LSA VARIABLE SERIES TRUST
LSA Variable Series Trust
3100 Sanders Road
Northbrook, IL 60062 Prospectus Dated September 16, 1999
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The LSA Variable Series Trust (the "Trust") is a group of mutual funds sold
exclusively to separate accounts of life insurance companies, including Allstate
Life Insurance Company and its subsidiaries. There are presently six portfolios
(the "Funds") that are available for investment.
The information in this prospectus is of interest to anyone who owns or is
considering purchasing a variable annuity or variable life contract issued by an
insurance company separate account that makes the Funds available as investment
options. This prospectus explains the investment objectives, risks and
strategies of each Fund.
You should read the prospectus to help you decide whether the insurance company
separate account that invests in a Fund is the right investment for you. You
should keep this prospectus for future reference along with the prospectus for
the insurance product which accompanies this prospectus.
The terms "you," "your" and "yours" refer to the contract owner as an investor
in the insurance company separate account.
To learn more about the Funds and their investments, you may obtain a copy of
the Statement of Additional Information (SAI) Dated September 16, 1999. The SAI
has been filed with the Securities and Exchange Commission (SEC) and is
incorporated herein by reference, which means it is legally part of the
prospectus. For a free copy contact your insurance company.
THE SECURITIES AND EXCHANGE COMMISSION HAS NOT APPROVED OR
IMPORTANT DISAPPROVED THESE SECURITIES OR PASSED UPON THE ADEQUACY OF
NOTICES THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE. THIS PROSPECTUS CONTAINS INFORMATION YOU
SHOULD KNOW BEFORE INVESTING, INCLUDING INFORMATION ABOUT
RISKS. PLEASE READ IT BEFORE YOU INVEST AND KEEP IT FOR
FUTURE REFERENCE.
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TABLE OF CONTENTS
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TABLE OF
CONTENTS
FUNDS AT A GLANCE 1
General information about the
Funds, the Manager, and the Advisers
FUND SUMMARIES 2
For each Fund, the investment objective, Adviser,
strategy, risks and who may want to invest
Emerging Growth Equity Fund 2
Focused Equity Fund 3
Growth Equity Fund 4
Disciplined Equity Fund 5
Value Equity Fund 6
Balanced Fund 7
MORE INFORMATION
ABOUT THE FUNDS 8
The types of investment strategies that
may be used by some or all of the Funds
and additional information about
investment risks
MANAGEMENT OF THE FUNDS 12
General information about the organization and
operations of the Funds, including details about
the Adviser to each Fund
PRIOR PERFORMANCE OF ADVISERS 15
General discussion about composite performance
for each Adviser's similarly managed accounts
VALUING A FUND'S ASSETS 16
General information on how a Fund's assets are
valued, including market value, fair value, and
the use of foreign currency conversion values
PRICING OF FUND SHARES 17
Details on how each Fund's per share
price (also known as "net asset value")
is determined, how to purchase and
redeem shares
FEES AND EXPENSES 18
Details on the cost of operating the Funds
including fees, expenses and calculations
ADDITIONAL FUND INFORMATION 19
Income and capital gain distributions, taxes,
year 2000 preparations, Statement of Additional
Information, annual reports
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FUNDS AT A GLANCE
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FUNDS AT A
GLANCE
THE TRUST
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The LSA Variable Series Trust (the "Trust") is a
group of mutual funds managed by LSA Asset
Management LLC (the "Manager").
THE MANAGER
The Manager carefully selects other professional
investment managers (the "Advisers") to carry out
the day-to-day management of each Fund. The
Manager receives a fee, payable monthly, based on
a percentage of average net assets of the Funds.
THE ADVISERS
The Advisers are the professional investment
managers who perform the day-to-day investing on
behalf of the Funds subject to the general
supervision of the Manager and the Trust's Board
of Trustees (the "Board"). The fees of the
Advisers are paid by the Manager, not the Funds.
Each Adviser is a registered investment adviser
with the SEC. The following chart lists the
Advisers and each Fund's investment objective.
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FUND ADVISER INVESTMENT OBJECTIVE
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<S> <C> <C>
Emerging RS Investment Seeks to provide capital appreciation through investing
Growth Equity Management, L.P. primarily in smaller, rapidly growing emerging companies.
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Morgan Stanley Seeks to provide capital appreciation by investing primarily in
Focused Equity Asset Management* equity securities.
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Goldman Sachs
Growth Equity Asset Management Seeks to provide long-term growth of capital.
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Seeks to provide a consistently high total return from a
broadly diversified portfolio of equity securities with risk
J.P. Morgan Investment characteristics similar to the Standard & Poor's 500 Composite
Disciplined Equity Management Inc. Stock Price Index.
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Salomon Brothers Seeks to provide long-term growth of capital with current
Value Equity Asset Management Inc income as a secondary objective.
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Seeks to provide a combination of growth of capital and
investment income (growth of capital is the primary objective)
Balanced OpCap Advisors by investing in a mix of equity and debt.
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*On December 1, 1998, Morgan Stanley Asset Management Inc. changed its name to Morgan Stanley Dean Witter
Investment Management Inc. but continues to do business in certain instances using the name Morgan Stanley
Asset Management.
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Prospectus 1
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FUND SUMMARIES
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FUND
SUMMARIES
EMERGING GROWTH EQUITY FUND
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ADVISED BY: RS INVESTMENT
MANAGEMENT, L.P.
INVESTMENT OBJECTIVE: The Emerging Growth Equity
Fund seeks to provide capital appreciation.
INVESTMENT STRATEGIES: The Fund invests in
smaller (usually companies with a market
capitalization of $1.5 billion or less), rapidly
growing emerging companies with proprietary
advantages, and generally in industry segments
that are experiencing rapid growth. The Adviser
considers several factors in evaluating potential
investments. These include whether a company is
gaining market share, earning superior margins,
or experiencing superior profitability.
Generally, the Fund invests at least 65% of its
assets in companies with some or all of the
previous characteristics. The Fund may also
invest part of its assets in technology
companies. The Fund may invest all of its assets
in securities of foreign companies; however, it
presently does not anticipate investing more than
20% of its total assets in foreign securities.
PRIMARY RISKS: The Fund is subject to the market
fluctuation risks associated with all investments
in common stocks and other equity securities. The
stocks of small companies often involve more risk
and volatility than those of larger companies.
Because small companies are often dependent on a
small number of products and have limited
financial resources, they may be severely
affected by economic changes, business cycles and
adverse market conditions. Stock markets tend to
move in cycles. Stock values fluctuate based on
the performance of individual companies and on
general market and economic conditions. You can
lose money over the short or even long-term. The
Fund is also subject to:
o The risk that returns on the types of
securities purchased by the Fund may not perform
as well as other types of investments.
o The risk that poor stock selection may cause
the Fund to underperform when compared with other
funds with similar objectives.
o The risk that returns on stocks of technology
companies may not perform as well as other types
of investments.
o The risk that the Fund's foreign investments
may be subject to fluctuations in foreign
currency values, adverse political or economic
events, greater market volatility and lower
liquidity.
WHO MAY WANT TO INVEST: You may wish to consider
investing in this Fund if:
o You are seeking high total returns from a
diversified portfolio of stocks of small size
U.S. companies.
o You are willing to accept greater volatility in
the hopes of a greater increase in share price.
o You are willing to accept the above-average
risks associated with investing in a portfolio of
common stocks which may include foreign stocks.
PAST PERFORMANCE: Because the Fund has been in
operation for less than one year, no performance
history has been provided.
2 LSA Variable Series Trust
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FUND SUMMARIES
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FOCUSED EQUITY FUND
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ADVISED BY: MORGAN STANLEY
ASSET MANAGEMENT
INVESTMENT OBJECTIVE: The Focused Equity Fund
seeks to provide capital appreciation by
investing primarily in equity securities. The
Fund is "non-diversified" meaning that it may,
and generally will, invest in securities of a
limited number of issuers; however, the Fund
presently does not intend to invest more than 25%
of its assets in securities of a single company.
INVESTMENT STRATEGIES: The Fund invests primarily
in common stocks. The Fund will invest in
securities of companies that the Adviser believes
possess above-average potential for capital
appreciation. The Adviser focuses on companies
with consistent or rising earnings growth records
and compelling business strategies. Valuation is
of secondary importance and is considered
generally in the context of prospects for
sustainable earnings growth. The Adviser's focus
on individual security selection may result in an
emphasis on particular industry sectors. In
general, the Fund invests in companies with
market size of $1 billion or more but may also
include smaller companies. The Fund may invest
all of its assets in securities of foreign
companies; however, it presently does not
anticipate investing more than 25% of its total
assets in foreign securities.
PRIMARY RISKS: The Fund is subject to the market
fluctuation risks associated with all investments
in common stocks and other equity securities.
Stock markets tend to move in cycles. Stock
values fluctuate based on the performance of
individual companies and on general market and
economic conditions. You can lose money over the
short or even long-term. The Fund is also subject
to:
o The risk that the Fund's market sector, mid- to
large-size growth oriented companies, may
underperform relative to other sectors.
o The risk that poor stock selection may cause
the Fund to underperform when compared with other
funds with similar objectives.
o The risk that, because the Fund is
"non-diversified", its value could decrease
significantly if one or more of its investments
performs poorly.
o The risk that the Fund's foreign investments
may be subject to fluctuations in foreign
currency values, adverse political or economic
events, greater market volatility and lower
liquidity.
WHO MAY WANT TO INVEST: You may wish to consider
investing in this Fund if:
o You are seeking capital appreciation.
o You are willing to accept the above-average
risks associated with investing in a portfolio of
common stocks which may include foreign stocks.
o You are willing to accept greater volatility in
hopes of a greater increase in share price.
PAST PERFORMANCE: Because the Fund has been in
operation for less than one year, no performance
history has been provided.
Prospectus 3
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FUND SUMMARIES
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GROWTH EQUITY FUND
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ADVISED BY: GOLDMAN SACHS
ASSET MANAGEMENT
INVESTMENT OBJECTIVE: The Growth Equity Fund seeks
long-term growth of capital.
INVESTMENT STRATEGIES: The Fund invests in a
diversified portfolio of equity securities
(mainly common stocks) of companies that the
Adviser believes have long-term capital
appreciation potential. The Fund invests at least
90% of its total assets in equity securities. The
Adviser primarily seeks companies showing a
relatively strong earnings growth trend.
PRIMARY RISKS: The Fund is subject to the market
fluctuation risks associated with all investments
in common stocks and other equity securities.
Stock markets tend to move in cycles. Stock
values fluctuate based on the performance of
individual companies and on general market and
economic conditions. You can lose money over the
short or even long-term. The Fund is also subject
to:
o The risk that returns on the types of
securities purchased by the Fund may not perform
as well as other types of investments.
o The risk that poor stock selection may cause
the Fund to underperform when compared with other
funds with similar objectives.
o The risk that the Fund's foreign investments
may be subject to fluctuations in foreign
currency values, adverse political or economic
events, greater market volatility and lower
liquidity.
WHO MAY WANT TO INVEST: You may wish to consider
investing in this Fund if:
o You are seeking potential capital appreciation
over the long-term.
o You are willing to accept the above-average
risks associated with investing in a portfolio of
common stocks which may include foreign stocks.
o You are willing to accept greater volatility in
the hopes of a greater increase in share price.
PAST PERFORMANCE: Because the Fund has been in
operation for less than one year, no performance
history has been provided.
4 LSA Variable Series Trust
<PAGE>
FUND SUMMARIES
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DISCIPLINED EQUITY FUND
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ADVISED BY: J.P. MORGAN INVESTMENT
MANAGEMENT INC.
INVESTMENT OBJECTIVE: The Disciplined Equity Fund
seeks to provide a consistently high total return
from a broadly diversified portfolio of equity
securities with risk characteristics similar to
the Standard & Poor's 500 (S&P 500) Composite
Stock Price Index.
INVESTMENT STRATEGIES: The Fund invests primarily
in large and medium size U.S. companies contained
in the S&P 500 Index. Industry by industry, the
Fund's assets are invested so that the Fund's
industry exposure is similar to that of the S&P
500. Within each industry, the Fund modestly
emphasizes stocks that the Adviser identifies as
being undervalued or fairly valued and modestly
underweights or does not hold stocks that appear
overvalued. By owning a large number of stocks
within the S&P 500, with an emphasis on those
that appear undervalued or fairly valued, and by
tracking the industry weightings of that index,
the Fund seeks returns that modestly exceed those
of the S&P 500 over the long term with virtually
the same level of volatility.
PRIMARY RISKS: The Fund is subject to the market
fluctuation risks associated with all investments
in common stocks and other equity securities.
Stock markets tend to move in cycles. Stock
values fluctuate based on the performance of
individual companies and on general market and
economic conditions. You can lose money over the
short or even long-term. The Fund is also subject
to:
o The risk that returns on the types of
securities purchased by the Fund may not perform
as well as other types of investments.
o The risk that poor stock selection may cause
the Fund to underperform when compared to other
funds with similar objectives.
o The risk that the Fund's foreign investments
may be subject to fluctuations in foreign
currency values, adverse political or economic
events, greater market volatility and lower
liquidity.
WHO MAY WANT TO INVEST: You may wish to consider
investing in this Fund if:
o You are seeking high total return from a
diversified portfolio of stocks of large and
medium size U.S. companies.
o You are willing to accept the above-average
risks associated with investing in a portfolio of
common stocks which may include foreign stocks.
o You are willing to accept greater volatility in
hopes of a greater increase in share price.
PAST PERFORMANCE: Because the Fund has been in
operation for less than one year, no performance
history has been provided.
Prospectus 5
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FUND SUMMARIES
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VALUE EQUITY FUND
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ADVISED BY: SALOMON BROTHERS ASSET
MANAGEMENT INC
INVESTMENT OBJECTIVES: The Value Equity Fund
seeks to provide long-term growth of capital.
Current income is a secondary objective.
INVESTMENT STRATEGIES: The Fund seeks to achieve
its objective by investing primarily in common
stocks of established U.S. companies. The Adviser
will favor companies believed to have growth
possibilities at reasonable values. The Fund will
maintain a carefully selected portfolio of
securities that is diversified among industries
and companies.
PRIMARY RISKS: The Fund is subject to the market
fluctuation risks associated with all investments
in common stocks and other equity securities.
Stock markets tend to move in cycles. Stock
values fluctuate based on the performance of
individual companies and on general market and
economic conditions. You can lose money over the
short or even long-term. The Fund is also subject to:
o The risk that returns on the types of
securities purchased by the Fund may not perform
as well as other types of investments.
o The risk that poor stock selection may cause
the Fund to underperform when compared with other
funds with similar objectives.
o The risk that the Fund's foreign investments
may be subject to fluctuations in foreign
currency values, adverse political or economic
events, greater market volatility and lower
liquidity.
WHO MAY WANT TO INVEST: You may wish to consider
investing in this Fund if:
o You are seeking long-term capital growth.
o You are willing to accept the above-average
risks associated with investing in a portfolio of
common stocks which may include foreign stocks.
o You would like a Fund that provides the
potential for current income as a secondary
objective.
o You are willing to accept greater volatility in
hopes of a greater increase in share price.
PAST PERFORMANCE: Because the Fund has been in
operation for less than one year, no performance
history has been provided.
6 LSA Variable Series Trust
<PAGE>
FUND SUMMARIES
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BALANCED FUND
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ADVISED BY: OPCAP ADVISORS
INVESTMENT OBJECTIVE: The Balanced Fund seeks to
provide a combination of growth of capital and
investment income by investing in a mix of debt
and equity securities. Growth of capital is the
Fund's primary objective.
