Filed Pursuant to Rule 497(c)
Registration Nos: 333-76293
811-9291
STATEMENT OF ADDITIONAL INFORMATION
Bearguard Funds, Inc.
BEARGUARD FUND
P.O. Box 701
Milwaukee, Wisconsin 53201-0701
1-888-288-2880
www.bearguardfund.com
This Statement of Additional Information is not a
prospectus and should be read in conjunction with the
Prospectus of the Bearguard Fund (the "Fund"), dated
October 28, 1999. The Fund is a series of Bearguard
Funds, Inc. (the "Corporation").
A copy of the Prospectus is available without
charge upon request to the above-noted address, toll-
free telephone number or website.
This Statement of Additional Information is dated October 28, 1999.
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TABLE OF CONTENTS
Page No.
FUND ORGANIZATION 3
INVESTMENT RESTRICTIONS 3
IMPLEMENTATION OF INVESTMENT OBJECTIVES 4
DIRECTORS AND OFFICERS 12
PRINCIPAL SHAREHOLDERS 15
INVESTMENT ADVISER 15
FUND TRANSACTIONS AND BROKERAGE 16
CUSTODIAN 17
TRANSFER AGENT AND DIVIDEND-DISBURSING AGENT 17
ADMINISTRATOR 17
DISTRIBUTOR AND PLAN OF DISTRIBUTION 17
PURCHASE AND PRICING OF SHARES 19
REDEMPTIONS IN KIND 21
TAXATION OF THE FUND 21
PERFORMANCE INFORMATION 22
INDEPENDENT ACCOUNTANTS 23
FINANCIAL STATEMENTS 23
APPENDIX A-1
In deciding whether to invest in the Fund, you
should rely on information in this Statement of
Additional Information and related Prospectus. The
Fund has not authorized others to provide additional
information. The Fund has not authorized the use of
this Statement of Additional Information in any state
or jurisdiction in which such offering may not legally
be made.
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FUND ORGANIZATION
The Corporation is an open-end, diversified,
management investment company, commonly referred to as
a mutual fund. The Fund is a series of common stock of
the Corporation, a Maryland company incorporated on
April 9, 1999. The Corporation is authorized to issue
shares of common stock in series and classes. The
Corporation currently offers one series of shares: the
Bearguard Fund. The shares of common stock of the Fund
are further divided into two classes: Investor Class
and Institutional Class. Each share of common stock of
each class of shares of the Fund is entitled to one
vote, and each share is entitled to participate equally
in dividends and capital gain distributions by the
respective class of shares and in the assets of the
respective class in the event of liquidation. However,
each class of shares bears its own expenses, and the
Investor Class has exclusive voting rights on matters
pertaining to its distribution and shareholder
servicing plan.
No certificates will be issued for shares held in
your account. You will, however, have full shareholder
rights. Generally, the Corporation will not hold
annual shareholders' meetings unless required by the
Investment Company Act of 1940, as amended (the "1940
Act"), or Maryland law. Shareholders have certain
rights, including the right to call an annual meeting
upon a vote of 10% of the Corporation's outstanding
shares for the purpose of voting to remove one or more
directors or to transact any other business. The 1940
Act requires the Corporation to assist the shareholders
in calling such a meeting.
INVESTMENT RESTRICTIONS
The investment objective of the Fund is to seek
capital appreciation. The following are the Fund's
fundamental investment restrictions which cannot be
changed without the approval of a majority of the
Fund's outstanding voting securities. As used herein,
a "majority of the Fund's outstanding voting
securities" means the lesser of (i) 67% of the shares
of common stock of the Fund represented at a meeting at
which more than 50% of the outstanding shares are
present, or (ii) more than 50% of the outstanding
shares of common stock of the Fund.
The Fund:
1. May not with respect to 75% of its total assets,
purchase the securities of any issuer (except
securities issued or guaranteed by the U.S.
government or its agencies or instrumentalities)
if, as a result, (i) more than 5% of the Fund's
total assets would be invested in the securities
of that issuer, or (ii) the Fund would hold more
than 10% of the outstanding voting securities of
that issuer.
2. May (i) borrow money from banks for temporary or
emergency purposes and (ii) make other investments
or engage in other transactions permissible under
the Investment Company Act of 1940, as amended
(the "1940 Act"), which may involve a borrowing,
including borrowing through reverse repurchase
agreements, provided that the combination of (i)
and (ii) shall not exceed 33 1/3% of the value of
the Fund's total assets (including the amount
borrowed), less the Fund's liabilities (other than
borrowings). If the amount borrowed at any time
exceeds 33 1/3% of the Fund's total assets, the
Fund will, within three days thereafter (not
including Sundays, holidays and any longer
permissible period), reduce the amount of the
borrowings such that the borrowings do not exceed
33 1/3% of the Fund's total assets. The Fund may
also borrow money from other persons to the extent
permitted by applicable law.
3. May not issue senior securities, except as
permitted under the 1940 Act.
4. May not act as an underwriter of another issuer's
securities, except to the extent that the Fund may
be deemed to be an underwriter within the meaning
of the Securities Act of 1933, as amended (the
"Securities Act"), in connection with the purchase
and sale of portfolio securities.
5. May not purchase or sell physical commodities
unless acquired as a result of ownership of
securities or other instruments (but this shall
not prevent the Fund from purchasing or selling
options, futures contracts or other derivative
instruments, or from investing in securities or
other instruments backed by physical commodities).
6. May not make loans if, as a result, more than 33
1/3% of the Fund's total assets would be lent to
other persons, except through (i) purchases of
debt securities or other debt instruments, or (ii)
engaging in repurchase agreements.
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7. May not purchase the securities of any issuer if,
as a result, more than 25% of the Fund's total
assets would be invested in the securities of
issuers, the principal business activities of
which are in the same industry.
8. May not purchase or sell real estate unless
acquired as a result of ownership of securities or
other instruments (but this shall not prohibit the
Fund from purchasing or selling securities or
other instruments backed by real estate or of
issuers engaged in real estate activities).
The following are the Fund's non-fundamental
investment policies which may be changed by the Board
of Directors without shareholder approval.
The Fund:
1. May engage in short sales of the Fund's securities
or maintain a short position if at all times when
a short position is open, the Fund (i) owns or has
the right to obtain securities equivalent in kind
and amount to the securities sold short or (ii)
covers such short position as required by the
current rules and positions of the Securities and
Exchange Commission (the "SEC") or its staff.
2. May not purchase securities on margin, except that
the Fund may obtain such short-term credits as are
necessary for the clearance of transactions; and
provided that margin deposits in connection with
futures contracts, options on futures contracts or
other derivative instruments shall not constitute
purchasing securities on margin.
3. May not invest more than 5% of its assets in
illiquid securities.
4. May not purchase securities of other investment
companies except in compliance with the 1940 Act.
5. May not engage in futures or options on futures
transactions, which are impermissible pursuant to
Rule 4.5 under the Commodity Exchange Act (the
"CEA") and, in accordance with Rule 4.5, will use
futures or options on futures transactions solely
for bona fide hedging transactions (within the
meaning of the CEA), provided, however, that the
Fund may, in addition to bona fide hedging
transactions, use futures and options on futures
transactions if the aggregate initial margins and
premiums required to establish such positions,
less the amount by which such options positions
are in the money (within the meaning of the CEA),
do not exceed 5% of the Fund's net assets.
6. May not make any loans, except through (i)
purchases of debt securities or other debt
instruments, or (ii) engaging in repurchase
agreements.
7. May not purchase securities when bank borrowings
exceed 5% of its total assets.
8. May not purchase the securities of any issuer if,
as a result, more than 15% of the Fund's total assets
would be invested in securities of issuers, the
principal business activities of which are in the same
industry.
9. May not purchase the securities of any issuer
(except securities issued or guaranteed by the U.S.
government or its agencies or instrumentalities) if, as
a result, more than 5% of the Fund's net assets would
be invested in securities of that issuer.
Except for the fundamental investment limitations
listed above and the Fund's investment objective, the
Fund's other investment policies are not fundamental
and may be changed with approval of the Corporation's
Board of Directors. Unless noted otherwise, if a
percentage restriction is adhered to at the time of
investment, a later increase or decrease in percentage
resulting from a change in the Fund's assets (i.e., due
to cash inflows or redemptions) or in market value of
the investment or the Fund's assets will not constitute
a violation of that restriction.
IMPLEMENTATION OF INVESTMENT OBJECTIVES
The following information supplements the
discussion of the Fund's investment objectives and
strategy described in the Prospectus under the captions
"Investment Objective" and "How the Fund Invests."
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Debt Securities
Debt Securities in General. To collateralize or
"cover" its short positions, the Fund will invest in a
wide variety of debt securities, including U.S.
government and corporate notes and bonds. Debt
securities are obligations of the issuer to pay
interest and repay principal.
Changes in market interest rates affect the value
of debt securities. If interest rates increase, the
value of debt securities generally decrease.
Similarly, if interest rates decrease, the value of
debt securities generally increase. Shares in the Fund
are likely to fluctuate in a similar manner. In
general, the longer the remaining maturity of a debt
security, the greater it will fluctuate in value based
on interest rate changes. Longer-term debt securities
generally pay a higher interest rate. The Fund
typically invests in short-term debt securities with
maturities of less than three years.
Changes in the credit quality of the issuer also
affect the value of debt securities. Lower-rated debt
securities generally pay a higher interest rate.
Although the Fund only invests in investment grade debt
securities, the value of these securities may decrease
due to changes in ratings over time.
Types of Debt Securities. The Fund may invest in
the following types of debt securities:
* Corporate debt securities, including bonds,
debentures and notes;
* U.S. government securities;
* Commercial paper (including variable amount master
demand notes); and
* Bank obligations, such as certificates of deposit,
banker's acceptances and time deposits of domestic and
foreign banks, domestic savings associations and their
subsidiaries and branches (in amounts in excess of the
current $100,000 per account insurance coverage
provided by the Federal Deposit Insurance Corporation).
Ratings. The Fund will generally limit
investments in debt securities to those that are rated
at the time of purchase as at least investment grade by
at least one national rating organization, such as S&P
or Moody's, or, if unrated, are determined to be of
equivalent quality by the Adviser. Investment grade
debt securities include:
* U.S. government securities;
* Bonds or bank obligations rated in one of the four
highest categories (e.g., BBB- or higher by S&P);
* Short-term notes rated in one of the two highest
categories (e.g., SP-2 or higher by S&P); and
* Commercial paper or short-term bank obligations
rated in one of the three highest categories (e.g., A-3
or higher by S&P).
Investment grade debt securities are generally believed
to have a lower degree of credit risk. If a security's
rating falls below the above criteria, the Adviser will
determine what action, if any, should be taken to
ensure compliance with the Fund's investment objective
and to ensure that the Fund will at no time have 5% or
more of its net assets invested in non-investment grade
debt securities. Additional information concerning
securities ratings is contained in the Appendix.
Government Securities. U.S. government securities
are issued or guaranteed by the U.S. government or its
agencies or instrumentalities. These securities may
have different levels of government backing. U.S.
Treasury obligations, such as Treasury bills, notes,
and bonds are backed by the full faith and credit of
the U.S. Treasury. Some U.S. government agency
securities are also backed by the full faith and credit
of the U.S. Treasury, such as securities issued by the
Government National Mortgage Association (GNMA). Other
U.S. government securities may be backed by the right
of the agency to borrow from the U.S. Treasury, such as
securities issued by the Federal Home Loan Bank, or may
be backed only by the credit of the agency. The U.S.
government and its agencies and instrumentalities only
guarantee the payment of principal and interest and not
the market value of the securities. The market value
of U.S. government securities will fluctuate based on
interest rate changes and other market factors.
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Variable- or Floating-Rate Securities. Variable-
rate securities provide for automatic establishment of
a new interest rate at fixed intervals (e.g., daily,
monthly, semi-annually, etc.). Floating-rate
securities generally provide for automatic adjustment
of the interest rate whenever some specified interest
rate index changes. The interest rate on variable- or
floating-rate securities is ordinarily determined by
reference to or is a percentage of a bank's prime rate,
the 90-day U.S. Treasury bill rate, the rate of return
on commercial paper or bank certificates of deposit, an
index of short-term interest rates or some other
objective measure.
Variable- or floating-rate securities frequently
include a demand feature entitling the holder to sell
the securities to the issuer at par. In many cases,
the demand feature can be exercised at any time on
seven days notice, in other cases, the demand feature
is exercisable at any time on 30 days notice or on
similar notice at intervals of not more than one year.
Some securities which do not have variable or floating
interest rates may be accompanied by puts producing
similar results and price characteristics.
