* 108
Balanced 2000 4,558
1999* 114
Growth with Income 2000 3,644
1999* 134
Growth 2000 6,504
1999* 120
* For the period beginning March 9, 1999 (commencement of operations)
The Agreements between each Portfolio and the Adviser provide that the
Adviser will pay each Portfolio's ordinary operating expenses. The following
expenses are not considered to be ordinary operating expenses of a Portfolio:
interest, all taxes or governmental fees payable by or with respect to the
Portfolios to federal, state or other governmental agencies, domestic or
foreign, including stamp or other transfer taxes; all brokers' commissions and
other charges incident to the purchase, sale or lending of the Portfolios'
portfolio securities, all compensation of Trustees, other than those affiliated
with the Adviser, and all expenses (including counsel fees and expenses)
incurred in connection with their service; and such non-recurring expenses that
may arise, including the cost of actions, suits or proceedings to which a
Portfolio is a party and the expenses a Portfolio may incur as a result of its
obligation to provide indemnification to its officers and agents; and expenses
incurred under the Portfolios' shareholder services and distribution plan.
The Adviser also receives management fees from managing the affiliated
Underlying Funds in which each Portfolio invests. Each affiliated Underlying
Fund pays the Adviser a management fee as determined by the Investment
Management Agreement between each Underlying Fund and the Adviser. As manager of
the assets of each affiliated Underlying Fund, the Adviser directs the
investments of an Underlying Fund in accordance with each Underlying Fund's
investment objective, policies and restrictions. The Adviser determines the
securities, instruments and other contracts relating to investments to be
purchased, sold or entered into by an Underlying Fund. If an Underlying Fund's
26
<PAGE>
expenses, exclusive of taxes, interest and extraordinary expenses, exceed
specified limits, such excess up to the amount of the management fee, will be
paid by the Adviser.
Officers and employees of the Adviser from time to time may have
transactions with various banks, including the Portfolios' custodian bank. It is
the Adviser's opinion that the terms and conditions of those transactions which
have occurred were not influenced by existing or potential custodial or other
Trust relationships.
The Adviser may serve as adviser to other funds with investment
objectives and policies similar to those of the Portfolios that may have
different distribution arrangements or expenses, which may affect performance.
None of the officers or Trustees may have dealings with the Trust as
principals in the purchase or sale of securities, except as individual
subscribers to or holders of shares of the Trust.
The term Scudder Investments is the designation given to the services
provided by Scudder Kemper Investments, Inc. and its affiliates to the Scudder
Family of Funds.
Personal Investments by Employees of the Adviser
The Fund, the Adviser and principal underwriter have each adopted codes
of ethics under rule 17j-1 of the Investment Company Act. Board members,
officers of the Fund and employees of the Adviser and principal underwriter are
permitted to make personal securities transactions, including transactions in
securities that may be purchased or held by the Fund, subject to requirements
and restrictions set forth in the applicable Code of Ethics. The Adviser's Code
of Ethics contains provisions and requirements designed to identify and address
certain conflicts of interest between personal investment activities and the
interests of the Fund. Among other things, the Adviser's Code of Ethics
prohibits certain types of transactions absent prior approval, imposes time
periods during which personal transactions may not be made in certain
securities, and requires the submission of duplicate broker confirmations and
quarterly reporting of securities transactions. Additional restrictions apply to
portfolio managers, traders, research analysts and others involved in the
investment advisory process. Exceptions to these and other provisions of the
Adviser's Code of Ethics may be granted in particular circumstances after review
by appropriate personnel.
<TABLE>
<CAPTION>
TRUSTEES AND OFFICERS
Position with
Position Underwriter, Kemper
Name, Age and Address With Trust Principal Occupation** Distributors, Inc.
--------------------- ---------- ---------------------- ------------------
<S> <C> <C> <C>
Kathryn L. Quirk*# (47) Trustee, Vice Managing Director of Scudder Director, Secretary,
President and Kemper Investments, Inc. Chief Legal Officer
Assistant Secretary & Vice President
Brian Cohen## (40) President President, Farmers Financial --
Solutions
Dr. Rosita P. Chang (45) Trustee Professor of Finance, University --
Department of Financial Economics & of Hawaii
Institutions
College of Business Administration
University of Hawaii
2404 Maile Way
E-6024
Honolulu, HI 98622
Edgar R. Fiedler*@ (71) Trustee Senior Fellow and Economic --
50023 Brogden Counselor, The Conference Board,
Chapel Hill, NC 27514 Inc.
27
<PAGE>
Position with
Position Underwriter, Kemper
Name, Age and Address With Trust Principal Occupation** Distributors, Inc.
--------------------- ---------- ---------------------- ------------------
Dr. J. D. Hammond@ (66) Trustee Dean Emeritus, Smeal College of --
801 Business Administration Building Business Administration,
Pennsylvania State University Pennsylvania State University
University Park, PA 16802
Richard M. Hunt@ (73) Trustee University Marshal and Senior --
University Marshal's Office Lecturer, Harvard University
Wadsworth House
1341 Massachusetts Avenue
Harvard University
Cambridge, MA 02138
Ann M. McCreary# (43) Vice President Managing Director of Scudder --
Kemper Investments, Inc.
Shahram Tajbakhsh### (43) Vice President Senior Vice President of Scudder --
Kemper Investments, Inc.
John Millette+ (38) Vice President and Assistant Vice President of --
Secretary Scudder Kemper Investments, Inc.
John R. Hebble+ (42) Treasurer Senior Vice President of Scudder --
Kemper Investments, Inc.
Brenda Lyons+ (37) Assistant Treasurer Senior Vice President of Scudder --
Kemper Investments, Inc.
Caroline Pearson+ (38) Assistant Secretary Senior Vice President of Scudder --
Kemper Investments, Inc.;
Associate, Dechert Price &
Rhoads (law firm) 1989 - 1997
</TABLE>
* Trustee considered by the Trust and its counsel to be an "interested
person" (as defined in the 1940 Act) of the Trust or of its investment
manager because of their employment by the Investment Manager and, in some
cases, holding offices with the Trust. Although Mr. Fiedler is currently
not an "interested person," he may be deemed to be so in the future by the
Commission because of his prior service as a director of Zurich American
Insurance Company, a subsidiary of Zurich. Mr. Fiedler resigned from that
position in July 1997 and has had no further affiliation with Zurich or any
of its subsidiaries since that date.
** Unless otherwise stated, all officers and Trustees have been associated
with their respective companies for more than five years, but not
necessarily in the same capacity.
@ Messrs. Fiedler and Hunt, and Dr. Hammond are members of the Executive
Committee which may exercise substantially all of the powers of the Board
of Trustees when it is not in session.
# Address: 345 Park Avenue, New York, New York
+ Address: Two International Place, Boston, Massachusetts
## Address: 4680 Wilshire Boulevard, Los Angeles, California
% Address: 222 South Riverside Plaza, Chicago, Illinois
### Address: 101 California Street, Suite 4100, San Francisco, California
28
<PAGE>
On July 31, 2000, all Trustees and officers as a group owned
beneficially (as that term is defined under Section 13(d) of the Securities
Exchange Act) less than 1% of any class of shares of a Portfolio outstanding on
such date.
To the best of the Trust's knowledge, as of July 31, 2000, no person
owned beneficially more than 5% of any class of shares of a Portfolio
outstanding on such date .
REMUNERATION
Responsibilities of the Board -- Board and Committee Meetings
The Board of Trustees is responsible for the general oversight of each
Portfolio's business. A majority of the Board's members are not affiliated with
the Adviser. These "Independent Trustees" have primary responsibility for
assuring that each Portfolio is managed in the best interests of its
shareholders.
The Board of Trustees meets at least quarterly to review the investment
performance of each Portfolio and other operational matters, including policies
and procedures designated to assure compliance with various regulatory
requirements. At least annually, the Independent Trustees review the fees paid
to the Adviser and its affiliates for investment advisory services and other
administrative and shareholder services. In this regard, they evaluate, among
other things, each Portfolio's investment performance, the quality and
efficiency of the various other services provided, costs incurred by the Adviser
and its affiliates, and comparative information regarding fees and expenses of
competitive funds. They are assisted in this process by the Portfolios'
independent public accountants and by independent legal counsel selected by the
Independent Trustees.
All of the Independent Trustees serve on the Committee on Independent
Trustees, which nominates Independent Trustees and considers other related
matters, and the Audit Committee, which selects each Portfolio's independent
public accountants and reviews accounting policies and controls.
Compensation of Officers and Trustees
The Independent Trustees will receive the following compensation from
each Portfolio of Farmers Investment Trust: an annual trustee's fee of $2,000; a
fee of $200 for attendance at each board meeting, audit committee meeting, or
other meeting held for the purposes of considering arrangements between the
Trust on behalf of each Portfolio and the Adviser or any affiliate of the
Adviser; $100 for all other committee meetings and reimbursement of expenses
incurred for travel to and from Board Meetings. No additional compensation will
be paid to any Independent Trustee for travel time to meetings, attendance at
Trustees' educational seminars or conferences, service on industry or
association committees, participation as speakers at Trustees' conferences or
service on special trustee task forces or subcommittees. Independent Trustees do
not receive any employee benefits such as pension or retirement benefits or
health insurance. Notwithstanding the schedule of fees, the Independent Trustees
may defer or waive a portion of their compensation or other activities.
The Independent Trustees also serve in the same capacity for other
funds managed by the Adviser. These funds differ broadly in type and complexity
and in some cases have substantially different Trustee fee schedules. The
following table shows the aggregate compensation received by each Independent
Trustee during 1999 from the Trust and from all of Scudder funds as a group.
<TABLE>
<CAPTION>
All Funds Advised by Scudder Kemper
Name Farmers Investment Trust^(1)^(2) Investments, Inc.
---- ------------------------------
<S> <C> <C> <C>
Dr. Rosita P. Chang, Trustee $0^(3) $59,907 (22 funds)
Edgar R. Fiedler, Trustee $0^(3) $63,330 (29 funds)
Dr. J .D. Hammond, Trustee $0^(3) $59,907 (21 funds)
Richard Hunt, Trustee $0^(3) $39,563 (14 funds)
</TABLE>
29
<PAGE>
^(1) The Portfolios commenced operations on March 9, 1999.
^(2) Farmers Investment Trust consists of five Portfolios: Income Portfolio,
Income with Growth Portfolio, Balanced Portfolio, Growth with Income
Portfolio, and Growth Portfolio.
^(3) The independent Trustees have agreed to waive a portion of their
compensation, and Scudder Kemper has agreed to reimburse the Trust for
the remaining portion, until such time that each Portfolio of the Trust
reaches $50,000,000 in assets.
Members of the Board of Trustees who are employees of the Adviser or
its affiliates receive no direct compensation from the Trust, although they are
compensated as employees of the Adviser, or its affiliates, as a result of which
they may be deemed to participate in fees paid by each Portfolio.
PRINCIPAL UNDERWRITER
Pursuant to a separate shareholder services and distribution agreement
("distribution agreement"), Kemper Distributors, Inc. ("KDI"), 222 South
Riverside Plaza, Chicago, Illinois, 60606, an affiliate of the Adviser, serves
as principal underwriter and distributor for the shares of each Portfolio and
acts as agent of each Portfolio in the continuous offering of its shares. KDI
bears all its expenses of providing services pursuant to the distribution
agreement, including the payment of any commissions. KDI, as principal
underwriter, pays for the printing and distribution of copies of prospectuses
and shareholder reports used in connection with the offering of shares to
prospective investors. KDI also pays for supplementary sales literature and
advertising costs. KDI provides execution services for the Portfolios in
connection with the Portfolios' purchase of Underlying Fund shares and will
receive compensation of up to 1% of the purchase price of such shares from the
Underlying Funds' underwriters in connection therewith. In providing execution
services, KDI will (a) accept orders from the Adviser to purchase Underlying
Fund shares for the Portfolios; (b) place such orders with the Underlying Fund's
underwriter; (c) confirm the trade, price and number of Underlying Fund shares
purchased by a Portfolio pursuant to such orders; and (d) assure prompt payment
by a Portfolio to the Underlying Fund and proper completion of such orders.
SHAREHOLDER SERVICES AND DISTRIBUTION PLAN
Each Portfolio has adopted a shareholder services and distribution plan
under Rule 12b-1 (the "Plan") under the 1940 Act. Rule 12b-1 regulates the
manner in which an investment company may, directly or indirectly, bear the
expenses of distributing its shares. The Plan provides for fees payable as an
expense of the Class A and Class B shares that are used by KDI to pay for
distribution and services for those classes. The fee is payable monthly by a
Portfolio to KDI at an annual rate of 0.25% and 1.00% of average daily net
assets attributable to the Class A and Class B shares of the Portfolio,
respectively. KDI may pay a portion of this fee to compensate selling firms for
sales of Class B shares. KDI compensates selling firms for sales of Class B
shares at the time of sale at a commission rate of 2.93% of the amount of Class
B shares sold. Because 12b-1 fees are paid out of Portfolio assets on an ongoing
basis, they will, over time, increase the cost of investment and may cost more
than other types of sales charges. Long-term shareholders may pay more than the
economic equivalent of the maximum initial sales charges permitted by the
National Association of Securities Dealers, although KDI believes that it is
unlikely, in the case of Class B shares, because of the automatic conversion
feature of those shares.
KDI may engage other firms to provide information and shareholder
services for shareholders of each Portfolio. KDI may pay each such firm a
service fee at an annual rate of up to 0.25% of net assets of the Class A and
Class B shares maintained and serviced by the firm. Firms to which service fees
may be paid include broker-dealers affiliated with KDI.
If the Plan is terminated in accordance with its terms, the obligation
of a Portfolio to make payments to KDI pursuant to the Plan will cease and the
Portfolio will not be required to make any payments past the termination date.
Thus, there is no legal obligation for the Portfolio to pay any expenses
incurred by KDI in excess of its fees under a Plan, if for any reason the Plan
is terminated in accordance with its terms. Future fees under a Plan may or may
not be sufficient to reimburse KDI for its expenses incurred.
Each distribution agreement and the Plan continues in effect from year
to year so long as such continuance is approved for each class at least annually
by a vote of the Board of Trustees of the Trust, including the Trustees who are
not interested persons of the Trust and who have no direct or indirect financial
interest in the agreement. Each agreement automatically terminates in the event
of its assignment and may be terminated for a class at any time without
30
<PAGE>
penalty by a Portfolio or by KDI upon 60 days' notice. Termination by a
Portfolio with respect to a class may be by vote of a majority of the Board of
Trustees, or a majority of the Trustees who are not interested persons of the
Trust and who have no direct or indirect financial interest in the agreement, or
a "majority of the outstanding voting securities" of the class of the Portfolio,
as defined under the 1940 Act. The agreement may not be amended for a class to
increase the fee to be paid by a Portfolio with respect to such class without
approval by a majority of the outstanding voting securities of such class of the
Portfolio and all material amendments must in any event be approved by the Board
of Trustees in the manner described above with respect to the continuation of
the agreement. The provisions concerning the continuation, amendment and
termination of the distribution agreement are on a Portfolio by Portfolio basis
and for each Portfolio on a class by class basis.
KDI also receives any contingent deferred sales charges for Class B
shares. See "Redemption or Repurchase of Shares--Contingent Deferred Sales
Charge--Class B Shares." For the fiscal year ended April 30, 2000, there were
$2,281 of contingent deferred sales charges incurred by Class B shareholders of
the Growth Portfolio, payable to KDI, and for the period ended April 30, 1999,
there were no contingent deferred sales charges incurred by Class B shareholders
of any Portfolio payable to KDI. The distribution fees were as follows:
Portfolio Year Fee incurred by the Portfolio
--------- ---- -----------------------------
Income 2000 $ 383
1999* 53
Income with Growth 2000 1,523
1999* 54
Balanced 2000 2,554
1999* 58
Growth with Income 2000 1,802
1999* 55
Growth 2000 3,150
1999* 55
* For the period beginning March 9, 1999 (commencement of operations)
KDI may enter into related arrangements with various broker-dealer
firms and other service or administrative firms ("firms"), that provide services
and facilities for their customers or clients who are investors in the
Portfolios. The firms provide such office space and equipment, telephone
facilities and personnel as is necessary or beneficial for providing information
and services to their clients. Such services and assistance may include, but are
not limited to, establishing and maintaining accounts and records, processing
purchase and redemption transactions, account designations and addresses and
such other shareholder services as may be agreed upon from time to time and
permitted by applicable statute, rule or regulation. With respect to Class A
shares, KDI may pay each such firm a service fee, normally payable quarterly, at
an annual rate of up to 0.25% of the net assets in the Portfolios' accounts that
it maintains and services attributable to Class A shares, commencing with the
month after investment. With respect to Class B shares, KDI may advance to firms
the first-year service fee at a rate of up to 0.25% of the purchase price of
such shares. For periods after the first year, KDI currently intends to pay
firms a service fee at a rate of up to 0.25% (calculated monthly and normally
paid quarterly) of the net assets attributable to Class B shares maintained and
serviced by the firm. After the first year, a firm becomes eligible for the
quarterly service fee and the fee continues until terminated by KDI or a
Portfolio. Firms to which service fees may be paid include affiliates of KDI.
During the fiscal year ended April 30, 2000 and the period ended April
30, 1999, such fees paid to KDI were as follows:
Portfolio Year Fee incurred by the Portfolio
--------- ---- -----------------------------
Income 2000 $ 366
1999* 46
31
<PAGE>
Income with Growth 2000 1,047
1999* 36
Balanced 2000 1,518
1999* 38
Growth with Income 2000 1,213
1999* 45
Growth 2000 2,175
1999* 40
* For the period beginning March 9, 1999 (commencement of operations)
KDI also may provide some of the above services and may retain any
portion of the fee under the shareholder services agreement not paid to firms to
compensate itself for shareholder services functions performed for the
Portfolios. Currently, the shareholder services fee payable to KDI is based only
upon Portfolio assets in accounts for which a firm provides shareholder services
and it is intended that KDI will pay all the shareholder services fee that it
receives from a Portfolio to firms in the form of service fees. The effective
shareholder services fee rate to be charged against all assets of a Portfolio
while this procedure is in effect will depend upon the proportion of a
Portfolio's assets that is in accounts for which a firm of record provides
shareholder services.
Certain Board members or officers of the Portfolios are also directors
or officers of Scudder Kemper Investments, Inc. and Kemper Distributors, Inc. as
indicated under "Trustees and Officers."
CUSTODIAN, TRANSFER AGENT AND SHAREHOLDER SERVICE AGENT
State Street Bank and Trust Company, 225 Franklin Street, Boston,
Massachusetts 02110, as custodian, has custody of all securities and cash of
each Portfolio. It attends to the collection or principal and income, and
payment for and collection of proceeds of securities bought and sold by each
Portfolio. Pursuant to a services agreement with State Street Bank and Trust
Company, Kemper Service Company, an affiliate of the Adviser, serves as
"Shareholder Service Agent" of each Portfolio, and as such, performs all of the
duties as transfer agent and dividend paying agent. State Street Bank and Trust
Company receives as transfer agent, and pays to Kemper Service Company, annual
account fees of $10.00 ($18.00 for retirement accounts) plus set up charges,
annual fees associated with the contingent deferred sales charges (Class B
only), an asset-based fee of 0.08% and out-of-pocket reimbursement.
FUND ACCOUNTING AGENT
Scudder Fund Accounting Corporation ("SFAC"), Two International Place,
Boston, Massachusetts 02110-4103, a subsidiary of the Adviser, is responsible
for determining the daily net asset value per share of the Portfolios and
maintaining all account records thereto. Currently, SFAC receives no fee for its
services to the Portfolios; however, subject to Board approval, at some time in
the future, SFAC may seek payment for its services under this agreement.
TAXES
Taxation of the Portfolios and their Shareholders
Each Portfolio intends to qualify annually and elects to be treated as
a regulated investment company under Subchapter M of the Internal Revenue Code
(the "Code"). As a regulated investment company, each Portfolio is required to
distribute to its shareholders at least 90 percent of its investment company
taxable income (including net short-term capital gain) and generally is not
subject to federal income tax to the extent that it distributes annually its
investment company taxable income and net realized capital gains in the manner
required under the Code.