INVESTMENT STRATEGIES: The Fund invests in common
stocks (with an emphasis on dividend paying
stocks), preferred stocks, securities convertible
into common stock, and debt securities. The Fund
will invest at least 25% of its assets in equity
securities and at least 25% in debt securities.
In general, the Fund expects to be 50-75%
invested in equity securities. However, the
Balanced Fund's day-to-day investment allocation
mix among equity and debt securities will be
determined by the Adviser based on the Adviser's
perception of prevailing market conditions and
risks. By investing in both debt and equity
securities, it is anticipated that the Balanced
Fund will generally be less volatile than the
overall market. The Fund's equity investments
will be primarily in dividend paying common
stocks that the Adviser believes to be
"undervalued" in the marketplace. Generally,
equity securities that the Adviser believes are
undervalued may have certain characteristics such
as substantial and growing discretionary cash
flow; strong shareholder value-oriented
management; valuable consumer or commercial
franchises; and favorable price to intrinsic
value relationship. The Fund may invest up to 25%
of its total assets in below investment grade,
high-yield debt securities (commonly known as
"junk bonds"). The Fund may also invest all of
its assets in securities of foreign companies,
though it presently does not anticipate investing
more than 25% of its assets in foreign
securities.
PRIMARY RISKS: The Fund is subject to the market
fluctuation risks associated with all investments
in common stocks and other equity securities.
Stock markets tend to move in cycles. Stock
values fluctuate based on the performance of
individual companies and on general market and
economic conditions. You can lose money over the
short or even long-term. The Fund is also subject
to:
o The risk that (1) an issuer of debt securities
held by the Fund may fail to repay interest and
principal in a timely manner and (2) the prices
of debt securities will decline over short or
even long periods due to rising interest rates.
While all debt securities in which the Fund
invests will be subject to these risks, the
Fund's ability to invest up to 25% of its assets
in junk bonds increases these risks.
o The risk that poor security selection may cause
the Fund to under-perform when compared with
other funds with similar objectives.
o The risk that the Fund's foreign investments
may be subject to fluctuations in foreign
currency values, adverse political or economic
events, greater market volatility and lower
liquidity.
o The risk that returns on the types of
securities purchased by the Fund may not perform
as well as other types of investments.
WHO MAY WANT TO INVEST: You may wish to consider
investing in this Fund if:
o You wish to invest in a fund emphasizing a
combination of growth of capital and investment
income by investing in a combination of equity
and debt securities.
o You are seeking exposure to foreign investments
and are willing to assume the related risks.
o You are seeking exposure to junk bonds and are
willing to assume the related risks.
PAST PERFORMANCE: Because the Fund has been in
operation for less than one year, no performance
history has been provided.
Prospectus 7
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MORE INFORMATION ABOUT THE FUNDS
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MORE INFORMATION
ABOUT THE FUNDS
Some of the Funds have been established by
investment advisers which manage other mutual
funds having similar names and investment
objectives. While some of the Funds may be
similar to, and may in fact be modeled after,
other mutual funds, you should understand that
the Funds are not otherwise directly related to
any other mutual fund. Consequently, the
investment performance of other mutual funds and
any similarly named fund may differ substantially
from that of the Funds.
INVESTMENT STRATEGIES
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Each Fund follows a distinct set of investment
strategies. Five of the Funds, the Focused Equity
Fund, Growth Equity Fund, Disciplined Equity
Fund, Emerging Growth Equity Fund and Value
Equity Fund are considered "Equity Funds" because
they invest primarily in equity securities
(mostly common stocks). The Balanced Fund is
considered a "balanced" fund because its
principal strategy is to invest in a mix of
equity and debt securities. Each Fund may change
its investment objectives without shareholder
approval in accordance with applicable law. All
percentage limitations relating to the Funds'
investment strategies are applied at the time a
Fund acquires a security. The Disciplined Equity
Fund, Focused Equity Fund, Emerging Growth Equity
Fund and Value Equity Fund will normally invest
at least 65% of their assets in equity
securities; the Growth Equity Fund will normally
invest at least 90% of its assets in equity
securities. Therefore, as an investor in these
Funds, the return on your investment will be
based primarily on the risks and rewards relating
to equity securities. The Balanced Fund will
invest at least 25% of its assets in equity
securities and at least 25% in debt securities.
As an investor in the Balanced Fund, the return
on your investment will be based on the risks and
rewards relating to both equity and debt
securities.
EQUITY SECURITIES
Each Fund will invest in equity securities. There
are various types of equity securities such as
common stocks, preferred stocks, and warrants. In
addition, the Funds may treat debt instruments
which are "convertible" into equity as equity
securities (or as debt securities). However, it
is expected that the Funds' equity investments
will be primarily in common stocks.
Common stocks represent partial ownership in a
company and entitle stockholders to share in the
company's profits (or losses). Common stocks also
entitle the holder to share in any of the
company's dividends. The value of a company's
stock may fall as a result of factors which
directly relate to that company, such as lower
demand for the company's products or services or
poor management decisions. A stock's value may
also fall because of economic conditions which
affect many companies, such as increases in
production costs. The value of a company's stock
may also be affected by changes in financial
market conditions that are not directly related
to the company or its industry, such as changes
in interest rates or currency exchange rates. In
addition, a company's stock generally pays
dividends only after the company makes required
payments to holders of its bonds and other debt.
For this reason, the value of the stock will
usually react more strongly than bonds and other
debt to actual or perceived changes in the
company's financial condition or progress.
As a general matter, other types of equity
securities are subject to many of the same risks
as common stocks.
The Funds may invest in equity securities of U.S.
and foreign companies. Investments in foreign
securities present special risks and other
considerations. These are discussed under
"Foreign Securities" on page 10.
8 LSA Variable Series Trust
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MORE INFORMATION ABOUT THE FUNDS
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SMALL CAP COMPANIES
All of the Funds may invest in small cap
companies. Small cap companies typically include
companies with a market capitalization of $1.5
billion or less. The Emerging Growth Equity Fund
may invest a substantial portion, or at times
all, of its assets in small cap companies.
Companies that are small or unseasoned (less than
3 years of operating history) are more likely not
to survive or accomplish their goals with the
result that the value of their stock could
decline significantly. These companies are less
likely to survive since they are often dependent
upon a small number of products and may have
limited financial resources.
Small or unseasoned companies often have a
greater degree of change in earnings and business
prospects than larger companies resulting in more
volatility in the price of their securities. As
well, the securities of small or unseasoned
companies may not have wide marketability. This
fact could cause a Fund to lose money if it needs
to sell the securities when there are few
interested buyers. Small or unseasoned companies
also normally have fewer outstanding shares than
larger companies. As a result, it may be more
difficult to buy or sell large amounts of these
shares without unfavorably impacting the price of
the security. Finally, there may be less publicly
available information about small or unseasoned
companies. As a result, when making a decision to
purchase a security for a Fund, an Adviser may
not be aware of some problems associated with the
company issuing the security.
DEBT SECURITIES
Investments in debt securities are part of the
Balanced Fund's principal investment strategy.
The other Funds will generally have a portion of
their assets invested in debt securities as a
cash reserve or for other appropriate reasons.
Convertible debt securities may be considered
equity or debt securities, and, in either event,
they possess many of the attributes and risks of
debt securities. A prospective investor in any of
the Funds should be aware of the risks associated
with investing in debt securities.
Debt securities can generally be classified into
two categories as follows: (1) "investment grade"
debt securities and (2) "non-investment grade"
debt securities (also known as "junk bonds").
Investment grade debt securities are those which
are rated within the four highest rating
categories of a nationally recognized rating
organization (or if unrated, securities of
comparable quality as determined by an Adviser).
A discussion of the ratings services appears in
an Appendix to the Statement of Additional
Information. Investment grade debt securities are
considered to have less risk of issuer default
than non-investment grade debt securities.
However, investment grade debt securities will
generally have a lower yield than non-investment
grade debt securities. Debt securities in the
fourth highest rating category are viewed as
having adequate capacity for payment of interest
and repayment of principal, but do have
speculative characteristics and involve a higher
degree of risk than that associated with
investments in debt securities in the three
higher rating categories.
Money market instruments are short-term high
quality debt securities. They are the highest
investment grade quality and therefore carry the
lowest risk of issuer default. Some common types
of money market instruments include U.S. Treasury
bills and notes, commercial paper, banker's
acceptances and negotiable certificates of
deposit. All of the Funds may invest in money
market instruments and other types of debt
securities as a cash reserve.
Debt securities that are rated below the four
highest categories (or unrated securities of
comparable
Prospectus 9
<PAGE>
MORE INFORMATION ABOUT THE FUNDS
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quality as determined by an Adviser) are known as
"junk bonds". Junk bonds are considered to be of
poor standing and predominantly speculative. Junk
bonds are considered speculative with respect to
the issuer's capacity to pay interest and repay
principal in accordance with the terms of the
obligations. Accordingly, they present
considerable risk of issuer default.
Junk bonds may be subject to substantial market
fluctuations. They are also subject to greater
risk of loss of income and principal than
investment-grade securities. There may be less of
a market for junk bonds and therefore they may be
harder to sell at a desirable price.
FOREIGN SECURITIES
The Focused Equity, Emerging Growth Equity and
Balanced Funds may each invest all of their
respective assets in foreign securities, though
the Focused Equity Fund and the Balanced Fund
presently do not anticipate investing over 25% of
their respective assets in foreign securities,
and the Emerging Growth Equity Fund does not
anticipate its investments in foreign securities
exceeding 20%. The Disciplined Equity Fund and
the Value Equity Fund may each invest up to 20%
in foreign securities; the Growth Equity Fund may
invest up to 10% of its assets in foreign
securities. For these purposes, foreign
securities include securities of issuers in
emerging countries and securities quoted in
foreign currencies.
Foreign equity and debt securities generally have
the same risk characteristics as U.S. equity and
debt securities. However, they also present a
number of additional risks and considerations
that are not associated with U.S. investments.
For example, investments in foreign securities
may subject a Fund to the adverse political or
economic conditions of the foreign country. These
risks increase in the case of "emerging market"
countries which are more likely to be politically
and economically unstable. Foreign countries,
especially emerging market countries, may prevent
or delay a Fund from selling its investments and
taking money out of the country. In addition,
foreign securities may not be as liquid as U.S.
securities which could result in a Fund being
unable to sell its investments in a timely
manner. Foreign countries, especially emerging
market countries, also have less stringent
investor protection, disclosure and accounting
standards than the U.S. As a result, there is
generally less publicly available information
about foreign companies than U.S. companies.
Investments in foreign securities may cause a
Fund to lose money when converting investments
from foreign currencies into U.S. dollars due to
unfavorable currency exchange rates.
Additionally, even with respect to U.S. issuers,
such issuers may have substantial non-U.S.
activities, and thus, face similar risks as
foreign issuers. Conversely, certain foreign
issuers may also have significant U.S. activities
and may face the same risks as U.S. issuers with
regard to those activities.
DERIVATIVES
Derivatives are financial instruments designed to
achieve a particular economic result when the
price of an underlying security, index, interest
rate, commodity, or other financial instrument
changes. Derivatives may be used by each Fund to
hedge investments and potential investments,
manage risks, or to manage interest or
currency-sensitive assets. However, hedging
techniques may not always be available to the
Funds; and it may not always be feasible for a
Fund to use hedging techniques even when they are
available. Each Fund may enter into certain
derivative transactions to enhance total return.
For example, each Fund may, in lieu of purchasing
the underlying assets, enter into futures
contracts on stock indices or options on such
futures contracts. Derivatives can subject a Fund
to various levels of risk. There are four basic
derivative products: forward contracts, futures
contracts, options, and swaps.
10 LSA Variable Series Trust
<PAGE>
MORE INFORMATION ABOUT THE FUNDS
- -------------------------------------------------------------------------------
Forward contracts commit the parties to a
transaction at a time in the future at a price
determined when the transaction is initiated.
They are the predominant means of hedging
currency or commodity exposures. Futures
contracts are similar to forwards but differ in
that (1) they are traded through regulated
exchanges, and (2) are "marked to market" daily.
Options differ from forwards and futures in that
the buyer has no obligation to perform under the
contract. The buyer pays a fee, called a premium,
to the seller, who is called a writer. The writer
gets to keep the premium in any event but must
deliver (in the context of the type of option) at
the buyer's demand. Caps and floors are
specialized options which enable floating-rate
borrowers and lenders, for a fee, to reduce their
exposure to interest rate swings.
A swap is an agreement between two parties to
exchange certain financial instruments or
components of financial instruments. Parties may
exchange streams of interest rate payments,
principal denominated in two different
currencies, or virtually any payment stream as
agreed to by the parties.
Derivatives involve special risks. If an Adviser
judges market conditions incorrectly or employs a
strategy that does not correlate well with a
Fund's investments, these techniques could result
in a loss. These techniques may increase a Fund's
volatility and may involve a small investment of
cash relative to the magnitude of the risk
assumed. In addition, these techniques could
result in a loss if the counterparty to the
transaction does not perform as promised. In
addition, the use of derivatives for non-hedging
purposes (that is, to seek to increase total
return) is considered a speculative practice and
presents even greater risk of loss when these
instruments are leveraged.
TEMPORARY DEFENSIVE STRATEGIES
Each Fund may take temporary defensive positions
that depart from its principal investment
strategies in response to adverse market,
economic, political or other conditions. During
these times, a Fund may not be actively pursuing
its investment goals and may have up to 100% of
its assets in short-term debt securities or cash.
OTHER INVESTMENT RISKS
- --------------------------------------------------
This prospectus describes the main risks an
investor faces in any of the Funds. It is
important to keep in mind one of the main
principles of investing: the higher the risk of
losing your money, the higher the potential
reward. The reverse is also generally true: the
lower the risk, the lower the potential reward.
Risk tolerances vary among investors.
LIQUIDITY RISK
In addition to the primary risks described in the
Fund summaries, all of the Funds are subject to
liquidity risk. This is the risk that a Fund will
not be able to timely pay redemption proceeds
because of unusual market conditions, an
unusually high volume of redemption requests, or
other reasons.
PORTFOLIO TURNOVER
Consistent with the Emerging Growth Equity Fund's
and the Focused Equity Fund's respective
investment policies, each Fund may engage in
active trading without regard to the effect on
portfolio turnover. Higher portfolio turnover
(e.g., 100% or more per year) would cause the
Emerging Growth Equity Fund and the Focused
Equity Fund to incur additional transaction costs
on the sale of securities and reinvestment in
other securities. Such sales may result in
realization of taxable capital gains including
short-term capital gains which are generally
taxed to shareholders at ordinary income tax
rates.
Prospectus 11
<PAGE>
MANAGEMENT OF THE FUNDS
- -------------------------------------------------------------------------------
MANAGEMENT
OF THE FUNDS
BOARD OF TRUSTEES
- ----------------------------------------------------
The Board is responsible for overseeing all
operations of the Funds, including retaining and
supervising the performance of the Manager.
INVESTMENT MANAGER
- -----------------------------------------------------
LSA Asset Management LLC, the Manager, located at
3100 Sanders Road, Northbrook, Illinois, is each
Fund's investment adviser. The Manager is a
wholly owned subsidiary of Allstate Life
Insurance Company ("Allstate Life"). The Manager
was organized in Delaware in 1999 and is
registered with the SEC as an investment adviser.