Variable-rate demand notes include master demand
notes which are obligations that permit the Fund to
invest fluctuating amounts, which may change daily
without penalty, pursuant to direct arrangements
between the Fund, as lender, and the borrower. The
interest rates on these notes fluctuate from time to
time. The issuer of such obligations normally has a
corresponding right, after a given period, to prepay in
its discretion the outstanding principal amount of the
obligations plus accrued interest upon a specified
number of days' notice to the holders of such
obligations. The interest rate on a floating-rate
demand obligation is based on a known lending rate,
such as a bank's prime rate, and is adjusted
automatically each time such rate is adjusted. The
interest rate on a variable-rate demand obligation is
adjusted automatically at specified intervals.
Frequently, such obligations are secured by letters of
credit or other credit support arrangements provided by
banks. Because these obligations are direct lending
arrangements between the lender and borrower, it is not
contemplated that such instruments will generally be
traded. There generally is not an established
secondary market for these obligations, although they
are redeemable at face value. Accordingly, where the
obligations are not secured by letters of credit or
other credit support arrangements, the Fund's right to
redeem is dependent on the ability of the borrower to
pay principal and interest on demand. Such obligations
frequently are not rated by credit rating agencies and,
if not so rated, the Fund may invest in them only if
the Adviser determines that at the time of investment
other obligations are of comparable quality to the
other obligations in which the Fund may invest.
In addition, each variable- and floating-rate
obligation must meet the credit quality requirements
applicable to all the Fund's investments at the time of
purchase. When determining whether such an obligation
meets the Fund's credit quality requirements, the Fund
may look to the credit quality of the financial
guarantor providing a letter of credit or other credit
support arrangement.
Derivative Instruments
In General. The Fund may invest up to 10% of its
net assets in derivative instruments subject to
applicable regulatory requirements. Derivative
instruments may be used for any lawful purpose
consistent with the Fund's investment objective such as
hedging or managing risk, but not for speculation.
Derivative instruments are commonly defined to include
securities or contracts whose value depend on (or
"derive" from) the value of one or more other assets,
such as securities, currencies or commodities. These
"other assets" are commonly referred to as "underlying
assets."
A derivative instrument generally consists of, is
based upon, or exhibits characteristics similar to
options or forward contracts. Options and forward
contracts are considered to be the basic "building
blocks" of derivatives. For example, forward-based
derivatives include forward contracts and exchange-
traded futures. Option-based derivatives include
exchange-traded options on securities and options on
futures. Diverse types of derivatives may be created
by combining options or forward contracts in different
ways, and by applying these structures to a wide range
of underlying assets.
An option is a contract in which the "holder" (the
buyer) pays a certain amount (the "premium") to the
"writer" (the seller) to obtain the right, but not the
obligation, to buy from the writer (in a "call") or
sell to the writer (in a "put") a specific asset at an
agreed upon price at or before a certain time. The
holder pays the premium at inception and has no further
financial obligation. The holder of an option-based
derivative generally will benefit from favorable
movements in the price of the underlying asset but is
not exposed to corresponding losses due to adverse
movements in
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the value of the underlying asset. The
writer of an option-based derivative generally will
receive fees or premiums but generally is exposed to
losses due to changes in the value of the underlying
asset.
A forward is a sales contract between a buyer
(holding the "long" position) and a seller (holding the
"short" position) for an asset with delivery deferred
until a future date. The buyer agrees to pay a fixed
price at the agreed future date and the seller agrees
to deliver the asset. The seller hopes that the market
price on the delivery date is less than the agreed upon
price, while the buyer hopes for the contrary. The
change in value of a forward-based derivative generally
is roughly proportional to the change in value of the
underlying asset.
Hedging. The Fund may use derivative instruments
to protect against possible adverse changes in the
market value of positions in the Fund's portfolio or
positions anticipated to be entered into. Derivatives
may also be used by the Fund to "lock-in" its realized
but unrecognized gains in the value of its portfolio
securities. Hedging strategies, if successful, can
reduce the risk of loss by wholly or partially
offsetting the negative effect of unfavorable price
movements in the investments being hedged. However,
hedging strategies can also reduce the opportunity for
gain by offsetting the positive effect of favorable
price movements in the hedged investments.
Managing Risk. The Fund may also use derivative
instruments to manage the risks of the Fund's
portfolio. Risk management strategies include, but are
not limited to, facilitating the sale of portfolio
investments, managing the effective maturity or
duration of debt obligations in the Fund's portfolio,
establishing a position in the derivatives markets as a
substitute for taking positions, or creating or
altering exposure to certain asset classes, such as
equity or debt. The use of derivative instruments may
provide a less expensive, more expedient or more
specifically focused way for the Fund to invest.
Exchange Derivatives. Derivative instruments may
be exchange-traded. Exchange-traded derivatives are
standardized options and futures contracts traded in an
auction on the floor of a regulated exchange. Exchange
contracts are generally liquid. The exchange
clearinghouse is the counterparty of every contract.
Thus, each holder of an exchange contract bears the
credit risk of the clearinghouse (and has the benefit
of its financial strength) rather than that of a
particular counterparty.
Risks and Special Considerations. The use of
derivative instruments involves risks and special
considerations as described below. Risks pertaining to
particular derivative instruments are described in the
sections that follow.
(1) Market Risk. The primary risk of derivatives
is the same as the risk of the underlying assets;
namely, that the value of the underlying asset may go
up or down. Adverse movements in the value of an
underlying asset can expose the Fund to losses.
Derivative instruments may include elements of leverage
and, accordingly, the fluctuation of the value of the
derivative instrument in relation to the underlying
asset may be magnified. The successful use of
derivative instruments depends upon a variety of
factors, particularly the Adviser's ability to predict
movements of the securities, currencies and commodities
markets, which requires different skills than
predicting changes in the prices of individual
securities. There can be no assurance that any
particular strategy adopted will succeed. A decision
to engage in a derivative transaction will reflect the
Adviser's judgment that the derivative transaction will
provide value to the Fund and its shareholders and is
consistent with the Fund's objectives, investment
limitations and operating policies. In making such a
judgment, the Adviser will analyze the benefits and
risks of the derivative transaction and weigh them in
the context of the Fund's entire portfolio and
investment objective.
(2) Credit Risk. The Fund will be subject to the
risk that a loss may be sustained by the Fund as a
result of the failure of a counterparty to comply with
the terms of a derivative instrument. The counterparty
risk for exchange-traded derivative instruments is
generally less than for privately-negotiated or OTC
derivative instruments, since generally a clearing
agency, which is the issuer or counterparty to each
exchange-traded instrument, provides a guarantee of
performance. For privately-negotiated instruments,
there is no similar clearing agency guarantee. In all
transactions, the Fund will bear the risk that the
counterparty will default, and this could result in a
loss of the expected benefit of the derivative
transaction and possibly other losses to the Fund. The
Fund will enter into transactions in derivative
instruments only with counterparties that the Adviser
reasonably believes are capable of performing under the
contract.
(3) Correlation Risk. When a derivative
transaction is used to completely hedge another
position, changes in the market value of the combined
position (the derivative instrument plus the position
being hedged) result from an imperfect correlation
between the price movements of the two instruments.
With a perfect hedge, the value of
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the combined
position remains unchanged for any change in the price
of the underlying asset. With an imperfect hedge, the
value of the derivative instrument and its hedge are
not perfectly correlated. Correlation risk is the risk
that there might be imperfect correlation, or even no
correlation, between price movements of an instrument
and price movements of investments being hedged. For
example, if the value of a derivative instrument used
in a short hedge (such as writing a call option, buying
a put option, or selling a futures contract) increased
by less than the decline in value of the hedged
investments, the hedge would not be perfectly
correlated. Such a lack of correlation might occur due
to factors unrelated to the value of the investments
being hedged, such as speculative or other pressures on
the markets in which these instruments are traded. The
effectiveness of hedges using instruments on indices
will depend, in part, on the degree of correlation
between price movements in the index and price
movements in the investments being hedged.
(4) Liquidity Risk. Derivatives are also subject
to liquidity risk. Liquidity risk is the risk that a
derivative instrument cannot be sold, closed out, or
replaced quickly at or very close to its fundamental
value. Generally, exchange contracts are very liquid
because the exchange clearinghouse is the counterparty
of every contract. The Fund might be required by
applicable regulatory requirement to maintain assets as
"cover," maintain segregated accounts, and/or make
margin payments when it takes positions in derivative
instruments involving obligations to third parties
(i.e., instruments other than purchased options). If
the Fund is unable to close out its positions in such
instruments, it might be required to continue to
maintain such assets or accounts or make such payments
until the position expired, matured or is closed out.
The requirements might impair the Fund's ability to
sell a portfolio security or make an investment at a
time when it would otherwise be favorable to do so, or
require that the Fund sell a portfolio investment at a
disadvantageous time. The Fund's ability to sell or
close out a position in an instrument prior to
expiration or maturity depends on the existence of a
liquid secondary market or, in the absence of such a
market, the ability and willingness of the counterparty
to enter into a transaction closing out the position.
Therefore, there is no assurance that any derivatives
position can be sold or closed out at a time and price
that is favorable to the Fund.
(5) Legal Risk. Legal risk is the risk of loss
caused by the legal unenforceability of a party's
obligations under the derivative. While a party
seeking price certainty agrees to surrender the
potential upside in exchange for downside protection,
the party taking the risk is looking for a positive
payoff. Despite this voluntary assumption of risk, a
counterparty that has lost money in a derivative
transaction may try to avoid payment by exploiting
various legal uncertainties about certain derivative
products.
(6) Systemic or "Interconnection" Risk.
Interconnection risk is the risk that a disruption in
the financial markets will cause difficulties for all
market participants. In other words, a disruption in
one market will spill over into other markets, perhaps
creating a chain reaction.
General Limitations. The use of derivative
instruments is subject to applicable regulations of the
SEC, the several options and futures exchanges upon
which they may be traded, and the Commodity Futures
Trading Commission ("CFTC").
The Corporation has filed a notice of eligibility
for exclusion from the definition of the term
"commodity pool operator" with the CFTC and the
National Futures Association, which regulate trading in
the futures markets. In accordance with Rule 4.5 of
the regulations under the CEA, the notice of
eligibility for the Fund includes representations that
the Fund will use futures contracts and related options
solely for bona fide hedging purposes within the
meaning of CFTC regulations, provided that the Fund may
hold other positions in futures contracts and related
options that do not qualify as a bona fide hedging
position if the aggregate initial margin deposits and
premiums required to establish these positions, less
the amount by which any such futures contracts and
related options positions are "in the money," do not
exceed 5% of the Fund's net assets.
The SEC has identified certain trading practices
involving derivative instruments that involve the
potential for leveraging the Fund's assets in a manner
that raises issues under the 1940 Act. In order to
limit the potential for the leveraging of the Fund's
assets, as defined under the 1940 Act, the SEC has
stated that a Fund may use coverage or the segregation
of the Fund's assets. The Fund will also set aside
permissible liquid assets in a segregated custodial
account if required to do so by SEC and CFTC
regulations. Assets used as cover or held in a
segregated account cannot be sold while the derivative
position is open, unless they are replaced with similar
assets. As a result, the commitment of a large portion
of the Fund's assets to segregated accounts could
impede portfolio management or the Fund's ability to
meet redemption requests or other current obligations.
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In some cases the Fund may be required to maintain
or limit exposure to a specified percentage of its
assets to a particular asset class. In such cases,
when the Fund uses a derivative instrument to increase
or decrease exposure to an asset class and is required
by applicable SEC guidelines to set aside liquid assets
in a segregated account to secure its obligations under
the derivative instruments, the Adviser may, where
reasonable in light of the circumstances, measure
compliance with the applicable percentage by reference
to the nature of the economic exposure created through
the use of the derivative instrument and not by
reference to the nature of the exposure arising from
the assets set aside in the segregated account (unless
another interpretation is specified by applicable
regulatory requirements).
Options. The Fund may use options for any lawful
purpose consistent with the Fund's investment objective
such as hedging or managing risk but not for
speculation. An option is a contract in which the
"holder" (the buyer) pays a certain amount (the
"premium") to the "writer" (the seller) to obtain the
right, but not the obligation, to buy from the writer
(in a "call") or sell to the writer (in a "put") a
specific asset at an agreed upon price (the "strike
price" or "exercise price") at or before a certain time
(the "expiration date"). The holder pays the premium
at inception and has no further financial obligation.
The holder of an option will benefit from favorable
movements in the price of the underlying asset but is
not exposed to corresponding losses due to adverse
movements in the value of the underlying asset. The
writer of an option will receive fees or premiums but
is exposed to losses due to changes in the value of the
underlying asset. The Fund may purchase (buy) or write
(sell) put and call options on assets, such as
securities, currencies, commodities, and indices of
debt and equity securities ("underlying assets") and
enter into closing transactions with respect to such
options to terminate an existing position. Options
used by the Fund may include European, American, and
Bermuda style options. If an option is exercisable
only at maturity, it is a "European" option; if it is
also exercisable prior to maturity, it is an "American"
option. If it is exercisable only at certain times, it
is a "Bermuda" option.