If for any taxable year a Portfolio does not qualify for the special
federal income tax treatment afforded regulated investment companies, all of its
taxable income will be subject to federal income tax at regular corporate rates
(without any deduction for distributions to its shareholders). In such event,
dividend distributions would be taxable to shareholders to the extent of the
Portfolio's earnings and profits, and would be eligible for the
dividends-received deduction in the case of corporate shareholders.
32
<PAGE>
Each Portfolio is subject to a 4% nondeductible excise tax on amounts
required to be but not distributed under a prescribed formula. The formula
requires payment to shareholders during a calendar year of distributions
representing at least 98% of each Portfolio's ordinary income for the calendar
year, at least 98% of the excess of its capital gains over capital losses
(adjusted for certain ordinary losses) realized during the one-year period
ending October 31 during such year, and all ordinary income and capital gains
for prior years that were not previously distributed.
Investment company taxable income generally is made up of dividends,
interest and net short-term capital gains in excess of net long-term capital
losses, less expenses. Net realized capital gains for a fiscal year are computed
by taking into account any capital loss carryforward of a Portfolio. Presently,
each Portfolio has no capital loss carryforwards.
If any net realized long-term capital gains in excess of net realized
short-term capital losses are retained by a Portfolio for reinvestment,
requiring federal income taxes to be paid thereon by the Portfolio, the
Portfolio intends to elect to treat such capital gains as having been
distributed to shareholders. As a result, each shareholder will report such
capital gains as long-term capital gains, will be able to claim a proportionate
share of federal income taxes paid by the Portfolio on such gains as a credit
against the shareholder's federal income tax liability, and will be entitled to
increase the adjusted tax basis of the shareholder's Portfolio shares by the
difference between such reported gains and the shareholder's tax credit. If a
Portfolio makes such an election, it may not be treated as having met the excise
tax distribution requirement.
Distributions of investment company taxable income are taxable to
shareholders as ordinary income.
To the extent that an Underlying Fund derives dividends from domestic
corporations, a portion of the income distributions of a Portfolio which invests
in that Fund may be eligible for the 70% deduction for dividends received by
corporations. Shareholders will be informed of the portion of dividends which so
qualify. The dividends-received deduction is reduced to the extent the shares
held by Underlying Fund with respect to which the dividends are received are
treated as debt-financed under federal income tax law and is eliminated if
either those shares or the shares of the Underlying Fund or the Portfolio are
deemed to have been held by the Underlying Fund, the Portfolio or the
shareholders, as the case may be, for less than 46 days during the 90-day period
beginning 45 days before the shares become ex-dividend.
Income received by an Underlying Fund from sources within a foreign
country may be subject to withholding and other taxes imposed by that country.
If more than 50% of the value of an Underlying Fund's total assets at the close
of its taxable year consists of stock or securities of foreign corporations, the
Underlying Fund will be eligible and may elect to "pass-through" to its
shareholders, including a Portfolio, the amount of such foreign income and
similar taxes paid by the Underlying Fund. Pursuant to this election, the
Portfolio would be required to include in gross income (in addition to taxable
dividends actually received), its pro rata share of foreign income and similar
taxes and to deduct such amount in computing its taxable income or to use it as
a foreign tax credit against its U.S. federal income taxes, subject to
limitations. A Portfolio would not, however, be eligible to elect to
"pass-through" to its shareholders the ability to claim a deduction or credit
with respect to foreign income and similar taxes paid by the Underlying Fund.
Properly designated distributions of the excess of net long-term
capital gain over net short-term capital loss are taxable to shareholders as
long-term capital gains, regardless of the length of time the shares of a
Portfolio have been held by such shareholders. Such distributions are not
eligible for the dividends-received deduction. Any loss realized upon the
redemption of shares held at the time of redemption for 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 during such six-month period.
Distributions of investment company taxable income and net realized
capital gains will be taxable as described above, whether received in shares or
in cash. Shareholders electing to receive distributions in the form of
additional shares will have a cost basis for federal income tax purposes in each
share so received equal to the net asset value of a share on the reinvestment
date.
All distributions of investment company taxable income and net realized
capital gain, whether received in shares or in cash, must be reported by each
shareholder on his or her federal income tax return. Dividends declared in
October, November or December with a record date in such a month will be deemed
to have been received by shareholders on December 31, if paid during January of
the following year. Redemptions of shares, including
33
<PAGE>
exchanges for shares of another Farmers Mutual Fund Portfolio, may result in tax
consequences (gain or loss) to the shareholder and are also subject to these
reporting requirements.
A qualifying individual may make a deductible IRA contribution of up to
$2,000 or, if less, the amount of the individual's earned income for any taxable
year only if (i) neither the individual nor his or her spouse (unless filing
separate returns) is an active participant in an employer's retirement plan, or
(ii) the individual (and his or her spouse, if applicable) has an adjusted gross
income below a certain level ($52,000 for married individuals filing a joint
return, with a phase-out of the deduction for adjusted gross income between
$52,000 and $62,000; $32,000 for a single individual, with a phase-out for
adjusted gross income between $32,000 and $42,000). However, an individual not
permitted to make a deductible contribution to an IRA for any such taxable year
may nonetheless make nondeductible contributions up to $2,000 to an IRA (up to
$2,500 per individual for married couples if only one spouse has earned income)
for that year. There are special rules for determining how withdrawals are to be
taxed if an IRA contains both deductible and nondeductible amounts. In general,
a proportionate amount of each withdrawal will be deemed to be made from
nondeductible contributions; amounts treated as a return of nondeductible
contributions will not be taxable. Also, annual contributions may be made to a
spousal IRA even if the spouse has earnings in a given year if the spouse elects
to be treated as having no earnings (for IRA contribution purposes) for the
year.
Distributions by a Portfolio result in a reduction in the net asset
value of the Portfolio's shares. Should a distribution reduce the net asset
value below a shareholder's cost basis, such distribution would nevertheless be
taxable to the shareholder as ordinary income or capital gain as described
above, even though, from an investment standpoint, it may constitute a partial
return of capital. In particular, investors should consider the tax implications
of buying shares just prior to a distribution. The price of shares purchased at
that time includes the amount of the forthcoming distribution. Those purchasing
just prior to a distribution will then receive a partial return of capital upon
the distribution, which will nevertheless be taxable to them.
Upon a redemption, sale or exchange of his or her shares, a shareholder
will realize a taxable gain or loss depending upon his or her basis in the
shares. Such gain or loss will be treated as capital gain or loss if the shares
are capital assets in the shareholder's hands and will be long-term or
short-term, generally, depending upon the shareholder's holding period for the
shares. Any loss realized on a redemption, sale or exchange will be disallowed
to the extent the shares disposed of are replaced (including through
reinvestment of dividends) within a period of 61 days beginning 30 days before
and ending 30 days after the shares are disposed of. In such a case, the basis
of the shares acquired will be adjusted to the reflect the disallowed loss. Any
loss realized by a shareholder on the sale of Portfolio shares held by the
shareholder for six months or less will be treated as a long-term capital loss
to the extent of any distributions of net capital gains received or treated as
having been received by the shareholder with respect to such shares.
In some cases, shareholders will not be permitted to take sales charges
into account for purposes of determining the amount of gain or loss realized on
the disposition of their Portfolio shares. This prohibition generally applies
where (1) the shareholder incurs a sales charge in acquiring shares of a
Portfolio, (2) the shares are disposed of before the 91st day after the date on
which they were acquired, and (3) the shareholder subsequently acquires the
shares of the same or another Portfolio and the otherwise applicable sales
charge is reduced under a "reinvestment right" received upon the initial
purchase of regulated investment company shares. The term "reinvestment right"
means any right to acquire stock of one or more Portfolios without the payment
of a sales charge or with the payment of a reduced sales charge. Sales charges
affected by this rule are treated as if they were incurred with respect to the
shares acquired under the reinvestment right. This provision may be applied to
successive acquisitions of Portfolio shares.
Each Portfolio will be required to report to the Internal Revenue
Service ("IRS") all distributions of investment company taxable income and
capital gains as well as gross proceeds from the redemption or exchange of
Portfolio shares, except in the case of certain exempt shareholders. Under the
backup withholding provisions of Section 3406 of the Code, distributions of
investment company taxable income and capital gains and proceeds from the
redemption or exchange of the shares of a regulated investment company may be
subject to withholding of federal income tax at the rate of 31% in the case of
non-exempt shareholders who fail to furnish the investment company with their
taxpayer identification numbers and with required certifications regarding their
status under the federal income tax law. Withholding may also be required if a
Portfolio is notified by the IRS or a broker that the taxpayer identification
number furnished by the shareholder is incorrect or that the shareholder has
previously failed to report interest or dividend
34
<PAGE>
income. If the withholding provisions are applicable, any such distributions and
proceeds, whether taken in cash or reinvested in additional shares, will be
reduced by the amounts required to be withheld.
Shareholders of a Portfolio may be subject to state and local taxes on
distributions received from the Portfolio and on redemptions of the Portfolio's
shares.
The foregoing discussion of U.S. federal income tax law relates solely
to the application of that law to U.S. persons, i.e., U.S. citizens and
residents and U.S. corporations, partnerships, trusts and estates. Each
shareholder who is not a U.S. person should consider the U.S. and foreign tax
consequences of ownership of shares of a Portfolio, including the possibility
that such a shareholder may be subject to a U.S. withholding tax at a rate of
30% (or at a lower rate under an applicable income tax treaty) on amounts
constituting ordinary income received by him or her, where such amounts are
treated as income from U.S. sources under the Code.
Taxation of the Underlying Funds
Each Underlying Fund intends to qualify annually and elects to be
treated as a regulated investment company under Subchapter M of the Code. In any
year in which an Underlying Fund qualifies as a regulated investment company and
timely distributes all of its taxable income, the Fund generally will not pay
any federal income or excise tax.
If for any taxable year an Underlying Fund does not qualify for the
special federal income tax treatment afforded regulated investment companies,
all of its taxable income will be subject to federal income tax at regular
corporate rates (without any deduction for distributions to its shareholders).
In such event, dividend distributions would be taxable to shareholders
(including the Portfolios) to the extent of the Fund's earnings and profits, and
would be eligible for the dividends-received deduction in the case of corporate
shareholders (including the Portfolios).
Distributions of an Underlying Fund's investment company taxable income
are taxable as ordinary income to a Portfolio which invests in the Underlying
Fund. Distributions of the excess of an Underlying Fund's net long-term capital
gain over its net short-term capital loss, which are properly designated as
"capital gain dividends," are taxable as long-term capital gain to a Portfolio
which invests in the Underlying Fund, regardless of how long the Portfolio held
the Underlying Fund's shares, and are not eligible for the corporate
dividends-received deduction. Upon the sale or other disposition by a Portfolio
of shares of an Underlying Fund, the Portfolio generally will realize a capital
gain or loss which will be long-term or short-term, generally depending upon the
Portfolio's holding period for the shares.
Shareholders should consult their tax advisers about the application of
the provisions of tax law described in this statement of additional information
in light of their particular tax situations.
PORTFOLIO TRANSACTIONS
Portfolio Turnover
Each Portfolio's average annual portfolio turnover rate is the ratio of
the lesser of sales or purchases to the monthly average value of the portfolio
securities owned during the year, excluding all securities with maturities or
expiration dates at the time of acquisition of one year or less. Purchases and
sales are made for each Portfolio whenever necessary, in management's opinion,
to meet that Portfolio's objective. The payment of a Portfolio's expenses is
subject to the investment management agreements and certain provisions mentioned
in the Agreements with the Adviser.
The table below sets forth the average annual portfolio turnover rate
for each of the Portfolios for the fiscal year ended April 30, 2000:
Portfolio Portfolio Turnover Rate
Income Portfolio 59%
Income with Growth Portfolio 38%
Balanced Portfolio 20%
Growth with Income Portfolio 56%
Growth Portfolio 31%
35
<PAGE>
The table below sets forth the average annual portfolio turnover rate
for each of the affiliated Underlying Funds' last two fiscal periods:
<TABLE>
<CAPTION>
Affiliated Underlying Fund Portfolio Turnover Rate^(1)
-------------------------- --------------------------
2000 1999
---- ----
<S> <C> <C> <C>
Zurich Money Market Fund N/A^(2) NA^(2)
Kemper High Yield Fund 47.0%^(3) 67.0%
Kemper U.S. Government Securities Fund 122.0%^(3)^(4) 177.0%^(4)
Scudder Income Fund 81.0% 61.3%^(3)
Kemper-Dreman High Return Equity Fund 4.0%^(3) 33.0%
Scudder Growth and Income Fund 58.0%^(3) 70.0%
Scudder International Fund 91.0% ^(3) 82.0%^(5)
Scudder Small Company Value Fund 61.0%^(3) 34.0%^(6)
</TABLE>
------------------------------
^(1) As of each affiliated Underlying Fund's most recent fiscal
reporting period.
^(2) Zurich Money Market Fund is a money market fund.
^(3) Annualized (based on a 6-month period).
^(4) Based on monthly average shares outstanding during the period.
^(5) Annualized (based on a 5-month period).
^(6) Annualized based on an 11-month period).
NET ASSET VALUE
The net asset value per share of each Portfolio is the value of one
share and is determined separately for each class by dividing the value of the
Portfolio's net assets attributable to that class by the number of shares of
that class outstanding. The per share net asset value of the Class B shares of
each Portfolio will generally be lower than that of the Class A shares of that
Portfolio because of the higher expenses borne by the Class B shares. The net
asset value of shares of each Portfolio is computed as of the close of regular
trading on the Exchange on each day the Exchange is open for trading. The
Exchange is scheduled to be closed on the following holidays: New Year's Day,
Dr. Martin Luther King, Jr. Day, Presidents' Day, Good Friday, Memorial Day,
Independence Day, Labor Day, Thanksgiving and Christmas.
The net asset value of each Underlying Fund is determined based upon
the nature of the securities as set forth in the prospectus and statement of
additional information of such Underlying Fund. Shares of each Underlying Fund
in which a Portfolio may invest are valued at the net asset value per share of
each Underlying Fund as of the close of regular trading on the Exchange on each
day the Exchange is open for trading. The net asset value per share of the
Underlying Funds will be calculated and reported to a Portfolio by each
Underlying Fund's accounting agent. Short-term securities with a remaining
maturity of sixty days or less are valued by the amortized cost method.
If, in the opinion of a Portfolio's Valuation Committee, the value of a
portfolio asset as determined in accordance with these procedures does not
represent the fair market value of the portfolio asset, the value of the
portfolio asset is taken to be an amount which, in the opinion of the Valuation
Committee, represents fair market value on the basis of all available
information. The value of other portfolio holdings owned by a Portfolio
determined in a manner which, in the discretion of the Valuation Committee most
fairly reflects fair market value of the property on the valuation date.
If a foreign exchange or market is closed on a day when the Exchange is
open, the value of a portfolio asset of the Portfolio that is traded in the
particular closed foreign exchange or market shall be the last available market
quotation from the date the foreign exchange or market was last open. If, in the
opinion of the Valuation Committee of the Trust, that value does not represent
the fair market value of the asset, the value of the asset shall be taken to be
an amount which, in the opinion of the Valuation Committee of the Trust,
represents fair market value on the basis of all available information.
36
<PAGE>
ADDITIONAL INFORMATION
Experts
The financial highlights of the Portfolios included in the Portfolios'
prospectus, and the Financial Statements incorporated by reference in this
Statement of Additional Information, have been so included or incorporated by
reference in reliance on the report of PricewaterhouseCoopers LLP, 160 Federal
Street, Boston, Massachusetts 02110, independent accountants, given on the
authority of said firm as experts in auditing and accounting.
PricewaterhouseCoopers LLP audits the financial statements of each Portfolio and
provides other audit, tax and related services.
Shareholder Indemnification
The Trust is an organization of the type commonly known as a
Massachusetts business trust. Under Massachusetts law, shareholders of such a
trust may, under certain circumstances, be held personally liable as partners
for the obligations of the Trust. The Declaration of Trust contains an express
disclaimer of shareholder liability in connection with the Portfolios' property
or the acts, obligations or affairs of the Trust. The Declaration of Trust also
provides for indemnification out of the Portfolios' property of any shareholder
held personally liable for the claims and liabilities which a shareholder may
become subject by reason of being or having been a shareholder. Thus, the risk
of a shareholder incurring financial loss on account of shareholder liability is
limited to circumstances in which a Portfolio itself would be unable to meet its
obligations.
Other Information
Many of the investment changes in a Portfolio will be made at prices
different from those prevailing at the time they may be reflected in a regular
report to shareholders of the Portfolio. These transactions will reflect
investment decisions made by the Adviser in light of the objective and policies
of the Portfolio, and other factors such as its other portfolio holdings and tax
considerations, and should not be construed as recommendations for similar
action by other investors.
The name Farmers Investment Trust is the designation of the Trustees
for the time being under a Declaration of Trust dated October 26, 1998, as
amended from time to time, and all persons dealing with a Portfolio must look
solely to the property of the Portfolio for the enforcement of any claims
against the Portfolio as neither the Trustees, officers, agents or shareholders
assume any personal liability for obligations entered into on behalf of the
Portfolio. No series of the Trust shall be liable for the obligations of any
other series. Upon the initial purchase of shares, the shareholder agrees to be
bound by the Trust's Declaration of Trust, as amended from time to time. The
Declaration of Trust is on file at the Massachusetts Secretary of State's Office
in Boston, Massachusetts.
The CUSIP number of Income Portfolio Class A shares is 309622-10-8. The
CUSIP number of Income Portfolio Class B shares is 309622-20-7.
The CUSIP number of Income with Growth Portfolio Class A shares is
309622-30-6. The CUSIP number of Income with Growth Portfolio Class B
shares is 309622-40-5.
The CUSIP number of Balanced Portfolio Class A shares is 309622-50-4.
The CUSIP number of Balanced Portfolio Class B shares is 309622-60-3.
The CUSIP number of Growth with Income Portfolio Class A shares is
309622-87-6. The CUSIP number of Growth with Income Portfolio Class B
shares is 309622-88-4.
The CUSIP number of Growth Portfolio Class A shares is 309622-70-2. The
CUSIP number of Growth Portfolio Class B shares is 309622-80-1.
37
<PAGE>
Each Portfolio has a fiscal year end of April 30.
The firm of Dechert Price & Rhoads is counsel to the Trust.
The Portfolios, or the Adviser (including any affiliate of the
Adviser), or both, may pay unaffiliated third parties for providing
recordkeeping and other administrative services with respect to accounts of
participants in retirement plans or other beneficial owners of Fund shares whose
interests are held in an omnibus account.
The Portfolios' prospectus and this Statement of Additional Information
omit certain information contained in the Registration Statement which the Trust
has filed with the SEC under the Securities Act of 1933 and reference is hereby
made to the Registration Statement for further information with respect to the
Portfolios and the securities offered hereby. This Registration Statement and
its amendments are available for inspection by the public at the SEC in
Washington, D.C.
FINANCIAL STATEMENTS
The financial statements, including the investment portfolio, of each
Portfolio together with the Report of Independent Accountants, Financial
Highlights and notes to financial statements in the Annual Report to the
Shareholders of the Portfolios dated April 30, 2000, are incorporated herein by
reference and are hereby deemed to be a part of this Statement of Additional
Information.
38
<PAGE>
GLOSSARY
Descriptions in this Statement of Additional Information of a
particular investment practice or technique in which an affiliated Underlying
Fund may engage (such as short selling, hedging, etc.) or a financial instrument
which an Underlying Fund may purchase (such as options, forward foreign currency
contracts, etc.) are meant to describe the spectrum of investments that the
Adviser, in its discretion, might, but is not required to, use in managing an
Underlying Fund's portfolio assets. The Adviser may, in its discretion, at any
time employ such practice, technique or instrument for one or more Underlying
Funds but not for all Underlying Funds advised by it. Furthermore, it is
possible that certain types of financial instruments or investment techniques
described herein may not be available, permissible, economically feasible or
effective for their intended purposes in all markets. Certain practices,
techniques, or instruments may not be principal activities of an Underlying Fund
but, to the extent employed, could from time to time have a material impact on
an Underlying Fund's performance.