The Funds are the only investment companies
managed by the Manager. Allstate Life,
incorporated in 1957 in Illinois, has established
a record of financial strength that has
consistently resulted in superior ratings. A.M.
Best Company assigns an A+ (Superior) to Allstate
Life. Standard & Poor's Insurance Rating Services
assigns an AA+ (Very Strong) financial strength
rating and Moody's Investors Service, Inc.
assigns an Aa2 (Excellent) financial strength
rating to Allstate Life.
The Manager has overall responsibility for
providing investment advisory and related
services to the Funds, including responsibility
for selecting Advisers to carry out the
day-to-day investment management of the Funds.
The Manager will review and monitor the
performance of each Fund for purposes of
considering whether changes should be made in
regard to a Fund's investment strategies as well
as whether a change in the Adviser to a Fund is
warranted. The Manager will also monitor the
Funds for compliance purposes and will instruct
each of the Advisers as to their compliance
duties for their respective Fund.
The Manager considers various factors in
selecting the Advisers, including:
o level of knowledge and skill
o performance as compared to a peer group of
other advisers or to an appropriate index
o consistency of performance over five years or
more
o adherence to investment style and Fund
objectives
o employees, facilities and financial strength
o quality of service
o how the Adviser's investment style compliments
other selected Advisers' investment styles.
Two or more Advisers may manage a Fund, with each
managing a portion of the Fund's assets. If a
Fund has more than one Adviser, the Manager may
change these allocations from time to time, often
based upon the results of the Manager's
evaluations of the Advisers.
THE ADVISERS
- --------------------------------------------------
The Advisers make the day-to-day decisions to buy
and sell specific securities for a Fund. Each
Adviser manages a Fund's investments according to
the Fund's investment objective and strategies.
The Funds and the Manager have applied for an
order from the SEC which permits the Manager to
hire and fire Advisers or change the terms of
these advisory agreements without obtaining
shareholder approval. The Manager has ultimate
responsibility to oversee the Advisers and
their hiring, termination and replacement.
12 LSA Variable Series Trust
<PAGE>
MANAGEMENT OF THE FUNDS
- -------------------------------------------------------------------------------
ADVISER TO THE EMERGING GROWTH
EQUITY FUND
RS INVESTMENT MANAGEMENT, L.P. ("RSIM"), 388
Market Street, Suite 200, San Francisco,
California 99111, is the Adviser to the Emerging
Growth Equity Fund. RSIM commenced operations in
March, 1993. RSIM is a wholly owned subsidiary of
RS Investment Management Co. LLC, a Delaware
limited liability company. James L. Callinan is
responsible for managing the Emerging Growth
Equity Fund's portfolio. Mr. Callinan also serves
as portfolio manager of the RS Emerging Growth
Fund. From 1986 until June 1996, Mr. Callinan was
employed by Putnam Investments, where, beginning
in June 1994, he served as portfolio manager of
the Putnam OTC Emerging Growth Equity Fund.
ADVISER TO THE FOCUSED EQUITY FUND
MORGAN STANLEY ASSET MANAGEMENT ("MSAM"), 1221
Avenue of the Americas, New York, New York 10020,
is the adviser to the Focused Equity Fund. MSAM
conducts a worldwide portfolio management
business and provides a broad range of portfolio
management services to customers in the United
States and abroad. Morgan Stanley Dean Witter &
Co. is the direct parent of MSAM. Philip W.
Freidman and William S. Auslander are the
portfolio managers for the Focused Equity Fund,
and have served in that capacity since
commencement of the Fund's operations.
Philip W. Friedman is a Managing Director of MSAM
and is head of MSAM's Institutional Equity Group.
He has been with MSAM and its affiliates since
1990. William S. Auslander is a Principal of MSAM
and a portfolio manager in the Institutional
Equity Group. He joined MSAM in 1995 as an equity
analyst in the Institutional Equity Group. Prior
to 1990, he worked at Icahn & Co. for nine years
as an equity analyst.
On December 1, 1998, Morgan Stanley Asset
Management Inc. changed its name to Morgan
Stanley Dean Witter Investment Management Inc.,
but continues to do business in certain instances
using the name Morgan Stanley Asset Management.
ADVISER TO THE GROWTH EQUITY FUND
GOLDMAN SACHS ASSET MANAGEMENT ("GSAM"), 32 Old
Slip, New York, New York 10005, a separate
operating division of Goldman, Sachs and Co.
("Goldman Sachs"), serves as the Adviser to the
Growth Equity Fund. Goldman Sachs provides a wide
range of fully discretionary investment advisory
services including quantitatively driven and
actively managed U.S. and international equity
portfolios, U.S. and global fixed income
portfolios, commodity and currency products, and
money markets. The portfolio management team is
led by Herbert E. Ehlers, Robert G. Collins, and
Gregory H. Ekizian, all of whom joined GSAM in
1997. From 1994 - 1997, Mr. Ehlers, Managing
Director, was Chief Investment Officer and
Chairman of Liberty Investment Management, Inc.
("Liberty"). From 1984 - 1994, Mr. Ehlers was a
portfolio manager and President of Liberty's
predecessor firm, Eagle Asset Management
("Eagle"). From 1991 - 1997, Mr. Collins, Vice
President, was a portfolio manager at Liberty.
From 1990 - 1997, Mr. Ekizian, Vice President,
was a portfolio manager at Liberty and its
predecessor firm, Eagle.
Prospectus 13
<PAGE>
MANAGEMENT OF THE FUNDS
- -------------------------------------------------------------------------------
ADVISER TO THE DISCIPLINED EQUITY FUND
J.P. MORGAN INVESTMENT MANAGEMENT INC. ("JPMIM"),
522 Fifth Avenue, New York, New York 10036, is
the Adviser to the Disciplined Equity Fund. JPMIM
is a wholly owned subsidiary of J.P. Morgan & Co.
Incorporated. JPMIM manages employee benefit
funds of corporations, labor unions and state and
local governments and the accounts of other
institutional investors, including investment
companies.
The portfolio management team is led by James C.
Wiess and Timothy J. Devlin, both vice presidents
of JPMIM. Mr. Wiess has been at J.P. Morgan since
1992, and prior to managing the Fund managed
other disciplined equity portfolios for J.P.
Morgan. Mr. Devlin has been at J.P. Morgan since
July of 1996, and prior to that time was an
equity portfolio manager at Mitchell Hutchins
Asset Management Inc.
ADVISER TO THE VALUE EQUITY FUND
SALOMON BROTHERS ASSET MANAGEMENT INC ("SBAM"), 7
World Trade Center, New York, New York 10048, is
the Adviser to the Value Equity Fund. SBAM is an
indirect wholly owned subsidiary of Citigroup,
Inc. John B. Cunningham, a Vice President of SBAM
from 1995 - 1998 and a Director of SBAM since
1998, is primarily responsible for the day-to-day
management of the Value Equity Fund. Prior to
1995, Mr. Cunningham was an Associate in the
Investment Banking Group of Salomon Brothers, Inc.
ADVISER TO THE BALANCED FUND
OPCAP ADVISORS ("OPCAP"), 1345 Avenue of the
Americas, New York, New York 10105, is the
Adviser to the Balanced Fund. OpCap is a majority
owned subsidiary of Oppenheimer Capital.
Oppenheimer Capital has been an investment
advisory firm since 1969 and has $59.8 billion of
assets under management as of March 31, 1999.
OpCap has been an investment adviser since 1987.
Oppenheimer Capital and OpCap are indirect,
wholly owned subsidiaries of PIMCO Advisors L.P.
("PIMCO Advisors"). PIMCO Advisors has two
general partners: PIMCO Partners, G.P., a
California general partnership, and PIMCO
Advisors Holdings L.P., an NYSE-listed Delaware
limited partnership of which PIMCO Partners, GP
is the sole general partner. Colin Glinsman is
the portfolio manager for the Balanced Fund. Mr.
Glinsman is the chief investment officer and a
managing director of Oppenheimer Capital and has
been with Oppenheimer Capital since 1989.
14 LSA Variable Series Trust
<PAGE>
PRIOR PERFORMANCE OF THE ADVISERS
- -------------------------------------------------------------------------------
PRIOR PERFORMANCE
OF THE ADVISERS
Each Adviser manages assets of client accounts
that have investment objectives and strategies
that are similar to those of the corresponding
Fund that the Adviser manages. These client
accounts consist of individuals, institutions,
and other mutual funds. Listed below is
"composite performance" for each Adviser with
regard to all of these similarly managed
accounts. Composite performance is essentially
the Adviser's "average" performance with regard
to such accounts, net of fees and expenses. The
composite performance information shown below is
based on a composite of all accounts of each
Adviser (and its predecessors, if any) having
substantially similar investment objectives,
policies and strategies as the corresponding
Fund, adjusted to give effect to the applicable
Fund's estimated annualized expenses (giving
effect to any expense waivers or reimbursements)
during its first fiscal year. Some of the
accounts included in the composites are not
mutual funds registered under the 1940 Act, and
hence, these accounts are not subject to
investment limitations, diversification
requirements, and other restrictions imposed by
the 1940 Act and the Internal Revenue Code. If
such requirements were applicable to these
accounts, the performance shown may have been
lower. This composite data is provided to
illustrate the past performance of each Adviser
in managing similar accounts and does not
represent the performance of any Fund. You should
not consider this performance data as an
indication of future performance of any Fund or
any Adviser. You should also note that the
performance shown would be lower upon taking into
account charges assessed in connection with a
variable annuity or variable life contract.
<TABLE>
<CAPTION>
Inception Average Average Average Total Total
Date Annual Total Annual Total Annual Total Return Return Five Total Return
Name of Adviser Return One Return Five Return Ten One Year Years Ten Years
and Year Ended Years Ended Years Ended Ended Ended Ended
Investment Objective 6/30/99 6/30/99 6/30/99* 6/30/99 6/30/99 6/30/99*
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
RS INVESTMENT MANAGEMENT, L.P.
Emerging Growth Equity 11/87 59.65% 31.22% 23.69% 59.65% 289.00% 738.09%
- -----------------------------------------------------------------------------------------------------------------------------------
MORGAN STANLEY ASSET
MANAGEMENT
Focused Equity 3/95 25.91% N/A 34.38% 25.91% N/A 251.12%
- -----------------------------------------------------------------------------------------------------------------------------------
GOLDMAN SACHS ASSET
MANAGEMENT
Growth Equity 5/90 24.51% 25.78% 20.54% 24.51% 214.94% 454.13%
- -----------------------------------------------------------------------------------------------------------------------------------
J.P. MORGAN INVESTMENT
MANAGEMENT INC.
Disciplined Equity 10/89 24.79% 28.11% 18.87% 24.79% 245.05% 431.75%
- -----------------------------------------------------------------------------------------------------------------------------------
SALOMON BROTHERS ASSET
MANAGEMENT INC
Value Equity 5/90 18.03% 24.69% 17.79% 18.03% 201.37% 348.47%
- -----------------------------------------------------------------------------------------------------------------------------------
OPCAP ADVISORS
Balanced 11/91 34.39% 24.09% 18.76% 34.39% 194.23% 273.73%
- -----------------------------------------------------------------------------------------------------------------------------------
*Note: If life of composite is less than ten years, figure shown is for the life of the composite.
</TABLE>
Prospectus 15
<PAGE>
VALUING A FUND'S ASSETS
- -------------------------------------------------------------------------------
VALUING A
FUND'S ASSETS
A Fund's investments are valued based on market
value or, if no market value is available, based
on fair value as determined under guidelines set
by the Board. All assets and liabilities
initially expressed in foreign currency values
will be converted into U.S. dollar values.
o All short-term dollar-denominated investments
that mature in 60 days or less are valued on the
basis of "amortized" cost.
o Securities mainly traded on a U.S. exchange are
valued at the last sale price on that exchange
or, if no sales occurred during the day, at the
current quoted bid price.
o Securities mainly traded on a non-U.S. exchange
are generally valued according to the preceding
closing values on that exchange. However, if an
event which may change the value of a security
occurs after that time, the "fair value" might be
adjusted under guidelines set by the Board.
o Securities that are not traded on an exchange
and securities for which market quotations are
not readily available will be valued in good
faith at fair value by, or under guidelines
established by, the Board.
16 LSA Variable Series Trust
<PAGE>
PRICING OF FUND SHARES
- -------------------------------------------------------------------------------
PRICING OF
FUND SHARES
NET ASSET VALUE
- --------------------------------------------------
Each Fund's per share price (also known as "net
asset value" or "NAV") is determined at the close
of trading (normally 4:00 p.m., Eastern Standard
Time) every day that the New York Stock Exchange
(NYSE) is open for business. If the NYSE closes
at any other time, or if an emergency exists, the
time at which the NAV is calculated may differ.
Each Fund calculates the price per share based on
the values of the securities it owns. The price
per share is calculated separately for each Fund
by dividing the value of a Fund's assets, minus
all liabilities, by the number of the Fund's
outstanding shares. Each Fund may purchase
securities that are primarily listed on foreign
exchanges that trade on weekends or other days
when the Funds do not price their shares;
therefore, the Funds' NAV may change on days when
shareholders will not be able to purchase or
redeem the Funds' shares.
PURCHASING AND REDEEMING SHARES
- --------------------------------------------------
The per share price received will be the price
next determined after a Fund receives and accepts
a purchase or redemption order. Payments for
redemptions generally will be made no later than
seven days after receipt of a redemption request,
and generally on the date of receipt.
Investors may purchase or redeem shares of the
Funds in connection with variable annuity
contracts and variable life insurance policies
offered through insurance company separate
accounts. Individuals may not place orders
directly with the Funds. You should refer to the
prospectus of your variable insurance contract
for information on how to select specific Funds
as investment options for your contract and how
to redeem monies from the Funds.
Orders received by the Funds are effected only on
days when the NYSE is open for trading (Business
Days). The insurance company separate accounts
purchase and redeem shares of each Fund at the
Fund's net asset value per share calculated as of
the close of the NYSE (generally 4:00 p.m.
Eastern Standard Time) although purchases and
redemptions may be executed the next morning.
Redemption proceeds paid by wire transfer will
normally be wired in federal funds on the next
Business Day after the Fund receives actual
notice of the redemption order, but may be paid
within three Business Days after receipt of
actual notice of the order (or longer as
permitted by the SEC). The Funds may suspend the
right of redemption under certain extraordinary
circumstances in accordance with the rules of the
SEC. In addition, each Fund reserves the right to
suspend the offering of its shares for any period
of time, and reserves the right to reject any
specific purchase order. The Funds do not assess
any fees when they sell or redeem their shares.
The Funds reserve the right to refuse to sell
their shares if the request to purchase or sell
shares is based on market timing decisions as
determined by the Adviser(s).
TRANSFERS
- --------------------------------------------------
The separate account issuing your variable
insurance contract may transfer assets between
the Funds consistent with timely receipt of all
information necessary to process transfer
requests. The Funds reserve the right to limit or
terminate these transfer privileges at any time.
Prospectus 17
<PAGE>
FEES AND EXPENSES
- --------------------------------------------------------------------------------
FEES AND
EXPENSES
BREAKDOWN OF EXPENSES
- --------------------------------------------------
Investors in the Funds will incur various
operating costs which are described below. Each
Fund pays a management fee for the management of
its investments and business affairs. Each Fund
also pays its own operational expenses. Some of
the Funds may engage in active trading to achieve
their investment objectives. As a result, a Fund
may incur higher brokerage and other transaction
costs.