The Fund may purchase (buy) and write (sell) put
and call options and enter into closing transactions
with respect to such options to terminate an existing
position. The purchase of call options serves as a
long hedge, and the purchase of put options serves as a
short hedge. Writing put or call options can enable
the Fund to enhance income by reason of the premiums
paid by the purchaser of such options. Writing call
options serves as a limited short hedge because
declines in the value of the hedged investment would be
offset to the extent of the premium received for
writing the option. However, if the security
appreciates to a price higher than the exercise price
of the call option, it can be expected that the option
will be exercised and the Fund will be obligated to
sell the security at less than its market value or will
be obligated to purchase the security at a price
greater than that at which the security must be sold
under the option. Writing put options serves as a
limited long hedge because increases in the value of
the hedged investment would be offset to the extent of
the premium received for writing the option. However,
if the security depreciates to a price lower than the
exercise price of the put option, it can be expected
that the put option will be exercised and the Fund will
be obligated to purchase the security at more than its
market value.
The value of an option position will reflect,
among other things, the historical price volatility of
the underlying investment, the current market value of
the underlying investment, the time remaining until
expiration, the relationship of the exercise price to
the market price of the underlying investment, and
general market conditions.
The Fund may effectively terminate its right or
obligation under an option by entering into a closing
transaction. For example, the Fund may terminate its
obligation under a call or put option that it had
written by purchasing an identical call or put option;
this is known as a closing purchase transaction.
Conversely, the Fund may terminate a position in a put
or call option it had purchased by writing an identical
put or call option; this is known as a closing sale
transaction. Closing transactions permit the Fund to
realize the profit or limit the loss on an option
position prior to its exercise or expiration.
The Fund may purchase or write exchange-traded
options. Exchange-traded options are issued by a
clearing organization affiliated with the exchange on
which the option is listed that, in effect, guarantees
completion of every exchange-traded option transaction.
The Fund's ability to establish and close out
positions in exchange-listed options depends on the
existence of a liquid market. The Fund intends to
purchase or write only those exchange-traded options
for which there appears to be a liquid secondary
market. However, there can be no assurance that such a
market will exist at any particular time. If the Fund
were unable to effect a closing transaction for an
option it had purchased, it would have to exercise the
option to realize any profit.
<PAGE>
The Fund may engage in options transactions on
indices in much the same manner as the options on
securities discussed above, except the index options
may serve as a hedge against overall fluctuations in
the securities market in general.
The writing and purchasing of options is a highly
specialized activity that involves investment
techniques and risks different from those associated
with ordinary portfolio securities transactions.
Imperfect correlation between the options and
securities markets may detract from the effectiveness
of attempted hedging.
Futures Contracts. The Fund may use futures
contracts for any lawful purpose consistent with the
Fund's investment objective such as hedging and
managing risk but not for speculation. The Fund may
enter into futures contracts, including interest rate,
index, and currency futures. The Fund may also
purchase put and call options, and write covered put
and call options, on futures in which it is allowed to
invest. The purchase of futures or call options
thereon can serve as a long hedge, and the sale of
futures or the purchase of put options thereon can
serve as a short hedge. Writing covered call options
on futures contracts can serve as a limited short
hedge, and writing covered put options on futures
contracts can serve as a limited long hedge, using a
strategy similar to that used for writing covered
options in securities. The Fund's hedging may include
purchases of futures as an offset against the effect of
expected increases in currency exchange rates and
securities prices and sales of futures as an offset
against the effect of expected declines in currency
exchange rates and securities prices.
To the extent required by regulatory authorities,
the Fund may enter into futures contracts that are
traded on national futures exchanges and are
standardized as to maturity date and underlying
financial instrument. Futures exchanges and trading
are regulated under the CEA by the CFTC. Although
techniques other than sales and purchases of futures
contracts could be used to reduce the Fund's exposure
to market, currency, or interest rate fluctuations, the
Fund may be able to hedge its exposure more effectively
and perhaps at a lower cost through using futures
contracts.
An interest rate futures contract provides for the
future sale by one party and purchase by another party
of a specified amount of a specific financial
instrument (e.g., debt security) or currency for a
specified price at a designated date, time, and place.
An index futures contract is an agreement pursuant to
which the parties agree to take or make delivery of an
amount of cash equal to the difference between the
value of the index at the close of the last trading day
of the contract and the price at which the index
futures contract was originally written. Transaction
costs are incurred when a futures contract is bought or
sold and margin deposits must be maintained. A futures
contract may be satisfied by delivery or purchase, as
the case may be, of the instrument or the currency or
by payment of the change in the cash value of the
index. More commonly, futures contracts are closed out
prior to delivery by entering into an offsetting
transaction in a matching futures contract. Although
the value of an index might be a function of the value
of certain specified securities, no physical delivery
of those securities is made. If the offsetting
purchase price is less than the original sale price,
the Fund realizes a gain; if it is more, the Fund
realizes a loss. Conversely, if the offsetting sale
price is more than the original purchase price, the
Fund realizes a gain; if it is less, the Fund realizes
a loss. The transaction costs must also be included in
these calculations. There can be no assurance,
however, that the Fund will be able to enter into an
offsetting transaction with respect to a particular
futures contract at a particular time. If the Fund is
not able to enter into an offsetting transaction, the
Fund will continue to be required to maintain the
margin deposits on the futures contract.
No price is paid by the Fund upon entering into a
futures contract. Instead, at the inception of a
futures contract, the Fund is required to deposit in a
segregated account with its custodian, in the name of
the futures broker through whom the transaction was
effected, "initial margin," consisting of cash, U.S.
government securities or other liquid, high-grade debt
obligations, in an amount generally equal to 10% or
less of the contract value. Margin must also be
deposited when writing a call or put option on a
futures contract, in accordance with applicable
exchange rules. Unlike margin in securities
transaction, initial margin on futures contracts does
not represent a borrowing, but rather is in the nature
of a performance bond or good-faith deposit that is
returned to the Fund at the termination of the
transaction if all contractual obligations have been
satisfied. Under certain circumstances, such as
periods of high volatility, the Fund may be required by
an exchange to increase the level of its initial margin
payment, and initial margin requirements might be
increased generally in the future by regulatory action.
Subsequent "variation margin" payments are made to
and from the futures broker daily as the value of the
futures position varies, a process known as "marking to
market." Variation margin does not involve borrowing,
but rather represents a daily settlement of the Fund's
obligations to or from a futures broker. When the Fund
purchases an option on a future, the premium paid plus
transaction costs is all that is at risk. In contrast,
when the Fund purchases or
<PAGE>
sells a futures contract or
writes a call or put option thereon, it is subject to
daily variation margin calls that could be substantial
in the event of adverse price movements. If the Fund
has insufficient cash to meet daily variation margin
requirements, it might need to sell securities at a
time when such sales are disadvantageous. Purchasers
and sellers of futures positions and options on futures
can enter into offsetting closing transactions by
selling or purchasing, respectively, an instrument
identical to the instrument held or written. Positions
in futures and options on futures may be closed only on
an exchange or board of trade that provides a secondary
market. The Fund intends to enter into futures
transactions only on exchanges or boards of trade where
there appears to be a liquid secondary market.
However, there can be no assurance that such a market
will exist for a particular contract at a particular
time.
Under certain circumstances, futures exchanges may
establish daily limits on the amount that the price of
a future or option on a futures contract can vary from
the previous day's settlement price; once that limit is
reached, no trades may be made that day at a price
beyond the limit. Daily price limits do not limit
potential losses because prices could move to the daily
limit for several consecutive days with little or no
trading, thereby preventing liquidation of unfavorable
positions.
If the Fund were unable to liquidate a futures or
option on a futures contract position due to the
absence of a liquid secondary market or the imposition
of price limits, it could incur substantial losses.
The Fund would continue to be subject to market risk
with respect to the position. In addition, except in
the case of purchased options, the Fund would continue
to be required to make daily variation margin payments
and might be required to maintain the position being
hedged by the future or option or to maintain certain
liquid securities in a segregated account.
Certain characteristics of the futures market
might increase the risk that movements in the prices of
futures contracts or options on futures contracts might
not correlate perfectly with movements in the prices of
the investments being hedged. For example, all
participants in the futures and options on futures
contracts markets are subject to daily variation margin
calls and might be compelled to liquidate futures or
options on futures contracts positions whose prices are
moving unfavorably to avoid being subject to further
calls. These liquidations could increase the price
volatility of the instruments and distort the normal
price relationship between the futures or options and
the investments being hedged. Also, because initial
margin deposit requirements in the futures markets are
less onerous than margin requirements in the securities
markets, there might be increased participation by
speculators in the future markets. This participation
also might cause temporary price distortions. In
addition, activities of large traders in both the
futures and securities markets involving arbitrage,
"program trading," and other investment strategies
might result in temporary price distortions.
Additional Derivative Instruments and Strategies.
In addition to the derivative instruments and
strategies described above, the Adviser expects to
discover additional derivative instruments and other
hedging or risk management techniques. The Adviser may
utilize these new derivative instruments and techniques
to the extent that they are consistent with the Fund's
investment objective and permitted by the Fund's
investment limitations, operating policies and
applicable regulatory authorities.
Temporary Strategies
Prior to investing the proceeds from sales of Fund
shares, to meet ordinary daily cash needs or to respond
to adverse market, economic, political or other
conditions, the Adviser may hold cash and/or invest all
or a portion of the Fund's assets in money market
instruments, which are short-term fixed income
securities issued by private and governmental
institutions. Money market instruments include:
* Commercial paper;
* Short-term U.S. government securities;
* Banker's acceptances;
* Certificates of deposit;
* Time deposits; and
* Other short-term fixed income securities.
<PAGE>
If these temporary strategies are used for adverse
market, economic or political conditions, it is
impossible to predict when or for how long the Adviser
may employ these strategies for the Fund. To the
extent the Fund engages in this temporary strategy, the
Fund may not achieve its investment objective.
American Depositary Receipts
The Fund may take short positions in American
Depositary Receipts ("ADRs"). These securities may not
necessarily be denominated in the same currency as the
securities into which they may be converted.
Generally, ADRs, in registered form, are denominated in
U.S. dollars and are designed for use in the U.S.
securities markets. ADRs are receipts typically issued
by a U.S. Bank or trust company evidencing ownership of
the underlying securities. For purposes of the Fund's
investment objectives, ADRs are deemed to have the same
classification as the underlying securities they
represent. Although denominated in U.S. dollars, the
market price of ADRs may be affected by currency
fluctuations in the currency of the underlying
security.
ADR facilities may be established as either
"unsponsored" or "sponsored." The Fund may take short
positions in sponsored ADRs. A sponsored depositary is
required to provide shareholder information under its
contractual arrangements with the issuer, including
reliable financial statements. Under the terms of most
sponsored arrangements, depositories agree to
distribute notices of shareholder meetings and voting
instructions, and to provide shareholder communications
and other information to the ADR holders at the request
of the issuer of the deposited securities.
DIRECTORS AND OFFICERS
Under the laws of the State of Maryland, the Board
of Directors of the Corporation is responsible for
managing its business and affairs. The directors and
officers of the Corporation, together with information
as to their principal business occupations during the
last five years, and other information, are shown
below. Each director who is deemed an "interested
person," as defined in the 1940 Act, is indicated by an
asterisk.
Education and Principal
Name, Address Position(s) Held Business Occupations
and Age with the Corporation During Past 5 Years
*Paul L. McEntire Director and Mr. McEntire graduated
Skye Investment President Phi Beta Kappa with a
Advisors LLC, Bachelor of Science
985 University Avenue, degree in mathematics
Suite 26, from Stanford University
Los Gatos, California 95032 in 1965. Mr. McEntire
54 years old received a Masters of
Science in mathematics
from the State
University of New York
at Buffalo in 1972 and a
Ph.D. in Engineering-
Economic Systems from
Stanford University in
1982. Since 1989,
Mr. McEntire has served
as Chairman and chief
executive officer of
Skye Investments, Inc.,
the predecessor of the
Adviser. From 1994 to
1997, Mr. McEntire was a
broker with Brookstreet
Securities Corporation
in Irvine, California,
and from 1993 to 1994,
Mr. McEntire was a
broker with PaineWebber,
Inc. in Menlo Park,
California.
Mr. McEntire was
President and chief
executive officer of
Skye Investment
Advisors, Inc. from 1985
to 1988. Mr. McEntire
has been the Adviser's
Chairman and Managing
Member since 1996.
<PAGE>
*Robert E. Larson Director Mr. Larson received a
Skye Investment Bachelor of Science
Advisors LLC, degree in electrical
985 University Avenue, engineering from the
Suite 26, Massachusetts Institute
Los Gatos, California 95032 of Technology in 1960
60 years old and M.S. and Ph.D.
degrees in electrical
engineering from
Stanford University in
1961 and 1964,
respectively.