Prospective investors should consider that certain affiliated
Underlying Funds may engage in the following investment practices:
Common stocks. Under normal circumstances, certain Underlying Funds invest
primarily in common stocks. Common stock is issued by companies to raise cash
for business purposes and represents a proportionate interest in the issuing
companies. Therefore, an Underlying Fund may participate in the success or
failure of any company in which it holds stock. The market values of common
stock can fluctuate significantly, reflecting the business performance of the
issuing company, investor perception and general economic or financial market
movements. Smaller companies are especially sensitive to these factors and may
even become valueless. Despite the risk of price volatility, however, common
stocks also offer a greater potential for gain on investment, compared to other
classes of financial assets such as bonds or cash equivalents.
Convertible Securities. Certain Underlying Funds may invest in convertible
securities; that is, bonds, notes, debentures, preferred stocks and other
securities which are convertible into common stock. Investments in convertible
securities can provide an opportunity for capital appreciation and/or income
through interest and dividend payments by virtue of their conversion or exchange
features.
The convertible securities in which an Underlying Fund may invest are
either fixed income or zero coupon debt securities which may be converted or
exchanged at a stated or determinable exchange ratio into underlying shares of
common stock. The exchange ratio for any particular convertible security may be
adjusted from time to time due to stock splits, dividends, spin-offs, other
corporate distributions or scheduled changes in the exchange ratio. Convertible
debt securities and convertible preferred stocks, until converted, have general
characteristics similar to both debt and equity securities. Although to a lesser
extent than with debt securities generally, the market value of convertible
securities tends to decline as interest rates increase and, conversely, tends to
increase as interest rates decline. In addition, because of the conversion or
exchange feature, the market value of convertible securities typically changes
as the market value of the underlying common stocks changes, and, therefore,
also tends to follow movements in the general market for equity securities. A
unique feature of convertible securities is that as the market price of the
underlying common stock declines, convertible securities tend to trade
increasingly on a yield basis, and so may not experience market value declines
to the same extent as the underlying common stock. When the market price of the
underlying common stock increases, the prices of the convertible securities tend
to rise as a reflection of the value of the underlying common stock, although
typically not as much as the underlying common stock. While no securities
investments are without risk, investments in convertible securities generally
entail less risk than investments in common stock of the same issuer.
As debt securities, convertible securities are investments which
provide for a stream of income (or in the case of zero coupon securities,
accretion of income) with generally higher yields than common stocks. Of course,
like all debt securities, there can be no assurance of income or principal
payments because the issuers of the convertible securities may default on their
obligations. Convertible securities generally offer lower yields than
non-convertible securities of similar quality because of their conversion or
exchange features.
Small Company Risk. The Adviser believes that small companies often have sales
and earnings growth rates which exceed those of larger companies, and that such
growth rates may in turn be reflected in more rapid share price
<PAGE>
appreciation over time. However, investing in smaller company stocks involves
greater risk than is customarily associated with investing in larger, more
established companies. For example, smaller companies can have limited product
lines, markets, or financial and managerial resources. Smaller companies may
also be dependent on one or a few key persons, and may be more susceptible to
losses and risks of bankruptcy. Also, the securities of the smaller companies in
which certain Underlying Funds may invest, may be thinly traded (and therefore
have to be sold at a discount from current market prices or sold in small lots
over an extended period of time). Transaction costs in smaller company stocks
may be higher than those of larger companies.
Investing in emerging growth companies. The investment risk associated with
emerging growth companies is higher than that normally associated with larger,
older companies due to the greater business risks of small size, the relative
age of the company, limited product lines, distribution channels and financial
and managerial resources. Further, there is typically less publicly available
information concerning smaller companies than for larger, more established ones.
The securities of small companies are often traded over-the-counter and
may not be traded in the volumes typical on a national securities exchange.
Consequently, in order to sell this type of holding, an Underlying Fund may need
to discount the securities from recent prices or dispose of the securities over
a long period of time. The prices of this type of security may be more volatile
than those of larger companies which are often traded on a national securities
exchange.
Investments Involving Above-Average Risk. Certain Underlying Funds may purchase
securities involving above-average risk. For example, an Underlying Fund has
invested from time to time in relatively new companies but is limited by a
non-fundamental policy that it may not invest more than 5% of its total assets
in companies that, with their predecessors, have been in continuous operation
for less than three years. The Underlying Fund's portfolio may also include the
securities of small or little-known companies, commonly referred to as emerging
growth companies, that the Adviser believes have above-average earnings growth
potential and/or may receive greater market recognition. Both factors are
believed to offer significant opportunity for capital appreciation. Investment
risk is higher than that normally associated with larger, older companies due to
the higher business risks associated with small size, frequently narrow product
lines and relative immaturity. To help reduce risk, the Underlying Fund
allocates its investments among many companies and different industries.
The securities of such companies are often traded only over-the-counter
and may not be traded in the volume typical of trading on a national securities
exchange. As a result, the disposition by the Underlying Fund of holdings of
such securities may require the Underlying Fund to offer a discount from recent
prices or to make many small sales over a lengthy period of time. Such
securities may be subject to more abrupt or erratic market movements than those
typically encountered on national securities exchanges.
Debt securities. In general, the prices of debt securities rise when interest
rates fall, and vice versa. This effect is usually more pronounced for longer
term debt securities.
The debt securities in which certain of the Underlying Funds may invest
are rated, or determined by the Adviser to be the equivalent of those rated, by
two nationally recognized statistical rating organizations, Moody's and S&P.
High quality securities are those rated in the two highest categories by Moody's
(Aaa or Aa) or S&P (AAA or AA). High-grade securities are those rated in the
three highest categories by Moody's (Aaa, Aa, or A) or by S&P (AAA, AA, or A).
Investment-grade securities are those rated in the four highest categories by
Moody's (Aaa, Aa, A, or Baa) or by S&P (AAA, AA, A or BBB).
Certain Underlying Funds may invest in debt securities which are rated
below investment-grade; that is, rated below Baa by Moody's or BBB by S&P
(commonly referred to as "junk bonds"). The lower the ratings of such debt
securities, the greater their risks render them like equity securities. Moody's
considers bonds it rates Baa to have speculative elements as well as
investment-grade characteristics. Certain Underlying Funds may also make a
portion of their below investment-grade investments in securities which are
rated D by S&P or, if unrated, are of equivalent quality. Securities rated D may
be in default with respect to payment of principal or interest. Information
regarding the ratings of debt securities and the identity of those Underlying
Funds that can invest in investment-grade or below investment-grade debt
securities may be found in this Statement of Additional Information.
2
<PAGE>
To the extent an Underlying Fund invests in high-grade securities, it
will be unable to avail itself of opportunities for higher income which may be
available with lower grade investments. Conversely, although some lower-grade
securities have produced higher yields in the past than the investment-grade
securities, lower-grade securities are considered to be predominantly
speculative and, therefore, carry greater risk.
High Yield, High Risk Securities. Below investment grade securities (rated Ba
and lower by Moody's and BB and lower by S&P) or unrated securities of
equivalent quality (commonly referred to as "junk bonds"), in which certain
Underlying Funds may invest, carry a high degree of risk (including the
possibility of default or bankruptcy of the issuers of such securities),
generally involve greater volatility of price and risk of principal and income,
and may be less liquid, than securities in the higher rating categories and are
considered speculative. The lower the ratings of such debt securities, the
greater their risks render them like equity securities. See the Appendix to this
combined Statement of Additional Information for a more complete description of
the ratings assigned by ratings organizations and their respective
characteristics.
Economic downturns have in the past, and could in the future, disrupted
the high yield market and impaired the ability of issuers to repay principal and
interest. Also, an increase in interest rates would likely have a greater
adverse impact on the value of such obligations than on comparable higher
quality debt securities. During an economic downturn or period of rising
interest rates, highly leveraged issues may experience financial stress which
would adversely affect their ability to service their principal and interest
payment obligations. Prices and yields of high yield securities will fluctuate
over time and, during periods of economic uncertainty, volatility of high yield
securities may adversely affect an Underlying Fund's net asset value. In
addition, investments in high yield zero coupon or pay-in-kind bonds, rather
than income-bearing high yield securities, may be more speculative and may be
subject to greater fluctuations in value due to changes in interest rates.
The trading market for high yield securities may be thin to the extent
that there is no established retail secondary market or because of a decline in
the value of such securities. A thin trading market may limit the ability of an
Underlying Fund to accurately value high yield securities in the Underlying
Fund's portfolio and to dispose of those securities. Adverse publicity and
investor perceptions may decrease the values and liquidity of high yield
securities. These securities may also involve special registration
responsibilities, liabilities and costs. Lower rated and unrated securities are
especially subject to adverse changes in general economic conditions, to changes
in the financial condition of their issuers, and to price fluctuation in
response to changes in interest rates. During periods of economic downturn or
rising interest rates, issuers of these instruments may experience financial
stress that could adversely affect their ability to make payments of principal
and interest and increase the possibility of default.
Credit quality in the high yield securities market can change suddenly
and unexpectedly, and even recently issued credit ratings may not fully reflect
the actual risks posed by a particular high-yield security. For these reasons,
it is the policy of the Adviser not to rely exclusively on ratings issued by
established credit rating agencies, but to supplement such ratings with its own
independent and on-going review of credit quality. The achievement of an
Underlying Fund's investment objective by investment in such securities may be
more dependent on the Adviser's credit analysis than is the case for higher
quality bonds. Should the rating of a portfolio security be downgraded, the
Adviser will determine whether it is in the best interests of the Underlying
Fund to retain or dispose of such security.
Prices for below investment-grade securities may be affected by
legislative and regulatory developments. For example, new federal rules require
savings and loan institutions to gradually reduce their holdings of this type of
security. Also, Congress has from time to time considered legislation which
would restrict or eliminate the corporate tax deduction for interest payments in
these securities and regulate corporate restructurings. Such legislation may
significantly depress the prices of outstanding securities of this type.
Municipal Obligations. Certain Underlying Funds may acquire municipal
obligations when, due to disparities in the debt securities markets, the
anticipated total return on such obligations is higher than that on taxable
obligations. The Underlying Fund has no current intention of purchasing
tax-exempt municipal obligations that would amount to greater than 5% of the
Underlying Fund's total assets.
Municipal obligations are issued by or on behalf of states,
territories, and possessions of the U.S., and their political subdivisions,
agencies, and instrumentalities, and the District of Columbia to obtain funds
for various public purposes. The interest on these obligations is generally
exempt from federal income tax in the hands of most investors.
3
<PAGE>
The two principal classifications of municipal obligations are "notes" and
"bonds." The return on municipal obligations is ordinarily lower than that of
taxable obligations.
Zero Coupon Securities. Certain Underlying Funds may invest in zero coupon
securities, which pay no cash income and are sold at substantial discounts from
their value at maturity. When held to maturity, their entire income, which
consists of accretion of discount, comes from the difference between the issue
price and their value at maturity. Zero coupon securities are subject to greater
market value fluctuations from changing interest rates than debt obligations of
comparable maturities which make current distributions of interest (cash). Zero
coupon convertible securities offer the opportunity for capital appreciation (or
depreciation) as increases (or decreases) in market value of such securities
closely follow the movements in the market value of the underlying common stock.
Zero coupon convertible securities generally are expected to be less volatile
than the underlying common stocks because zero coupon convertible securities are
usually issued with shorter maturities (15 years or less) and with options
and/or redemption features exercisable by the holder of the obligation entitling
the holder to redeem the obligation and receive a defined cash payment.
Zero coupon securities include securities issued directly by the U.S.
Treasury, and U.S. Treasury bonds or notes and their unmatured interest coupons
and receipts for their underlying principal ("coupons") which have been
separated by their holder, typically a custodian bank or investment brokerage
firm. A holder will separate the interest coupons from the underlying principal
(the "corpus") of the U.S. Treasury security. A number of securities firms and
banks have stripped the interest coupons and receipts and then resold them in
custodial receipt programs with a number of different names, including "Treasury
Income Growth Receipts" ("TIGRS") and Certificate of Accrual on Treasuries
("CATS"). The underlying U.S. Treasury bonds and notes themselves are held in
book-entry form at the Federal Reserve Bank or, in the case of bearer securities
(i.e., unregistered securities which are owned ostensibly by the bearer or
holder thereof), in trust on behalf of the owners thereof. Counsel to the
underwriters of these certificates or other evidences of ownership of the U.S.
Treasury securities has stated that for federal tax and securities purposes, in
their opinion purchasers of such certificates, such as an Underlying Fund, most
likely will be deemed to be the beneficial holder of the underlying U.S.
government securities.
The Treasury has facilitated transfers of ownership of zero coupon
securities by accounting separately for the beneficial ownership of particular
interest coupons and corpus payments on Treasury securities through the Federal
Reserve book-entry record-keeping system. The Federal Reserve program as
established by the Treasury Department is known as "STRIPS" or "Separate Trading
of Registered Interest and Principal of Securities." Under the STRIPS program,
the Fund will be able to have its beneficial ownership of zero coupon securities
recorded directly in the book-entry record-keeping system in lieu of having to
hold certificates or other evidences of ownership of the underlying U.S.
Treasury securities.
When U.S. Treasury obligations have been stripped of their unmatured
interest coupons by the holder, the principal or corpus is sold at a deep
discount because the buyer receives only the right to receive a future fixed
payment on the security and does not receive any rights to periodic interest
(cash) payments. Once stripped or separated, the corpus and coupons may be sold
separately. Typically, the coupons are sold separately or grouped with other
coupons with like maturity dates and sold in such bundled form. Purchasers of
stripped obligations acquire, in effect, discount obligations that are
economically identical to the zero coupon securities that the Treasury sells
itself. (See "TAXES.")
Brady Bonds. Brady Bonds are debt securities issued under a plan
implemented to allow debtor nations to restructure their outstanding commercial
bank indebtedness. Foreign governmental issuers of debt or the governmental
authorities that control the repayment of the debt may be unable or unwilling to
repay principal or pay interest when due. In the event of default, there may be
limited or no legal recourse in that, generally, remedies for defaults must be
pursued in the courts of the defaulting party. Political conditions, especially
a sovereign entity's willingness to meet the terms of its fixed income
securities, are of considerable significance. Also, there can be no assurance
that the holders of commercial bank loans to the same sovereign entity may not
contest payments to the holders of sovereign debt in the event of default under
commercial bank loan agreements. In addition, there is no bankruptcy proceeding
with respect to sovereign debt on which a sovereign has defaulted, and the Fund
may be unable to collect all or any part of its investment in a particular
issue. Foreign investment in certain sovereign debt is restricted or controlled
to varying degrees, including requiring governmental approval for the
repatriation of income, capital or proceed of sales by foreign investors. These
restrictions or controls may at times limit or preclude foreign investment in
certain sovereign debt or increase the costs and expenses of the Fund. Sovereign
debt may be issued as part of debt restructuring and such debt is
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to be considered speculative. There is a history of defaults with respect to
commercial bank loans by public and private entities issuing Brady Bonds. All or
a portion of the interest payments and/or principal repayment with respect to
Brady Bonds may be uncollateralized.
Sovereign Debt. Investment in sovereign debt can involve a high degree of risk.
The governmental entity that controls the repayment of sovereign debt may not be
able or willing to repay the principal and/or interest when due in accordance
with the terms of such debt. A governmental entity's willingness or ability to
repay principal and interest due in a timely manner may be affected by, among
other factors, its cash flow situation, the extent of its foreign reserves, the
availability of sufficient foreign exchange on the date a payment is due, the
relative size of the debt service burden to the economy as a whole, the
governmental entity's policy towards the International Monetary Fund, and the
political constraints to which a governmental entity may be subject.
Governmental entities may also be dependent on expected disbursements from
foreign governments, multilateral agencies and others abroad to reduce principal
and interest arrearages on their debt. The commitment on the part of these
governments, agencies and others to make such disbursements may be conditioned
on a governmental entity's implementation of economic reforms and/or economic
performance and the timely service of such debtor's obligations. Failure to
implement such reforms, achieve such levels of economic performance or repay
principal or interest when due may result in the cancellation of such third
parties' commitments to lend funds to the governmental entity, which may further
impair such debtor's ability or willingness to service its debts in a timely
manner. Consequently, governmental entities may default on their sovereign debt.
Holders of sovereign debt may be requested to participate in the rescheduling of
such debt and to extend further loans to governmental entities. There is no
bankruptcy proceeding by which sovereign debt on which governmental entities
have defaulted may be collected in whole or in part.
Mortgage-Backed Securities and Mortgage Pass-Through Securities. Certain
Underlying Funds may also invest in mortgage-backed securities, which are
interests in pools of mortgage loans, including mortgage loans made by savings
and loan institutions, mortgage bankers, commercial banks, and others. Pools of
mortgage loans are assembled as securities for sale to investors by various
governmental, government-related, and private organizations as further described
below. An Underlying Fund may also invest in debt securities which are secured
with collateral consisting of mortgage-backed securities (see "Collateralized
Mortgage Obligations"), and in other types of mortgage-related securities.
A decline in interest rates may lead to a faster rate of repayment of
the underlying mortgages, and expose an Underlying Fund to a lower rate of
return upon reinvestment. To the extent that such mortgage-backed securities are
held by an Underlying Fund, the prepayment right will tend to limit to some
degree the increase in net asset value of the Underlying Fund because the value
of the mortgage-backed securities held by the Underlying Fund may not appreciate
as rapidly as the price of non-callable debt securities. When interest rates
rise, mortgage prepayment rates tend to decline, thus lengthening the life of
mortgage-related securities and increasing their volatility, affecting the price
volatility of the Underlying Fund's shares.
Interests in pools of mortgage-backed securities differ from other
forms of debt securities, which normally provide for periodic payment of
interest in fixed amounts with principal payments at maturity or specified call
dates. Instead, these securities provide a monthly payment which consists of
both interest and principal payments. In effect, these payments are a
"pass-through" of the monthly payments made by the individual borrowers on their
mortgage loans, net of any fees paid to the issuer or guarantor of such
securities. Additional payments are caused by repayments of principal resulting
from the sale of the underlying property, refinancing, or foreclosure, net of
fees or costs which may be incurred. Because principal may be prepaid at any
time, mortgage-backed securities may involve significantly greater price and
yield volatility than traditional debt securities. Some mortgage-related
securities such as securities issued by the Government National Mortgage
Association ("GNMA") are described as "modified pass-through." These securities
entitle the holder to receive all interest and principal payments owed on the
mortgage pool, net of certain fees, at the scheduled payment dates regardless of
whether or not the mortgagor actually makes the payment.
The principal governmental guarantor of mortgage-related securities is
GNMA. GNMA is a wholly-owned U.S. Government corporation within the Department
of Housing and Urban Development. GNMA is authorized to guarantee, with the full
faith and credit of the U.S. Government, the timely payment of principal and
interest on securities issued by institutions approved by GNMA (such as savings
and loan institutions, commercial banks, and mortgage bankers) and backed by
pools of FHA-insured or VA-guaranteed mortgages. These guarantees, however, do
not apply to the market value or yield of mortgage-backed securities or to the
value of Underlying Fund shares. Also,
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GNMA securities often are purchased at a premium over the maturity value of the
underlying mortgages. This premium is not guaranteed and will be lost if
prepayment occurs.
Government-related guarantors (i.e., not backed by the full faith and
credit of the U.S. Government) include the Federal National Mortgage Association
("FNMA") and the Federal Home Loan Mortgage Corporation ("FHLMC"). FNMA is a
government-sponsored corporation owned entirely by private stockholders. It is
subject to general regulation by the Secretary of Housing and Urban Development.
FNMA purchases conventional (i.e., not insured or guaranteed by any governmental
agency) mortgages from a list of approved seller/servicers which include state
and federally-chartered savings and loan associations, mutual savings banks,
commercial banks, credit unions, and mortgage bankers. Pass-through securities
issued by FNMA are guaranteed as to timely payment of principal and interest by
FNMA but are not backed by the full faith and credit of the U.S. Government.
FHLMC is a corporate instrumentality of the U.S. Government and was
created by Congress in 1970 for the purpose of increasing the availability of
mortgage credit for residential housing. Its stock is owned by the twelve
Federal Home Loan Banks. FHLMC issues Participation Certificates ("PCs") which
represent interests in conventional mortgages from FHLMC's national portfolio.
FHLMC guarantees the timely payment of interest and ultimate collection of
principal, but PCs are not backed by the full faith and credit of the U.S.
Government.