MANAGEMENT FEES
- --------------------------------------------------
The Manager is entitled to receive from each Fund
a management fee, payable monthly, at an annual
rate as a percentage of average daily net assets
of the Fund as set forth in the table below.
MANAGEMENT
FUND FEE
- --------------------------------------------------------------------
Emerging Growth Equity Fund 1.05%
- --------------------------------------------------------------------
Focused Equity Fund 0.95%
- --------------------------------------------------------------------
Growth Equity Fund 0.85%
- --------------------------------------------------------------------
Disciplined Equity Fund 0.75%
- --------------------------------------------------------------------
Value Equity Fund 0.80%
- --------------------------------------------------------------------
Balanced Fund 0.80%
- --------------------------------------------------------------------
The Manager compensates the Advisers from the
management fee it receives. No additional
management fees are paid by the Funds to the
Advisers.
OPERATIONAL EXPENSES
- --------------------------------------------------
Each Fund pays other operational expenses not
assumed by the Manager. These expenses may
include, among others, the following: fees for
Fund accounting and Fund administration; fees
related to the purchase, sale or loan of
securities such as brokers' commissions; fees of
independent accountants and legal counsel;
expenses for preparing and printing shareholder
annual and semi-annual reports; bank transaction
charges; custodian fees and expenses; federal,
state or local income or other taxes; independent
Trustee compensation; SEC fees; and costs of
Trustee and shareholder meetings.
All of these expenses that are incurred by the
Fund will be passed on to shareholders through a
daily charge made to the assets held in the
Funds, which will be reflected in share prices.
The Manager has currently agreed to reduce its
fees or reimburse the Funds for expenses above
certain limits. Currently this limit is set so
that no Fund will incur expenses (not including
interest, taxes, or brokerage commissions) that
exceed the amount of its management fee plus .30%
of its assets. The Manager is contractually
obligated to continue this arrangement through
October 1, 2000. These fee reductions or expense
reimbursements can decrease a Fund's expenses and
increase its performance.
18 LSA Variable Series Trust
<PAGE>
ADDITIONAL FUND INFORMATION
- -------------------------------------------------------------------------------
ADDITIONAL
FUND INFORMATION
TAX INFORMATION
- --------------------------------------------------
Shares of the Funds are owned for federal tax
purposes by life insurance company separate
accounts established in connection with variable
contracts, not by the owners of these variable
contracts. Owners of variable contracts should
refer to the prospectuses for these contracts for
a description of the tax consequences of owning
contracts and receiving distributions or other
contract related payments. Each Fund intends to
comply with the federal tax diversification and
other federal tax requirements with which it must
comply in order for variable contracts to qualify
for the tax treatment described in the applicable
variable contract prospectus. A Fund's failure to
comply with these requirements could cause the
holder of a variable contract based on a separate
account that invested in whole or in part in that
Fund to be subject to current taxation on all
income on the contract, unless the Internal
Revenue Service permits correction of the
failure, which cannot be assured.
DIVIDENDS AND OTHER DISTRIBUTIONS
- --------------------------------------------------
Each Fund intends to distribute substantially all
of its income and capital gains each year. All
dividend and capital gain distributions will
automatically be reinvested in additional shares
of the Funds.
YEAR 2000 PREPARATION
- --------------------------------------------------
Allstate Life is heavily dependent upon complex
computer systems for all phases of its
operations, including customer service, and
policy and contract administration. As a wholly
owned subsidiary of Allstate Life, the Manager is
also heavily dependent upon these computer
systems in connection with its duties in regard
to the Funds. Since many of Allstate Life's older
computer software programs recognize only the
last two digits of the year in any date, some
software may fail to operate properly in or after
the year 1999, if the software is not
reprogrammed or replaced ("Year 2000 Issue").
Allstate Life believes that many of its service
providers and suppliers also have Year 2000
Issues which could adversely affect Allstate
Life. In 1995, Allstate Life commenced a plan
intended to mitigate and/or prevent the adverse
effects of Year 2000 Issues. These strategies
include normal development and enhancement of new
and existing systems, upgrades to operating
systems already covered by maintenance agreements
and modifications to existing systems to make
them Year 2000 compliant. The plan also includes
Allstate Life actively working with its major
external service providers and suppliers
(including the Advisers and the Funds' other
service providers) to assess their compliance
efforts and Allstate Life's exposure to them.
Allstate Life presently believes that it will
resolve the Year 2000 Issue in a timely manner,
and that the financial impact will not materially
affect its results of operations, liquidity or
financial position. The Manager also believes
that the Year 2000 Issue will not materially harm
the Funds or their shareholders. However, there
can be no assurances that the Year 2000 Issue
will not adversely affect the Funds and their
shareholders or issuers of securities purchased
by the Funds.
Prospectus 19
<PAGE>
ADDITIONAL FUND INFORMATION
- -------------------------------------------------------------------------------
CUSTODIAN, TRANSFER AGENT, FUND
ACCOUNTANT AND ADMINISTRATOR
- --------------------------------------------------
Investors Bank & Trust Company is the custodian,
transfer agent, and fund accountant and
administrator.
PERFORMANCE
- --------------------------------------------------
From time to time, the Funds may advertise yield
and total return figures. Yield is a measure of
past dividend income. Total return includes both
past dividend income plus realized and unrealized
capital appreciation (or depreciation). Yield and
total return should not be used to predict the
future performance of a Fund. Yields and total
returns are presented net of the Funds' operating
expenses. Fund performance information does not
reflect any fees or charges imposed under a
variable insurance contract.
STATEMENT OF ADDITIONAL INFORMATION
- --------------------------------------------------
The Statement of Additional Information (SAI)
provides more detailed information about the
Funds and is legally considered to be a part of
this prospectus. The Funds' annual and
semi-annual reports provide additional
information about the Funds' investments. The
annual report includes a discussion of the market
conditions and investment strategies that
significantly affected a Fund's performance
during its last fiscal year. Copies of the SAI,
the annual and semi-annual reports, and other
information may be obtained, at no cost, by
contacting 1-800-865-5237.
FINANCIAL INFORMATION
- --------------------------------------------------
Financial statements for the Trust are not
included herein, because, as of the date of this
Prospectus, the Trust had not yet commenced
operations, and, therefore, had no assets.
OTHER INFORMATION
- --------------------------------------------------
Information can also be reviewed and copied at
the Public Reference Room of the SEC in
Washington, D.C. For a fee, text-only copies can
be obtained by writing to the Public Reference
Room of the SEC, Washington, D.C. 20549-6009. You
can also call 1-800-SEC-0330. Additionally,
information about the Funds can be obtained on
the SEC's Internet website at http://www.sec.gov.
Investment Company Act file no. 811-09379.
20 LSA Variable Series Trust
<PAGE>
LSA VARIABLE SERIES TRUST
Emerging Growth Equity Fund
Focused Equity Fund
Growth Equity Fund
Disciplined Equity Fund
Value Equity Fund
Balanced Fund
STATEMENT OF ADDITIONAL INFORMATION
September 16, 1999
This Statement of Additional Information is not a prospectus. It should
be read in conjunction with the current Prospectus dated September 16, 1999 of
the Funds. To obtain the Prospectus please call 1-800-865-5237. This Statement
of Additional Information is intended to provide additional information about
the activities and operations of the Funds and should be read in conjunction
with the Prospectus.
You can review the Funds' Prospectus as well as other reports relating
to the Funds at the Public Reference Room of the Securities and Exchange
Commission ("SEC").
You can get text-only copies:
For a fee by writing to or calling the Public Reference Room of
the SEC, Washington, D.C. 20549-6009. Telephone: 1-800-SEC-0330
or; free, from the SEC's Internet website at http://www.sec.gov.
B-1
<PAGE>
TABLE OF CONTENTS PAGE
- ----------------- ----
The Trust and the Funds B - 3
Investment Objectives and Policies B - 3
Board of Trustees B - 25
Capital Structure B - 26
Control Persons B - 27
Investment Management Arrangements B - 27
Fund Expenses B - 29
Portfolio Transactions and Brokerage B - 30
Determination of Net Asset Value B - 31
Purchase and Redemption of Shares B - 32
Suspension of Redemptions and Postponement
of Payments B - 32
Investment Performance B - 32
Taxes B - 36
Custodian, Transfer Agent, Fund
Accountant and Administrator B - 40
Independent Auditors B - 40
Appendix A
B-2
<PAGE>
THE TRUST AND THE FUNDS
LSA Variable Series Trust (the "Trust") presently consists of six
portfolios: the Emerging Growth Equity Fund, the Focused Equity Fund, the Growth
Equity Fund, the Disciplined Equity Fund, the Value Equity Fund, and the
Balanced Fund (each referred to as a "Fund" and together as the "Funds"). The
Trust is registered as an open-end, management investment company under the
Investment Company Act of 1940, as amended ("1940 Act"). The Trust was formed as
a Delaware business trust on March 2, 1999. Shares of the Funds are sold
exclusively to insurance company separate accounts as a funding vehicle for
variable life and/or variable annuity contracts, including separate accounts of
Allstate Life Insurance Company ("Allstate Life") and its subsidiaries.
LSA Asset Management LLC (the "Manager"), located at 3100 Sanders Road,
Northbrook, Illinois 60062, is a wholly owned subsidiary of Allstate Life and is
the investment manager of each Fund. The specific investments of each Fund are
managed on a day-to-day basis by investment advisers selected by the Manager who
are called the "Advisers".
INVESTMENT OBJECTIVES AND POLICIES
A. FUNDAMENTAL RESTRICTIONS OF THE FUNDS
Each Fund has adopted the following fundamental investment restrictions
which may not be changed without approval of a majority of the applicable Fund's
outstanding voting securities. Under the 1940 Act, a "majority of the
outstanding voting securities" means the approval of the lesser of (1) the
holders of 67% or more of the shares of a Fund represented at a meeting if the
holders of more than 50% of the outstanding shares of the Fund are present in
person or by proxy or (2) the holders of more than 50% of the outstanding shares
of the Fund. Those investment policies that are not fundamental investment
restrictions may be changed by the Board of Trustees of the Trust (the "Board")
without a shareholder vote under the 1940 Act. In addition, each Fund's
investment objective may be changed without a shareholder vote.
Each Fund may not:
1. Issue senior securities. For purposes of this restriction, the
issuance of shares of common stock in multiple classes or series, obtaining of
short-term credits as may be necessary for the clearance of purchases and sales
of portfolio securities, short sales against the box, the purchase or sale of
permissible options and futures transactions (and the use of initial and
maintenance margin arrangements with respect to futures contracts or related
options transactions), the purchase or sale of securities on a when issued or
delayed delivery basis, permissible borrowings entered into in accordance with a
Fund's investment policies, and reverse repurchase agreements are not deemed to
be issuances of senior securities.
2. Borrow money, except from banks and then only if immediately after
each such borrowing there is asset coverage of at least 300% (including the
amount borrowed) as defined in the 1940 Act. For purposes of this investment
restriction, reverse repurchase agreements, mortgage dollar rolls, short sales,
futures contracts, options on futures contracts, securities or indices, when
issued and delayed delivery transactions and securities lending shall not
constitute borrowing for purposes of this limitation to the extent they are
covered by a segregated account consisting of appropriate liquid assets or by an
offsetting position.
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3. Act as an underwriter, except to the extent that, in connection with
the disposition of portfolio securities, a Fund may be deemed to be an
underwriter for purposes of the Securities Act of 1933 (the "1933 Act").
4. Purchase or sell real estate, except that a Fund may (i) acquire or
lease office space for its own use, (ii) invest in securities of issuers that
invest in real estate or interests therein, (e.g., real estate investment
trusts), (iii) invest in securities that are secured by real estate or interests
therein, (iv) purchase and sell mortgage-related securities, (v) hold and sell
real estate acquired by the Fund as a result of the ownership of securities and
(vi) invest in real estate limited partnerships.
5. Invest in commodities, except that a Fund may (i) invest in
securities of issuers that invest in commodities, and (ii) engage in permissible
options and futures transactions and forward foreign currency contracts, entered
into in accordance with the Fund's investment policies.
6. Make loans, except that a Fund may (i) lend portfolio securities in
accordance with the Fund's investment policies in amounts up to 331/3% of the
Fund's total assets (including collateral received) taken at market value, (ii)
enter into fully collateralized repurchase agreements, and (iii) purchase debt
obligations in which the Fund may invest consistent with its investment
policies.
7. Purchase the securities of any issuer (other than obligations issued
or guaranteed by the U.S. Government or any of its agencies or
instrumentalities) if, as a result, more than 25% of the Fund's total assets
would be invested in the securities of companies whose principal business
activities are in the same industry, except that this limitation does not apply
to the Focused Equity Fund. For these purposes, each Adviser determines
appropriate industry classification which means that different Funds will use
different industry classification standards.
In addition, each Fund, except the Focused Equity Fund, will operate as
a "diversified" fund within the meaning of the 1940 Act. This means that with
respect to 75% of a Fund's total assets, a Fund will not purchase securities of
an issuer (other than cash, cash items or securities issued or guaranteed by the
U.S. government, its agencies, instrumentalities or authorities), if
o such purchase would cause more than 5% of the Fund's total assets
taken at market value to be invested in the securities of such issuer;
or
o such purchase would at the time result in more than 10% of the
outstanding voting securities of such issuer being held by the Fund.
If a percentage restriction on investment or utilization of assets as set
forth above is adhered to at the time an investment is made, a later change in
percentage resulting from changes in the values of a Fund's assets will not be
considered a violation of the restriction; provided, however, that the asset
coverage requirement applicable to borrowings under Section 18(f)(1) of the 1940
Act shall be maintained in the manner contemplated by that Section.
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B. MISCELLANEOUS INVESTMENT PRACTICES
The following discussion provides additional information about the
types of securities which may be purchased by one or more of the Funds,
including information about risk factors. An investor in a Fund would be exposed
to all of the investment risks associated with the securities purchased by that
Fund. Therefore, these risks should be considered carefully by all prospective
investors. In addition, due to the numerous factors that affect investment
results, it is not possible to identify every possible risk factor.
All investment limitations that are expressed as a percentage of a
Fund's assets are applied as of the time a Fund purchases a particular security,
except those limitations relating to a Fund's asset coverage requirements
applicable to certain borrowings under Section 18 of the 1940 Act. Not all Funds
will necessarily engage in all of the strategies discussed below, even where it
is permissible for a Fund to do so.
MONEY MARKET INSTRUMENTS AND TEMPORARY INVESTMENT STRATEGIES
Each Fund may hold cash items and invest in money market instruments
under appropriate circumstances as determined by the Manager or the Advisers.
Each Fund may invest up to 100% of its assets in cash or money market
instruments for temporary defensive purposes.
Money market instruments include (but are not limited to): (1) bankers'
acceptances; (2) obligations of governments (whether U.S. or non-U.S.) and their
agencies and instrumentalities; (3) short-term corporate obligations, including
commercial paper, notes, and bonds; (4) other short-term debt obligations; (5)
obligations of U.S. banks, non-U.S. branches of U.S. banks (Eurodollars), U.S.
branches and agencies of non-U.S. banks (Yankee dollars), and non-U.S. branches
of non-U.S. banks; (6) asset-backed securities; and (7) repurchase agreements.