Mr. Larson has been a
General Partner of
Woodside Fund, a venture
capital fund, since
1983. Mr. Larson has
been a director of the
Adviser since 1997.
*Robert. W. Lishman, Jr. Director Mr. Lishman received a
Skye Investment Bachelor of Arts degree
Advisors LLC, in English from Harvard
985 University Avenue, College in 1969. In
Suite 26, 1989, Mr. Lishman
Los Gatos, California 95032 founded MCT, a medical
54 years old technology company and
served as its President
until 1994. Mr. Lishman
was self-employed as an
investment consultant in
1994. From 1995 to
1997, Mr. Lishman was an
adviser with Oxcal
Partners, an investment
advisory firm in Palo
Alto, California.
Mr. Lishman has been a
director of the Adviser
since 1996. Mr. Lishman
is also a director of
Wickersham Asset
Management, Imagesmith,
a web site development
firm, and Pantechnicon,
an aviation company, and
is an adviser with
Glenbrook Partners.
Thomas M. Cover Director Mr. Cover received a
Durand Building, Bachelor or Science
Room 121, degree from the
Stanford, California 94305 Massachusetts Institute
60 years old of Technology in 1960
and M.S. and Ph.D.
degrees from Stanford
University in 1961 and
1964, respectively. Mr.
Cover, is a Professor
jointly in the departments
of Electrical Engineering
and Statistics at Stanford
University since 1964.
Charles D. Feinstein Director Mr. Feinstein received
200 Cervantes Road, his Ph.D. in Engineering-
Redwood City, Economic Systems from
California 94062 Stanford University.
52 years old Mr. Feinstein, has been
an Associate Professor
at Santa Clara
University since 1983.
Mr. Feinstein is
President of the VMN
Group, a consulting firm.
David G. Luenberger Director Mr. Luenberger, has been
813 Tolman Drive, a Professor at Stanford
Stanford, California 94305 University since 1963.
61 years old Since 1981 Mr. Luenberger
has also been the President
and a director of Luenberger &
Associates, a consulting
firm. Mr. Luenberger
has been a director of
Onward, Inc., a software
and consulting business,
since 1998.
Edward C. Murphy Director Mr. Murphy, has been the
111 1/2 Cooper Street, Vice President of Sales
Santa Cruz, and Marketing of
California 95060 Imagesmith since May
45 years old 1999. From 1997 to
1999, Mr. Murphy was
Vice President of
Creative Services of
Dazai Advertising.
Mr. Murphy was Vice
President of Marketing
of Borealis Software,
<PAGE>
a company specializing in
sales force automation,
from 1995 to 1997 and of
Live Picture, Inc., a
professional imaging
software firm, from 1992
to 1995.
Thomas F. Burns, Jr. Secretary and Mr. Burns, received a
Skye Investment Treasurer Bachelor of Science
Advisors LLC, degree in accounting
985 University Avenue, from Quinnipiac College
Suite 26, in 1970. Prior to 1986,
Los Gatos, California 95032 Mr. Burns worked in
55 years old accounting at a Big Five
public accounting firm
and a Fortune 500
company and as a
financial officer of a
diversified holding
company and Equity Guard
Stock Fund, Inc., a
closed-end investment
company. From 1986 to
1992, Mr. Burns was
Chief Financial Officer
of Skye Investment
Advisors, Inc. and its
successor firm. From
1992 to 1997, Mr. Burns
was an independent
financial and business
consultant. Mr. Burns
has been the Adviser's
Chief Financial Officer
since July 1998.
As of October 18, 1999, Mr. Lishman, a director of
the Corporation, beneficially owned 100% of the Fund's
then outstanding shares of common stock. Directors and
officers of the Corporation who are also officers,
directors, employees or shareholders of the Adviser do
not receive any remuneration from the Fund for serving
as directors or officers.
The following table provides information relating
to annual compensation to be paid to directors of the
Corporation for their services as such (1):
Pension or
Name Aggregate Retirement Total
Compensation(2) Benefits Compensation
Paul L. McEntire $ 0 $ 0 $ 0
Robert E. Larson 0 0 0
Robert W.Lishman, Jr. 0 0 0
Thomas M. Cover 1,250 0 1,250
Charles D.Feinstein 1,250 0 1,250
David G. Luenberger 1,250 0 1,250
Edward C. Murphy 1,250 0 1,250
All directors $5,000 $0 $5,000
as a group
(7 persons)
____________________
(1) The amounts indicated are estimates of amounts to
be paid by the Corporation.
(2) Each director who is not deemed an "interested
person" as defined in the 1940 Act, will receive $500
for each in-person Board of Directors meeting attended
by such person and $250 for each telephonic Board of
Directors meeting attended by such person and
reasonable expenses incurred in connection therewith.
The Board anticipates holding four
<PAGE>
meetings during
fiscal 2000, one of which the Fund expects will be in-
person. Thus, each disinterested director is entitled
to up to $1,250 during such time period from the
Corporation, plus reasonable expenses.
PRINCIPAL SHAREHOLDERS
As of October 18, 1999, the following person owned
of record or is known by the Corporation to own of
record or beneficially 5% or more of the outstanding
shares of the Fund:
Name and Address No. Shares Percentage
Robert W. Lishman, Jr. 10,000 100%
985 University Avenue, Suite 26
Los Gatos, California 95032
Based on the foregoing, as of October 18, 1999,
Mr. Lishman owned a controlling interest in the
Corporation. Shareholders with a controlling interest
could effect the outcome of proxy voting or the
direction of management of the Corporation.
INVESTMENT ADVISER
Skye Investment Advisors LLC (the "Adviser") is
the investment adviser to the Fund. Hambrecht & Quist,
a broker-dealer, owns approximately 35% of the Adviser
and is deemed to "control" the Adviser within the
meaning of the 1940 Act. Messrs. McEntire, Larson and
Lishman, all of whom are officers and/or directors of
the Corporation, together own approximately 28% of the
Adviser and together are also deemed to "control" the
Adviser within the meaning of the 1940 Act.
The investment advisory agreement between the
Corporation and the Adviser dated as of October 28,
1999 (the "Advisory Agreement") has an initial term of
two years and thereafter is required to be approved
annually by the Board of Directors of the Corporation
or by vote of a majority of the Fund's outstanding
voting securities. Each annual renewal must also be
approved by the vote of a majority of the Corporation's
directors who are not parties to the Advisory Agreement
or interested persons of any such party, cast in person
at a meeting called for the purpose of voting on such
approval. The Advisory Agreement was approved by the
Board of Directors, including a majority of the
disinterested directors on June 3, 1999 and by the
initial shareholder of the Fund on October 18, 1999.
The Advisory Agreement is terminable without penalty,
on 60 days' written notice by the Board of Directors of
the Corporation, by vote of a majority of the Fund's
outstanding voting securities or by the Adviser, and
will terminate automatically in the event of its
assignment.
Under the terms of the Advisory Agreement, the
Adviser manages the Fund's investments and business
affairs, subject to the supervision of the
Corporation's Board of Directors. At its expense, the
Adviser provides office space and all necessary office
facilities, equipment and personnel for managing the
investments of the Fund. As compensation for its
services, the Fund pays the Adviser an annual
management fee of 1.25% of the Fund's average daily net
assets attributable to each class of shares. The
advisory fee is accrued daily and paid monthly.
Pursuant to the Advisory Agreement, the Adviser
has contractually agreed that until October 31, 2000,
the Adviser will waive its management fee and/or
reimburse the Fund's operating expenses to the extent
necessary to ensure that the total operating expenses
(on an annual basis) do not exceed 2.50% of the
Investor Class's average daily net assets and 2.75% of
the Institutional Class's average daily net assets.
After such date, the Adviser may from time to time
voluntarily waive all or a portion of its fee and/or
absorb expenses for the Fund. Any waiver of fees or
absorption of expenses will be made on a monthly basis
and, with respect to the latter, will be paid to the
Fund by reduction of the Adviser's fee. Any such
waiver/absorption is subject to later adjustment during
the term of the Advisory Agreement to allow the Adviser
to recoup amounts waived/absorbed, including initial
organization costs of the Fund, provided, however,
that, the Adviser shall only be entitled to recoup such
amounts for a maximum period of three years from the
date such amount was waived or reimbursed.
<PAGE>
FUND TRANSACTIONS AND BROKERAGE
Under the Advisory Agreement, the Adviser, in its
capacity as portfolio manager, is responsible for
decisions to buy and sell securities for the Fund and
for the placement of the Fund's securities business,
the negotiation of the commissions to be paid on such
transactions and the allocation of portfolio brokerage
business. The Adviser seeks to obtain the best
execution at the best security price available with
respect to each transaction. The best price to the
Fund means the best net price without regard to the mix
between purchase or sale price and commission, if any.
While the Adviser seeks reasonably competitive
commission rates, the Fund does not necessarily pay the
lowest available commission. The Adviser does not
anticipate that brokerage will be allocated based on
the sale of the Fund's shares.
When the Adviser buys or sells the same security
for two or more advisory accounts, including the Fund,
the Adviser may place concurrent orders with a single
broker to be executed as a single, aggregated block in
order to facilitate orderly and efficient execution.
Whenever the Adviser does so, each advisory account on
whose behalf an order was placed will receive the
average price at which the block was executed and will
bear a proportionate share of all transaction costs,
based on the size of the advisory account's order.
While the Adviser believes combining orders for
advisory accounts will, over time, be advantageous to
all participants, in particular cases the average price
at which the block was executed could be less
advantageous to one particular advisory account than if
the advisory account had been the only account
effecting the transaction or had completed its
transaction before the other participants.
Section 28(e) of the Securities Exchange Act of
1934, as amended ("Section 28(e)"), permits an
investment adviser, under certain circumstances, to
cause an account to pay a broker or dealer who supplies
brokerage and research services a commission for
effecting a transaction in excess of the amount of
commission another broker or dealer would have charged
for effecting the transaction. Brokerage and research
services include (a) furnishing advice as to the value
of securities, the advisability of investing,
purchasing or selling securities and the availability
of securities or purchasers or sellers of securities;
(b) furnishing analyses and reports concerning issuers,
industries, securities, economic factors and trends,
portfolio strategy and the performance of accounts; and
(c) effecting securities transactions and performing
functions incidental thereto (such as clearance,
settlement and custody).
In selecting brokers or dealers, the Adviser
considers investment and market information and other
research, such as economic, securities and performance
measurement research provided by such brokers or
dealers and the quality and reliability of brokerage
services, including execution capability, performance
and financial responsibility. Accordingly, the
commissions charged by any such broker or dealer may be
greater than the amount another firm might charge if
the Adviser determines in good faith that the amount of
such commissions is reasonable in relation to the value
of the research information and brokerage services
provided by such broker or dealer to the Fund. The
Adviser believes that the research information received
in this manner provides the Fund with benefits by
supplementing the research otherwise available to the
Fund. Such higher commissions will not be paid by the
Fund unless (a) the Adviser determines in good faith
that the amount is reasonable in relation to the
services in terms of the particular transaction or in
terms of the Adviser's overall responsibilities with
respect to the accounts, including the Fund, as to
which it exercises investment discretion; (b) such
payment is made in compliance with the provisions of
Section 28(e) and other applicable state and federal
laws; and (c) in the opinion of the Adviser, the total
commissions paid by the Fund will be reasonable in
relation to the benefits to the Fund over the long
term.
The Adviser places portfolio transactions for
other advisory accounts managed by the Adviser.
Research services furnished by firms through which the
Fund effects its securities transactions may be used by
the Adviser in servicing all of its accounts; not all
of such services may be used by the Adviser in
connection with the Fund. The Adviser believes it is
not possible to measure separately the benefits from
research services to each of the accounts (including
the Fund) managed by it. Because the volume and nature
of the trading activities of the accounts are not
uniform, the amount of commissions in excess of those
charged by another broker paid by each account for
brokerage and research services will vary. However,
the Adviser believes such costs to the Fund will not be
disproportionate to the benefits received by the Fund
on a continuing basis. The Adviser seeks to allocate
portfolio transactions equitably whenever concurrent
decisions are made to purchase or sell securities by
the Fund and another advisory account. In some cases,
this procedure could have an adverse effect on the
price or the amount of securities available to the
Fund. In making such allocations between the Fund and
other advisory accounts, the main factors considered by
the Adviser are the respective investment objectives,
the relative size of portfolio holdings of the same or
comparable securities, the availability of cash for
investment and the size of investment commitments
generally held.
<PAGE>
CUSTODIAN
As custodian of the Fund's assets, Firstar Bank
Milwaukee, N.A. ("Firstar Bank"), 777 East Wisconsin
Avenue, Milwaukee, Wisconsin 53202, has custody of all
securities and cash of the Fund, delivers and receives
payment for portfolio securities sold, receives and
pays for portfolio securities purchased, collects
income from investments and performs other duties, all
as directed by the officers of the Corporation.