Commercial banks, savings and loan institutions, private mortgage
insurance companies, mortgage bankers, and other secondary market issuers also
create pass-through pools of conventional mortgage loans. Such issuers may, in
addition, be the originators and/or servicers of the underlying mortgage loans
as well as the guarantors of the mortgage-related securities. Pools created by
such non-governmental issuers generally offer a higher rate of interest than
governmental and government-related pools because there are no direct or
indirect government or agency guarantees of payments. However, timely payment of
interest and principal of these pools may be supported by various forms of
insurance or guarantees, including individual loan, title, pool and hazard
insurance, and letters of credit. The insurance and guarantees are issued by
governmental entities, private insurers, and the mortgage poolers. Such
insurance and guarantees and the creditworthiness of the issuers thereof will be
considered in determining whether a mortgage-related security meets an
Underlying Fund's investment quality standards. There can be no assurance that
the private insurers or guarantors can meet their obligations under the
insurance policies or guarantee arrangements. An Underlying Fund may buy
mortgage-related securities without insurance or guarantees, if through an
examination of the loan experience and practices of the originators/servicers
and poolers, the Adviser determines that the securities meet the Underlying
Fund's quality standards. Although the market for such securities is becoming
increasingly liquid, securities issued by certain private organizations may not
be readily marketable.
Collateralized Mortgage Obligations ("CMOs"). A CMO is a hybrid between a
mortgage-backed bond and a mortgage pass-through security. Similar to a bond,
interest and prepaid principal are paid, in most cases, semiannually. CMOs may
be collateralized by whole mortgage loans but are more typically collateralized
by portfolios of mortgage pass-through securities guaranteed by GNMA, FHLMC, or
FNMA, and their income streams.
CMOs are structured into multiple classes, each bearing a different
stated maturity. Actual maturity and average life will depend upon the
prepayment experience of the collateral. CMOs provide for a modified form of
call protection through a de facto breakdown of the underlying pool of mortgages
according to how quickly the loans are repaid. Monthly payment of principal
received from the pool of underlying mortgages, including prepayments, is first
returned to investors holding the shortest maturity class. Investors holding the
longer maturity classes receive principal only after the first class has been
retired. An investor is partially guarded against a sooner than desired return
of principal because of the sequential payments. The prices of certain CMOs,
depending on their structure and the rate of prepayments, can be volatile. Some
CMOs may not be as liquid as other securities.
In a typical CMO transaction, a corporation issues multiple series,
(e.g., A, B, C, Z) of CMO bonds ("Bonds"). Proceeds of the Bond offering are
used to purchase mortgages or mortgage pass-through certificates ("Collateral").
The Collateral is pledged to a third party trustee as security for the Bonds.
Principal and interest payments from the Collateral are used to pay principal on
the Bonds in the order A, B, C, Z. The Series A, B, and C bonds all bear current
interest. Interest on the Series Z Bond is accrued and added to principal and a
like amount is paid as principal on the Series A, B, or C Bond currently being
paid off. When the Series A, B, and C Bonds are paid in full, interest and
principal on the Series Z Bond begins to be paid currently. With some CMOs, the
issuer serves as a conduit to allow loan originators (primarily builders or
savings and loan associations) to borrow against their loan portfolios.
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FHLMC Collateralized Mortgage Obligations. FHLMC CMOs are debt obligations of
FHLMC issued in multiple classes having different maturity dates which are
secured by the pledge of a pool of conventional mortgage loans purchased by
FHLMC. Unlike FHLMC PCs, payments of principal and interest on the CMOs are made
semiannually, as opposed to monthly. The amount of principal payable on each
semiannual payment date is determined in accordance with FHLMC's mandatory
sinking fund schedule, which, in turn, is equal to approximately 100% of FHA
prepayment experience applied to the mortgage collateral pool. All sinking fund
payments in the CMOs are allocated to the retirement of the individual classes
of bonds in the order of their stated maturities. Payment of principal on the
mortgage loans in the collateral pool in excess of the amount of FHLMC's minimum
sinking fund obligation for any payment date are paid to the holders of the CMOs
as additional sinking fund payments. Because of the "pass-through" nature of all
principal payments received on the collateral pool in excess of FHLMC's minimum
sinking fund requirement, the rate at which principal of the CMOs is actually
repaid is likely to be such that each class of bonds will be retired in advance
of its scheduled maturity date.
If collection of principal (including prepayments) on the mortgage
loans during any semiannual payment period is not sufficient to meet FHLMC's
minimum sinking fund obligation on the next sinking fund payment date, FHLMC
agrees to make up the deficiency from its general funds.
Criteria for the mortgage loans in the pool backing the CMOs are
identical to those of FHLMC PCs. FHLMC has the right to substitute collateral in
the event of delinquencies and/or defaults.
Other Mortgage-Backed Securities. The Adviser expects that governmental,
government-related, or private entities may create mortgage loan pools and other
mortgage-related securities offering mortgage pass-through and
mortgage-collateralized investments in addition to those described above. The
mortgages underlying these securities may include alternative mortgage
instruments, that is, mortgage instruments whose principal or interest payments
may vary or whose terms to maturity may differ from customary long-term fixed
rate mortgages. An Underlying Fund will not purchase mortgage-backed securities
or any other assets which, in the opinion of the Adviser, are illiquid if, as a
result, more than 10% to 15% (depending on that particular Underlying Fund's
policy) of the value of the Underlying Fund's total assets will be illiquid. As
new types of mortgage-related securities are developed and offered to investors,
the Adviser will, consistent with the Underlying Fund's investment objective,
policies, and quality standards, consider making investments in such new types
of mortgage-related securities.
Other Asset-Backed Securities. The securitization techniques used to develop
mortgaged-backed securities are now being applied to a broad range of assets.
Through the use of trusts and special purpose corporations, various types of
assets, including automobile loans, computer leases and credit card receivables,
are being securitized in pass-through structures similar to the mortgage
pass-through structures described above or in a structure similar to the CMO
structure. Consistent with an Underlying Fund's investment objectives and
policies, the Underlying Fund may invest in these and other types of
asset-backed securities that may be developed in the future. In general, the
collateral supporting these securities is of shorter maturity than mortgage
loans and is less likely to experience substantial prepayments with interest
rate fluctuations.
Several types of asset-backed securities have already been offered to
investors, including Certificates for Automobile ReceivablesSM ("CARSSM").
CARSSM represent undivided fractional interests in a trust ("Trust") whose
assets consist of a pool of motor vehicle retail installment sales contracts and
security interests in the vehicles securing the contracts. Payments of principal
and interest on CARSSM are passed through monthly to certificate holders, and
are guaranteed up to certain amounts and for a certain time period by a letter
of credit issued by a financial institution unaffiliated with the trustee or
originator of the Trust. An investor's return on CARSSM may be affected by early
prepayment of principal on the underlying vehicle sales contracts. If the letter
of credit is exhausted, the Trust may be prevented from realizing the full
amount due on a sales contract because of state law requirements and
restrictions relating to foreclosure sales of vehicles and the obtaining of
deficiency judgments following such sales or because of depreciation, damage to
or loss of a vehicle, the application of federal and state bankruptcy and
insolvency laws, or other factors. As a result, certificate holders may
experience delays in payments or losses if the letter of credit is exhausted.
Asset-backed securities present certain risks that are not presented by
mortgage-backed securities. Primarily, these securities may not have the benefit
of any security interest in the related assets. Credit card receivables are
generally unsecured and the debtors are entitled to the protection of a number
of state and federal consumer credit laws, many of which give such debtors the
right to set off certain amounts owed on the credit cards, thereby reducing the
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balance due. There is the possibility that recoveries on repossessed collateral
may not, in some cases, be available to support payments on these securities.
Asset-backed securities are often backed by a pool of assets
representing the obligations of a number of different parties. To lessen the
effect of failures by obligors on underlying assets to make payments, the
securities may contain elements of credit support which fall into two
categories: (i) liquidity protection, and (ii) protection against losses
resulting from ultimate default by an obligor on the underlying assets.
Liquidity protection refers to the provision of advances, generally by the
entity administering the pool of assets, to ensure that the receipt of payments
on the underlying pool occurs in a timely fashion. Protection against losses
results from payment of the insurance obligations on at least a portion of the
assets in the pool. This protection may be provided through guarantees, policies
or letters of credit obtained by the issuer or sponsor from third parties,
through various means of structuring the transaction or through a combination of
such approaches. An Underlying Fund will not pay any additional or separate fees
for credit support. The degree of credit support provided for each issue is
generally based on historical information respecting the level of credit risk
associated with the underlying assets. Delinquency or loss in excess of that
anticipated or failure of the credit support could adversely affect the return
on an investment in such a security.
An Underlying Fund may also invest in residual interests in
asset-backed securities. In the case of asset-backed securities issued in a
pass-through structure, the cash flow generated by the underlying assets is
applied to make required payments on the securities and to pay related
administrative expenses. The residual interest in an asset-backed security
pass-through structure represents the interest in any excess cash flow remaining
after making the foregoing payments. The amount of residual cash flow resulting
from a particular issue of asset-backed securities will depend on, among other
things, the characteristics of the underlying assets, the coupon rates on the
securities, prevailing interest rates, the amount of administrative expenses and
the actual prepayment experience on the underlying assets. Asset-backed security
residuals not registered under the Securities Act of 1933 may be subject to
certain restrictions on transferability and would be subject to the Underlying
Fund's restriction on illiquid securities. In addition, there may be no liquid
market for such securities.
The availability of asset-backed securities may be affected by
legislative or regulatory developments. It is possible that such developments
may require the Underlying Fund to dispose of any then existing holdings of such
securities.
Investment Company Securities. Certain Underlying Funds may acquire securities
of other investment companies to the extent consistent with its investment
objective and subject to the limitations of the 1940 Act. Each Underlying Fund
will indirectly bear its proportionate share of any management fees and other
expenses paid by such other investment companies.
For example, an Underlying Fund may invest in a variety of investment companies
which seek to track the composition and performance of specific indexes or a
specific portion of an index. These index-based investments hold substantially
all of their assets in securities representing their specific index.
Accordingly, the main risk of investing in index-based investments is the same
as investing in a portfolio of equity securities comprising the index. The
market prices of index-based investments will fluctuate in accordance with both
changes in the market value of their underlying portfolio securities and due to
supply and demand for the instruments on the exchanges on which they are traded
(which may result in their trading at a discount or premium to their NAVs).
Index-based investments may not replicate exactly the performance of their
specified index because of transaction costs and because of the temporary
unavailability of certain component securities of the index.
Examples of index-based investments include:
SPDRs(R): SPDRs, an acronym for "Standard & Poor's Depositary Receipts," are
based on the S&P 500 Composite Stock Price Index. They are issued by the SPDR
Trust, a unit investment trust that holds shares of substantially all the
companies in the S&P 500 in substantially the same weighting and seeks to
closely track the price performance and dividend yield of the Index.
MidCap SPDRs(R): MidCap SPDRs are based on the S&P MidCap 400 Index. They are
issued by the MidCap SPDR Trust, a unit investment trust that holds a portfolio
of securities consisting of substantially all of the common stocks in
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the S&P MidCap 400 Index in substantially the same weighting and seeks to
closely track the price performance and dividend yield of the Index.
Select Sector SPDRs(R): Select Sector SPDRs are based on a particular sector or
group of industries that are represented by a specified Select Sector Index
within the Standard & Poor's Composite Stock Price Index. They are issued by The
Select Sector SPDR Trust, an open-end management investment company with nine
portfolios that each seeks to closely track the price performance and dividend
yield of a particular Select Sector Index.
DIAMONDS(SM): DIAMONDS are based on the Dow Jones Industrial Average(SM). They
are issued by the DIAMONDS Trust, a unit investment trust that holds a portfolio
of all the component common stocks of the Dow Jones Industrial Average and seeks
to closely track the price performance and dividend yield of the Dow.
Nasdaq-100 Shares: Nasdaq-100 Shares are based on the Nasdaq 100 Index. They are
issued by the Nasdaq-100 Trust, a unit investment trust that holds a portfolio
consisting of substantially all of the securities, in substantially the same
weighting, as the component stocks of the Nasdaq-100 Index and seeks to closely
track the price performance and dividend yield of the Index.
WEBs(SM): WEBs, an acronym for "World Equity Benchmark Shares," are based on 17
country-specific Morgan Stanley Capital International Indexes. They are issued
by the WEBs Index Fund, Inc., an open-end management investment company that
seeks to generally correspond to the price and yield performance of a specific
Morgan Stanley Capital International Index.
Illiquid Securities. Underlying Funds may purchase securities other than in the
open market. While such purchases may often offer attractive opportunities for
investment not otherwise available on the open market, the securities so
purchased are often "restricted securities" or "not readily marketable," i.e.,
securities which cannot be sold to the public without registration under the
Securities Act of 1933, as amended (the "1933 Act"), or the availability of an
exemption from registration (such as Rule 144A) or because they are subject to
other legal or contractual delays in or restrictions on resale. The absence of a
trading market can make it difficult to ascertain a market value for these
investments and there is a risk that an Underlying Fund may not be able to
dispose of them at an advantageous time or price. This investment practice,
therefore, could have the effect of increasing the level of illiquidity of a
Fund. It is a Fund's policy that illiquid securities (including repurchase
agreements of more than seven days duration, certain restricted securities, and
other securities which are not readily marketable) may not constitute, at the
time of purchase, more than 10% to 15% (depending on that particular Underlying
Fund's policy) of the value of the Underlying Fund's net assets. Each
Corporation/Trust's Board of Directors/Trustees has approved guidelines for use
by the Adviser in determining whether a security is illiquid.
Generally speaking, restricted securities may be sold (i) only to
qualified institutional buyers; (ii) in a privately negotiated transaction to a
limited number of purchasers; (iii) in limited quantities after they have been
held for a specified period of time and other conditions are met pursuant to an
exemption from registration; or (iv) in a public offering for which a
registration statement is in effect under the 1933 Act. Issuers of restricted
securities may not be subject to the disclosure and other investor protection
requirements that would be applicable if their securities were publicly traded.
If adverse market conditions were to develop during the period between a
Underlying Fund's decision to sell a restricted or illiquid security and the
point at which the Underlying Fund is permitted or able to sell such security,
the Underlying Fund might obtain a price less favorable than the price that
prevailed when it decided to sell. Where a registration statement is required
for the resale of restricted securities, a Underlying Fund may be required to
bear all or part of the registration expenses. A Underlying Fund may be deemed
to be an "underwriter" for purposes of the 1933 Act when selling restricted
securities to the public and, in such event, the Underlying Fund may be liable
to purchasers of such securities if the registration statement prepared by the
issuer is materially inaccurate or misleading.
Since it is not possible to predict with assurance that the market for
securities eligible for resale under Rule 144A will continue to be liquid, the
Adviser will monitor such restricted securities subject to the supervision of
the Board of Trustees/Directors. Among the factors the Adviser may consider in
reaching liquidity decisions relating to Rule 144A securities are: (1) the
frequency of trades and quotes for the security; (2) the number of dealers
wishing to purchase or sell the security and the number of other potential
purchasers; (3) dealer undertakings to make a market in the security; and (4)
the nature of the security and the nature of the market for the security (i.e.,
the time needed to dispose of the security, the method of soliciting offers, and
the mechanics of the transfer).
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Repurchase Agreements. Certain Underlying Funds may enter into repurchase
agreements with member banks of the Federal Reserve System, any foreign bank, if
the repurchase agreement is fully secured by government securities of the
particular foreign jurisdiction, or with any domestic or foreign broker/dealer
which is recognized as a reporting government securities dealer if the
creditworthiness of the bank or broker/dealer has been determined by the Adviser
to be at least as high as that of other obligations the relevant Underlying Fund
may purchase, or to be at least equal to that of issuers of commercial paper
rated within the two highest grades assigned by Moody's or S&P.
A repurchase agreement provides a means for an Underlying Fund to earn
income on assets for periods as short as overnight. It is an arrangement under
which the purchaser (i.e., the Underlying Fund) acquires a security
("Obligation") and the seller agrees, at the time of sale, to repurchase the
Obligation at a specified time and price. Securities subject to a repurchase
agreement are held in a segregated account and the value of such securities kept
at least equal to the repurchase price on a daily basis. The repurchase price
may be higher than the purchase price, the difference being income to the
Underlying Fund, or the purchase and repurchase prices may be the same, with
interest at a stated rate due to the Underlying Fund together with the
repurchase price upon repurchase. In either case, the income to the Underlying
Fund is unrelated to the interest rate on the Obligation itself. Obligations
will be held by the Custodian or in the Federal Reserve Book Entry system.
For purposes of the 1940 Act, a repurchase agreement is deemed to be a
loan from an Underlying Fund to the seller of the Obligation subject to the
repurchase agreement and is therefore subject to that Underlying Fund's
investment restriction applicable to loans. It is not clear whether a court
would consider the Obligation purchased by an Underlying Fund subject to a
repurchase agreement as being owned by the Underlying Fund or as being
collateral for a loan by the Underlying Fund to the seller. In the event of the
commencement of bankruptcy or insolvency proceedings with respect to the seller
of the Obligation before repurchase of the Obligation under a repurchase
agreement, an Underlying Fund may encounter delay and incur costs before being
able to sell the security. Delays may involve loss of interest or decline in
price of the Obligation. If the court characterizes the transaction as a loan
and the Underlying Fund has not perfected a security interest in the Obligation,
the Underlying Fund may be required to return the Obligation to the seller's
estate and be treated as an unsecured creditor of the seller. As an unsecured
creditor, the Underlying Fund would be at risk of losing some or all of the
principal and income involved in the transaction. As with any unsecured debt
instrument purchased for the Underlying Fund, the Adviser seeks to minimize the
risk of loss through repurchase agreements by analyzing the creditworthiness of
the obligor, in this case the seller of the Obligation. Apart from the risk of
bankruptcy or insolvency proceedings, there is also the risk that the seller may
fail to repurchase the Obligation, in which case the particular Underlying Fund
may incur a loss if the proceeds to the Underlying Fund of the sale to a third
party are less than the repurchase price. However, if the market value of the
Obligation subject to the repurchase agreement becomes less than the repurchase
price (including interest), the Underlying Fund will direct the seller of the
Obligation to deliver additional securities so that the market value of all
securities subject to the repurchase agreement will equal or exceed the
repurchase price. It is possible that an Underlying Fund will be unsuccessful in
seeking to impose on the seller a contractual obligation to deliver additional
securities.
Repurchase Commitments. Certain Underlying Funds may enter into repurchase
commitments with any party deemed creditworthy by the Adviser, including foreign
banks and broker/dealers, if the transaction is entered into for investment
purposes and the counterparty's creditworthiness is at least equal to that of
issuers of securities which an Underlying Fund may purchase. Such transactions
may not provide the Underlying Fund with collateral marked-to-market during the
term of the commitment.
Reverse Repurchase Agreements. Certain Underlying Funds may enter into "reverse
repurchase agreements," which are repurchase agreements in which the Underlying
Fund, as the seller of the securities, agrees to repurchase them at an agreed
upon time and price. The Underlying Fund maintains a segregated account in
connection with outstanding reverse repurchase agreements. The Underlying Fund
will enter into reverse repurchase agreements only when the Adviser believes
that the interest income to be earned from the investment of the proceeds of the
transaction will be greater than the interest expense of the transaction.
Strategic Transactions and Derivatives. Certain Underlying Funds may, but are
not required to, utilize various other investment strategies as described below
for a variety of purposes, such as hedging various market risks, managing the
effective maturity or duration of fixed-income securities in the Fund's
portfolio, or enhancing potential gain. These strategies may be executed through
the use of derivative contracts.