Money market instruments are subject, to a limited extent, to credit
risk. Credit risk is the possibility that the issuer of a security may fail to
repay interest and principal in a timely manner. Eurodollar and Yankee
obligations have the same risks, such as income risk and credit risk, as U.S.
money market instruments. Other risks of Eurodollar and Yankee obligations
include the possibility that a foreign government will not let U.S.
dollar-denominated assets leave the country; the possibility that the banks that
issue Eurodollar obligations may not be subject to the same regulations as U.S.
banks; and the possibility that adverse political or economic developments will
affect investments in a foreign country.
CERTIFICATES OF DEPOSIT AND BANKERS' ACCEPTANCES
Each Fund may purchase certificates of deposit and bankers'
acceptances. Certificates of deposit are receipts issued by a depository
institution in exchange for the deposit of funds. The issuer agrees to pay the
amount deposited plus interest to the bearer of the receipt on the date
specified on the certificate. The certificate usually can be traded in the
secondary market prior to maturity. Bankers' acceptances typically arise from
short-term credit arrangements designed to enable businesses to obtain funds to
finance commercial transactions. Generally, an acceptance is a time draft drawn
on a bank by an exporter or an importer to obtain a stated amount of funds to
pay for specific merchandise. The draft is then "accepted" by a bank that, in
effect, unconditionally guarantees to pay the face value of the instrument on
its maturity date. The acceptance may then be held by the accepting bank as an
earning asset or it may be sold in the
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secondary market at the going rate of discount for a specific maturity. Although
maturities for acceptances can be as long as 270 days, most acceptances have
maturities of six months or less.
REPURCHASE AGREEMENTS
Each Fund is permitted to enter into fully collateralized repurchase
agreements. The Funds' Board has established standards for evaluation of the
creditworthiness of the banks and securities dealers with which the Funds may
engage in repurchase agreements. The Board also monitors, on a quarterly basis,
each Adviser's compliance with such standards. The Fund will enter into
repurchase agreements only with banks and broker/dealers believed by the Manager
to present minimal credit risks in accordance with guidelines approved by the
Board of Trustees and in consultation with the Advisers. The Manager will review
and monitor the creditworthiness of such institutions, and will consider the
capitalization of the institution, any rating of the institution or its debt by
independent rating agencies and other relevant factors.
A repurchase agreement is an agreement by which the seller of a
security agrees to repurchase the security sold to a Fund at a mutually agreed
upon time and price. It may also be viewed as the loan of money by a Fund to the
seller of the security. The resale price would be in excess of the purchase
price, reflecting an agreed upon market interest rate.
The Advisers will monitor such transactions to ensure that the value of
underlying collateral will be at least equal at all times to the total amount of
the repurchase obligation, including the accrued interest. If the seller
defaults, the Fund could realize a loss on the sale of the underlying security
to the extent that the proceeds of sale, including accrued interest, are less
than the resale price (including interest).
Further, a Fund could experience: delays in liquidating the underlying
securities while it enforces its rights to the collateral; below normal levels
of income; decline in value of the underlying securities; or a lack of access to
income during this period. A Fund may also incur unanticipated expenses
associated with enforcing its rights in connection with a repurchase agreement
transaction.
Each of the Funds, may, together with other registered investment
companies managed by the particular Fund's Adviser or its affiliates, transfer
uninvested cash balances into a single joint account, the daily aggregate
balance of which may be invested in one or more repurchase agreements.
REVERSE REPURCHASE AGREEMENTS
Each Fund, except the Growth Equity Fund, may enter into reverse
repurchase agreements. Reverse repurchase agreements involve sales by a Fund of
portfolio assets concurrently with an agreement by a Fund to repurchase the same
assets at a later date at a fixed price. Reverse repurchase agreements carry the
risk that the market value of the securities which a Fund is obligated to
repurchase may decline below the repurchase price. A reverse repurchase
agreement is viewed as a collateralized borrowing by a Fund. Borrowing magnifies
the potential for gain or loss on the portfolio securities of a Fund and,
therefore, increases the possibility of fluctuation in a Fund's net asset value.
A Fund will establish a segregated account with its custodian bank in which the
Fund will maintain liquid assets equal in value to a Fund's obligations in
respect of any reverse repurchase agreements.
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DEBT SECURITIES
Each Fund is permitted to invest in debt securities including: (1)
securities issued or guaranteed as to principal or interest by the U.S.
Government, its agencies or instrumentalities; (2) non-convertible debt
securities issued or guaranteed by U.S. corporations or other issuers (including
foreign governments or corporations); (3) asset-backed securities; (4)
mortgage-related securities, including collateralized mortgage obligations
("CMO's"); and (5) securities issued or guaranteed as to principal or interest
by a sovereign government or one of its agencies or political subdivisions,
supranational entities such as development banks, non-U.S. corporations, banks
or bank holding companies, or other non-U.S. issuers. Debt securities may be
classified as investment grade debt securities or non-investment grade debt
securities.
INVESTMENT GRADE DEBT SECURITIES
Each Fund is permitted under its investment policies to invest in debt
securities rated within the four highest rating categories (i.e., Aaa, Aa, A or
Baa by Moody's or AAA, AA, A or BBB by S&P) (or, if unrated, securities of
comparable quality as determined by an Adviser). Appendix A contains a
description of the ratings of the ratings services. These securities are
generally referred to as "investment grade securities." Each rating category has
within it different gradations or sub-categories. If a Fund is authorized to
invest in a certain rating category, the Fund is also permitted to invest in any
of the sub-categories or gradations within that rating category. If a security
is downgraded to a rating category which does not qualify for investment, the
Adviser will use its discretion in determining whether to hold or sell based
upon its opinion on the best method to maximize value for shareholders over the
long term. Debt securities carrying the fourth highest rating (i.e., "Baa" by
Moody's and "BBB" by S&P), and unrated securities of comparable quality (as
determined by an Adviser) are considered to have adequate capacity for payment
of principal and interest, but do involve a higher degree of risk than that
associated with investments in debt securities in the higher rating categories.
Such securities lack outstanding investment characteristics and have speculative
characteristics. Ratings made available by S&P and Moody's are relative and
subjective and are not absolute standards of quality. Although these ratings are
initial criteria for selection of portfolio investments, an Adviser also will
make its own evaluation of these securities. Among the factors that will be
considered are the long-term ability of the issuers to pay principal and
interest and general economic trends.
BELOW INVESTMENT GRADE DEBT SECURITIES
Securities rated below investment grade are commonly referred to as
"high yield-high risk securities" or "junk bonds". Each rating category has
within it different gradations or sub-categories. For instance the "Ba" rating
for Moody's includes "Ba3", "Ba2" and "Ba1". Likewise the S&P rating category of
"BB" includes "BB+", "BB" and "BB-". If a Fund is authorized to invest in a
certain rating category, the Fund is also permitted to invest in any of the
sub-categories or gradations within that rating category. Securities in the
highest category below investment grade are considered to be of poor standing
and predominantly speculative. These securities are considered speculative with
respect to the issuer's capacity to pay interest and repay principal in
accordance with the terms of the obligations. Accordingly, it is possible that
these types of factors could, in certain instances, reduce the value of
securities held by a Fund with a commensurate effect on the value of a Fund's
shares. If a security is downgraded, the Adviser
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will use its discretion in determining whether to hold or sell based upon its
opinion on the best method to maximize value for shareholders over the long
term.
The Value Equity Fund has no limit on the amount of assets it may
invest in non-investment grade convertible debt securities and it may invest up
to 5% in non-investment grade, non-convertible debt securities. The Value Equity
Fund does not expect to invest more than 10% of total assets in non-investment
grade securities of any type. The Disciplined Equity Fund and the Focused Equity
Fund may each invest up to 10% of the Fund's total assets in non-investment
grade convertible debt securities. The Balanced Fund may invest up to 25% of its
total assets in below investment grade debt securities. The Growth Equity Fund
may invest up to 10% of its total assets in below investment grade debt
securities. The Emerging Growth Equity Fund will not invest in below investment
grade debt securities.
Junk bonds pay higher interest yields in an attempt to attract
investors. Junk bonds may be issued by small, less-seasoned companies, or by
larger companies as part of a corporate restructuring such as a merger,
acquisition or leveraged buy out. Junk bonds have special risks that make them
riskier investments than investment-grade securities. They may be subject to
greater market fluctuations and risk of loss of income and principal than are
lower-yielding, investment-grade securities. There may be less of a market for
them and therefore they may be harder to sell at an acceptable price. There is a
greater possibility that an issuer's earnings may be insufficient to make the
payments of interest due on the bonds. The issuer's low creditworthiness may
increase the potential for its insolvency.
These risks mean that the Funds investing in junk bonds may not achieve
the expected income from lower-grade securities, and that the net asset value
per share of such Funds may be affected by declines in the value of these
securities. However, the Funds' limitations on investing in junk bonds may
reduce some of these risks.
The market value of certain of these securities also tend to be more
sensitive to individual corporate developments and changes in economic
conditions than do higher quality bonds. Additionally, medium and lower-rated
securities and comparable unrated securities generally present a higher degree
of credit risk. The risk of loss due to default by these issuers is
significantly greater because medium and lower-rated securities and unrated
securities of comparable quality generally are unsecured and frequently are
subordinated to the prior payment of senior indebtedness.
MORTGAGE-RELATED SECURITIES
Each Fund (other than the Disciplined Equity Fund) may invest in pools
of mortgage loans made by lenders such as savings and loan institutions,
mortgage bankers, commercial banks and others. Each Fund may also invest in
other types of mortgage backed securities. Pools of mortgage loans are assembled
for sale to investors (such as the Funds) by various governmental,
government-related and private organizations. A Fund may also invest in similar
mortgage-related securities which provide funds for multi-family residences or
commercial real estate properties.
In general, there are several risks associated with mortgage-related
securities. One is the risk that the monthly cash inflow from the underlying
loan may be insufficient to meet the monthly payment requirements of the
mortgage-related security.
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Prepayment of principal by mortgagors or mortgage foreclosures will
shorten the term of the underlying mortgage pool for a mortgage-related
security. Early returns of principal will affect the average life of the
mortgage-related securities remaining in a Fund. The occurrence of mortgage
prepayments is affected by factors including the level of interest rates,
general economic conditions, the location and age of the mortgage and other
social and demographic conditions. In periods of rising interest rates, the rate
of prepayment tends to decrease, thereby lengthening the average life of a pool
of mortgage-related securities. Conversely, in periods of falling interest
rates, the rate of prepayment tends to increase, thereby shortening the average
life of a pool. Reinvestment of prepayments may occur at higher or lower
interest rates than the original investment, thus affecting the yield of a Fund.
Because prepayments of principal generally occur when interest rates are
declining, it is likely that a Fund will have to reinvest the proceeds of
prepayments at lower interest rates than those at which the assets were
previously invested. If this occurs, a Fund's yield will correspondingly
decline. Thus, mortgage-related securities may have less potential for capital
appreciation in periods of falling interest rates than other fixed-income
securities of comparable maturity, although these securities may have a
comparable risk of decline in market value in periods of rising interest rates.
To the extent that a Fund purchases mortgage-related securities at a premium,
unscheduled prepayments, which are made at par, will result in a loss equal to
any unamortized premium.
Collateralized Mortgage Obligations ("CMOs") are obligations fully
collateralized by a portfolio of mortgages or mortgage-related securities.
Payments of principal and interest on the mortgages are passed through to the
holders of the CMOs on the same schedule as they are received, although certain
classes of CMOs have priority over others with respect to the receipt of
prepayments on the mortgages. Therefore, depending on the type of CMOs in which
a Fund invests, the investment may be subject to a greater or lesser risk of
prepayment than other types of mortgage-related securities.
Mortgage-related securities may not be readily marketable. To the
extent any of these securities are not readily marketable in the judgment of the
Adviser, the investment restriction limiting a Fund's investment in illiquid
investments to not more than 15% of the value of the Fund's net assets is
applicable. See the discussion of Illiquid Securities on page B-36.
The value of these securities may be significantly affected by interest
rates, the market's perception of the issuers and the creditworthiness of the
parties involved. These securities may also be subject to prepayment risk which
is the risk that prepayments of the underlying mortgages may shorten the life of
the investment, adversely affecting yield to maturity. The yield characteristics
of the mortgage securities differ from those of traditional debt securities.
Among the major differences are that interest and principal payments are made
more frequently on mortgage securities, usually monthly, and that principal may
be prepaid at any time because the underlying mortgage loans or other assets
generally permit prepayment at any time. Evaluation of the risks associated with
prepayment and determination of the rate at which prepayment will occur, is
influenced by a variety of economic, geographic, demographic, social and other
factors including interest rate levels, changes in housing needs, net equity
built by mortgagors in the mortgaged properties, job transfers, and unemployment
rates. If a Fund purchases these securities at a premium, a prepayment rate that
is faster than expected will reduce yield to maturity while a prepayment rate
that is slower than expected will have the opposite effect of increasing yield
to maturity. Conversely, if a Fund purchases these securities at a discount,
faster than expected prepayments will increase, and slower than expected
prepayments will reduce, yield to maturity.
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Amounts available for reinvestment are likely to be greater during a period of
declining interest rates and, as a result, are likely to be reinvested at lower
interest rates than during a period of rising interest rates. Accelerated
prepayments on securities purchased by a Fund at a premium may also impose a
risk of loss of principal because the premium may not have been fully amortized
at the time the principal is repaid in full.
Mortgage securities differ from conventional bonds in that principal is
paid back over the life of the mortgage securities rather than at maturity. As a
result, the holder of the mortgage securities (i.e., a Fund) receives monthly
scheduled payments of principal and interest, and may receive unscheduled
principal payments representing prepayments on the underlying mortgages. As
noted, the mortgage loans underlying mortgage-backed securities are generally
subject to a greater rate of principal prepayments in a declining interest rate
environment and to a lesser rate of principal prepayments in an increasing
interest rate environment. Under certain interest and prepayment scenarios, a
Fund may fail to recover the full amount of its investment in mortgage-backed
securities notwithstanding any direct or indirect governmental or agency
guarantee. Since faster than expected prepayments must usually be invested in
lower yielding securities, mortgage-backed securities are less effective at
"locking in" a specified interest rate than are conventional bonds or certain
types of U.S. government securities.
REITs are pooled investment vehicles that invest primarily in either
real estate or real estate related loans. The value of a REIT is affected by
changes in the value of the properties owned by the REIT or securing mortgage
loans held by the REIT. REITs are dependent upon the ability of the REITs'
managers, and are subject to heavy cash flow dependency, default by borrowers
and the qualification of the REITs, under applicable regulatory requirements,
for favorable income tax treatment. REITs are also subject to risks generally
associated with investments in real estate including possible declines in the
value of real estate, adverse general and local economic conditions,
environmental problems and changes in interest rates. To the extent that assets
underlying a REIT are concentrated geographically by property type or in certain
other respects, these risks may be heightened. A Fund that invests in a REIT
will indirectly bear its proportionate share of any expenses, including
management fees, paid by a REIT in which that Fund invests.
ASSET-BACKED SECURITIES
Each Fund (other than the Disciplined Equity Fund) may invest in
asset-backed securities. The securitization techniques used for asset-backed
securities are similar to those used for mortgage-related securities. The
collateral for these securities has included home equity loans, automobile and
credit card receivables, boat loans, computer leases, airplane leases, mobile
home loans, recreational vehicle loans and hospital accounts receivables. The
Funds may invest in these and other types of asset-backed securities that may be
developed in the future. These securities may be subject to the risk of
prepayment or default. The ability of an issuer of asset-backed securities to
enforce its security interest in the underlying securities may be limited.