TRANSFER AGENT AND DIVIDEND-DISBURSING AGENT
Firstar Mutual Fund Services, LLC ("Firstar"),
Third Floor, 615 East Michigan Street, Milwaukee,
Wisconsin 53202, acts as transfer agent and dividend-
disbursing agent for the Fund. Firstar is compensated
based on an annual fee per open account of $16.00
(subject to a minimum annual fee of $35,500) plus out-
of-pocket expenses, such as postage and printing
expenses in connection with shareholder communications.
From time to time, the Corporation, on behalf of
the Fund, directly or indirectly through arrangements
with the Adviser, the Distributor (as defined below) or
Firstar, may pay amounts to third parties that provide
transfer agent type services and other administrative
services relating to the Fund to persons who
beneficially have interests in the Fund, such as
participants in 401(k) plans. These services may
include, among other things, sub-accounting services,
transfer agent type activities, answering inquiries
relating to the Fund, transmitting proxy statements,
annual reports, updated prospectuses, other
communications regarding the Fund and related services
as the Fund or beneficial owners may reasonably
request. In such cases, the Fund will not pay fees
based on the number of beneficial owners at a rate that
is greater than the rate the Fund is currently paying
Firstar for providing these services to the Fund's
shareholders (i.e., $16.00 per account plus expenses).
ADMINISTRATOR
Pursuant to a Fund Administration Servicing
Agreement and a Fund Accounting Servicing Agreement,
Firstar also performs accounting and certain compliance
and tax reporting functions for the Corporation. For
these services, Firstar receives from the Corporation
out-of-pocket expenses plus the following aggregate
annual fees, computed daily and payable monthly, based
on the Fund's aggregate average net assets:
Administrative Services Fees
First $200 million of average net assets .06%*
Next $500 million of average net assets .05%
Average net assets in excess of $700 million .03%
_____________________________
* Subject to a minimum fee of $55,000.
Accounting Services Fees
First $40 million of average net assets $27,500
Next $200 million of average net assets .0125%
Average net assets in excess of $240 million .00625%
DISTRIBUTOR AND PLAN OF DISTRIBUTION
Distributor
Under a distribution agreement dated October 28,
1999 (the "Distribution Agreement"), Rafferty Capital
Markets, Inc. (the "Distributor"), 1311 Mamaroneck
Avenue, White Plains, New York 10605, acts as principal
distributor of the Fund's shares. The Distribution
Agreement provides that the Distributor will use its
best efforts to distribute the Fund's shares, which
shares are offered for sale by the Fund continuously at
net asset value per share without the imposition of a
sales charge. Pursuant to the terms of the
Distribution Agreement, the Distributor receives from
the Corporation out-of-pocket expenses plus an annual
fee equal to the greater of (i) $18,000 or (ii) .01% of
the Fund's average net assets, computed daily and
payable monthly. All or a portion of the distribution
and shareholder
<PAGE>
servicing fee may be used by the
Distributor to pay such expenses with respect to the
Investor Class shares under the distribution and
shareholder servicing plan discussed below.
Distribution and Shareholder Servicing Plan
The Corporation, on behalf of the Fund's Investor
Class, has adopted a plan pursuant to Rule 12b-1 under
the 1940 Act (the "12b-1 Plan"), which authorizes it to
pay the Distributor, in its capacity as the principal
distributor of Investor Class shares, or any Recipient
(as defined below) a distribution and shareholder
servicing fee of up to 0.25% per annum of the Fund's
average daily net assets attributable to the Investor
Class. Under the terms of the 12b-1 Plan, the
Corporation or the Distributor may pay all or a portion
of this fee to any securities dealer, financial
institution or any other person (the "Recipient") who
renders assistance in distributing or promoting the
sale of Investor Class shares, or who provides certain
shareholder services to Investor Class shareholders,
pursuant to a written agreement (the "Related
Agreement"). The 12b-1 Plan is a "reimbursement" plan,
which means that the fees paid by the Fund are intended
as reimbursement for services rendered up to the
maximum allowable fee. If more money for services
rendered is due than is immediately payable because of
the expense limitation under the 12b-1 Plan, the unpaid
amount is carried forward from period to period while
the 12b-1 Plan is in effect until such time as it may
be paid. No interest, carrying or other forward charge
will be borne by the Fund with respect to unpaid
amounts carried forward. The 12b-1 Plan has the effect
of increasing the Investor Class's expenses from what
they would otherwise be. The Board of Directors
reviews the Fund's distribution and shareholder
servicing fee payments in connection with its
determination as to the continuance of the 12b-1 Plan.
The 12b-1 Plan, including forms of Related
Agreements, has been unanimously approved by a majority
of the Board of Directors of the Corporation, and of
the members of the Board who are not "interested
persons" of the Corporation as defined in the 1940 Act
and who have no direct or indirect financial interest
in the operation of the 12b-1 Plan or any Related
Agreements (the "Disinterested Directors") voting
separately. The 12b-1 Plan, and any Related Agreement
which is entered into, will continue in effect for a
period of more than one year only so long as its
continuance is specifically approved at least annually
by a vote of a majority of the Corporation's Board of
Directors and of the Disinterested Directors, cast in
person at a meeting called for the purpose of voting on
the 12b-1 Plan or the Related Agreement, as applicable.
In addition, the 12b-1 Plan and any Related Agreement
may be terminated at any time, without penalty, by vote
of a majority of the outstanding voting securities of
the Investor Class, or by vote of a majority of
Disinterested Directors (on not more than 60 days'
written notice in the case of the Related Agreement
only). Payment of the distribution and shareholder
servicing fee is to be made monthly. The Distributor
and/or Recipients will provide reports or invoices to
the Corporation of all amounts payable to them (and the
purposes for which the amounts were expended) pursuant
to the 12b-1 Plan.
Interests of Certain Persons
With the exception of the Adviser, in its capacity
as the Fund's investment adviser, and the Distributor,
in its capacity as principal distributor of Fund
shares, no "interested person" of the Fund, as defined
in the 1940 Act, and no director of the Fund who is not
an "interested person" has or had a direct or indirect
financial interest in the 12b-1 Plan or any Related
Agreement.
Anticipated Benefits to the Fund
The Board of Directors considered various factors
in connection with its decision to approve the 12b-1
Plan, including: (a) the nature and causes of the
circumstances which make implementation of the 12b-1
Plan necessary and appropriate; (b) the way in which
the 12b-1 Plan would address those circumstances,
including the nature and potential amount of
expenditures; (c) the nature of the anticipated
benefits; (d) the merits of possible alternative plans
or pricing structures; (e) the relationship of the
12b-1 Plan to other distribution efforts of the Fund;
and (f) the possible benefits of the 12b-1 Plan to any
other person relative to those of the Fund.
Based upon its review of the foregoing factors and
the material presented to it, and in light of its
fiduciary duties under relevant state law and the 1940
Act, the Board of Directors determined, in the exercise
of its business judgment, that the 12b-1 Plan was
reasonably likely to benefit the Investor Class and its
shareholders in at least one or several potential ways.
Specifically, the Board concluded that the Distributor
and any Recipients operating under Related Agreements
would have little or no incentive to incur promotional
expenses on behalf of the Investor Class if a 12b-1
Plan were not in place to reimburse them, thus making
the adoption of such 12b-1 Plan important to the
initial success and thereafter, continued viability of
the Investor Class. In addition, the Board determined
that the payment of
<PAGE>
distribution fees to these persons
should motivate them to provide an enhanced level of
service to Investor Class shareholders, which would, of
course, benefit such shareholders. Finally, the
adoption of the 12b-1 Plan would help to increase net
assets under management in a relatively short amount of
time, given the marketing efforts on the part of the
Distributor and Recipients to sell Investor Class
shares, which should result in certain economies of
scale.
While there is no assurance that the expenditure
of Investor Class assets to finance distribution of
Investor Class shares will have the anticipated
results, the Board of Directors believes there is a
reasonable likelihood that one or more of such benefits
will result, and since the Board will be in a position
to monitor the distribution and shareholder servicing
expenses of the Investor Class, it will be able to
evaluate the benefit of such expenditures in deciding
whether to continue the 12b-1 Plan.
PURCHASE AND PRICING OF SHARES
Automatic Investment Plan
The Automatic Investment Plan ("AIP") allows you
to make regular, systematic investments in Investor
Class shares from your bank checking or NOW account.
The minimum initial investment for investors using the
AIP is $1,000. To establish the AIP, complete the
appropriate section in the shareholder application.
Under certain circumstances (such as discontinuation of
the AIP before the Fund's minimum initial investment is
reached), the Fund reserves the right to close the
investor's account. Prior to closing any account for
failure to reach the minimum initial investment, the
Fund will give the investor written notice and 60 days
in which to reinstate the AIP or otherwise reach the
minimum initial investment. You should consider your
financial ability to continue in the AIP until the
minimum initial investment amount is met because the
Fund has the right to close an investor's account for
failure to reach the minimum initial investment. Such
closing may occur in periods of declining share prices.
Under the AIP, you may choose to make monthly
investments on the days of your choosing (or the next
business day thereafter) from your financial
institution in amounts of $50 or more. There is no
service fee for participating in the AIP. However, a
service fee of $20 will be deducted from your Fund
account for any AIP purchase that does not clear due to
insufficient funds or, if prior to notifying the Fund
in writing or by telephone of your intention to
terminate the plan, you close your bank account or in
any manner prevent withdrawal of funds from the
designated checking or NOW account. You can set up the
AIP with any financial institution that is a member of
the Automated Clearing House.
The AIP is a method of using dollar cost averaging
which is an investment strategy that involves investing
a fixed amount of money at a regular time interval.
However, a program of regular investment cannot ensure
a profit or protect against a loss from declining
markets. By always investing the same amount, you will
be purchasing more shares when the price is low and
fewer shares when the price is high. Since such a
program involves continuous investment regardless of
fluctuating share values, you should consider your
financial ability to continue the program through
periods of low share price levels.
Individual Retirement Accounts
In addition to purchasing Investor Class shares as
described in the Prospectus under "How to Purchase
Shares," individuals may establish their own tax-
sheltered individual retirement accounts ("IRAs"). The
Fund offers two types of IRAs, including the
Traditional IRA, that can be adopted by executing the
appropriate Internal Revenue Service ("IRS") Form.
Traditional IRA. In a Traditional IRA, amounts
contributed to the IRA may be tax deductible at the
time of contribution depending on whether the investor
is an "active participant" in an employer-sponsored
retirement plan and the investor's income.
Distributions from a Traditional IRA will be taxed at
distribution except to the extent that the distribution
represents a return of the investor's own contributions
for which the investor did not claim (or was not
eligible to claim) a deduction. Distributions prior to
age 59-1/2 may be subject to an additional 10% tax
applicable to certain premature distributions.
Distributions must commence by April 1 following the
calendar year in which the investor attains age 70-1/2.
Failure to begin distributions by this date (or
distributions that do not equal certain minimum
thresholds) may result in adverse tax consequences.
Roth IRA. In a Roth IRA, amounts contributed to
the IRA are taxed at the time of contribution, but
distributions from the IRA are not subject to tax if
the investor has held the IRA for certain minimum
periods of
<PAGE>
time (generally, until age 59-1/2).
Investors whose income exceeds certain limits are
ineligible to contribute to a Roth IRA. Distributions
that do not satisfy the requirements for tax-free
withdrawal are subject to income taxes (and possibly
penalty taxes) to the extent that the distribution
exceeds the investor's contributions to the IRA. The
minimum distribution rules applicable to Traditional
IRAs do not apply during the lifetime of the investor.
Following the death of the investor, certain minimum
distribution rules apply.
For Traditional and Roth IRAs, the maximum annual
contribution generally is equal to the lesser of $2,000
or 100% of the investor's compensation (earned income).
An individual may also contribute to a Traditional IRA
or Roth IRA on behalf of his or her spouse provided
that the individual has sufficient compensation (earned
income). Contributions to a Traditional IRA reduce the
allowable contributions under a Roth IRA, and
contributions to a Roth IRA reduce the allowable
contribution to a Traditional IRA.
Simplified Employee Pension Plan. A Traditional
IRA may also be used in conjunction with a Simplified
Employee Pension Plan ("SEP-IRA"). A SEP-IRA is
established through execution of Form 5305-SEP together
with a Traditional IRA established for each eligible
employee. Generally, a SEP-IRA allows an employer
(including a self-employed individual) to purchase
shares with tax deductible contributions not exceeding
annually for any one participant 15% of compensation
(disregarding for this purpose compensation in excess
of $160,000 per year). The $160,000 compensation limit
applies for 1999 and is adjusted periodically for cost
of living increases. A number of special rules apply
to SEP Plans, including a requirement that
contributions generally be made on behalf of all
employees of the employer (including for this purpose a
sole proprietorship or partnership) who satisfy certain
minimum participation requirements.