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In the course of pursuing these investment strategies, the Underlying
Fund may purchase and sell exchange-listed and over-the-counter put and call
options on securities, equity and fixed-income indices and other instruments,
purchase and sell futures contracts and options thereon, enter into various
transactions such as swaps, caps, floors, collars, currency forward contracts,
currency futures contracts, currency swaps or options on currencies, or currency
futures and various other currency transactions (collectively, all the above are
called "Strategic Transactions"). In addition, strategic transactions may also
include new techniques, instruments or strategies that are permitted as
regulatory changes occur. Strategic Transactions may be used without limit
(subject to certain limitations imposed by the 1940 Act) to attempt to protect
against possible changes in the market value of securities held in or to be
purchased for the Underlying Fund's portfolio resulting from securities markets
or currency exchange rate fluctuations, to protect the Underlying Fund's
unrealized gains in the value of its portfolio securities, to facilitate the
sale of such securities for investment purposes, to manage the effective
maturity or duration of fixed-income securities in the Underlying Fund's
portfolio, or to establish a position in the derivatives markets as a substitute
for purchasing or selling particular securities. Some Strategic Transactions may
also be used to enhance potential gain although no more than 5% of the
Underlying Fund's assets will be committed to Strategic Transactions entered
into for non-hedging purposes. Any or all of these investment techniques may be
used at any time and in any combination, and there is no particular strategy
that dictates the use of one technique rather than another, as use of any
Strategic Transaction is a function of numerous variables including market
conditions. The ability of the Underlying Fund to utilize these Strategic
Transactions successfully will depend on the Adviser's ability to predict
pertinent market movements, which cannot be assured. The Underlying Fund will
comply with applicable regulatory requirements when implementing these
strategies, techniques and instruments. Strategic Transactions will not be used
to alter fundamental investment purposes and characteristics of the Underlying
Fund, and the Underlying Fund will segregate assets (or as provided by
applicable regulations, enter into certain offsetting positions) to cover its
obligations under options, futures and swaps to limit leveraging of the Fund.
Strategic Transactions, including derivative contracts, have risks
associated with them including possible default by the other party to the
transaction, illiquidity and, to the extent the Adviser's view as to certain
market movements is incorrect, the risk that the use of such Strategic
Transactions could result in losses greater than if they had not been used. Use
of put and call options may result in losses to the Underlying Fund, force the
sale or purchase of portfolio securities at inopportune times or for prices
higher than (in the case of put options) or lower than (in the case of call
options) current market values, limit the amount of appreciation the Underlying
Fund can realize on its investments or cause the Fund to hold a security it
might otherwise sell. The use of currency transactions can result in the
Underlying Fund incurring losses as a result of a number of factors including
the imposition of exchange controls, suspension of settlements, or the inability
to deliver or receive a specified currency. The use of options and futures
transactions entails certain other risks. In particular, the variable degree of
correlation between price movements of futures contracts and price movements in
the related portfolio position of the Underlying Fund creates the possibility
that losses on the hedging instrument may be greater than gains in the value of
the Underlying Fund's position. In addition, futures and options markets may not
be liquid in all circumstances and certain over-the-counter options may have no
markets. As a result, in certain markets, the Underlying Fund might not be able
to close out a transaction without incurring substantial losses, if at all.
Although the use of futures and options transactions for hedging should tend to
minimize the risk of loss due to a decline in the value of the hedged position,
at the same time they tend to limit any potential gain which might result from
an increase in value of such position. Finally, the daily variation margin
requirements for futures contracts would create a greater ongoing potential
financial risk than would purchases of options, where the exposure is limited to
the cost of the initial premium. Losses resulting from the use of Strategic
Transactions would reduce net asset value, and possibly income, and such losses
can be greater than if the Strategic Transactions had not been utilized.
General Characteristics of Options. Put options and call options typically have
similar structural characteristics and operational mechanics regardless of the
underlying instrument on which they are purchased or sold. Thus, the following
general discussion relates to each of the particular types of options discussed
in greater detail below. In addition, many Strategic Transactions involving
options require segregation of Underlying Fund assets in special accounts, as
described below under "Use of Segregated and Other Special Accounts."
A put option gives the purchaser of the option, upon payment of a
premium, the right to sell, and the writer the obligation to buy, the underlying
security, commodity, index, currency or other instrument at the exercise price.
For instance, an Underlying Fund's purchase of a put option on a security might
be designed to protect its holdings in the underlying instrument (or, in some
cases, a similar instrument) against a substantial decline in the market value
by giving the Underlying Fund the right to sell such instrument at the option
exercise price. A call option, upon payment of
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a premium, gives the purchaser of the option the right to buy, and the seller
the obligation to sell, the underlying instrument at the exercise price. An
Underlying Fund's purchase of a call option on a security, financial future,
index, currency or other instrument might be intended to protect the Underlying
Fund against an increase in the price of the underlying instrument that it
intends to purchase in the future by fixing the price at which it may purchase
such instrument. An American style put or call option may be exercised at any
time during the option period while a European style put or call option may be
exercised only upon expiration or during a fixed period prior thereto. The
Underlying Fund is authorized to purchase and sell exchange listed options and
over-the-counter options ("OTC options"). Exchange listed options are issued by
a regulated intermediary such as the Options Clearing Corporation ("OCC"), which
guarantees the performance of the obligations of the parties to such options.
The discussion below uses the OCC as an example, but is also applicable to other
financial intermediaries.
With certain exceptions, OCC issued and exchange listed options
generally settle by physical delivery of the underlying security or currency,
although in the future cash settlement may become available. Index options and
Eurodollar instruments are cash settled for the net amount, if any, by which the
option is "in-the-money" (i.e., where the value of the underlying instrument
exceeds, in the case of a call option, or is less than, in the case of a put
option, the exercise price of the option) at the time the option is exercised.
Frequently, rather than taking or making delivery of the underlying instrument
through the process of exercising the option, listed options are closed by
entering into offsetting purchase or sale transactions that do not result in
ownership of the new option.
An Underlying Fund's ability to close out its position as a purchaser
or seller of an OCC or exchange listed put or call option is dependent, in part,
upon the liquidity of the option market. Among the possible reasons for the
absence of a liquid option market on an exchange are: (i) insufficient trading
interest in certain options; (ii) restrictions on transactions imposed by an
exchange; (iii) trading halts, suspensions or other restrictions imposed with
respect to particular classes or series of options or underlying securities
including reaching daily price limits; (iv) interruption of the normal
operations of the OCC or an exchange; (v) inadequacy of the facilities of an
exchange or OCC to handle current trading volume; or (vi) a decision by one or
more exchanges to discontinue the trading of options (or a particular class or
series of options), in which event the relevant market for that option on that
exchange would cease to exist, although outstanding options on that exchange
would generally continue to be exercisable in accordance with their terms.
The hours of trading for listed options may not coincide with the hours
during which the underlying financial instruments are traded. To the extent that
the option markets close before the markets for the underlying financial
instruments, significant price and rate movements can take place in the
underlying markets that cannot be reflected in the option markets.
OTC options are purchased from or sold to securities dealers, financial
institutions or other parties ("Counterparties") through direct bilateral
agreement with the Counterparty. In contrast to exchange listed options, which
generally have standardized terms and performance mechanics, all of the terms of
an OTC option, including such terms as method of settlement, term, exercise
price, premium, guarantees and security, are set by negotiation of the parties.
The Underlying Fund will only sell OTC options (other than OTC currency options)
that are subject to a buy-back provision permitting the Underlying Fund to
require the Counterparty to sell the option back to the Underlying Fund at a
formula price within seven days. The Underlying Fund expects generally to enter
into OTC options that have cash settlement provisions, although it is not
required to do so.
Unless the parties provide for it, there is no central clearing or
guaranty function in an OTC option. As a result, if the Counterparty fails to
make or take delivery of the security, currency or other instrument underlying
an OTC option it has entered into with the Underlying Fund or fails to make a
cash settlement payment due in accordance with the terms of that option, the
Underlying Fund will lose any premium it paid for the option as well as any
anticipated benefit of the transaction. Accordingly, the Adviser must assess the
creditworthiness of each such Counterparty or any guarantor or credit
enhancement of the Counterparty's credit to determine the likelihood that the
terms of the OTC option will be satisfied. The Underlying Fund will engage in
OTC option transactions only with U.S. government securities dealers recognized
by the Federal Reserve Bank of New York as "primary dealers" or broker/dealers,
domestic or foreign banks or other financial institutions which have received
(or the guarantors of the obligation of which have received) a short-term credit
rating of A-1 from S&P or P-1 from Moody's or an equivalent rating from any
nationally recognized statistical rating organization ("NRSRO") or, in the case
of OTC currency transactions, are determined to be of equivalent credit quality
by the Adviser. The staff of the SEC currently takes the position that OTC
options purchased
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by the Underlying Fund, and portfolio securities "covering" the amount of the
Underlying Fund's obligation pursuant to an OTC option sold by it (the cost of
the sell-back plus the in-the-money amount, if any) are illiquid, and are
subject to the Underlying Fund's limitation on investing no more than 15% of its
net assets in illiquid securities.
If an Underlying Fund sells a call option, the premium that it receives
may serve as a partial hedge, to the extent of the option premium, against a
decrease in the value of the underlying securities or instruments in its
portfolio or will increase the Underlying Fund's income. The sale of put options
can also provide income.
An Underlying Fund may purchase and sell call options on securities
including U.S. Treasury and agency securities, mortgage-backed securities,
foreign sovereign debt, corporate debt securities, equity securities (including
convertible securities) and Eurodollar instruments that are traded on U.S. and
foreign securities exchanges and in the over-the-counter markets, and on
securities indices, currencies and futures contracts. All calls sold by the
Underlying Fund must be "covered" (i.e., the Underlying Fund must own the
securities or futures contract subject to the call) or must meet the asset
segregation requirements described below as long as the call is outstanding.
Even though the Underlying Fund will receive the option premium to help protect
it against loss, a call sold by the Underlying Fund exposes the Underlying Fund
during the term of the option to possible loss of opportunity to realize
appreciation in the market price of the underlying security or instrument and
may require the Underlying Fund to hold a security or instrument which it might
otherwise have sold.
An Underlying Fund may purchase and sell put options on securities
including U.S. Treasury and agency securities, mortgage-backed securities,
foreign sovereign debt, corporate debt securities, equity securities (including
convertible securities) and Eurodollar instruments (whether or not it holds the
above securities in its portfolio), and on securities indices, currencies and
futures contracts other than futures on individual corporate debt and individual
equity securities. The Underlying Fund will not sell put options if, as a
result, more than 50% of the Underlying Fund's assets would be required to be
segregated to cover its potential obligations under such put options other than
those with respect to futures and options thereon. In selling put options, there
is a risk that the Underlying Fund may be required to buy the underlying
security at a disadvantageous price above the market price.
General Characteristics of Futures. An Underlying Fund may enter into futures
contracts or purchase or sell put and call options on such futures as a hedge
against anticipated interest rate, currency or equity market changes, and for
duration management, risk management and return enhancement purposes. Futures
are generally bought and sold on the commodities exchanges where they are listed
with payment of initial and variation margin as described below. The sale of a
futures contract creates a firm obligation by the Underlying Fund, as seller, to
deliver to the buyer the specific type of financial instrument called for in the
contract at a specific future time for a specified price (or, with respect to
index futures and Eurodollar instruments, the net cash amount). Options on
futures contracts are similar to options on securities except that an option on
a futures contract gives the purchaser the right in return for the premium paid
to assume a position in a futures contract and obligates the seller to deliver
such position.
An Underlying Fund's use of futures and options thereon will in all
cases be consistent with applicable regulatory requirements and in particular
the rules and regulations of the Commodity Futures Trading Commission and will
be entered into for bona fide hedging, risk management (including duration
management) or other portfolio and return enhancement management purposes.
Typically, maintaining a futures contract or selling an option thereon requires
the Underlying Fund to deposit with a financial intermediary as security for its
obligations an amount of cash or other specified assets (initial margin) which
initially is typically 1% to 10% of the face amount of the contract (but may be
higher in some circumstances). Additional cash or assets (variation margin) may
be required to be deposited thereafter on a daily basis as the mark to market
value of the contract fluctuates. The purchase of an option on financial futures
involves payment of a premium for the option without any further obligation on
the part of the Underlying Fund. If the Underlying Fund exercises an option on a
futures contract it will be obligated to post initial margin (and potential
subsequent variation margin) for the resulting futures position just as it would
for any position. Futures contracts and options thereon are generally settled by
entering into an offsetting transaction but there can be no assurance that the
position can be offset prior to settlement at an advantageous price, nor that
delivery will occur.
The Underlying Fund will not enter into a futures contract or related
option (except for closing transactions) if, immediately thereafter, the sum of
the amount of its initial margin and premiums on open futures contracts and
options thereon would exceed 5% of the Underlying Fund's total assets (taken at
current value); however, in the case of an
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option that is in-the-money at the time of the purchase, the in-the-money amount
may be excluded in calculating the 5% limitation. The segregation requirements
with respect to futures contracts and options thereon are described below.
Options on Securities Indices and Other Financial Indices. The Underlying Fund
also may purchase and sell call and put options on securities indices and other
financial indices and in so doing can achieve many of the same objectives it
would achieve through the sale or purchase of options on individual securities
or other instruments. Options on securities indices and other financial indices
are similar to options on a security or other instrument except that, rather
than settling by physical delivery of the underlying instrument, they settle by
cash settlement, i.e., an option on an index gives the holder the right to
receive, upon exercise of the option, an amount of cash if the closing level of
the index upon which the option is based exceeds, in the case of a call, or is
less than, in the case of a put, the exercise price of the option (except if, in
the case of an OTC option, physical delivery is specified). This amount of cash
is equal to the excess of the closing price of the index over the exercise price
of the option, which also may be multiplied by a formula value. The seller of
the option is obligated, in return for the premium received, to make delivery of
this amount. The gain or loss on an option on an index depends on price
movements in the instruments making up the market, market segment, industry or
other composite on which the underlying index is based, rather than price
movements in individual securities, as is the case with respect to options on
securities.
Currency Transactions. The Underlying Fund may engage in currency transactions
with Counterparties primarily in order to hedge, or manage the risk of the value
of portfolio holdings denominated in particular currencies against fluctuations
in relative value. Currency transactions include forward currency contracts,
exchange listed currency futures, exchange listed and OTC options on currencies,
and currency swaps. A forward currency contract involves a privately negotiated
obligation to purchase or sell (with delivery generally required) a specific
currency at a future date, which may be any fixed number of days from the date
of the contract agreed upon by the parties, at a price set at the time of the
contract. A currency swap is an agreement to exchange cash flows based on the
notional difference among two or more currencies and operates similarly to an
interest rate swap, which is described below. The Underlying Fund may enter into
currency transactions with Counterparties which have received (or the guarantors
of the obligations which have received) a credit rating of A-1 or P-1 by S&P or
Moody's, respectively, or that have an equivalent rating from a NRSRO or (except
for OTC currency options) are determined to be of equivalent credit quality by
the Adviser.
The Underlying Fund's dealings in forward currency contracts and other
currency transactions such as futures, options, options on futures and swaps
generally will be limited to hedging involving either specific transactions or
portfolio positions except as described below. Transaction hedging is entering
into a currency transaction with respect to specific assets or liabilities of
the Underlying Fund, which will generally arise in connection with the purchase
or sale of its portfolio securities or the receipt of income therefrom. Position
hedging is entering into a currency transaction with respect to portfolio
security positions denominated or generally quoted in that currency.
The Underlying Fund generally will not enter into a transaction to
hedge currency exposure to an extent greater, after netting all transactions
intended wholly or partially to offset other transactions, than the aggregate
market value (at the time of entering into the transaction) of the securities
held in its portfolio that are denominated or generally quoted in or currently
convertible into such currency, other than with respect to proxy hedging or
cross hedging as described below.
The Underlying Fund may also cross-hedge currencies by entering into
transactions to purchase or sell one or more currencies that are expected to
decline in value relative to other currencies to which the Underlying Fund has
or in which the Underlying Fund expects to have portfolio exposure.
To reduce the effect of currency fluctuations on the value of existing
or anticipated holdings of portfolio securities, the Underlying Fund may also
engage in proxy hedging. Proxy hedging is often used when the currency to which
the Underlying Fund's portfolio is exposed is difficult to hedge or to hedge
against the dollar. Proxy hedging entails entering into a commitment or option
to sell a currency whose changes in value are generally considered to be
correlated to a currency or currencies in which some or all of the Underlying
Fund's portfolio securities are or are expected to be denominated, in exchange
for U.S. dollars. The amount of the commitment or option would not exceed the
value of the Underlying Fund's securities denominated in correlated currencies.
For example, if the Adviser considers that the Austrian schilling is correlated
to the German deutschemark (the "D-mark"), the Underlying Fund holds securities
denominated in schillings and the Adviser believes that the value of schillings
will decline against the U.S. dollar, the Adviser may enter into a commitment or
option to sell D-marks and buy dollars. Currency hedging
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involves some of the same risks and considerations as other transactions with
similar instruments. Currency transactions can result in losses to the
Underlying Fund if the currency being hedged fluctuates in value to a degree or
in a direction that is not anticipated. Further, there is the risk that the
perceived correlation between various currencies may not be present or may not
be present during the particular time that the Underlying Fund is engaging in
proxy hedging. If the Underlying Fund enters into a currency hedging
transaction, the Underlying Fund will comply with the asset segregation
requirements described below.
Risks of Currency Transactions. Currency transactions are subject to risks
different from those of other portfolio transactions. Because currency control
is of great importance to the issuing governments and influences economic
planning and policy, purchases and sales of currency and related instruments can
be negatively affected by government exchange controls, blockages, and
manipulations or exchange restrictions imposed by governments. These can result
in losses to the Underlying Fund if it is unable to deliver or receive currency
or funds in settlement of obligations and could also cause hedges it has entered
into to be rendered useless, resulting in full currency exposure as well as
incurring transaction costs. Buyers and sellers of currency futures are subject
to the same risks that apply to the use of futures generally. Further,
settlement of a currency futures contract for the purchase of most currencies
must occur at a bank based in the issuing nation. Trading options on currency
futures is relatively new, and the ability to establish and close out positions
on such options is subject to the maintenance of a liquid market which may not
always be available. Currency exchange rates may fluctuate based on factors
extrinsic to that country's economy.
Combined Transactions. The Underlying Fund may enter into multiple transactions,
including multiple options transactions, multiple futures transactions, multiple
currency transactions (including forward currency contracts) and multiple
interest rate transactions and any combination of futures, options, currency and
interest rate transactions ("component" transactions), instead of a single
Strategic Transaction, as part of a single or combined strategy when, in the
opinion of the Adviser, it is in the best interests of the Underlying Fund to do
so. A combined transaction will usually contain elements of risk that are
present in each of its component transactions. Although combined transactions
are normally entered into based on the Adviser's judgment that the combined
strategies will reduce risk or otherwise more effectively achieve the desired
portfolio management goal, it is possible that the combination will instead
increase such risks or hinder achievement of the portfolio management objective.
Swaps, Caps, Floors and Collars. Among the Strategic Transactions into which the
Underlying Fund may enter are interest rate, currency, index and other swaps and
the purchase or sale of related caps, floors and collars. The Underlying Fund
expects to enter into these transactions primarily to preserve a return or
spread on a particular investment or portion of its portfolio, to protect
against currency fluctuations, as a duration management technique or to protect
against any increase in the price of securities the Underlying Fund anticipates
purchasing at a later date. The Underlying Fund will not sell interest rate caps
or floors where it does not own securities or other instruments providing the
income stream the Underlying Fund may be obligated to pay. Interest rate swaps
involve the exchange by the Underlying Fund with another party of their
respective commitments to pay or receive interest, e.g., an exchange of floating
rate payments for fixed rate payments with respect to a notional amount of
principal. A currency swap is an agreement to exchange cash flows on a notional
amount of two or more currencies based on the relative value differential among
them and an index swap is an agreement to swap cash flows on a notional amount
based on changes in the values of the reference indices. The purchase of a cap
entitles the purchaser to receive payments on a notional principal amount from
the party selling such cap to the extent that a specified index exceeds a
predetermined interest rate or amount. The purchase of a floor entitles the
purchaser to receive payments on a notional principal amount from the party
selling such floor to the extent that a specified index falls below a
predetermined interest rate or amount. A collar is a combination of a cap and a
floor that preserves a certain return within a predetermined range of interest
rates or values.
The Underlying Fund will usually enter into swaps on a net basis, i.e.,
the two payment streams are netted out in a cash settlement on the payment date
or dates specified in the instrument, with the Underlying Fund receiving or
paying, as the case may be, only the net amount of the two payments. Inasmuch as
the Underlying Fund will segregate assets (or enter into offsetting positions)
to cover its obligations under swaps, the Adviser and the Underlying Fund
believes such obligations do not constitute senior securities under the 1940 Act
and, accordingly, will not treat them as being subject to its borrowing
restrictions. The Fund will not enter into any swap, cap, floor or collar
transaction unless, at the time of entering into such transaction, the unsecured
long-term debt of the Counterparty, combined with any credit enhancements, is
rated at least A by S&P or Moody's or has an equivalent rating from a NRSRO or
is determined to be of equivalent credit quality by the Adviser. If there is a
default by the Counterparty, the Underlying Fund may have
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contractual remedies pursuant to the agreements related to the transaction. The
swap market has grown substantially in recent years with a large number of banks
and investment banking firms acting both as principals and as agents utilizing
standardized swap documentation. As a result, the swap market has become
relatively liquid. Caps, floors and collars are more recent innovations for
which standardized documentation has not yet been fully developed and,
accordingly, they are less liquid than swaps.