Asset-backed securities entail certain risks not presented by
mortgage-backed securities. The collateral underlying asset-backed securities
may entail features that make them less effective as security for payments than
real estate collateral. Debtors may have the right to set off certain amounts
owed on the credit cards or other obligations underlying the asset-backed
security, such as credit card receivables, or the debt holder may not have a
first (or proper) security interest in all of the obligations backing the
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receivable because of the nature of the receivable or state or federal laws
granting protection to the debtor. Certain collateral may be difficult to locate
in the event of default, and recoveries on depreciated or damaged collateral may
not support payments on these securities.
EQUITY SECURITIES
Each Fund may invest in equity securities which include common stocks,
preferred stocks (including convertible preferred stock) and rights to acquire
such securities (such as warrants). In addition, the Funds may invest in
securities such as bonds, debentures and corporate notes which are convertible
into common stock at the option of the holder. These convertible debt securities
are considered equity securities for purposes of the Funds' investment policies
and limitations. Generally, the Funds' equity securities will consist mostly of
common stocks.
The value of a company's stock may fall as a result of factors which
directly relate to that company, such as lower demand for the company's products
or services or poor management decisions. A stock's value may also fall because
of economic conditions which affect many companies, such as increases in
production costs. The value of a company's stock may also be affected by changes
in financial market conditions that are not directly related to the company or
its industry, such as changes in interest rates or currency exchange rates. In
addition, a company's stock generally pays dividends only after the company
makes required payments to holders of its bonds and other debt. For this reason,
the value of the stock will usually react more strongly than the bonds and other
debt to actual or perceived changes in the company's financial condition or
progress.
WARRANTS
Each Fund may invest in warrants, which are certificates that give the
holder the right to buy a specific number of shares of a company's stocks at a
stipulated price within a certain time limit (generally, two or more years).
Because a warrant does not carry with it the right to dividends or voting rights
with respect to the securities which it entitles a holder to purchase, and
because it does not represent any rights in the assets of the issuer, warrants
may be considered more speculative than certain other types of investments.
Also, the value of a warrant does not necessarily change in tandem with the
value of the underlying securities, and a warrant ceases to have value if it is
not exercised prior to its expiration date.
SMALL CAPITALIZATION SECURITIES
Each Fund may invest in equity securities (including securities issued
in initial public offerings) of companies with market capitalizations within the
range represented by the Russell 2000 Index ("Small Capitalization Securities").
Because the issuers of Small Capitalization Securities tend to be smaller or
less well-established companies, they may have limited product lines, market
share or financial resources and may have less historical data with respect to
operations and management. As a result, Small Capitalization Securities are
often less marketable and experience a higher level of price volatility than
securities of larger or more well-established companies. In addition, companies
whose securities are offered in initial public offerings may be more dependent
on a limited number of key employees. Because securities issued in initial
public offerings are being offered to the public for the first time, the market
for such securities may be inefficient and less liquid.
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NON-U.S. SECURITIES
Each Fund is permitted to invest a portion of its assets in non-U.S.
securities, including American Depositary Receipts ("ADRs"), European Depositary
Receipts ("EDRs"), and Global Depositary Receipts ("GDRs") and other similar
types of instruments. ADRs are certificates issued by a U.S. bank or trust
company and represent the right to receive securities of a non-U.S. issuer
deposited in a domestic bank or non-U.S. branch of a U.S. bank. ADRs are traded
on a U.S. securities exchange, or in an over-the-counter market, and are
denominated in U.S. dollars. EDRs, which are sometimes referred to as
Continental Depositary Receipts ("CDRs"), are generally issued by foreign banks
and evidence ownership of either foreign or domestic securities. GDRs are
certificates issued globally and evidence a similar ownership arrangement. GDRs
are traded on non-U.S. securities exchanges and are denominated in non-U.S.
currencies. The value of an ADR, EDR, or a GDR will fluctuate with the value of
the underlying security, will reflect any changes in exchange rates and
otherwise will involve risks associated with investing in non-U.S. securities.
When selecting securities of non-U.S. issuers, the Manager or the respective
Adviser will evaluate the economic and political climate and the principal
securities markets of the country in which an issuer is located.
Investing in securities issued by non-U.S. issuers involves
considerations and potential risks not typically associated with investing in
obligations issued by U.S. issuers. Less information may be available about
non-U.S. issuers compared with U.S. issuers. For example, non-U.S. companies
generally are not subject to uniform accounting, auditing and financial
reporting standards or to other regulatory practices and requirements comparable
to those applicable to U.S. companies. In addition, the values of non-U.S.
securities are affected by changes in currency rates or exchange control
regulations, restrictions or prohibitions on the repatriation of non-U.S.
currencies, application of non-U.S. tax laws, including withholding taxes,
changes in governmental administration or economic or monetary policy (in the
U.S. or outside the U.S.) or changed circumstances in dealings between nations.
Costs are also incurred in connection with conversions between various
currencies.
Investing in non-U.S. sovereign debt will expose a Fund to the direct
or indirect consequences of political, social or economic changes in the
countries that issue the securities. The ability and willingness of sovereign
obligors in developing and emerging countries or the governmental authorities
that control repayment of their external debt to pay principal and interest on
such debt when due may depend on general economic and political conditions with
the relevant country. Many foreign countries have historically experienced, and
may continue to experience, high rates of inflation, high interest rates,
exchange rate trade difficulties and unemployment. Many foreign countries are
also characterized by political uncertainty or instability. Additional factors
which may influence the ability or willingness to service debt include, but are
not limited to, a country's cash flow situation, the availability of sufficient
foreign exchange on the date a payment is due, the relative size of its debt
service burden to the economy as a whole, and its government's policy towards
the International Monetary Fund, the World Bank and other international
agencies.
From time to time, each Fund, except the Disciplined Equity Fund, may
invest in securities of issuers located in emerging countries. Compared to the
United States and other developed countries, developing countries may have
relatively unstable governments, economies based on only a few industries, and
securities markets that are less liquid and trade a small number of securities.
Prices on these exchanges tend to be volatile and, in the past, securities in
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these countries have offered greater potential for gain (as well as loss) than
securities of companies located in developed countries.
"Emerging markets" are located in the Asia-Pacific region, Eastern
Europe, Latin America, South America and Africa. Security prices in these
markets can be significantly more volatile than in more developed countries,
reflecting the greater uncertainties of investing in less established markets
and economies. Political, legal and economic structures in many of these
emerging market countries may be undergoing significant evolution and rapid
development, and they may lack the social, political, legal and economic
stability characteristics of more developed countries. Emerging market countries
may have failed in the past to recognize private property rights. They may have
relatively unstable governments, present the risk of nationalization of
businesses, restrictions on foreign ownership, or prohibitions on repatriation
of assets, and may have less protection of property rights than more developed
countries. Their economies may be predominantly based on only a few industries,
may be highly vulnerable to changes in local or global trade conditions, and may
suffer from extreme and volatile debt burdens or inflation rates. Local
securities markets may trade a small number of securities and may be unable to
respond effectively to increases in trading volume, potentially making prompt
liquidation of substantial holdings difficult or impossible at times. A Fund may
be required to establish special custodian or other arrangements before making
investments in securities of issuers located in emerging market countries.
Securities of issuers located in these countries may have limited marketability
and may be subject to more abrupt or erratic price movements.
CURRENCY TRANSACTIONS
Each Fund, except the Disciplined Equity Fund and the Emerging Growth
Equity Fund, may engage in currency transactions to hedge the value of portfolio
securities denominated in particular currencies against fluctuations in relative
value. Currency transactions include forward currency contracts, currency swaps,
exchange-listed and over-the-counter ("OTC") currency futures contracts and
options thereon, and exchange listed and OTC options on currencies. The Balanced
Fund, however, will not engage in currency swaps.
Forward currency contracts involve a privately negotiated obligation to
purchase or sell a specific currency at a future date, which may be any fixed
number of days from the date of the contract agreed upon by the parties, at a
price set at the time of the contract. Currency swaps are agreements to exchange
cash flows based on the notional difference between or among two or more
currencies. See "Swap Agreements" below. The Disciplined Equity, Balanced and
Emerging Growth Equity Funds will not engage in forward foreign currency
contracts.
A Fund may enter into currency transactions only with counterparties
deemed credit worthy by the Manager under standards established by the Board and
the Manager, in consultation with the Advisers.
A Fund may also enter into options and futures contracts relative to a
foreign currency to hedge against fluctuations in foreign currency rates. The
use of forward currency transactions and options and futures contracts relative
to a foreign currency to protect the value of a Fund's assets against a decline
in the value of a currency does not eliminate potential losses arising from
fluctuations in the value of a Fund's underlying securities. A Fund may, to the
extent it invests in foreign securities, purchase or sell foreign currencies on
a spot basis and may also purchase or sell forward foreign currency exchange
contracts for hedging purposes and to seek to protect
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against anticipated changes in future foreign currency exchange rates. If a Fund
enters into a forward foreign currency exchange contract to buy foreign
currency, the Fund will segregate cash or liquid assets in an amount equal to
the value of the Fund's total assets committed to the consummation of the
forward contract, or otherwise cover its position in a manner permitted by the
SEC.
A Fund would incur costs in connection with conversions between various
currencies. A Fund may hold foreign currency received in connection with
investments in foreign securities when, in the judgment of the Adviser, it would
be beneficial to convert such currency into U.S. dollars at a later date, based
on anticipated changes in the relevant exchange rate. See "Options and Futures
Contracts" below for a discussion of risk factors relating to foreign currency
transactions including options and futures contracts related thereto.
OPTIONS AND FUTURES CONTRACTS
Each Fund may purchase and sell futures contracts, and purchase and
write call and put options on futures contracts, in order to seek to increase
total return or to hedge against changes in interest rates, securities prices
or, to the extent a Fund invests in foreign securities, currency exchange rates,
or to otherwise manage the Fund's term structures, sector selection and
durations in accordance with the Fund's investment objectives and policies.
In seeking to protect against the effect of changes in equity market
values, currency exchange rates or interest rates that are adverse to the
present or prospective position of the Funds, and for cash flow management, a
Fund may employ certain hedging and risk management techniques. These techniques
include the purchase and sale of options, futures and options on futures
involving equity and debt securities and foreign currencies, aggregates of
equity and debt securities, indices of prices of equity and debt securities and
other financial indices. Although these hedging transactions are intended to
minimize the risk of loss due to a decline in the value of the hedged security,
asset class or currency, certain of them may limit any potential gain that might
be realized should the value of the hedged security increase. A Fund may engage
in these types of transactions for the purpose of enhancing returns. The use of
options can also increase a Fund's transaction costs.
The techniques described herein will not always be available to the
Funds, and it may not always be feasible for a Fund to use these techniques even
where they are available. For example, the cost of entering into these types of
transactions may be prohibitive in some situations. In addition, a Fund's
ability to engage in these transactions may also be limited by tax
considerations and certain other legal considerations.
A Fund may write covered call options and purchase put and call options
on individual securities as a partial hedge against an adverse movement in the
security and in circumstances consistent with the objective and policies of the
Fund. This strategy limits potential capital appreciation in the portfolio
securities subject to the put or call option.
The Funds may also write covered put and call options and purchase put
and call options on foreign currencies to hedge against the risk of foreign
exchange fluctuations on foreign securities the particular Fund holds in its
portfolio or that it intends to purchase. For example, if a Fund enters into a
contract to purchase securities denominated in foreign currency, it could
effectively establish the maximum U.S. dollar cost of the securities by
purchasing call options on
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that foreign currency. Similarly, if a Fund held securities denominated in a
foreign currency and anticipated a decline in the value of that currency against
the U.S. dollar, the Fund could hedge against such a decline by purchasing a put
option on the foreign currency involved.
In addition, a Fund may purchase put and call options and write covered
put and call options on aggregates of equity and debt securities, and may enter
into futures contracts and options thereon for the purchase or sale of
aggregates of equity and debt securities, indices of equity and debt securities
and other financial indices. Aggregates are composites of equity or debt
securities that are not tied to a commonly known index. An index is a measure of
the value of a group of securities or other interests. An index assigns relative
values to the securities included in that index, and the index fluctuates with
changes in the market value of those securities.
A Fund may write covered options only. "Covered" means that, so long as
a Fund is obligated as the writer of a call option on particular securities or
currency, it: (1) will own either the underlying securities or currency or an
option to purchase the same underlying securities or currency having an
expiration date not earlier than the expiration date of the covered option and
an exercise price equal to or less than the exercise price of the covered
option, or (2) will establish or maintain with its custodian for the term of the
option a segregated account consisting of liquid assets. A Fund will cover any
put option it writes on particular securities or currency by maintaining a
segregated account with its custodian as described above.
To hedge against fluctuations in currency exchange rates, a Fund may
purchase or sell foreign currency futures contracts, and write put and call
options and purchase put and call options on such futures contracts. For
example, a Fund may use foreign currency futures contracts when it anticipates a
general weakening of the foreign currency exchange rate that could adversely
affect the market values of the Fund's foreign securities holdings. In this
case, the sale of futures contracts on the underlying currency may reduce the
risk of a reduction in market value caused by foreign currency variations. This
provides an alternative to the liquidation of securities positions in the Fund
and resulting transaction costs. When the Fund anticipates a significant foreign
exchange rate increase while intending to invest in a non-U.S. security, the
Fund may purchase a foreign currency futures contract to hedge against a rise in
foreign exchange rates pending completion of the anticipated transaction. Such a
purchase of a futures contract would serve as a temporary measure to protect the
Fund against any rise in the foreign exchange rate that may add additional costs
to acquiring the non-U.S. security position. The Fund similarly may use futures
contracts on equity and debt securities to hedge against fluctuations in the
value of securities it owns or expects to acquire or to increase or decrease
equity exposure in managing cash flows.
The Funds also may purchase call or put options on foreign currency
futures contracts to obtain a fixed foreign exchange rate at limited risk. A
Fund may purchase a call option on a foreign currency futures contract to hedge
against a rise in the foreign exchange rate while intending to invest in a
non-U.S. security of the same currency. A Fund may purchase put options on
foreign currency futures contracts to hedge against a decline in the foreign
exchange rate or the value of its non-U.S. securities. A Fund may write a
covered call option on a foreign currency futures contract as a partial hedge
against the effects of declining foreign exchange rates on the value of non-U.S.
securities.
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Options on indexes are settled in cash, not in delivery of securities.
The exercising holder of an index option receives, instead of a security, cash
equal to the difference between the closing price of the securities index and
the exercise price of the option. When a Fund writes a covered option on an
index, a Fund will be required to deposit and maintain liquid assets with a
custodian equal in value to the aggregate exercise price of a put or call option
pursuant to the requirements and the rules of the applicable exchange. If, at
the close of business on any day, the market value of the deposited securities
falls below the contract price, the Fund will deposit with the custodian
additional liquid assets equal in value to the deficiency.
To the extent that a Fund enters into futures contracts, options on
futures contracts and options on foreign currencies that are traded on an
exchange regulated by the Commodities Futures Trading Commission ("CFTC"), in
each case that are not for "bona fide hedging" purposes (as defined by
regulations of the CFTC), the aggregate initial margin and premiums required to
establish those positions may not exceed 5% of the liquidation value of the
Fund's portfolio, after taking into account the unrealized profits and
unrealized losses on any such contracts the Fund has entered into. However, the
"in-the-money" amount of such options may be excluded in computing the 5% limit.