SIMPLE IRA. An IRA may also be used in connection
with a SIMPLE Plan established by the investor's
employer (or by a self-employed individual). When this
is done, the IRA is known as a SIMPLE IRA, although it
is similar to a Traditional IRA with the exceptions
described below. Under a SIMPLE Plan, the investor may
elect to have his or her employer make salary reduction
contributions of up to $6,000 per year to the SIMPLE
IRA. The $6,000 limit applies for 1999 and is adjusted
periodically for cost of living increases. In
addition, the employer will contribute certain amounts
to the investor's SIMPLE IRA, either as a matching
contribution to those participants who make salary
reduction contributions or as a non-elective
contribution to all eligible participants whether or
not making salary reduction contributions. A number of
special rules apply to SIMPLE Plans, including (1) a
SIMPLE Plan generally is available only to employers
with fewer than 100 employees; (2) contributions must
be made on behalf of all employees of the employer
(other than bargaining unit employees) who satisfy
certain minimum participation requirements; (3)
contributions are made to a special SIMPLE IRA that is
separate and apart from the other IRAs of employees;
(4) the distribution excise tax (if otherwise
applicable) is increased to 25% on withdrawals during
the first two years of participation in a SIMPLE IRA;
and (5) amounts withdrawn during the first two years of
participation may be rolled over tax-free only into
another SIMPLE IRA (and not to a Traditional IRA or to
a Roth IRA). A SIMPLE IRA is established by executing
Form 5304-SIMPLE together with an IRA established for
each eligible employee.
Under current IRS regulations, all IRA applicants
must be furnished a disclosure statement containing
information specified by the IRS. Applicants generally
have the right to revoke their account within seven
days after receiving the disclosure statement and
obtain a full refund of their contributions. Firstar,
the Fund's custodian, may, in its discretion, hold the
initial contribution uninvested until the expiration of
the seven-day revocation period. Firstar does not
anticipate that it will exercise its discretion but
reserves the right to do so.
Systematic Withdrawal Plan
Investor Class shareholders may set up automatic
withdrawals from their Fund accounts at regular
intervals. To begin distributions, a shareholder's
account must have an initial balance of $1,000 and at
least $50 per payment must be withdrawn. To establish
the systematic withdrawal plan ("SWP"), the appropriate
section in the shareholder application must be
completed. Redemptions will take place on a monthly,
quarterly, semi-annual or annual basis (or the
following business day) as indicated on the shareholder
application. The amount or frequency of withdrawal
payments may be varied or temporarily discontinued by
calling 1-888-288-2880. Depending upon the size of the
account and the withdrawals requested (and fluctuations
in the net asset value of the shares redeemed),
redemptions for the purpose of satisfying such
withdrawals may reduce or even exhaust a shareholder's
account. If the amount remaining in a shareholder's
account is not sufficient to meet a plan payment, the
remaining amount will be redeemed and the SWP will be
terminated.
<PAGE>
Waiver of Institutional Class Minimum
The Fund will waive the Institutional Class's
minimums for persons who own shares of the hedge fund
managed by the Adviser.
Pricing of Shares
Shares of the Fund are sold on a continual basis
at the net asset value per share next computed
following receipt of an order in proper form by a
dealer, the Distributor or Firstar, the Fund's transfer
agent.
The net asset value per share for each class of
shares is determined as of the close of trading
(generally 4:00 p.m. Eastern Standard Time) on each day
the New York Stock Exchange (the "NYSE") is open for
business. Purchase orders received or shares tendered
for redemption on a day the NYSE is open for trading,
prior to the close of trading on that day, will be
valued as of the close of trading on that day.
Applications for purchase of shares and requests for
redemption of shares received after the close of
trading on the NYSE will be valued as of the close of
trading on the next day the NYSE is open. The net
asset value for each class of shares is calculated by
taking the fair value of the Fund's total assets
attributable to each class of shares, including
interest or dividends accrued, but not yet collected,
less all liabilities, and dividing by the total number
of shares outstanding. The result, rounded to the
nearest cent, is the net asset value per share.
In determining the net asset value, expenses are
accrued and applied daily and securities and other
assets for which market quotations are available are
valued at market value. Common stocks and other equity-
type securities are valued at the last sales price on
the national securities exchange or NASDAQ on which
such securities are primarily traded; however,
securities traded on a national securities exchange or
NASDAQ for which there were no transactions on a given
day, and securities not listed on a national securities
exchange or NASDAQ, are valued at the average of the
most recent bid and asked prices. Fixed income
securities are valued by a pricing service that
utilizes electronic data processing techniques to
determine values for normal institutional-sized trading
units of fixed income securities without regard to sale
or bid prices when such values are believed to more
accurately reflect the fair market value of such
securities; otherwise, actual sale or bid prices are
used. Any securities or other assets for which market
quotations are not readily available are valued at fair
value as determined in good faith by the Board of
Directors of the Corporation. The Board of Directors
may approve the use of pricing services to assist the
Fund in the determination of net asset value. Fixed
income securities having remaining maturities of 60
days or less when purchased are generally valued by the
amortized cost method. Under this method of valuation,
a security is initially valued at its acquisition cost
and, thereafter, amortization of any discount or
premium is assumed each day, regardless of the impact
of fluctuating interest rates on the market value of
the security.
REDEMPTIONS IN KIND
The Fund has filed a Notification under Rule 18f-1
of the 1940 Act, pursuant to which it has agreed to pay
in cash all requests for redemption by any shareholder
of record, limited in amount with respect to each
shareholder during any 90-day period to the lesser
amount of (i) $250,000 or (ii) 1% of the net asset
value of the class of shares of the Fund being
redeemed, valued at the beginning of the election
period. The Fund intends also to pay redemption
proceeds in excess of such lesser amount in cash, but
reserves the right to pay such excess amount in kind,
if it is deemed to be in the best interest of the Fund
to do so. If you receive an in kind distribution, you
will likely incur a brokerage charge on the disposition
of investments through a securities dealer.
TAXATION OF THE FUND
The Fund intends to qualify annually as a
"regulated investment company" under Subchapter M of
the Code, and, if so qualified, will not be liable for
federal income taxes to the extent earnings are
distributed to shareholders on a timely basis. In the
event the Fund fails to qualify as a "regulated
investment company," it will be treated as a regular
corporation for federal income tax purposes.
Accordingly, the Fund would be subject to federal
income taxes and any distributions that it makes would
be taxable and non-deductible by the Fund. This would
increase the cost of investing in the Fund for
shareholders and would make it more economical for
shareholders to invest directly in securities held by
the Fund instead of investing indirectly in such
securities through the Fund.
<PAGE>
PERFORMANCE INFORMATION
The Fund's historical performance or return may be
shown in the form of various performance figures. The
Fund's performance figures are based upon historical
results and are not necessarily representative of
future performance. Factors affecting the Fund's
performance include general market conditions,
operating expenses and investment management.
Total Return
The average annual total return of the Fund is
computed by finding the average annual compounded rates
of return over the periods that would equate the
initial amount invested to the ending redeemable value,
according to the following formula:
P(1+T)n = ERV
P = a hypothetical initial payment of $1,000.
T = average annual total return.
n = number of years.
ERV = ending redeemable value of a
hypothetical $1,000 payment made at
the beginning of the stated periods
at the end of the stated periods.
Performance for a specific period is calculated by
first taking an investment (assumed to be $1,000)
("initial investment") in the Fund's shares on the
first day of the period and computing the "ending
value" of that investment at the end of the period.
The total return percentage is then determined by
subtracting the initial investment from the ending
value and dividing the remainder by the initial
investment and expressing the result as a percentage.
The calculation assumes that all income and capital
gains dividends paid by the Fund have been reinvested
at the net asset value of the Fund on the reinvestment
dates during the period. Total return may also be
shown as the increased dollar value of the hypothetical
investment over the period.
Cumulative total return represents the simple
change in value of an investment over a stated period
and may be quoted as a percentage or as a dollar
amount. Total returns may be broken down into their
components of income and capital (including capital
gains and changes in share price) in order to
illustrate the relationship between these factors and
their contributions to total return.
Comparisons
From time to time, in marketing and other Fund
literature, the Fund's performance may be compared to
the performance of other mutual funds in general or to
the performance of particular types of mutual funds
with similar investment goals, as tracked by
independent organizations. Among these organizations,
Lipper Analytical Services, Inc. ("Lipper"), a widely
used independent research firm which ranks mutual funds
by overall performance, investment objectives and
assets, may be cited. Lipper performance figures are
based on changes in net asset value, with all income
and capital gains dividends reinvested. Such
calculations do not include the effect of any sales
charges imposed by other funds. The Fund will be
compared to Lipper's appropriate fund category, that
is, by fund objective and portfolio holdings.
The Fund's performance may also be compared to the
performance of other mutual funds by Morningstar, Inc.
("Morningstar"), which ranks funds on the basis of
historical risk and total return. Morningstar's
rankings range from five stars (highest) to one star
(lowest) and represent Morningstar's assessment of the
historical risk level and total return of a fund as a
weighted average for 3, 5 and 10 year periods.
Rankings are not absolute or necessarily predictive of
future performance.
Evaluations of Fund performance made by
independent sources may also be used in advertisements
concerning the Fund, including reprints of or
selections from, editorials or articles about the Fund.
Sources for Fund performance and articles about the
Fund may include publications such as Money, Forbes,
Kiplinger's, Financial World, Business Week, U.S. News
and World Report, the Wall Street Journal, Barron's and
a variety of investment newsletters.
<PAGE>
The Fund may compare its performance to a wide
variety of indices and measures of inflation including
the Standard & Poor's Index of 500 Stocks, the NASDAQ
Over-the-Counter Composite Index and the Russell 2000
Index. There are differences and similarities between
the investments that the Fund may purchase for its
portfolio and the investments measured by these
indices.
INDEPENDENT ACCOUNTANTS
PricewaterhouseCoopers LLP, 100 East Wisconsin
Avenue, Suite 1500, Milwaukee, Wisconsin 53202,
independent accountants for the Fund, audit and report
on the Fund's financial statements.
FINANCIAL STATEMENTS
The following financial statements of the Fund are
contained herein:
(a) Report of Independent Accountants.
(b) Statement of Assets and Liabilities.
(c) Statement of Operations.
(d) Notes to the Financial Statements.
<PAGE>
Report of Independent Accountants
To the Shareholders and Board of Directors of
Bearguard Funds, Inc.
In our opinion, the accompanying statement of assets
and liabilities and the related statement of operations
present fairly, in all material respects, the financial
position of Bearguard Fund (constituting the Bearguard
Funds, Inc. and hereafter referred to as the "Fund") at
October 18, 1999 and the results of its operations for
the period from April 8, 1999 (inception) through
October 18, 1999, in conformity with generally accepted
accounting principles. These financial statements are
the responsibility of the Fund's management; our
responsibility is to express an opinion on these
financial statements based on our audit. We conducted
our audit of these financial statements in accordance
with generally accepted auditing standards which
require that we plan and perform the audit to obtain
reasonable assurance about whether the financial
statements are free of material misstatement. An audit
includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used
and significant estimates made by management, and
evaluating the overall financial statement
presentation. We believe that our audit provides a
reasonable basis for the opinion expressed above.
/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
Milwaukee, Wisconsin
October 19, 1999
<PAGE>
Bearguard Fund
Statement of Assets and Liabilities
October 18, 1999
ASSETS
Cash $ 100,000
Receivable from Adviser 56,122
Prepaid Expenses 48,350
----------
Total Assests 204,472
LIABILITIES
Payable to Adviser 104,472
----------
Total Liabilities 104,472
----------
NET ASSETS $ 100,000
==========
INVESTOR CLASS
Net Assets $ 50,000
Shares issued and outstanding; ----------
50,000,000 shares authorized 5,000
Net asset value, offering and ----------
redemption price per share $ 10.00
INSTITUTIONAL CLASS
Net Assets 50,000
Shares issued and outstanding; ----------
50,000,000 shares authorized 5,000
Net asset vaule, offering and ----------
redemption price per share $ 10.00
The accompanying notes are an integral part of these financial statements.
<PAGE>
Bearguard Fund
Statement of Operations
For the period April 8, 1999 (inception) through October 18, 1999
EXPENSES:
Organization expenses $ 56,122
Less: Expenses reimbursed by Adviser (56,122)
---------
Net income/(loss) -
=========
The accompanying notes are an integral part of these financial statements.