Eurodollar Instruments. The Underlying Fund may make investments in Eurodollar
instruments. Eurodollar instruments are U.S. dollar-denominated futures
contracts or options thereon which are linked to the London Interbank Offered
Rate ("LIBOR"), although foreign currency-denominated instruments are available
from time to time. Eurodollar futures contracts enable purchasers to obtain a
fixed rate for the lending of funds and sellers to obtain a fixed rate for
borrowings. The Underlying Fund might use Eurodollar futures contracts and
options thereon to hedge against changes in LIBOR, to which many interest rate
swaps and fixed income instruments are linked.
Risks of Strategic Transactions Outside the U.S. When conducted outside the
U.S., Strategic Transactions may not be regulated as rigorously as in the U.S.,
may not involve a clearing mechanism and related guarantees, and are subject to
the risk of governmental actions affecting trading in, or the prices of, foreign
securities, currencies and other instruments. The value of such positions also
could be adversely affected by: (i) other complex foreign political, legal and
economic factors, (ii) lesser availability than in the U.S. of data on which to
make trading decisions, (iii) delays in the Underlying Fund's ability to act
upon economic events occurring in foreign markets during non-business hours in
the U.S., (iv) the imposition of different exercise and settlement terms and
procedures and margin requirements than in the U.S., and (v) lower trading
volume and liquidity.
Use of Segregated and Other Special Accounts. Many Strategic Transactions, in
addition to other requirements, require that the Underlying Fund segregate cash
or liquid assets with its custodian to the extent Underlying Fund obligations
are not otherwise "covered" through ownership of the underlying security,
financial instrument or currency. In general, either the full amount of any
obligation by the Underlying Fund to pay or deliver securities or assets must be
covered at all times by the securities, instruments or currency required to be
delivered, or, subject to any regulatory restrictions, an amount of cash or
liquid assets at least equal to the current amount of the obligation must be
segregated with the custodian. The segregated assets cannot be sold or
transferred unless equivalent assets are substituted in their place or it is no
longer necessary to segregate them. For example, a call option written by the
Underlying Fund will require the Underlying Fund to hold the securities subject
to the call (or securities convertible into the needed securities without
additional consideration) or to segregate cash or liquid assets sufficient to
purchase and deliver the securities if the call is exercised. A call option sold
by the Underlying Fund on an index will require the Underlying Fund to own
portfolio securities which correlate with the index or to segregate cash or
liquid assets equal to the excess of the index value over the exercise price on
a current basis. A put option written by the Underlying Fund requires the
Underlying Fund to segregate cash or liquid assets equal to the exercise price.
Except when the Underlying Fund enters into a forward contract for the
purchase or sale of a security denominated in a particular currency, which
requires no segregation, a currency contract which obligates the Underlying Fund
to buy or sell currency will generally require the Underlying Fund to hold an
amount of that currency or liquid assets denominated in that currency equal to
the Underlying Fund's obligations or to segregate cash or liquid assets equal to
the amount of the Underlying Fund's obligation.
OTC options entered into by the Underlying Fund, including those on
securities, currency, financial instruments or indices and OCC issued and
exchange listed index options, will generally provide for cash settlement. As a
result, when the Underlying Fund sells these instruments it will only segregate
an amount of cash or liquid assets equal to its accrued net obligations, as
there is no requirement for payment or delivery of amounts in excess of the net
amount. These amounts will equal 100% of the exercise price in the case of a non
cash-settled put, the same as an OCC guaranteed listed option sold by the
Underlying Fund, or the in-the-money amount plus any sell-back formula amount in
the case of a cash-settled put or call. In addition, when the Underlying Fund
sells a call option on an index at a time when the in-the-money amount exceeds
the exercise price, the Underlying Fund will segregate, until the option expires
or is closed out, cash or cash equivalents equal in value to such excess. OCC
issued and exchange listed options sold by the Underlying Fund other than those
above generally settle with physical delivery, or with an election of either
physical delivery or cash settlement and the Underlying Fund will segregate an
amount of cash or liquid assets equal to the full value of the option. OTC
options settling with physical delivery, or with an election of either physical
delivery or cash settlement will be treated the same as other options settling
with physical delivery.
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In the case of a futures contract or an option thereon, the Underlying
Fund must deposit initial margin and possible daily variation margin in addition
to segregating cash or liquid assets sufficient to meet its obligation to
purchase or provide securities or currencies, or to pay the amount owed at the
expiration of an index-based futures contract. Such liquid assets may consist of
cash, cash equivalents, liquid debt or equity securities or other acceptable
assets.
With respect to swaps, the Underlying Fund will accrue the net amount
of the excess, if any, of its obligations over its entitlements with respect to
each swap on a daily basis and will segregate an amount of cash or liquid assets
having a value equal to the accrued excess. Caps, floors and collars require
segregation of assets with a value equal to the Underlying Fund's net
obligation, if any.
Strategic Transactions may be covered by other means when consistent
with applicable regulatory policies. The Underlying Fund may also enter into
offsetting transactions so that its combined position, coupled with any
segregated assets, equals its net outstanding obligation in related options and
Strategic Transactions. For example, the Underlying Fund could purchase a put
option if the strike price of that option is the same or higher than the strike
price of a put option sold by the Underlying Fund. Moreover, instead of
segregating cash or liquid assets if the Underlying Fund held a futures or
forward contract, it could purchase a put option on the same futures or forward
contract with a strike price as high or higher than the price of the contract
held. Other Strategic Transactions may also be offset in combinations. If the
offsetting transaction terminates at the time of or after the primary
transaction no segregation is required, but if it terminates prior to such time,
cash or liquid assets equal to any remaining obligation would need to be
segregated.
Dollar Roll Transactions. Certain Underlying Funds may enter into "dollar roll"
transactions, which consist of the sale by an Underlying Fund to a bank or
broker/dealers (the "counterparty") of GNMA certificates or other
mortgage-backed securities together with a commitment to purchase from the
counterparty similar, but not identical, securities at a future date, at the
same price. The counterparty receives all principal and interest payments,
including prepayments, made on the security while it is the holder. The
Underlying Fund receives a fee from the counterparty as consideration for
entering into the commitment to purchase. Dollar rolls may be renewed over a
period of several months with a different purchase and repurchase price fixed
and a cash settlement made at each renewal without physical delivery of
securities. Moreover, the transaction may be preceded by a firm commitment
agreement pursuant to which the Underlying Fund agrees to buy a security on a
future date.
An Underlying Fund will segregate cash or liquid assets in an amount
sufficient to meet its purchase obligations under the transactions. An
Underlying Fund will also maintain asset coverage of at least 300% for all
outstanding firm commitments, dollar rolls and other borrowings.
Dollar rolls are treated for purposes of the 1940 Act as borrowings by
an Underlying Fund because they involve the sale of a security coupled with an
agreement to repurchase. Like all borrowings, a dollar roll involves costs to
the Underlying Fund. For example, while the Underlying Fund receives a fee as
consideration for agreeing to repurchase the security, the Underlying Fund
forgoes the right to receive all principal and interest payments while the
counterparty holds the security. These payments to the counterparty may exceed
the fee received by the Underlying Fund, thereby effectively charging the
Underlying Fund interest on its borrowing. Further, although the Underlying Fund
can estimate the amount of expected principal prepayment over the term of the
dollar roll, a variation in the actual amount of prepayment could increase or
decrease the cost of the Underlying Fund's borrowing.
The entry into dollar rolls involves potential risks of loss that are
different from those related to the securities underlying the transactions. For
example, if the counterparty becomes insolvent, an Underlying Fund's right to
purchase from the counterparty might be restricted. Additionally, the value of
such securities may change adversely before the Underlying Fund is able to
purchase them. Similarly, the Underlying Fund may be required to purchase
securities in connection with a dollar roll at a higher price than may otherwise
be available on the open market. Since, as noted above, the counterparty is
required to deliver a similar, but not identical security to the Underlying
Fund, the security that the Underlying Fund is required to buy under the dollar
roll may be worth less than an identical security. Finally, there can be no
assurance that an Underlying Fund's use of the cash that it receives from a
dollar roll will provide a return that exceeds borrowing costs.
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The Directors/Trustees of the Underlying Funds have adopted guidelines
to ensure that those securities received are substantially identical to those
sold. To reduce the risk of default, an Underlying Fund will engage in such
transactions only with counterparties selected pursuant to such guidelines.
Indexed Securities. Certain Underlying Funds may invest in indexed securities,
the value of which is linked to currencies, interest rates, commodities, indices
or other financial indicators ("reference instruments"). Most indexed securities
have maturities of three years or less.
Indexed securities differ from other types of debt securities in which
an Underlying Fund may invest in several respects. First, the interest rate or,
unlike other debt securities, the principal amount payable at maturity of an
indexed security may vary based on changes in one or more specified reference
instruments, such as an interest rate compared with a fixed interest rate or the
currency exchange rates between two currencies (neither of which need be the
currency in which the instrument is denominated). The reference instrument need
not be related to the terms of the indexed security. For example, the principal
amount of a U.S. dollar denominated indexed security may vary based on the
exchange rate of two foreign currencies. An indexed security may be positively
or negatively indexed; that is, its value may increase or decrease if the value
of the reference instrument increases. Further, the change in the principal
amount payable or the interest rate of an indexed security may be a multiple of
the percentage change (positive or negative) in the value of the underlying
reference instrument(s).
Investment in indexed securities involves certain risks. In addition to
the credit risk of the security's issuer and the normal risks of price changes
in response to changes in interest rates, the principal amount of indexed
securities may decrease as a result of changes in the value of reference
instruments. Further, in the case of certain indexed securities in which the
interest rate is linked to a reference instrument, the interest rate may be
reduced to zero, and any further declines in the value of the security may then
reduce the principal amount payable on maturity. Finally, indexed securities may
be more volatile than the reference instruments underlying the indexed
securities.
When-Issued Securities. Certain Underlying Funds may purchase securities on a
"when-issued" or "forward delivery" basis for payment and delivery at a later
date. The price of such securities, which is generally expressed in yield terms,
is generally fixed at the time the commitment to purchase is made, but delivery
and payment for the when-issued or forward delivery securities takes place at a
later date. During the period between purchase and settlement, no payment is
made by an Underlying Fund to the issuer and no interest on the when-issued or
forward delivery securities accrues to the Underlying Fund. To the extent that
assets of the Underlying Fund are held in cash pending the settlement of a
purchase of securities, the Underlying Fund will earn no income; however, it is
the Underlying Fund's intention to be fully invested to the extent practicable
and subject to the policies stated above. While when-issued or forward delivery
securities may be sold prior to the settlement date, the Underlying Fund intends
to purchase such securities with the purpose of actually acquiring them unless a
sale appears desirable for investment reasons. At the time the Underlying Fund
makes the commitment to purchase a security on a when-issued or forward delivery
basis, it will record the transaction and reflect the value of the security in
determining its net asset value. At the time of settlement, the market value of
the when-issued or forward delivery securities may be more or less than the
purchase price. The Underlying Fund does not believe that its net asset value or
income will be adversely affected by its purchase of securities on a when-issued
or forward delivery basis.
Short Sales Against the Box. Certain Underlying Funds may make short sales of
common stocks if, at all times when a short position is open, an Underlying Fund
owns the stock or owns preferred stocks or debt securities convertible or
exchangeable, without payment of further consideration, into the shares of
common stock sold short. Short sales of this kind are referred to as short sales
"against the box." The broker/dealer that executes a short sale generally
invests cash proceeds of the sale until they are paid to the Underlying Fund.
Arrangements may be made with the broker/dealer to obtain a portion of the
interest earned by the broker on the investment of short sale proceeds. The
Underlying Fund will segregate the common stock or convertible or exchangeable
preferred stock or debt securities in a special account with the Custodian.
Foreign Securities. Certain Underlying Funds may invest in foreign securities.
The Adviser believes that diversification of assets on an international basis
may decrease the degree to which events in any one country, including the U.S.,
will affect an investor's entire investment holdings. In certain periods since
World War II, many leading foreign economies and foreign stock market indices
have grown more rapidly than the U.S. economy and leading U.S. stock market
indices, although there can be no assurance that this will be true in the
future. Investors should recognize
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that investing in foreign securities involves certain special considerations,
including those set forth below, which are not typically associated with
investing in U.S. securities and which may favorably or unfavorably affect an
Underlying Fund's performance. As foreign companies are not generally subject to
uniform accounting, auditing and financial reporting standards, practices and
requirements comparable to those applicable to domestic companies, there may be
less publicly available information about a foreign company than about a
domestic company. Many foreign securities markets, while growing in volume of
trading activity, have substantially less volume than the U.S. market, and
securities of some foreign issuers are less liquid and more volatile than
securities of domestic issuers. Similarly, volume and liquidity in most foreign
bond markets is less than in the U.S. and, at times, volatility of price can be
greater than in the U.S. Fixed commissions on some foreign securities exchanges
and bid to asked spreads in foreign bond markets are generally higher than
commissions or bid to asked spreads on U.S. markets, although an Underlying Fund
will endeavor to achieve the most favorable net results on its portfolio
transactions. There is generally less governmental supervision and regulation of
securities exchanges, brokers and listed companies in most foreign countries
than in the U.S. It may be more difficult for an Underlying Fund's agents to
keep currently informed about corporate actions in foreign countries which may
affect the prices of portfolio securities. Communications between the U.S. and
foreign countries may be less reliable than within the U.S., thus increasing the
risk of delayed settlements of portfolio transactions or loss of certificates
for portfolio securities. Payment for securities without delivery may be
required in certain foreign markets. In addition, with respect to certain
foreign countries, there is the possibility of expropriation or confiscatory
taxation, political or social instability, or diplomatic developments which
could affect U.S. investments in those countries. Moreover, individual foreign
economies may differ favorably or unfavorably from the U.S. economy in such
respects as growth of gross national product, rate of inflation, capital
reinvestment, resource self-sufficiency and balance of payments position. The
management of an Underlying Fund seeks to mitigate the risks associated with the
foregoing considerations through continuous professional management.
Foreign Currencies. Because investments in foreign securities usually will
involve currencies of foreign countries, and because certain Underlying Funds
may hold foreign currencies and forward contracts, futures contracts and options
on foreign currencies and foreign currency futures contracts, the value of the
assets of such Underlying Fund as measured in U.S. dollars may be affected
favorably or unfavorably by changes in foreign currency exchange rates and
exchange control regulations, and the Underlying Fund may incur costs in
connection with conversions between various currencies. Although an Underlying
Fund values its assets daily in terms of U.S. dollars, it does not intend to
convert its holdings of foreign currencies into U.S. dollars on a daily basis.
It will do so from time to time, and investors should be aware of the costs of
currency conversion. Although foreign exchange dealers do not charge a fee for
conversion, they do realize a profit based on the difference (the "spread")
between the prices at which they are buying and selling various currencies.
Thus, a dealer may offer to sell a foreign currency to an Underlying Fund at one
rate, while offering a lesser rate of exchange should the Underlying Fund desire
to resell that currency to the dealer. An Underlying Fund will conduct its
foreign currency exchange transactions either on a spot (i.e., cash) basis at
the spot rate prevailing in the foreign currency exchange market, or through
entering into options or forward or futures contracts to purchase or sell
foreign currencies.
Investing in Emerging Markets. Most emerging securities markets in which certain
Underlying Funds may invest, may have substantially less volume and are subject
to less governmental supervision than U.S. securities markets. Securities of
many issuers in emerging markets may be less liquid and more volatile than
securities of comparable domestic issuers. In addition, there is less regulation
of securities exchanges, securities dealers, and listed and unlisted companies
in emerging markets than in the United States.
Emerging markets also have different clearance and settlement
procedures, and in certain markets there have been times when settlements have
been unable to keep pace with the volume of securities transactions. Delays in
settlement could result in temporary periods when a portion of the assets of an
Underlying Fund is uninvested and no cash is earned thereon. The inability of an
Underlying Fund to make intended security purchases due to settlement problems
could cause the Underlying Fund to miss attractive investment opportunities.
Inability to dispose of portfolio securities due to settlement problems could
result either in losses to the Underlying Fund due to subsequent declines in
value of the portfolio security or, if the Underlying Fund has entered into a
contract to sell the security, could result in possible liability to the
purchaser. Costs associated with transactions in foreign securities are
generally higher than costs associated with transactions in U.S. securities.
Such transactions also involve additional costs for the purchase or sale of
foreign currency.
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Foreign investment in certain emerging market debt obligations is
restricted or controlled to varying degrees. These restrictions or controls may
at times limit or preclude foreign investment in certain emerging markets debt
obligations and increase the costs and expenses of an Underlying Fund. Certain
emerging markets require prior governmental approval of investments by foreign
persons, limit the amount of investment by foreign persons in a particular
company, limit the investment by foreign persons only to a specific class of
securities of a company that may have less advantageous rights than the classes
available for purchase by domiciliaries of the countries and/or impose
additional taxes on foreign investors. Certain emerging markets may also
restrict investment opportunities in issuers in industries deemed important to
national interest.
Certain emerging markets may require governmental approval for the
repatriation of investment income, capital or the proceeds of sales of
securities by foreign investors. In addition, if a deterioration occurs in an
emerging market's balance of payments or for other reasons, a country could
impose temporary restrictions on foreign capital remittances. An Underlying Fund
could be adversely affected by delays in, or a refusal to grant, any required
governmental approval for repatriation of capital, as well as by the application
to the Underlying Fund of any restrictions on investments.
In the course of investment in emerging market debt obligations, an
Underlying Fund will be exposed to the direct or indirect consequences of
political, social and economic changes in one or more emerging markets.
Political changes in emerging market countries may affect the willingness of an
emerging market country's governmental issuer to make or provide for timely
payments of its obligations. The country's economic status, as reflected in,
among other things, its inflation rate, the amount of its external debt and its
gross domestic product, also affects its ability to honor its obligations. While
an Underlying Fund will manage its assets in a manner that will seek to minimize
the exposure to such risks, and will further reduce risk by owning the bonds of
many issuers, there can be no assurance that adverse political, social or
economic changes will not cause the Underlying Fund to suffer a loss of value in
respect of the securities in the Underlying Fund's portfolio.
The risk also exists that an emergency situation may arise in one or
more emerging markets as a result of which trading of securities may cease or
may be substantially curtailed and prices for an Underlying Fund's securities in
such markets may not be readily available. The Trust/Corporation may suspend
redemption of its shares for any period during which an emergency exists, as
determined by the SEC. Accordingly if the Underlying Fund believes that
appropriate circumstances exist, it will promptly apply to the Commission for a
determination that an emergency is present. During the period commencing from
the Underlying Fund's identification of such condition until the date of
Commission action, the Underlying Fund's securities in the affected markets will
be valued at fair value determined in good faith by or under the direction of
the Board of Trustees/Directors of the Trust/Corporation.
Volume and liquidity in most foreign bond markets are less than in the
United States and securities of many foreign companies are less liquid and more
volatile than securities of comparable U.S. companies. Fixed commissions on
foreign securities exchanges are generally higher than negotiated commissions on
U.S. exchanges, although an Underlying Fund endeavors to achieve the most
favorable net results on its portfolio transactions. There is generally less
governmental supervision and regulation of business and industry practices,
securities exchanges, brokers, dealers and listed companies than in the United
States. Mail service between the United States and foreign countries may be
slower or less reliable than within the United States, thus increasing the risk
of delayed settlements of portfolio transactions or loss of certificates for
portfolio securities. In addition, with respect to certain emerging markets,
there is the possibility of expropriation or confiscatory taxation, political or
social instability, or diplomatic developments which could affect the Underlying
Fund's investments in those countries. Moreover, individual emerging market
economies may differ favorably or unfavorably from the U.S. economy in such
respects as growth of gross national product, rate of inflation, capital
reinvestment, resource self-sufficiency and balance of payments position.