Adoption of this guideline will not limit the percentage of a Fund's assets at
risk to 5%.
A Fund's use of options, futures and options thereon and forward
currency contracts (as described under "Currency Transactions") involves certain
investment risks and transaction costs to which it might not be subject were
such strategies not employed. Such risks include:
o dependence on the ability of an Adviser to predict movements in the
prices of individual securities, fluctuations in the general
securities markets or market sections and movements in interest rates
and currency markets;
o imperfect correlation between movements in the price of the securities
or currencies hedged or used for cover;
o the fact that skills and techniques needed to trade options, futures
contracts and options thereon or to use forward currency contracts are
different from those needed to select the securities in which a Fund
invests;
o lack of assurance that a liquid secondary market will exist for any
particular option, futures contract, option thereon or forward
contract at any particular time, which may affect a Fund's ability to
establish or close out a position;
o possible impediments to effective portfolio management or the ability
to meet current obligations caused by the segregation of a large
percentage of a Fund's assets to cover its obligations; and
o the possible need to defer closing out certain options, futures
contracts, options hereon and forward contracts in order to continue
to qualify for the beneficial tax treatment afforded "regulated
investment companies" under the Internal Revenue Code of 1986, as
amended, (the "Code").
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In the event that the anticipated change in the price of the securities
or currencies that are the subject of such a strategy does not occur, it may be
that a Fund would have been in a better position had it not used such a strategy
at all. The Funds' ability to engage in certain investment strategies, including
hedging techniques, may be limited by tax considerations, cost considerations
and other factors.
Transactions in futures contracts and options on futures involve
brokerage costs, require margin deposits, and in the case of options obligating
a Fund to purchase securities, may require the Fund to establish a segregated
account consisting of cash or liquid securities in an amount equal to the
underlying value of such futures contracts and options to the extent not covered
by an offsetting position.
While transactions in futures contracts and options on futures may
reduce certain risks, these transactions themselves entail certain other risks.
For example, unanticipated changes in interest rates or securities prices may
result in a poorer overall performance for a Fund than if it had not entered
into any futures contracts or options transactions.
Perfect correlation between a Fund's futures positions and portfolio
positions is impossible to achieve. There are no futures contracts based upon
individual securities, except certain U.S. government securities. In the event
of an imperfect correlation between a futures position and a portfolio position
which is intended to be protected, the desired protection may not be obtained
and the Fund may be exposed to risk of loss.
Some futures contracts or options on futures may be inherently illiquid
or may become illiquid under adverse market conditions. In addition, during
periods of market volatility, a commodity exchange may suspend or limit trading
in a futures contract or related option, which may make the instrument
temporarily illiquid and difficult to price. Commodity exchanges may also
establish daily limits on the amount that the price of a futures contract or
related option can vary from the previous day's settlement price. Once the daily
price limit is reached no trades may be made that day at a price beyond the
limit. This may prevent a Fund from closing out positions and limiting its
losses.
The successful utilization of hedging and risk management transactions
requires skills different from those needed in the selection of a Fund's
portfolio securities and depends on an Adviser's ability to predict correctly
the direction and degree of movements in interest rates. Although it is believed
that use of the hedging and risk management techniques described above will
benefit the Funds, if an Adviser's judgment about the direction or extent of the
movement in interest rates is incorrect, a Fund's overall performance would be
worse than if it had not entered into any such transactions. For example, if a
Fund had purchased an interest rate swap or an interest rate floor to hedge
against its expectation that interest rates would decline but instead interest
rates rose, such Fund would lose part or all of the benefit of the increased
payments it would receive as a result of the rising interest rates because it
would have to pay amounts to its counterparties under the swap agreement or
would have paid the purchase price of the interest rate floor.
SWAP AGREEMENTS
A Fund may enter into interest rate swaps, currency swaps, and other
types of swap agreements such as caps, collars, and floors. The Focused Equity,
Value Equity, Balanced and
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Emerging Growth Equity Funds may invest up to 10% of their respective assets in
these types of instruments. The Growth Equity Fund, will not enter into credit,
currency, index, interest rate and mortgage swaps and up to 10% of its total
assets may be invested in equity swaps. The Disciplined Equity Fund may invest
up to 10% of its assets in equity swaps. In a typical interest rate swap, one
party agrees to make regular payments equal to a floating interest rate
multiplied by a "notional principal amount," in return for payments equal to a
fixed rate multiplied by the same amount, for a specified period of time. If a
swap agreement provides for payments in different currencies, the parties might
agree to exchange (swap) the notional principal amount as well. Swaps may also
depend on other prices or rates, such as the value of an index or mortgage
prepayment rates. Equity swaps allow the parties to a swap agreement to exchange
the dividend income or other component of return on an equity investment (for
example, a group of equity securities or an index) for a component of return on
another non-equity or equity investment.
In a typical cap or floor agreement, one party agrees to make payments
only under specified circumstances, usually in return for payment of a fee by
the other party. For example, the buyer of an interest rate cap obtains the
right to receive payments equal to the extent that a specified interest rate
exceeds an agreed-upon level, while the seller of an interest rate floor is
obligated to make payments equal to the extent that a specified interest rate
falls below an agreed-upon level. An interest rate collar combines elements of
buying a cap and selling a floor.
Swap agreements will tend to shift a Fund's investment exposure from
one type of investment to another. For example, if a Fund agreed to exchange
floating rate payments for fixed rate payments, the swap agreement would tend to
decrease the Fund's exposure to rising interest rates. Caps and floors have an
effect similar to buying or writing options. Depending on how they are used,
swap agreements may increase or decrease the overall volatility of a Fund's
investments and its share price and yield.
A Fund will usually enter into interest rate swaps on a net basis,
i.e., where the two parties make net payments with a Fund receiving or paying,
as the case may be, only the net amount of the two payments. The net amount of
the excess, if any, of a Fund's obligations over its entitlement with respect to
each interest rate swap will be covered by liquid assets having an aggregate net
asset value at least equal to the accrued excess maintained by the Fund's
custodian in a segregated account. If a Fund enters into a swap on other than a
net basis, the Fund will maintain in the segregated account the full amount of
the Fund's obligations under each such swap. Pursuant to procedures adopted and
reviewed on an ongoing basis by the Board and the Manager, a Fund may enter into
swaps, caps, collars and floors with member banks of the Federal Reserve System,
members of the New York Stock Exchange or other entities determined to be
creditworthy by an Adviser. If a default occurs by the other party to such
transaction, a Fund will have contractual remedies pursuant to the agreements
related to the transaction but such remedies may be subject to bankruptcy and
insolvency laws which could affect such Fund's rights as a creditor.
A Fund may invest in equity swaps. As noted, equity swaps allow one
party to exchange the dividend income or other components of return on an equity
investment for a component of return on another non-equity or equity investment.
An equity swap may be used by a Fund to invest in a market without owning or
taking physical custody of particular securities in circumstances in which
direct investment may be restricted for legal reasons or is otherwise
impractical.
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The swap market has grown substantially in recent years with a large
number of banks and financial services firms acting both as principals and as
agents utilizing standardized swap documentation. As a result, the swap market
has become relatively liquid. Caps, collars and floors are more recent
innovations and they are less liquid than swaps. There can be no assurance,
however, that a Fund will be able to enter into interest rate swaps or to
purchase interest rate caps, collars or floors at prices or on terms an Adviser
believes are advantageous to such Fund. In addition, although the terms of
interest rate swaps, caps, collars and floors may provide for termination, there
can be no assurance that a Fund will be able to terminate an interest rate swap
or to sell or offset interest rate caps, collars or floors that it has
purchased. Because interest rate swaps, caps, collars and floors are privately
negotiated transactions rather than publicly traded, they may be considered to
be illiquid securities. To the extent that an Adviser does not accurately
analyze and predict the potential relative fluctuation of the components swapped
with another party, a Fund may suffer a loss. Equity swaps are very volatile. To
the extent that an Adviser does not accurately analyze and predict the potential
relative fluctuation of the components swapped with another party, a Fund may
suffer a loss. The value of some components of an equity swap (such as the
dividends on a common stock) may also be sensitive to changes in interest rates.
Furthermore, during the period a swap is outstanding, a Fund may suffer a loss
if the counterparty defaults.
STRUCTURED INVESTMENTS
Each Fund may enter into Structured Investments. Structured Investments
are derivative securities that are convertible into, or the value of which is
based upon the value of, other debt or equity securities or indices or other
factors. Currency exchange rates, interest rates (such as the prime lending rate
and LIBOR) and stock indices (such as the S&P 500) may be used. The amount a
Fund receives when it sells a Structured Investment or at maturity of a
Structured Investment is not fixed, but is based on the price of the underlying
security or index or other factor. Particular Structured Investments may be
designed so that they move in conjunction with or differently from their
underlying security or index in terms of price or volatility. It is impossible
to predict whether the underlying index or price of the underlying security will
rise or fall, but prices of the underlying indices and securities (and,
therefore, the prices of Structured Investments) will be influenced by the same
types of political and economic events that affect particular issuers of fixed
income and equity securities and capital markets generally. Structured
Investments also may trade differently from their underlying securities.
Structured Investments generally trade on the secondary market, which is fairly
developed and liquid. However, the market for such securities may be shallow
compared to the market for the underlying securities or the underlying index.
Accordingly, periods of high market volatility may affect the liquidity of
Structured Investments, making high volume trades possible only with
discounting.
Structured Investments are a relatively new innovation and may be
designed to have various combinations of equity and fixed income
characteristics. The following sections describe 4 common types of Structured
Investments. A Fund may invest in other Structured Investments, including those
that may be developed in the future, to the extent that the Structured
Investments are otherwise consistent with the Fund's investment objective and
policies.
LYONS
Liquid Yield Option Notes ("LYONs") differ from ordinary debt
securities, in that the amount received prior to maturity is not fixed but is
based on the price of the issuer's
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common stock. LYONs are zero-coupon notes that sell at a large discount from
face value. For an investment in LYONs, the Fund will not receive any interest
payments until the notes mature, typically in 15 to 20 years, when the notes are
redeemed at face, or par, value. The yield on LYONs is typically
lower-than-market rate for debt securities of the same maturity, due in part to
the fact that the LYONs are convertible into common stock of the issuer at any
time at the option of the holder of the LYONs. Commonly, the LYONs are
redeemable by the issuer at any time after an initial period or if the issuer's
common stock is trading at a specified price level or better or, at the option
of the holder, upon certain fixed dates. The redemption price typically is the
purchase price of the LYONs plus accrued original issue discount on the date of
redemption, which amounts to the lower-than-market yield. A Fund would receive
only the lower-than-market yield unless the underlying common stock increase in
value at a substantial rate. LYONs are an attractive investment when it appears
that they will increase in value due to the rise in value of the underlying
common stock.
PERCS
Preferred Equity Redemption Cumulative Stock ("PERCS") technically is
preferred stock with some characteristics of common stock. PERCS are mandatorily
convertible into common stock after a period of time, usually three years,
during which the investors' capital gains are capped, usually at 30%. Commonly,
PERCS may be redeemed by the issuer at any time or if the issuer's common stock
is trading at a specified price level or better. The redemption price starts at
the beginning of the PERCS duration period at a price that is above the cap by
the amount of the extra dividends the PERCS holder is entitled to receive
relative to the common stock over the duration of the PERCS and declines to the
cap price shortly before maturity of the PERCS. In exchange for having the cap
on capital gains and giving the issuer the option to redeem the PERCS at any
time or at the specified common stock price level, a Fund may be compensated
with a substantially higher dividend yield than that on the underlying common
stock. Investors that seek current income find PERCS attractive because PERCS
provide a higher dividend income than that paid with respect to a company's
common stock.
ELKS
Equity-Linked Securities ("ELKS") differ from ordinary debt securities
in that the principal amount received at maturity is not fixed but is based on
the price of the issuer's common stock. ELKS are debt securities commonly issued
in fully registered form for a term of three years under a trust indenture. At
maturity, the holder of ELKS will be entitled to receive a principal amount
equal to the lesser of a cap amount, commonly in the range of 30% to 55% greater
than the current price of the issuer's common stock, or the average closing
price per share of the issuer's common stock, or the average closing price per
share of the issuer's common stock, subject to adjustment as a result of certain
dilution events, for the 10 trading days immediately prior to maturity. Unlike
PERCS, ELKS are commonly not subject to redemption prior to maturity. ELKS
usually bear interest during the three-year term at a substantially higher rate
than the dividend yield on the underlying common stock. In exchange for having
the cap on the return that might have been received as capital gains on the
underlying common stock, a Fund may be compensated with the higher yield,
contingent on how well the underlying common stock performs. Investors that seek
current income find ELKS attractive because ELKS provide a higher dividend
income than that paid with respect to a company's common stock. The return on
ELKS depends on the creditworthiness of the issuer of the securities, which may
be the issuer of the underlying securities or a third party investment banker or
other lender. The creditworthiness
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of such third party issuers of ELKS may, and often does, exceed the
creditworthiness of the issuer of the underlying securities. The advantage of
using ELKS over traditional equity and debt securities is that the former are
income producing vehicles that may provide a higher income than the dividend
income on the underlying securities while allowing some participation in the
capital appreciation of the underlying equity securities. Another advantage of
using ELKS is that they may be used as a form of hedging to reduce the risk of
investing in the generally more volatile underlying equity securities.
STRUCTURED NOTES
Structured Notes are derivative securities for which the amount of
principal repayments and/or interest payments is based upon the movement of one
or more "factors". These factors include, but are not limited to, currency
exchange rates, interest rates (such as the prime lending rate and LIBOR) and
stock indices (such as the S&P 500). In some cases, the impact of the movements
of these factors may increase or decrease through the use of multipliers or
deflators. Structured Notes may be designed to have particular quality and
maturity characteristics and may vary from money market quality to below
investment grade. Depending on the factor used and use of multipliers or
deflators, however, changes in interest rates and movement of the factor may
cause significant price fluctuations or may cause particular Structured Notes to
become illiquid. A Fund would use Structured Notes to tailor its investments to
the specific risks and returns an Adviser wishes to accept while avoiding or
reducing certain other risks.
RISK MANAGEMENT
Each Fund may employ non-hedging risk management techniques. Risk
management strategies are used to keep a Fund fully invested and to reduce the
transaction costs associated with incoming and outgoing cash flows. Where equity
futures are used to "equitize" cash, the objective is to match the notional
value of all futures contracts to a Fund's cash balance. The notional value of
futures and of the cash is monitored daily. As the cash is invested in
securities and/or paid out to participants in redemptions, the Adviser
simultaneously adjusts the futures positions. Through such procedures, a Fund
not only gains equity exposure from the use of futures, but also benefits from
increased flexibility in responding to a Fund's cash flow needs. Additionally,
because it can be less expensive to trade a list of securities as a package or
program trade rather than as a group of individual orders, futures provide a
means through which transaction costs can be reduced. Such non-hedging risk
management techniques are not speculative, but because they involve leverage
they include, as do all leveraged transactions, the possibility of losses or
gains that are greater than if these techniques involved the purchase and sale
of the securities themselves.