<PAGE>
Bearguard Fund
Notes to Financial Statements
As of October 18, 1999
1. Organization
The Bearguard Funds, Inc. (the "Corporation") was
organized as a Maryland corporation on April 8, 1999
and is registered under the Investment Company Act
of 1940, as amended (the "1940 Act"), as an open-end
management investment company issuing its shares in
series, each series representing a distinct
portfolio with its own investment objectives and
policies. The series presently authorized is the
Bearguard Fund (the "Fund"). Pursuant to the 1940
Act, the Fund is a "diversified" series of the
Corporation. The Corporation has the authority to
issue 500,000,000 shares of common stock and has the
authority to classify or reclassify these shares
into classes and/or series. Pursuant to such power,
the Board of Directors has initially designated the
authorized shares of the Corporation into two
classes, Investor and Institutional, at 50,000,000
each for the Bearguard Fund series. The Fund has
had no operations other than those related to
organizational matters, including the sale of 5,000
each of the Investor and Institutional shares of the
Fund for cash, in the amount of $10 per share, to
the initial investor (Robert W. Lishman, Jr.;
Director of the Corporation and Skye Investment
Advisors LLC - see Note 3) on October 18, 1999.
2. Significant Accounting Policies
Organization and Prepaid Initial State Registration
and Insurance Expenses
Expenses incurred by the Corporation in connection
with the organization and initial public offering
are expensed as incurred. These expenses were
advanced by the Adviser, and the Adviser has agreed
to reimburse the Fund for these expenses, subject to
potential recovery (see Note 3). Prepaid initial
state registration and insurance expenses are
deferred and amortized over twelve months.
Federal Income Taxes
The Fund intends to comply with the requirements of
the Internal Revenue Code necessary to qualify as a
regulated investment company and to make the
requisite distributions of income and capital gains
to its shareholders sufficient to relieve it from
all or substantially all Federal income taxes.
Use of Estimates
The preparation of financial statements in
conformity with generally accepted accounting
principles requires management to make estimates and
assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial
statements and the reported amounts of revenues and
expenses during the reporting period. Actual
results could differ from those estimates.
<PAGE>
3. Investment Adviser
The Fund has an Investment Advisory Agreement (the
"Agreement") with Skye Investment Advisors LLC (the
"Adviser"), with whom certain officers and directors
of the Corporation are affiliated, to furnish
investment advisory services to the Fund. Under the
terms of the Agreement the Fund compensates the
Adviser for its management services at the annual
rate of 1.25% of the Fund's average daily net
assets.
The Adviser has agreed to waive, through October 31,
2000, its management fee and/or reimburse the Fund's
other expenses, including organization expenses, to
the extent necessary to ensure that the Fund's
operating expenses do not exceed 2.75% of the
Investor Class's average daily net assets and 2.50%
of the Institutional Class's average daily net
assets. Any such waiver or reimbursement is subject
to later adjustment to allow the Adviser to recoup
amounts waived or reimbursed to the extent actual
fees and expenses for a fiscal year are less than
the expense limitation cap of 2.75% for the Investor
Class and 2.50% for the Institutional Class,
provided, however, that the Adviser shall only be
entitled to recoup such amounts for a period of
three years from the date such amount was waived or
reimbursed.
4. Distribution and Service Plan
The Corporation, on behalf of the Fund's Retail
Class, has adopted a plan pursuant to Rule 12b-1
under the 1940 Act (the "12b-1 Plan"), which
authorizes it to pay Rafferty Capital Markets, Inc.,
in its capacity as the principal distributor of
Investor Class shares, or any Recipient (as defined
below) a distribution and shareholder servicing fee
of up to 0.25% per annum of the Fund's average daily
net assets attributable to the Investor Class.
Under the terms of the 12b-1 Plan, the Corporation
or the Distributor may pay all or a portion of this
fee to any securities dealer, financial institution
or any other person (the "Recipient") who renders
assistance in distributing or promoting the sale of
Investor Class shares, or who provides certain
shareholder services to Investor Class shareholders,
pursuant to a written agreement (the "Related
Agreement"). The 12b-1 Plan is a "reimbursement"
plan, which means that the fees paid by the Fund are
intended as reimbursement for services rendered up
to the maximum allowable fee. If more money for
services rendered is due than is immediately payable
because of the expense limitation under the 12b-1
Plan, the unpaid amount is carried forward from
period to period while the 12b-1 Plan is in effect
until such time as it may be paid.
<PAGE>
APPENDIX
SHORT-TERM RATINGS
Standard & Poor's Short-Term Debt Credit Ratings
A Standard & Poor's credit rating is a current
opinion of the creditworthiness of an obligor with
respect to a specific financial obligation, a specific
class of financial obligations or a specific financial
program. It takes into consideration the
creditworthiness of guarantors, insurers or other forms
of credit enhancement on the obligation and takes into
account the currency in which the obligation is
denominated. The credit rating is not a recommendation
to purchase, sell or hold a financial obligation,
inasmuch as it does not comment as to market price or
suitability for a particular investor.
Credit ratings are based on current information
furnished by the obligors or obtained by Standard &
Poor's from other sources it considers reliable.
Standard & Poor's does not perform an audit in
connection with any credit rating and may, on occasion,
rely on unaudited financial information. Credit
ratings may be changed, suspended or withdrawn as a
result of changes in, or unavailability of, such
information, or based on other circumstances.
Short-term ratings are generally assigned to those
obligations considered short-term in the relevant
market. In the U.S., for example, that means
obligations with an original maturity of no more than
365 days-including commercial paper. Short-term
ratings are also used to indicate the creditworthiness
of an obligor with respect to put features on long-term
obligations. The result is a dual rating, in which the
short-term rating addresses the put feature, in
addition to the usual long-term rating.
Ratings are graded into several categories,
ranging from `A-1' for the highest quality obligations
to `D' for the lowest. These categories are as
follows:
A-1 A short-term obligation rated `A-1' is rated
in the highest category by Standard & Poor's.
The obligor's capacity to meet its financial
commitment on the obligation is strong.
Within this category, certain obligations are
designated with a plus sign (+). This
indicates that the obligor's capacity to meet
its financial commitment on these obligations
is extremely strong.
A-2 A short-term obligation rated `A-2' is
somewhat more susceptible to the adverse
effects of changes in circumstances and
economic conditions than obligations in
higher rating categories. However, the
obligor's capacity to meet its financial
commitment on the obligation is satisfactory.
A-3 A short-term obligation rated `A-3' exhibits
adequate protection parameters. However,
adverse economic conditions or changing
circumstances are more likely to lead to a
weakened capacity of the obligor to meet its
financial commitment on the obligation.
B A short-term obligation rated `B' is regarded
as having significant speculative
characteristics. The obligor currently has
the capacity to meet its financial commitment
on the obligation; however, it faces major
ongoing uncertainties which could lead to the
obligor's inadequate capacity to meet its
financial commitment on the obligation.
C A short-term obligation rated `C' is
currently vulnerable to nonpayment and is
dependent upon favorable business, financial
and economic conditions for the obligor to
meet its financial commitment on the
obligation.
D A short-term obligation rated `D' is in
payment default. The `D' rating category is
used when payments on an obligation are not
made on the date due even if the applicable
grace period has not expired, unless Standard
& Poor's believes that such payments will be
made during such grace period. The `D'
rating also will be used upon the filing of a
bankruptcy petition or the taking of a
similar action if payments on an obligation
are jeopardized.
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Moody's Short-Term Debt Ratings
Moody's short-term debt ratings are opinions of
the ability of issuers to repay punctually senior debt
obligations. These obligations have an original
maturity not exceeding one year, unless explicitly
noted. Moody's ratings are opinions, not
recommendations to buy or sell, and their accuracy is
not guaranteed.
Moody's employs the following three designations,
all judged to be investment grade, to indicate the
relative repayment ability of rated issuers:
PRIME-1 Issuers rated `Prime-1' (or supporting
institutions) have a superior ability for
repayment of senior short-term debt
obligations. Prime-1 repaying ability will
often be evidenced by many of the following
characteristics:
* Leading market positions in well-established
industries.
* High rates of return on funds employed.
* Conservative capitalization structure with
moderate reliance on debt and ample asset protection.
* Broad margins in earnings coverage of fixed
financial charges and high internal cash generation.
* Well-established access to a range of financial
markets and assured sources of alternate liquidity.
PRIME-2 Issuers rated `Prime-2' (or supporting
institutions) have a strong ability for
repayment of senior short-term debt
obligations. This will normally be evidenced
by many of the characteristics cited above,
but to a lesser degree. Earnings trends and
coverage ratios, while sound, may be more
subject to variation. Capitalization
characteristics, while still appropriate, may
be more affected by external conditions.
Ample alternate liquidity is maintained.
PRIME-3 Issuers rated `Prime-3' (or supporting
institutions) have an acceptable ability for
repayment of senior short-term obligations.
The effect of industry characteristics and
market compositions may be more pronounced.
Variability in earnings and profitability may
result in changes in the level of debt
protection measurements and may require
relatively high financial leverage. Adequate
alternate liquidity is maintained.
NOT PRIME Issuers rated `Not Prime' do not fall within
any of the Prime rating categories.
Fitch IBCA International Short-Term Debt Credit Ratings
Fitch IBCA's international debt credit ratings are
applied to the spectrum of corporate, structured and
public finance. They cover sovereign (including
supranational and subnational), financial, bank,
insurance and other corporate entities and the
securities they issue, as well as municipal and other
public finance entities, securities backed by
receivables or other financial assets and
counterparties. When applied to an entity, these short-
term ratings assess its general creditworthiness on a
senior basis. When applied to specific issues and
programs, these ratings take into account the relative
preferential position of the holder of the security and
reflect the terms, conditions and covenants attaching
to that security.
International credit ratings assess the capacity
to meet foreign currency or local currency commitments.
Both "foreign currency" and "local currency" ratings
are internationally comparable assessments. The local
currency rating measures the probability of payment
within the relevant sovereign state's currency and
jurisdiction and therefore, unlike the foreign currency
rating, does not take account of the possibility of
foreign exchange controls limiting transfer into
foreign currency.
A short-term rating has a time horizon of less
than 12 months for most obligations, or up to three
years for U.S. public finance securities, and thus
places greater emphasis on the liquidity necessary to
meet financial commitments in a timely manner.
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F-1 Highest credit quality. Indicates the
strongest capacity for timely payment of
financial commitments; may have an added "+"
to denote any exceptionally strong credit
feature.
F-2 Good credit quality. A satisfactory capacity
for timely payment of financial commitments,
but the margin of safety is not as great as
in the case of the higher ratings.
F-3 Fair credit quality. The capacity for timely
payment of financial commitments is adequate;
however, near term adverse changes could
result in a reduction to non-investment
grade.
B Speculative. Minimal capacity for timely
payment of financial commitments, plus
vulnerability to near term adverse changes in
financial and economic conditions.
C High default risk. Default is a real
possibility. Capacity for meeting financial
commitments is solely reliant upon a
sustained, favorable business and economic
environment.
D Default. Denotes actual or imminent payment
default.
Duff & Phelps, Inc. Short-Term Debt Ratings
Duff & Phelps Credit Ratings' short-term debt
ratings are consistent with the rating criteria used by
money market participants. The ratings apply to all
obligations with maturities of under one year,
including commercial paper, the uninsured portion of
certificates of deposit, unsecured bank loans, master
notes, bankers acceptances, irrevocable letters of
credit and current maturities of long-term debt. Asset-
backed commercial paper is also rated according to this
scale.
Emphasis is placed on liquidity which is defined
as not only cash from operations, but also access to
alternative sources of funds including trade credit,
bank lines and the capital markets. An important
consideration is the level of an obligor's reliance on
short-term funds on an ongoing basis.
The distinguishing feature of Duff & Phelps Credit
Ratings' short-term debt ratings is the refinement of
the traditional `1' category. The majority of short-
term debt issuers carry the highest rating, yet quality
differences exist within that tier. As a consequence,
Duff & Phelps Credit Rating has incorporated gradations
of `1+' (one plus) and `1-` (one minus) to assist
investors in recognizing those differences.
These ratings are recognized by the SEC for broker-
dealer requirements, specifically capital computation
guidelines. These ratings meet Department of Labor
ERISA guidelines governing pension and profit sharing
investments. State regulators also recognize the
ratings of Duff & Phelps Credit Rating for insurance
company investment portfolios.
Rating Scale: Definition
High Grade
D-1+ Highest certainty of timely payment. Short-
term liquidity, including internal operating
factors and/or access to alternative sources
of funds, is outstanding, and safety is just
below risk-free U.S. Treasury short-term
obligations.
D-1 Very high certainty of timely payment.
Liquidity factors are excellent and supported
by good fundamental protection factors. Risk
factors are minor.
D-1- High certainty of timely payment. Liquidity
factors are strong and supported by good
fundamental protection factors. Risk factors
are very small.
Good Grade
D-2 Good certainty of timely payment. Liquidity
factors and company fundamentals are sound.
Although ongoing funding needs may enlarge
total financing requirements, access to
capital markets is good. Risk factors are
small.
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Satisfactory Grade
D-3 Satisfactory liquidity and other protection
factors qualify issue as to investment grade.
Risk factors are larger and subject to more
variation. Nevertheless, timely payment is
expected.
Non-investment Grade
D-4 Speculative investment characteristics.