An Underlying Fund may have limited legal recourse in the event of a
default with respect to certain debt obligations it holds. If the issuer of a
fixed-income security owned by the Underlying Fund defaults, the Underlying Fund
may incur additional expenses to seek recovery. Debt obligations issued by
emerging market country governments differ from debt obligations of private
entities; remedies from defaults on debt obligations issued by emerging market
governments, unlike those on private debt, must be pursued in the courts of the
defaulting party itself. The Underlying Fund's ability to enforce its rights
against private issuers may be limited. The ability to attach assets to enforce
a judgment may be limited. Legal recourse is therefore somewhat diminished.
Bankruptcy, moratorium and other similar laws applicable to private issuers of
debt obligations may be substantially different from those of other countries.
The political context, expressed as an emerging market governmental issuer's
willingness to meet the terms of the debt
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obligation, for example, is of considerable importance. In addition, no
assurance can be given that the holders of commercial bank debt may not contest
payments to the holders of debt obligations in the event of default under
commercial bank loan agreements. Income from securities held by an Underlying
Fund could be reduced by a withholding tax at the source or other taxes imposed
by the emerging market countries in which the Underlying Fund makes its
investments. An Underlying Fund's net asset value may also be affected by
changes in the rates or methods of taxation applicable to the Underlying Fund or
to entities in which the Underlying Fund has invested. The Adviser will consider
the cost of any taxes in determining whether to acquire any particular
investments, but can provide no assurance that the taxes will not be subject to
change.
Many emerging markets have experienced substantial, and in some periods
extremely high, rates of inflation for many years. Inflation and rapid
fluctuations in inflation rates have had and may continue to have adverse
effects on the economies and securities markets of certain emerging market
countries. In an attempt to control inflation, wage and price controls have been
imposed in certain countries. Of these countries, some, in recent years, have
begun to control inflation through prudent economic policies.
Emerging market governmental issuers are among the largest debtors to
commercial banks, foreign governments, international financial organizations and
other financial institutions. Certain emerging market governmental issuers have
not been able to make payments of interest on or principal of debt obligations
as those payments have come due. Obligations arising from past restructuring
agreements may affect the economic performance and political and social
stability of those issuers.
Governments of many emerging market countries have exercised and
continue to exercise substantial influence over many aspects of the private
sector through the ownership or control of many companies, including some of the
largest in any given country. As a result, governmental actions in the future
could have a significant effect on economic conditions in emerging markets,
which in turn, may adversely affect companies in the private sector, general
market conditions and prices and yields of certain of the securities in an
Underlying Fund's portfolio. Expropriation, confiscatory taxation,
nationalization, political, economic or social instability or other similar
developments have occurred frequently over the history of certain emerging
markets and could adversely affect an Underlying Fund's assets should these
conditions recur.
The ability of emerging market country governmental issuers to make
timely payments on their obligations is likely to be influenced strongly by the
issuer's balance of payments, including export performance, and its access to
international credits and investments. An emerging market whose exports are
concentrated in a few commodities could be vulnerable to a decline in the
international prices of one or more of those commodities. Increased
protectionism on the part of an emerging market's trading partners could also
adversely affect the country's exports and diminish its trade account surplus,
if any. To the extent that emerging markets receive payment for their exports in
currencies other than dollars or non-emerging market currencies, their abilities
to make debt payments denominated in dollars or non-emerging market currencies
could be affected.
To the extent that an emerging market country cannot generate a trade
surplus, it must depend on continuing loans from foreign governments,
multilateral organizations or private commercial banks, aid payments from
foreign governments and inflows of foreign investment. The access of emerging
markets to these forms of external funding may not be certain, and a withdrawal
of external funding could adversely affect the capacity of emerging market
country governmental issuers to make payments on their obligations. In addition,
the cost of servicing emerging market debt obligations can be affected by a
change in international interest rates since the majority of these obligations
carry interest rates that are adjusted periodically based upon international
rates.
Another factor bearing on the ability of emerging market countries to
repay debt obligations is the level of international reserves of the country.
Fluctuations in the level of these reserves affect the amount of foreign
exchange readily available for external debt payments and thus could have a
bearing on the capacity of emerging market countries to make payments on these
debt obligations.
Investing in Latin America. The Adviser believes that investment opportunities
may result from recent trends in Latin America encouraging greater market
orientation and less governmental intervention in economic affairs. Investors,
however, should be aware that the Latin American economies have experienced
considerable difficulties in the past decade. Although there have been
significant improvements in recent years, the Latin American economies continue
to
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experience challenging problems, including high inflation rates and high
interest rates relative to the U.S. The emergence of the Latin American
economies and securities markets will require continued economic and fiscal
discipline which has been lacking at times in the past, as well as stable
political and social conditions. Recovery may also be influenced by
international economic conditions, particularly those in the U.S., and by world
prices for oil and other commodities. There is no assurance that recent economic
initiatives will be successful.
Certain risks associated with international investments and investing
in smaller, developing capital markets are heightened for investments in Latin
American countries. For example, some of the currencies of Latin American
countries have experienced steady devaluations relative to the U.S. dollar, and
major adjustments have been made in certain of these currencies periodically. In
addition, although there is a trend toward less government involvement in
commerce, governments of many Latin American countries have exercised and
continue to exercise substantial influence over many aspects of the private
sector. In certain cases, the government still owns or controls many companies,
including some of the largest in the country. Accordingly, governmental actions
in the future could have a significant effect on economic conditions in Latin
American countries, which could affect private sector companies and an
Underlying Fund, as well as the value of securities in an Underlying Fund's
portfolio.
Certain Latin American countries are among the largest debtors to
commercial banks and foreign governments. Some of these countries have in the
past defaulted on their sovereign debt. Holders of sovereign debt (including an
Underlying Fund) may be requested to participate in the rescheduling of such
debt and to extend further loans to governmental entities. There is no
bankruptcy proceeding by which sovereign debt on which governmental entities
have defaulted may be collected in whole or in part.
The portion of an Underlying Fund's assets invested directly in Chile
may be less than the portions invested in other countries in Latin America
because, at present, capital invested in Chile normally cannot be repatriated
for as long as five years.
The securities markets of Latin American countries are substantially
smaller, less developed, less liquid and more volatile than the major securities
markets in the U.S. Disclosure and regulatory standards are in many respects
less stringent than U.S. standards. Furthermore, there is a lower level of
monitoring and regulation of the markets and the activities of investors in such
markets.
The limited size of many Latin American securities markets and limited
trading volume in the securities of Latin American issuers compared to volume of
trading in the securities of U.S. issuers could cause prices to be erratic for
reasons apart from factors that affect the soundness and competitiveness of the
securities issuers. For example, limited market size may cause prices to be
unduly influenced by traders who control large positions. Adverse publicity and
investors' perceptions, whether or not based on in-depth fundamental analysis,
may decrease the value and liquidity of portfolio securities.
An Underlying Fund may invest a portion of its assets in securities
denominated in currencies of Latin American countries. Accordingly, changes in
the value of these currencies against the U.S. dollar may result in
corresponding changes in the U.S. dollar value of the Underlying Fund's assets
denominated in those currencies.
Some Latin American countries also may have managed currencies, which
are not free floating against the U.S. dollar. In addition, there is risk that
certain Latin American countries may restrict the free conversion of their
currencies into other currencies. Further, certain Latin American currencies may
not be internationally traded. Certain of these currencies have experienced a
steep devaluation relative to the U.S. dollar. Any devaluations in the
currencies in which the Underlying Fund's portfolio securities are denominated
may have a detrimental impact on the Underlying Fund's net asset value.
The economies of individual Latin American countries may differ
favorably or unfavorably from the U.S. economy in such respects as the rate of
growth of gross domestic product, the rate of inflation, capital reinvestment,
resource self-sufficiency and balance of payments position. Certain Latin
American countries have experienced high levels of inflation which can have a
debilitating effect on an economy, although some have begun to control inflation
in recent years through prudent economic policies. Furthermore, certain Latin
American countries may impose withholding taxes on dividends payable to the
Underlying Fund at a higher rate than those imposed by other foreign countries.
This may reduce the Underlying Fund's investment income available for
distribution to shareholders.
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Latin America is a region rich in natural resources such as oil,
copper, tin, silver, iron ore, forestry, fishing, livestock and agriculture. The
region has a large population (roughly 300 million) representing a large
domestic market. Economic growth was strong in the 1960's and 1970's, but slowed
dramatically (and in some instances was negative) in the 1980's as a result of
poor economic policies, higher international interest rates, and the denial of
access to new foreign capital. Although a number of Latin American countries are
currently experiencing lower rates of inflation and higher rates of real growth
in Gross Domestic Product than they have in the past, other Latin American
countries continue to experience significant problems, including high inflation
rates and high interest rates. Capital flight has proven a persistent problem
and external debt has been forcibly restructured. Political turmoil, high
inflation, capital repatriation restrictions, and nationalization have further
exacerbated conditions.
Governments of many Latin American countries have exercised and
continue to exercise substantial influence over many aspects of the private
sector through the ownership or control of many companies, including some of the
largest in those countries. As a result, government actions in the future could
have a significant effect on economic conditions which may adversely affect
prices of certain portfolio securities. Expropriation, confiscatory taxation,
nationalization, political, economic or social instability or other similar
developments, such as military coups, have occurred in the past and could also
adversely affect an Underlying Fund's investments in this region.
Changes in political leadership, the implementation of market oriented
economic policies, such as privatization, trade reform and fiscal and monetary
reform are among the recent steps taken to renew economic growth. External debt
is being restructured and flight capital (domestic capital that has left home
country) has begun to return. Inflation control efforts have also been
implemented. Free Trade Zones are being discussed in various areas around the
region, the most notable being a free zone among Mexico, the U.S. and Canada and
another zone among four countries in the southernmost point of Latin America.
Currencies are typically weak, but most are now relatively free floating, and it
is not unusual for the currencies to undergo wide fluctuations in value over
short periods of time due to changes in the market.
Special Considerations Affecting the Pacific Basin. Certain Underlying Funds are
susceptible to political and economic factors affecting issuers in Pacific Basin
countries. Many of the countries of the Pacific Basin are developing both
economically and politically. Pacific Basin countries may have relatively
unstable governments, economies based on only a few commodities or industries,
and securities markets trading infrequently or in low volumes. Some Pacific
Basin countries restrict the extent to which foreigners may invest in their
securities markets. Securities of issuers located in some Pacific Basin
countries tend to have volatile prices and may offer significant potential for
loss as well as gain. Further, certain companies in the Pacific Basin may not
have firmly established product markets, may lack depth of management, or may be
more vulnerable to political or economic developments such as nationalization of
their own industries.
Economies of individual Pacific Basin countries in which certain
Underlying Funds may invest, may differ favorably or unfavorably from the U.S.
economy in such respects as growth of gross national product, rate of inflation,
capital reinvestment, resource self-sufficiency, interest rate levels, and
balance of payments position. Of particular importance, most of the economies in
this region of the world are heavily dependent upon exports, particularly to
developed countries, and, accordingly, have been and may continue to be
adversely affected by trade barriers, managed adjustments in relative currency
values, and other protectionist measures imposed or negotiated by the U.S. and
other countries with which they trade. These economies also have been and may
continue to be negatively impacted by economic conditions in the U.S. and other
trading partners, which can lower the demand for goods produced in the Pacific
Basin.
With respect to the Peoples Republic of China and other markets in
which an Underlying Fund may participate, there is the possibility of
nationalization, expropriation or confiscatory taxation, political changes,
government regulation, social instability or diplomatic developments that could
adversely impact a Pacific Basin country or the Underlying Fund's investment in
that country.
Trading volume on Pacific Basin stock exchanges outside of Japan,
although increasing, is substantially less than in the U.S. stock market.
Further, securities of some Pacific Basin companies are less liquid and more
volatile than securities of comparable U.S. companies. Fixed commissions on
Pacific Basin stock exchanges are generally higher than negotiated commissions
on U.S. exchanges, although an Underlying Fund endeavors to achieve the most
favorable
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net results on its portfolio transactions and may be able to purchase securities
in which the Underlying Fund may invest on other stock exchanges where
commissions are negotiable.
Foreign companies, including Pacific Basin companies, are not generally
subject to uniform accounting, auditing and financial reporting standards,
practices and disclosure requirements comparable to those applicable to U.S.
companies. Consequently, there may be less publicly available information about
such companies than about U.S. companies. Moreover, there is generally less
governmental supervision and regulation of Pacific Basin stock exchanges,
brokers, and listed companies than in the U.S.
Investing in Africa. Many of the African countries in which certain Underlying
Funds may invest are fraught with political instability. However, there has been
a trend over the past five years toward democratization. Many countries are
moving from a military style, Marxist, or single party government to a
multi-party system. Still, there remain many countries that do not have a stable
political process. Other countries have been enmeshed in civil wars and border
clashes.
Africa is a continent of roughly 50 countries with a total population
of approximately 840 million people. Literacy rates (the percentage of people
who are over 15 years of age and who can read and write) are relatively low,
ranging from 20% to 60%. The primary industries include crude oil, natural gas,
manganese ore, phosphate, bauxite, copper, iron, diamond, cotton, coffee, cocoa,
timber, tobacco, sugar, tourism, and cattle.
Economically, the Northern Rim countries (including Morocco, Egypt, and
Algeria) and Nigeria, Zimbabwe and South Africa are the wealthier countries on
the continent. The market capitalization of these countries has been growing
recently as more international companies invest in Africa and as local companies
start to list on the exchanges. However, religious and ethnic strife has been a
significant source of instability.
On the other end of the economic spectrum are countries, such as
Burkina, Madagascar, and Malawi, that are considered to be among the poorest or
least developed in the world. These countries are generally landlocked or have
poor natural resources. The economies of many African countries are heavily
dependent on international oil prices. Of all the African industries, oil has
been the most lucrative, accounting for 40% to 60% of many countries' gross
domestic product ("GDP"). However, general decline in oil prices has had an
adverse impact on many economies.
Eastern Europe. Certain Underlying Funds may invest up to 5% of their total
assets in the securities of issuers domiciled in Eastern European countries.
Investments in companies domiciled in Eastern European countries may be subject
to potentially greater risks than those of other foreign issuers. These risks
include (i) potentially less social, political and economic stability; (ii) the
small current size of the markets for such securities and the low volume of
trading, which result in less liquidity and in greater price volatility; (iii)
certain national policies which may restrict the Underlying Fund's investment
opportunities, including restrictions on investment in issuers or industries
deemed sensitive to national interests; (iv) foreign taxation; (v) the absence
of developed legal structures governing private or foreign investment or
allowing for judicial redress for injury to private property; (vi) the absence,
until recently in certain Eastern European countries, of a capital market
structure or market-oriented economy; and (vii) the possibility that recent
favorable economic developments in Eastern Europe may be slowed or reversed by
unanticipated political or social events in such countries, or in the countries
of the former Soviet Union.
Investments in such countries involve risks of nationalization,
expropriation and confiscatory taxation. The Communist governments of a number
of East European countries expropriated large amounts of private property in the
past, in many cases without adequate compensation, and there may be no assurance
that such expropriation will not occur in the future. In the event of such
expropriation, the Underlying Fund could lose a substantial portion of any
investments it has made in the affected countries. Further, no accounting
standards exist in East European countries. Finally, even though certain East
European currencies may be convertible into U.S. dollars, the conversion rates
may be artificial to the actual market values and may be adverse to the
Underlying Fund's shareholders.
Investing in Europe. An Underlying Fund's performance may be susceptible to
political, social and economic factors affecting issuers in European countries.
Such factors may include, but are not limited to: growth of GDP or GNP, rate of
inflation, capital reinvestment, resource self-sufficiency and balance of
payments position, as well as interest and monetary exchange rates among
European countries.
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Eastern European countries and certain Southern European countries are
considered to be emerging markets. Securities traded in certain emerging
European markets may be subject to additional risks due to political and
economic reforms including efforts to decentralize the economic decision-making
process and move toward a market-oriented economy. Additionally, the
inexperience of financial intermediaries, lack of modern technology and the
possibility of permanent or temporary termination of trading of securities may
affect an Underlying Fund's performance. To the extent that an Underlying Fund
purchases equity securities of smaller companies, such securities may experience
greater volatility and have limited liquidity.
Former communist regimes of a number of Eastern European countries had
expropriated a large amount of property, the claims on which have not been
entirely settled. There can be no assurance that an Underlying Fund's
investments in Eastern Europe would not also be expropriated, nationalized or
otherwise confiscated. Finally, any change in the leadership or policies of
Eastern European countries, or the countries that exercise a significant
influence over those countries, may halt the expansion of or reverse the
liberalization of foreign investment policies now occurring and adversely affect
existing investment opportunity.
Although the governments of certain Eastern European countries
currently are implementing or considering reforms directed at political and
economic liberalization, there can be no assurance that these reforms will
continue or achieve their goals.
Most Eastern European nations in which certain Underlying Funds may
invest, including Hungary, Poland, Czechoslovakia, and Romania have had
centrally planned, socialist economies since shortly after World War II. A
number of their governments, including those of Hungary, the Czech Republic, and
Poland are currently implementing or considering reforms directed at political
and economic liberalization, including efforts to foster multi-party political
systems, decentralize economic planning, and move toward free market economies.
At present, no Eastern European country has a developed stock market, but
Poland, Hungary, and the Czech Republic have small securities markets in
operation. Ethnic and civil conflict currently rage through the former
Yugoslavia. The outcome is uncertain.
Both the European Commission (the "EC") and Japan, among others, have
made overtures to establish trading arrangements and assist in the economic
development of the Eastern European nations. A great deal of interest also
surrounds opportunities created by the reunification of East and West Germany.
Following reunification, the Federal Republic of Germany has remained a firm and
reliable member of the EC and numerous other international alliances and
organizations. To reduce inflation caused by the unification of East and West
Germany, Germany has adopted a tight monetary policy which has led to weakened
exports and a reduced domestic demand for goods and services. However, in the
long-term, reunification could prove to be an engine for domestic and
international growth.
The conditions that have given rise to these developments are
changeable, and there is no assurance that reforms will continue or that their
goals will be achieved.
Portugal is a genuinely emerging market which has experienced rapid
growth since the mid-1980s, except for a brief period of stagnation over
1990-91. Portugal's government remains committed to privatization of the
financial system away from one dependent upon the banking system to a more
balanced structure appropriate for the requirements of a modern economy.
Inflation continues to be about three times the EC average.
Economic reforms launched in the 1980s continue to benefit Turkey in
the 1990s. Turkey's economy has grown steadily since the early 1980s, with real
growth in per capita Gross Domestic Product (GDP) increasing more than 6%
annually. Agriculture remains the most important economic sector, employing
approximately 55% of the labor force, and accounting for nearly 20% of GDP and
20% of exports. Inflation and interest rates remain high, and a large budget
deficit will continue to cause difficulties in Turkey's substantial
transformation to a dynamic free market economy.
Like many other Western economies, Greece suffered severely from the
global oil price hikes of the 1970s, with annual GDP growth plunging from 8% to
2% in the 1980s, and inflation, unemployment, and budget deficits rising
sharply. The fall of the socialist government in 1989 and the inability of the
conservative opposition to obtain a clear majority have led to business
uncertainty and the continued prospects for flat economic performance. Once
Greece has sorted out its political situation, it will have to face the
challenges posed by the steadily increasing integration of the EC,
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including the progressive lowering of trade and investment barriers. Tourism
continues as a major industry, providing a vital offset to a sizable commodity
trade deficit.
Securities traded in certain emerging European securities markets may
be subject to risks due to the inexperience of financial intermediaries, the
lack of modern technology and the lack of a sufficient capital base to expand
business operations. Additionally, former Communist regimes of a number of
Eastern European countries had expropriated a large amount of property, the
claims of which have not been entirely settled. There can be no assurance that
the Underlying Fund's investments in Eastern Europe would not also be
expropriated, nationalized or otherwise confiscated. Finally, any change in
leadership or policies of Eastern European countries, or countries that exercise
a significant influence over those countries, may halt the expansion of or
reverse the liberalization of foreign investment policies now occurring and
adversely affect existing investment opportunities.