Liquidity is not sufficient to insure against
disruption in debt service. Operating
factors and market access may be subject to a
high degree of variation.
Default
D-5 Issuer failed to meet scheduled principal
and/or interest payments.
LONG-TERM RATINGS
Standard & Poor's Long-Term Debt Credit Ratings
A Standard & Poor's credit rating is a current
opinion of the creditworthiness of an obligor with
respect to a specific financial obligation, a specific
class of financial obligations or a specific financial
program. It takes into consideration the
creditworthiness of guarantors, insurers or other forms
of credit enhancement on the obligation and takes into
account the currency in which the obligation is
denominated. The credit rating is not a recommendation
to purchase, sell or hold a financial obligation,
inasmuch as it does not comment as to market price or
suitability for a particular investor.
Credit ratings are based on current information
furnished by the obligors or obtained by Standard &
Poor's from other sources it considers reliable.
Standard & Poor's does not perform an audit in
connection with any credit rating and may, on occasion,
rely on unaudited financial information. Credit
ratings may be changed, suspended or withdrawn as a
result of changes in, or unavailability of, such
information, or based on other circumstances.
Credit ratings are based, in varying degrees, on
the following considerations: (1) likelihood of
payment-capacity and willingness of the obligor to meet
its financial commitment on an obligation in accordance
with the terms of the obligation; (2) nature of and
provisions of the obligation; and (3) protection
afforded by, and relative position of, the obligation
in the event of bankruptcy, reorganization or other
arrangement under the laws of bankruptcy and other laws
affecting creditors' rights.
The rating definitions are expressed in terms of
default risk. As such, they pertain to senior
obligations of an entity. Junior obligations are
typically rated lower than senior obligations, to
reflect the lower priority in bankruptcy. (Such
differentiation applies when an entity has both senior
and subordinated obligations, secured and unsecured
obligations, or operating company and holding company
obligations.) Accordingly, in the case of junior debt,
the rating may not conform exactly with the category
definition.
AAA An obligation rated `AAA' has the highest
rating assigned by Standard & Poor's. The
obligor's capacity to meet its financial
commitment on the obligation is EXTREMELY
STRONG.
AA An obligation rated `AA' differs from the
highest rated obligations only in small
degree. The obligor's capacity to meet its
financial commitment on the obligation is
VERY STRONG.
A An obligation rated `A' is somewhat more
susceptible to the adverse effects of changes
in circumstances and economic conditions than
obligations in higher rated categories.
However, the obligor's capacity to meet its
financial commitment on the obligation is
still STRONG.
BBB An obligation rated `BBB' exhibits ADEQUATE
protection parameters. However, adverse
economic conditions or changing circumstances
are more likely to lead to a weakened
capacity of the obligor to meet its financial
commitment on the obligation.
Obligations rated `BB', `B', `CCC, `CC', and `C'
are regarded as having significant speculative
characteristics. `BB' indicates the least degree of
speculation and `C' the highest. While such
obligations will likely
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have some quality and
protective characteristics, these may be outweighed by
large uncertainties or major exposures to adverse
conditions.
BB An obligation rated `BB' is LESS VULNERABLE
to nonpayment than other speculative issues.
However, it faces major ongoing uncertainties
or exposure to adverse business, financial or
economic conditions which could lead to the
obligor's inadequate capacity to meet its
financial commitment on the obligation.
B An obligation rated `B' is MORE VULNERABLE to
nonpayment than obligations rated `BB', but
the obligor currently has the capacity to
meet its financial commitment on the
obligation. Adverse business, financial or
economic conditions will likely impair the
obligor's capacity or willingness to meet its
financial commitment on the obligation.
CCC An obligation rated `CCC' is CURRENTLY
VULNERABLE to nonpayment, and is dependent
upon favorable business, financial and
economic conditions for the obligor to meet
its financial commitment on the obligation.
In the event of adverse business, financial
or economic conditions, the obligor is not
likely to have the capacity to meet its
financial commitment on the obligation.
CC An obligation rated `CC' is CURRENTLY HIGHLY
VULNERABLE to nonpayment.
C The `C' rating may be used to cover a
situation where a bankruptcy petition has
been filed or similar action has been taken,
but payments on this obligation are being
continued.
D An obligation rated `D' is in payment
default. The `D' rating category is used
when payments on an obligation are not made
on the date due even if the applicable grace
period has not expired, unless Standard &
Poor's believes that such payments will be
made during such grace period. The `D'
rating also will be used upon the filing of a
bankruptcy petition or the taking of a
similar action if payments on an obligation
are jeopardized.
Plus (+) or minus (-): The ratings from `AA' to
`CCC' may be modified by the addition of a plus or
minus sign to show relative standing within the major
rating categories.
Moody's Long-Term Debt Ratings
Aaa Bonds which are rated `Aaa' are judged to be
of the best quality. They carry the smallest
degree of investment risk and are generally
referred to as "gilt edged." Interest
payments are protected by a large or by an
exceptionally stable margin and principal is
secure. While the various protective
elements are likely to change, such changes
as can be visualized are most unlikely to
impair the fundamentally strong position of
such issues.
Aa Bonds which are rated `Aa' are judged to be
of high quality by all standards. Together
with the Aaa group they comprise what are
generally known as high-grade bonds. They
are rated lower than the best bonds because
margins of protection may not be as large as
in Aaa securities or fluctuation of
protective elements may be of greater
amplitude or there may be other elements
present which make the long-term risk appear
somewhat larger than Aaa securities.
A Bonds which are rated `A' possess many
favorable investment attributes and are to be
considered as upper-medium-grade obligations.
Factors giving security to principal and
interest are considered adequate, but
elements may be present which suggest a
susceptibility to impairment some time in the
future.
Baa Bonds which are rated `Baa' are considered as
medium-grade obligations (i.e., they are
neither highly protected nor poorly secured).
Interest payments and principal security
appear adequate for the present but certain
protective elements may be lacking or may be
characteristically unreliable over any great
length of time. Such bonds lack outstanding
investment characteristics and in fact have
speculative characteristics as well.
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Ba Bonds which are rated `Ba' are judged to have
speculative elements; their future cannot be
considered as well-assured. Often the
protection of interest and principal payments
may be very moderate, and thereby not well
safeguarded during both good and bad times
over the future. Uncertainty of position
characterizes bonds in this class.
B Bonds which are rated `B' generally lack
characteristics of the desirable investment.
Assurance of interest and principal payments
or of maintenance of other terms of the
contract over any long period of time may be
small.
Caa Bonds which are rated `Caa' are of poor
standing. Such issues may be in default or
there may be present elements of danger with
respect to principal or interest.
Ca Bonds which are rated `Ca' represent
obligations which are speculative in a high
degree. Such issues are often in default or
have other marked shortcomings.
C Bonds which are rated `C' are the lowest
rated class of bonds, and issues so rated can
be regarded as having extremely poor
prospects of ever attaining any real
investment standing.
Moody's applies numerical modifiers 1, 2 and 3 in
each generic rating classification from `Aa' through
`B.' The modifier 1 indicates that the obligation
ranks in the higher end of its generic rating category;
the modifier 2 indicates a mid-range ranking; and the
modifier 3 indicates a ranking in the lower end of that
generic rating category.
Fitch IBCA International Long-Term Debt Credit Ratings
Fitch IBCA's international debt credit ratings are
applied to the spectrum of corporate, structured and
public finance. They cover sovereign (including
supranational and subnational), financial, bank,
insurance and other corporate entities and the
securities they issue, as well as municipal and other
public finance entities, securities backed by
receivables or other financial assets and
counterparties. When applied to an entity, these long-
term ratings assess its general creditworthiness on a
senior basis. When applied to specific issues and
programs, these ratings take into account the relative
preferential position of the holder of the security and
reflect the terms, conditions and covenants attaching
to that security.
International credit ratings assess the capacity
to meet foreign currency or local currency commitments.
Both "foreign currency" and "local currency" ratings
are internationally comparable assessments. The local
currency rating measures the probability of payment
within the relevant sovereign state's currency and
jurisdiction and therefore, unlike the foreign currency
rating, does not take account of the possibility of
foreign exchange controls limiting transfer into
foreign currency.
Investment Grade
AAA Highest credit quality. `AAA' ratings
denote the lowest expectation of credit
risk. They are assigned only in case of
exceptionally strong capacity for timely
payment of financial commitments. This
capacity is highly unlikely to be
adversely affected by foreseeable
events.
AA Very high credit quality. `AA' ratings
denote a very low expectation of credit
risk. They indicate very strong
capacity for timely payment of financial
commitments. This capacity is not
significantly vulnerable to foreseeable
events.
A High credit quality. `A' ratings denote
a low expectation of credit risk. The
capacity for timely payment of financial
commitments is considered strong. This
capacity may, nevertheless, be more
vulnerable to changes in circumstances
or in economic conditions than is the
case for higher ratings.
BBB Good credit quality. `BBB' ratings
indicate that there is currently a low
expectation of credit risk. The
capacity for timely payment of financial
commitments is considered adequate, but
adverse changes in circumstances and in
economic conditions are more likely to
impair this capacity. This is the
lowest investment grade category.
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Speculative Grade
BB Speculative. `BB' ratings indicate that
there is a possibility of credit risk
developing, particularly as the result
of adverse economic change over time;
however, business or financial
alternatives may be available to allow
financial commitments to be met.
B Highly speculative. `B' ratings
indicate that significant credit risk is
present, but a limited margin of safety
remains. Financial commitments are
currently being met; however, capacity
for continued payment is contingent upon
a sustained, favorable business and
economic environment.
CCC, CC, C High default risk. Default is a
real possibility. Capacity for meeting
financial commitments is solely reliant
upon sustained, favorable business or
economic developments. A `CC' rating
indicates that default of some kind
appears probable. `C' ratings signal
imminent default.
DDD, DD and D Default. Securities are not
meeting current obligations and are
extremely speculative. `DDD' designates
the highest potential for recovery of
amounts outstanding on any securities
involved. For U.S. corporates, for
example, `DD' indicates expected
recovery of 50% - 90% of such
outstandings, and `D' the lowest
recovery potential, i.e. below 50%.
Duff & Phelps, Inc. Long-Term Debt Ratings
These ratings represent a summary opinion of the
issuer's long-term fundamental quality. Rating
determination is based on qualitative and quantitative
factors which may vary according to the basic economic
and financial characteristics of each industry and each
issuer. Important considerations are vulnerability to
economic cycles as well as risks related to such
factors as competition, government action, regulation,
technological obsolescence, demand shifts, cost
structure and management depth and expertise. The
projected viability of the obligor at the trough of the
cycle is a critical determination.
Each rating also takes into account the legal form
of the security (e.g., first mortgage bonds,
subordinated debt, preferred stock, etc.). The extent
of rating dispersion among the various classes of
securities is determined by several factors including
relative weightings of the different security classes
in the capital structure, the overall credit strength
of the issuer and the nature of covenant protection.
The Credit Rating Committee formally reviews all
ratings once per quarter (more frequently, if
necessary). Ratings of `BBB-` and higher fall within
the definition of investment grade securities, as
defined by bank and insurance supervisory authorities.
Structured finance issues, including real estate, asset-
backed and mortgage-backed financings, use this same
rating scale. Duff & Phelps Credit Rating claims
paying ability ratings of insurance companies use the
same scale with minor modification in the definitions.
Thus, an investor can compare the credit quality of
investment alternatives across industries and
structural types. A "Cash Flow Rating" (as noted for
specific ratings) addresses the likelihood that
aggregate principal and interest will equal or exceed
the rated amount under appropriate stress conditions.
Rating Scale Definition
AAA Highest credit quality. The risk factors are
negligible, being only slightly more
than for risk-free U.S. Treasury debt.
AA+ High credit quality. Protection factors are
AA strong. Risk is modest but may
AA- vary slightly from time to time because of
economic conditions.
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A+ Protection factors are average but adequate.
A However, risk factors are more
A- variable and greater in periods of economic
stress.
BBB+ Below-average protection factors but still
BBB considered sufficient for prudent
BBB- investment. Considerable variability in risk
during economic cycles.
BB+ Below investment grade but deemed likely to
BB meet obligations when due.
BB- Present or prospective financial protection
factors fluctuate according to
industry conditions or company fortunes.
Overall quality may move up or
down frequently within this category.
B+ Below investment grade and possessing risk
B that obligations will not be met
B- when due. Financial protection factors will
fluctuate widely according to
economic cycles, industry conditions and/or
company fortunes. Potential
exists for frequent changes in the rating
within this category or into a higher
or lower rating grade.
CCC Well below investment grade securities.
Considerable uncertainty exists as to
timely payment of principal, interest or
preferred dividends.
Protection factors are narrow and risk can be
substantial with unfavorable
economic/industry conditions, and/or with
unfavorable company developments.
DD Defaulted debt obligations. Issuer failed to
meet scheduled principal and/or
interest payments.
DP Preferred stock with dividend arrearages.