Interfund Borrowing and Lending Program The Trust has received exemptive relief
from the SEC, which permits each Portfolio to participate in an interfund
lending program among certain investment companies advised by the Adviser. The
interfund lending program allows the participating funds to borrow money from
and loan money to each other for temporary or emergency purposes. The program is
subject to a number of conditions designed to ensure fair and equitable
treatment of all participating funds, including the following: (1) no fund may
borrow money through the program unless it receives a more favorable interest
rate than a rate approximating the lowest interest rate at which bank loans
would be available to any of the participating funds under a loan agreement; and
(2) no fund may lend money through the program unless it receives a more
favorable return than that available from an investment in repurchase agreements
and, to the extent applicable, money market cash sweep arrangements. In
addition, a fund may participate in the program only if and to the extent that
such participation is consistent with the fund's investment objectives and
policies (for instance, money market funds would normally participate only as
lenders and tax exempt funds only as borrowers). Interfund loans and borrowings
may extend overnight, but could have a maximum duration of seven days. Loans may
be called on one day's notice. A fund may have to borrow from a bank at a higher
interest rate if an interfund loan is called or not renewed. Any delay in
repayment to a lending fund could result in a lost investment opportunity or
additional costs. The program is subject to the oversight and periodic review of
the Boards of the participating funds. To the extent a Portfolio is actually
engaged in borrowing through the interfund lending program, a Portfolio, as a
matter of non-fundamental policy, may not borrow for other than temporary or
emergency purposes (and not for leveraging), except that the Portfolio may
engage in reverse repurchase agreements and dollar rolls for any purpose.
Depositary Receipts. Certain Underlying Funds may invest indirectly in
securities of emerging market country issuers through sponsored or unsponsored
American Depositary Receipts ("ADRs"), Global Depositary Receipts ("GDRs"),
International Depositary Receipts ("IDRs") and other types of Depositary
Receipts (which, together with ADRs, GDRs and IDRs are hereinafter referred to
as "Depositary Receipts"). Depositary Receipts may not necessarily be
denominated in the same currency as the underlying securities into which they
may be converted. In addition, the issuers of the stock of unsponsored
Depositary Receipts are not obligated to disclose material information in the
United States and, therefore, there may not be a correlation between such
information and the market value of the Depositary Receipts. ADRs are Depositary
Receipts typically issued by a U.S. bank or trust company which evidence
ownership of underlying securities issued by a foreign corporation. GDRs, IDRs
and other types of Depositary Receipts are typically issued by foreign banks or
trust companies, although they also may be issued by United States banks or
trust companies, and evidence ownership of underlying securities issued by
either a foreign or a United States corporation. Generally, Depositary Receipts
in registered form are designed for use in the United States securities markets
and Depositary Receipts in bearer form are designed for use in securities
markets outside the United States. For purposes of an Underlying Fund's
investment policies, the Underlying Fund's investments in ADRs, GDRs and other
types of Depositary Receipts will be deemed to be investments in the underlying
securities. Depositary Receipts other than those denominated in U.S. dollars
will be subject to foreign currency exchange rate risk. Certain Depositary
Receipts may not be listed on an exchange and therefore may be illiquid
securities subject to an Underlying Fund's restrictions on investment in
illiquid securities. The value of Depository Receipts may be more volatile than
if they were sponsored by the issuers of the underlying securities.
Loan Participations and Assignments. Certain Underlying Funds may invest in
fixed and floating rate loans ("Loans") arranged through private negotiations
between an issuer of emerging market debt instruments and one or more financial
institutions ("Lenders"). An Underlying Fund's investments in Loans in Latin
America are expected in most instances to be in the form of participations in
Loans ("Participations") and assignments of portions of Loans ("Assignments")
from
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third parties. Participations typically will result in the Underlying Fund
having a contractual relationship only with the Lender and not with the
borrower. The Underlying Fund will have the right to receive payments of
principal, interest and any fees to which it is entitled only from the Lender
selling the Participation and only upon receipt by the Lender of the payments
from the borrower. In connection with purchasing Participations, the Underlying
Fund generally will have no right to enforce compliance by the borrower with the
terms of the loan agreement relating to the Loan, nor any rights of set-off
against the borrower, and the Underlying Fund may not directly benefit from any
collateral supporting the Loan in which it has purchased the Participation. As a
result, the Underlying Fund will assume the credit risk of both the borrower and
the Lender that is selling the Participation. In the event of the insolvency of
the Lender selling a Participation, the Underlying Fund may be treated as a
general creditor of the Lender and may not benefit from any set-off between the
Lender and the borrower. The Underlying Fund will acquire Participations only if
the Lender interpositioned between the Underlying Fund and the borrower is
determined by the Adviser to be creditworthy.
When an Underlying Fund purchases Assignments from Lenders, the
Underlying Fund will acquire direct rights against the borrower on the Loan.
Because Assignments are arranged through private negotiations between potential
assignees and potential assignors, however, the rights and obligations acquired
by the Underlying Fund as the purchaser of an Assignment may differ from, and
may be more limited than, those held by the assigning Lender.
An Underlying Fund may have difficulty disposing of Assignments and
Participations. Because no liquid market for these obligations typically exists,
the Underlying Fund anticipates that these obligations could be sold only to a
limited number of institutional investors. The lack of a liquid secondary market
will have an adverse effect on the Underlying Fund's ability to dispose of
particular Assignments or Participations when necessary to meet the Underlying
Fund's liquidity needs or in response to a specific economic event, such as a
deterioration in the creditworthiness of the borrower. The lack of a liquid
secondary market for Assignments and Participations may also make it more
difficult for the Underlying Fund to assign a value to those securities for
purposes of valuing the Underlying Fund's portfolio and calculating its net
asset value.
Real Estate Investment Trusts. Certain Underlying Funds invest in REITs. REITs
are sometimes informally characterized as equity REITs, mortgage REITs and
hybrid REITs. REITs, which invest the majority of their assets directly in real
property and derive their income primarily from rents. Equity REITs can also
realize capital gains by selling properties that have appreciated in value.
Mortgage REITs, which invest the majority of their assets in real estate
mortgages, derive their income primarily from interest payments on real estate
mortgages in which they are invested. Hybrid REITs combine the characteristics
of both equity REITs and mortgage REITs. Investment in REITs may subject an
Underlying Fund to risks associated with the direct ownership of real estate,
such as decreases in real estate values, overbuilding, increased competition and
other risks related to local or general economic conditions, increases in
operating costs and property taxes, changes in zoning laws, casualty or
condemnation losses, possible environmental liabilities, regulatory limitations
on rent and fluctuations in rental income. Equity REITs generally experience
these risks directly through fee or leasehold interests, whereas mortgage REITs
generally experience these risks indirectly through mortgage interests, unless
the mortgage REIT forecloses on the underlying real estate. Changes in interest
rates may also affect the value of an Underlying Fund's investment in REITs. For
instance, during periods of declining interest rates, certain mortgage REITs may
hold mortgages that the mortgagors elect to prepay, which prepayment may
diminish the yield on securities issued by those REITs.
Certain REITs have relatively small market capitalizations, which may
tend to increase the volatility of the market prices of their securities.
Furthermore, REITs are dependent upon specialized management skill and have
limited diversification and are, therefore, subject to risks inherent in
operating and financing a limited number of projects. REITs are also subject to
heavy cash flow dependency, defaults by borrowers and the possibility of failing
to qualify for tax-free pass-through of income under the Internal Revenue Code
of 1986, as amended, and to maintain exemption from the registration
requirements of the 1940 Act. By investing in REITs indirectly through an
Underlying Fund, a shareholder will bear not only his or her proportionate share
of the expenses of an Underlying Fund, but also, indirectly, similar expenses of
the REITs. In addition, REITs depend generally on their ability to generate cash
flow to make distributions to shareholders.
Trust Preferred Securities. Certain Underlying Funds invest in Trust Preferred
Securities, which are hybrid instruments issued by a special purpose trust (the
"Special Trust"), the entire equity interest of which is owned by a single
issuer. The proceeds of the issuance to the Underlying Funds of Trust Preferred
Securities are typically used to
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purchase a junior subordinated debenture, and distributions from the Special
Trust are funded by the payments of principal and interest on the subordinated
debenture.
If payments on the underlying junior subordinated debentures held by
the Special Trust are deferred by the debenture issuer, the debentures would be
treated as original issue discount ("OID") obligations for the remainder of
their term. As a result, holders of Trust Preferred Securities, such as the
Underlying Funds, would be required to accrue daily for Federal income tax
purposes their share of the stated interest and the de minimis OID on the
debentures (regardless of whether an Underlying Fund receives any cash
distributions from the Special Trust), and the value of Trust Preferred
Securities would likely be negatively affected. Interest payments on the
underlying junior subordinated debentures typically may only be deferred if
dividends are suspended on both common and preferred stock of the issuer. The
underlying junior subordinated debentures generally rank slightly higher in
terms of payment priority than both common and preferred securities of the
issuer, but rank below other subordinated debentures and debt securities. Trust
Preferred Securities may be subject to mandatory prepayment under certain
circumstances. The market values of Trust Preferred Securities may be more
volatile than those of conventional debt securities. Trust Preferred Securities
may be issued in reliance on Rule 144A under the Securities Act of 1933, as
amended, and, unless and until registered, are restricted securities; there can
be no assurance as to the liquidity of Trust Preferred Securities and the
ability of holders of Trust Preferred Securities, such as the Underlying Funds,
to sell their holdings.
Non-diversified investment company. Certain Underlying Funds are classified as
non-diversified investment companies under the 1940 Act, which means that an
Underlying Fund is not limited by the 1940 Act in the proportion of its assets
that it may invest in the obligations of a single issuer. The investment of a
large percentage of an Underlying Fund's assets in the securities of a small
number of issuers may cause an Underlying Fund's share price to fluctuate more
than that of a diversified investment company.
Precious metals. Investments in precious metals and in precious metals-related
securities and companies involve a relatively high degree of risk. Prices of
gold and other precious metals can be influenced by a variety of global
economic, financial and political factors and may fluctuate markedly over short
periods of time. Among other things, precious metals values can be affected by
changes in inflation, investment speculation, metal sales by governments or
central banks, changes in industrial and commercial demand, and any governmental
restrictions on private ownership of gold or other precious metals.
Correlation of gold and gold securities. The Adviser believes that the value of
the securities of firms that deal in gold will correspond generally, over time,
with the prices of the underlying metal. At any given time, however, changes in
the price of gold may not strongly correlate with changes in the value of
securities related to gold, which are expected to constitute part of certain
Underlying Funds' assets. In fact, there may be periods in which the price of
gold stocks and gold will move in different directions. The reason for this
potential disparity is that political and economic factors, including behavior
of the stock market, may have differing impacts on gold versus gold stocks.
Mining and exploration risks. The business of gold mining by its nature involves
significant risks and hazards, including environmental hazards, industrial
accidents, labor disputes, discharge of toxic chemicals, fire, drought, flooding
and natural acts. The occurrence of any of these hazards can delay production,
increase production costs and result in liability to the operator of the mines.
A mining operation may become subject to liability for pollution or other
hazards against which it has not insured or cannot insure, including those in
respect of past mining activities for which it was not responsible.
Exploration for gold and other precious metals is speculative in
nature, involves many risks and frequently is unsuccessful. There can be no
assurance that any mineralisation discovered will result in an increase in the
proven and probable reserves of a mining operation. If reserves are developed,
it can take a number of years from the initial phases of drilling and
identification of mineralisation until production is possible, during which time
the economic feasibility of production may change. Substantial expenditures are
required to establish ore reserves properties and to construct mining and
processing facilities. As a result of these uncertainties, no assurance can be
given that the exploration programs undertaken by a particular mining operation
will actually result in any new commercial mining.
Asset-Indexed Securities. Certain Underlying Funds may purchase asset-indexed
securities which are debt securities usually issued by companies in precious
metals related businesses such as mining, the principal amount, redemption
terms, or interest rates of which are related to the market price of a specified
precious metal. An Underlying Fund will
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only enter into transactions in publicly traded asset-indexed securities. Market
prices of asset-indexed securities will relate primarily to changes in the
market prices of the precious metals to which the securities are indexed rather
than to changes in market rates of interest. However, there may not be a perfect
correlation between the price movements of the asset-indexed securities and the
underlying precious metals. Asset-indexed securities typically bear interest or
pay dividends at below market rates (and in certain cases at nominal rates). The
Underlying Fund will purchase asset-indexed securities to the extent permitted
by law.
Special situation securities. From time to time, an Underlying Fund may invest
in equity or debt securities issued by companies that are determined by the
Adviser to possess "special situation" characteristics. In general, a special
situation company is a company whose securities are expected to increase in
value solely by reason of a development particularly or uniquely applicable to
the company. Developments that may create special situations include, among
others, a liquidation, reorganization, recapitalization or merger, material
litigation, technological breakthrough and new management or management
policies. The principal risk with investments in special situation companies is
that the anticipated development thought to create the special situation may not
occur and the investments therefore may not appreciate in value or may decline
in value.
Borrowing. As a matter of fundamental policy, the Portfolios will not borrow
money, except as permitted under the 1940 Act, as amended, and as interpreted or
modified by regulatory authority having jurisdiction, from time to time. While
the Trustees do not currently intend for an Underlying Fund to borrow for
investment leveraging purposes, if such a strategy were implemented in the
future it would increase a Portfolio's volatility and the risk of loss in a
declining market. Borrowing by the Portfolios will involve special risk
considerations. Although the principal of a Portfolio's borrowing will be fixed,
a Portfolio's assets may change in value during the time that a borrowing is
outstanding, thus increasing exposure to capital risk.
Certain Underlying Funds are authorized to borrow money for purposes of
liquidity and to provide for redemptions and distributions. An Underlying Fund
will borrow only when the Adviser believes that borrowing will benefit the
Underlying Fund after taking into account considerations such as the costs of
the borrowing. No Underlying Fund expects to borrow for investment purposes, to
increase return or leverage the portfolio. Borrowing by Underlying Funds will
involve special risk considerations. Although the principal of an Underlying
Fund's borrowings will be fixed, the Underlying Fund's assets may change in
value during the time a borrowing is outstanding, thus increasing exposure to
capital risk.
Lending of Portfolio Securities. Certain Underlying Funds may seek to increase
their income by lending portfolio securities. Such loans may be made to
registered broker/dealers, and are required to be secured continuously by
collateral in cash or liquid asset maintained on a current basis at an amount at
least equal to the market value and accrued interest of the securities loaned.
An Underlying Fund has the right to call a loan and obtain the securities loaned
on no more than five days' notice. During the existence of a loan, the
Underlying Fund continues to receive the equivalent of any distributions paid by
the issuer on the securities loaned and also receives compensation based on
investment of the collateral. As with other extensions of credit there are risks
of delay in recovery or even loss of rights in the collateral should the
borrower of the securities fail financially. However, the loans may be made only
to firms deemed by the Adviser to be of good standing and will not be made
unless, in the judgment of the Adviser, the consideration to be earned from such
loans would justify the risk.
Corporate and Municipal Bond Ratings. The following is a description of the
ratings given by S&P and Moody's to corporate and municipal bonds. Should the
rating of a portfolio security held by an Underlying Fund be downgraded, the
Adviser will determine whether it is in the best interest of the Underlying Fund
to retain or dispose of such security.
S&P. Debt rated AAA has the highest rating assigned by S&P. Capacity to pay
interest and repay principal is extremely strong. 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. 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. Debt rated BBB is regarded as having an adequate
capacity to pay interest and repay principal. Whereas it normally exhibits
adequate protection parameters, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity to pay interest and
repay principal for debt in this category than in higher rated categories.
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Debt rated BB, B, CCC, CC and C is regarded as having predominantly
speculative characteristics with respect to capacity to pay interest and repay
principal. BB indicates the least degree of speculation and C the highest. While
such debt will likely have some quality and protective characteristics, these
are outweighed by large uncertainties or major exposures to adverse conditions.
Debt rated BB has less near-term vulnerability to default than other
speculative issues. However, it faces major ongoing uncertainties or exposure to
adverse business, financial, or economic conditions which could lead to
inadequate capacity to meet timely interest and principal payments. The BB
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied BBB- rating. Debt rated B has a greater
vulnerability to default but currently has the capacity to meet interest
payments and principal repayments. Adverse business, financial, or economic
conditions will likely impair capacity or willingness to pay interest and repay
principal. The B rating category is also used for debt subordinated to senior
debt that is assigned an actual or implied BB or BB- rating.
Debt rated CCC has a currently identifiable vulnerability to default,
and is dependent upon favorable business, financial, and economic conditions to
meet timely payment of interest and repayment of principal. In the event of
adverse business, financial, or economic conditions, it is not likely to have
the capacity to pay interest and repay principal. The CCC rating category is
also used for debt subordinated to senior debt that is assigned an actual or
implied B or B- rating. The rating CC typically is applied to debt subordinated
to senior debt that is assigned an actual or implied CCC rating. The rating C
typically is applied to debt subordinated to senior debt which is assigned an
actual or implied CCC- debt rating. The C rating may be used to cover a
situation where a bankruptcy petition has been filed, but debt service payments
are continued. The rating C1 is reserved for income bonds on which no interest
is being paid. Debt rated D is in payment default. The D rating category is used
when interest payments or principal payments are not made on the date due even
if the applicable grace period had not expired, unless S&P believes that such
payments will be made during such grace period. The D rating also will be used
upon the filing of a bankruptcy petition if debt service payments are
jeopardized.
Moody's. 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. Bonds which are rated Aa are
judged to be of high quality by all standards. Together with the Aaa group they
comprise what are generally known as high grade bonds. They are rated lower than
the best bonds because margins of protection may not be as large as in Aaa
securities or fluctuation of protective elements may be of greater amplitude or
there may be other elements present which make the long term risks appear
somewhat larger than in Aaa securities. 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 sometime in the future.
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. 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 other good and bad times over
the future. Uncertainty of position characterizes bonds in this class. Bonds
which are rated B generally lack characteristics of the desirable investment.
Assurance of interest and principal payments or of maintenance of other terms of
the contract over any long period of time may be small.
Bonds which are rated Caa are of poor standing. Such issues may be in default or
there may be present elements of danger with respect to principal or interest.
Bonds which are rated Ca represent obligations which are speculative in a high
degree. Such issues are often in default or have other marked shortcomings.
Bonds which are rated C are the lowest rated class of bonds and issues so rated
can be regarded as having extremely poor prospects of ever attaining any real
investment standing.A-1, A-2 and Prime-1, Prime-2 Commercial Paper Ratings.
Commercial paper rated by Standard & Poor's Corporation has the following
characteristics: Liquidity ratios are adequate to meet cash requirements.
Long-term senior debt is rated "A" or better. The issuer has access to at least
two additional channels of borrowing. Basic earnings and cash flow have an
upward trend with allowance made for unusual circumstances. Typically, the
issuer's industry is well established and the issuer has a strong position
within the industry. The reliability
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and quality of management are unquestioned. Relative strength or weakness of the
above factors determine whether the issuer's commercial paper is rated A-1, A-2
or A-3.
The ratings Prime-1 and Prime-2 are the two highest commercial paper ratings
assigned by Moody's Investors Service, Inc. Among the factors considered by it
in assigning ratings are the following: (1) evaluation of the management of the
issuer; (2) economic evaluation of the issuer's industry or industries and an
appraisal of speculative-type risks which may be inherent in certain areas; (3)
evaluation of the issuer's products in relation to competition and customer
acceptance; (4) liquidity; (5) amount and quality of long-term debt; (6) trend
of earnings over a period of ten years; (7) financial strength of a parent
company and the relationships which exist with the issuer; and (8) recognition
by the management of obligations which may be present or may arise as a result
of public interest questions and preparations to meet such obligations. Relative
strength or weakness of the above factors determines whether the issuer's
commercial paper is rated Prime-1, 2 or 3.
MIG-1 and MIG-2 Municipal Notes. Moody's ratings for state and municipal notes
and other short-term loans will be designated Moody's Investment Grade (MIG).
This distinction is in recognition of the differences between short-term credit
risk and long-term risk. Factors affecting the liquidity of the borrower are
uppermost in importance in short-term borrowing, while various factors of the
first importance in bond risk are of lesser importance in the short run. Loans
designated MIG-1 are of the best quality, enjoying strong protection from
established cash flows of funds for their servicing or from established and
broad-based access to the market for refinancing, or both. Loans designated
MIG-2 are of high quality, with margins of protection ample although not so
large as in the preceding group.
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