ILLIQUID SECURITIES
Each Fund is permitted to invest in illiquid securities. No illiquid
securities will be acquired if upon the purchase thereof more than 15% of a
Fund's net assets would consist of illiquid securities. "Illiquid securities"
are securities that may not be sold or disposed of in the ordinary course of
business within seven days at approximately the price used to determine a Fund's
net asset value. Each Fund may purchase certain restricted securities commonly
known as Rule 144A securities that can be resold to institutions and which may
be determined to be liquid pursuant to policies and guidelines of the Board. A
Fund may not be able to sell illiquid securities when an Adviser considers it
desirable to do so or may have to sell such securities at a
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price that is lower than the price that could be obtained if the securities were
more liquid. A sale of illiquid securities may require more time and may result
in higher dealer discounts and other selling expenses than does the sale of
liquid securities. Illiquid securities also may be more difficult to value due
to the unavailability of reliable market quotations for such securities, and
investment in illiquid securities may have an adverse impact on net asset value.
Further, the purchase price and subsequent valuation of illiquid securities
normally reflect a discount, which may be significant, from the market price of
comparable securities for which a liquid market exists.
Under current interpretations of the Staff of the SEC, the following
types of securities in which a Fund may invest will be considered illiquid:
o repurchase agreements maturing in more than seven days;
o certain restricted securities (securities whose public resale is
subject to legal or contractual restrictions);
o options, with respect to specific securities, not traded on a national
securities exchange that are not readily marketable; and
o any other securities in which a Fund may invest that are not readily
marketable.
SHORT SALES
Each Fund, except the Emerging Growth Equity and Balanced Funds, may
make short sales of securities. The Focused Equity, Growth Equity, Disciplined
Equity, and Value Equity Funds may make short sales against the box. The Focused
Equity, Disciplined Equity and Value Equity Funds may engage in short sales
other than against the box. A short sale is a transaction in which a Fund sells
a security it does not own in anticipation that the market price of that
security will decline. A Fund expects to make short sales both to obtain capital
gains from anticipated declines in securities and as a form of hedging to offset
potential declines in long positions in the same or similar securities. The
short sale of a security is considered a speculative investment technique. When
a Fund makes a short sale, it must borrow the security sold short and deliver it
to the broker-dealer through which it made the short sale in order to satisfy
its obligation to deliver the security upon conclusion of the sale. A Fund may
have to pay a fee to borrow particular securities and is often obligated to pay
over any payments received on such borrowed securities. A Fund's obligation to
replace the borrowed security will be secured by collateral deposited with the
broker-dealer, usually cash, U.S. Government securities or other liquid high
grade debt obligations. A Fund will also be required to deposit in a segregated
account established and maintained with such Fund's custodian, liquid assets to
the extent necessary so that the value of both collateral deposits in the
aggregate is at all times equal to the greater of the price at which the
security is sold short or 100% of the current market value of the security sold
short. Depending on arrangements made with the broker-dealer from which it
borrowed the security, a Fund may not receive any payments (including interest)
on its collateral deposited with such broker-dealer. If the price of the
security sold short increases between the time of the short sale and the time a
Fund replaces the borrowed security, a Fund will incur a loss.
B-22
<PAGE>
Although a Fund's gain is limited to the price at which it sold the
security short, its potential loss is theoretically unlimited. In a "short sale
against the box," at the time of the sale, a Fund owns or has the immediate and
unconditional right to acquire at no additional cost the security and maintains
that right at all times when the short position is open. A Fund may make short
sales of securities or maintain a short position, provided that at all times
when a short position is open the Fund owns an equal amount of such securities
or securities convertible into or exchangeable for, without payment of any
further consideration, an equal amount of the securities of the same issuer as
the securities sold short (a short sale against-the-box).
As a result of recent tax legislation, short sales may not generally be
used to defer the recognition of gain for tax purposes with respect to
appreciated securities in a Fund's portfolio.
WHEN-ISSUED AND DELAYED-DELIVERY SECURITIES
Each Fund is permitted to purchase or sell securities on a when-issued
or delayed-delivery basis. When-issued or delayed-delivery transactions arise
when securities are purchased or sold with payment and delivery taking place in
the future in order to secure what is considered to be an advantageous price and
yield at the time of entering into the transaction. While the Funds generally
purchase securities on a when-issued or delayed delivery basis with the
intention of acquiring the securities, the Funds may sell the securities before
the settlement date if an Adviser deems it advisable. The purchase of securities
on a when-issued basis involves a risk of loss if the value of the security to
be purchased declines prior to the settlement date. At the time a Fund makes the
commitment to purchase securities on a when-issued or delayed delivery basis,
the Fund will record the transaction and thereafter reflect the value, each day,
of such security in determining the net asset value of the Fund. At the time of
delivery of the securities, the value may be more or less than the purchase
price. A Fund will maintain, in a segregated account, liquid assets having a
value equal to or greater than the Fund's purchase commitments in respect of any
obligations relating to when-issued or delayed delivery securities; a Fund will
likewise segregate securities sold on a delayed-delivery basis.
INVESTING IN OTHER INVESTMENT COMPANIES
Each Fund is permitted to invest in other investment companies
including investment companies which are not registered under the 1940 Act. Each
Fund may invest in investment companies located outside the United States.
Investments in other investment companies will involve the indirect payment of a
portion of the expenses, including advisory fees, of such other investment
companies. Pursuant to Section 12(d)(1) of the 1940 Act, a Fund will not
purchase a security of an investment company, if as a result: (1) more than 10%
of the Fund's total assets would be invested in securities of other investment
companies, (2) such purchase would result in more than 3% of the total
outstanding voting securities of any one such investment company being held by
the Fund, or (3) more than 5% of the Fund's total assets would be invested in
any one such investment company; unless an exemption from the limitations of
Section 12(d)(1) is available.
The Funds may also purchase Standard & Poor's Depository Receipts
("SPDRs"). SPDRs are American Stock Exchange-traded securities that represent
ownership in the SPDR Trust, a trust which has been established to accumulate
and hold a portfolio of common stocks that is intended to track the price
performance and dividend yield of the S&P 500. With regard to each
B-23
<PAGE>
Fund, SPDRs and other similar types of instruments would be subject to the
requirements of Section 12(d)(1) of the 1940 Act.
The Focused Equity and the Growth Equity Funds may invest in World
Equity Benchmark Shares ("WEBS") consistent with the limitations of Section
12(d)(1) of the 1940 Act. WEBS are shares of an investment company that invests
substantially all of its assets in securities included in the Morgan Stanley
Composite Index ("MSCI") indices for specified countries. WEBS are listed on the
American Stock Exchange ("AMEX") and were initially offered to the public in
1996. The market prices of WEBS are expected to fluctuate in accordance with
both changes in the net asset values of their underlying indices and supply and
demand of WEBS on the AMEX. To date, WEBS have traded at relatively modest
discounts and premiums to their NAVS. However, WEBS have a limited operating
history and information is lacking regarding the actual performance and trading
liquidity of WEBS for extended periods or over complete market cycles. In
addition, there is no assurance that the requirements of the AMEX necessary to
maintain the listing of WEBS will continue to be met or will remain unchanged.
In the event substantial market or other disruptions affecting WEBS should occur
in the future, the liquidity and value of a Fund's shares could also be
substantially and adversely affected. If such disruptions were to occur, a Fund
could be required to reconsider the use of WEBS as part of its investment
strategy.
PORTFOLIO SECURITIES LENDING
Each of the Funds may lend its portfolio securities to broker/dealers
and other institutions as a means of earning interest income. The borrower is
required to deposit as collateral, liquid assets that at all times will be at
least equal to 100% of the market value of the loaned securities and such amount
will be maintained in a segregated account of the respective Fund. While the
securities are on loan the borrower will pay the respective Fund any income
accruing thereon.
Delays or losses could result if a borrower of portfolio securities
becomes bankrupt or defaults on its obligation to return the loaned securities.
The Funds may lend securities only if: (1) each loan is fully secured
by appropriate collateral at all times; and (2) the value of all loaned
securities and borrowings of the Fund (not including transactions that are
covered by a segregated account or an offsetting position) would not exceed 33%
of the Fund's total assets taken at the time of the loan (including
collateral received in connection with any loans).
Under present regulatory policies, loans of portfolio securities may be
made to financial institutions such as brokers or dealers and are required to be
secured continuously by collateral in cash, cash equivalents or U.S. Government
securities maintained on a current basis at an amount at least equal to the
market value of the securities loaned. A Fund is required to have the right to
call a loan and obtain the securities loaned at any time on five days' notice.
For the duration of a loan, a Fund continues to receive the equivalent of the
interest or dividends paid by the issuer on the securities loaned and also
receives compensation from investment of the collateral. A Fund does not have
the right to vote any loaned securities having voting rights during the
existence of the loan, but a Fund could call the loan in anticipation of an
important vote to be taken among holders of the securities or the giving or
withholding of their consent on a material matter
B-24
<PAGE>
affecting the investment. As with other extensions of credit, there are risks of
delay in recovering, or even loss of rights in, the collateral should the
borrower of the securities default. However, the loans are made only to firms
deemed by the Advisers to be of good standing under guidelines established by
the Manager and the Board, and only when, in the judgment of an Adviser, the
money which can be earned by loaning the particular securities justifies the
attendant risks.
BOARD OF TRUSTEES
The Board of Trustees of the Trust is responsible for overseeing all
operations of the Funds, including supervising the Manager. The Manager is
responsible for overseeing the Advisers and establishing and monitoring
investment guidelines for the Trust. The Trustees and officers of the Trust,
some of whom are directors and officers of Allstate Life and affiliates thereof,
and their principal business occupations for the last five years, are set forth
below. Trustees who are deemed to be "interested persons" of the Trust under the
1940 Act are indicated by an asterisk next to their respective names.
TRUSTEES:
Listed below are the names of the Trustees of the Trust, along with
each Trustee's age, business address, and principal business occupation(s)
during the previous five years.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------
Principal Occupation(s)
Name, Address, and Age Position(s) Held with Trust During Past Five Years
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Robert S. Engelman, Jr. (57) Trustee (1998-Present), Chairman of the
MB Financial Inc. Board, MB Financial Inc. (Successor
1200 N. Ashland Avenue to Avondale Financial Corp.);
Chicago, Illinois 60622 (1993-1998), President and Chief
Executive Officer, Avondale
Financial Corp./Avondale Bank.
- ----------------------------------------------------------------------------------------------------------------------
Karen J. May (41) Trustee (1998-Present), Vice President,
180 Pembroke Global Planning and Staffing;
Lake Forest, Illinois 60045 (1997-1998), Vice President,
International Finance; (1994-1997),
Vice President, Corporate Audit,
Baxter International Inc.
- ----------------------------------------------------------------------------------------------------------------------
Arthur S. Nicholas (69) Trustee (1993-Present), Owner-President, The
655 Oak Road Antech Group.
Barrington, Illinois 60010
- ----------------------------------------------------------------------------------------------------------------------
Michael J. Velotta *(53) Trustee (1994 - Present), General Counsel,
3100 Sanders Road Allstate Life Insurance Company.
Northbrook, Illinois 60062
- ----------------------------------------------------------------------------------------------------------------------
Thomas J. Wilson* (41) Chairman of the Board (1999-Present), President, Allstate
3100 Sanders Road Life Insurance Company; (1995-1998),
Northbrook, Illinois 60062 Vice President, Senior Vice
President, Chief Financial Officer
and Director, Allstate Insurance
Company; (1993-1995), Vice
President, Sears Roebuck and Co.
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
B-25
<PAGE>
OFFICERS:
Listed below are the names of the officers of the Trust, along with
each officer's age, business address, position held with the Trust, and
principal business occupation(s) during the previous five years.
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------
Principal Occupation(s)
Name, Address, and Age Position(s) Held with Trust During Past Five Years
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Jeanette J. Donahue (49), Vice President, Chief Operations (1993-Present), Director, Allstate
3100 Sanders Road Officer, LSA Variable Series Trust Life Insurance Company.
Northbrook, Illinois 60062
- ----------------------------------------------------------------------------------------------------------------------
Keith A. Hauschildt (38) Treasurer, LSA Variable Series Trust (1996-Present), Director and
3100 Sanders Road Controller, Allstate Life Insurance
Northbrook, Illinois 60062 Company; (1993-1996), Director of
Finance, Allstate Insurance Company.
- ----------------------------------------------------------------------------------------------------------------------
John R. Hunter (44) President, LSA Variable Series Trust (1993-Present), Assistant Vice
3100 Sanders Road President, Allstate Life Insurance
Northbrook, Illinois 60062 Company.
- ----------------------------------------------------------------------------------------------------------------------
Barbara J. Whisler (34) Secretary and Chief Compliance (1997-Present), Assistant Counsel,
3100 Sanders Road Officer, LSA Variable Series Trust Allstate Life Insurance Company;
Northbrook, Illinois 60062 (1993-1997), Senior Counsel, Acting
Assistant Chief, Office of Insurance
Products, Division of Investment
Management, U.S. Securities and
Exchange Commission.
- ----------------------------------------------------------------------------------------------------------------------
Douglas G. Wolff (34) Vice President, Investments, LSA (1995-Present), Director, Allstate
3100 Sanders Road Variable Series Trust Life Insurance Company; (1993-
Northbrook, Illinois 60062 1995), Consulting Actuary, Ernst &
Young.
- ----------------------------------------------------------------------------------------------------------------------
</TABLE>
COMPENSATION OF OFFICERS AND DIRECTORS
The Trust pays no salaries or compensation to any officer or Trustee
affiliated with the Manager. The chart below sets forth the fees to be paid by
the Trust each fiscal year to the non-interested Trustees, along with certain
other information as of September 30, 1999.
<TABLE>
<CAPTION>
Pension or Total Compensation
Aggregate Retirement Benefits Estimated Annual From the Funds and
Compensation Accrual as Part of Benefits Upon Complex Paid to
Name of Person, Position From Trust Fund Expenses Retirement Trustee
- ------------------------ ---------- ------------- ---------- -------
<S> <C> <C> <C> <C>
Each Non-Interested $15,000 -0- -0- $15,000
Trustee
*As of September 30, 1999, there were six Funds in the Trust.
</TABLE>
CAPITAL STRUCTURE
The Trust was organized under Delaware law on March 2, 1999. The Trust
is a Delaware Business Trust and has the authority to authorize and issue an
unlimited number of shares. The Board may reclassify authorized shares to
increase or decrease the allocation of shares among the Funds or to add any new
Funds. The Board has the power, from time to time
B-26
<PAGE>
and without shareholder approval, to classify and reclassify existing and new
Funds into one or more classes.
CONTROL PERSONS
As of September 30, 1999, a separate account of Allstate Life owned
100% of the shares of the Funds.
VOTING
Shareholders are entitled to vote on a matter if: (i) a shareholder
vote is required under the 1940 Act; (ii) the matter concerns an amendment to
the Declaration of Trust that would adversely affect to a material degree the
rights and preferences of any Fund or any class thereof; or (iii) the Trustees
determine that it is necessary or desirable to obtain a shareholder vote. The
1940 Act requires a shareholder vote under various circumstances, including to
change any fundamental policy of a Fund. Shareholders of the Funds receive one
vote for each share owned on the record date; except that with respect to a
matter submitted for a vote of shareholders of all Funds, shareholders will be
entitled to vote on a dollar weighted basis. However, only shareholders of a
Fund that is affected by a particular matter are entitled to vote on that
matter. Voting rights are non-cumulative and cannot be modified without a
majority vote of shareholders.
OTHER RIGHTS
Each Fund share representing interests in a Fund, when issued and paid
for in accordance with the terms of the offering, will be fully paid and
non-assessable. These shares have no pre-emptive, subscription or conversion
rights and are redeemable. There are no shareholder pre-emptive rights. Upon
liquidation of a Fund, the shareholders of that Fund shall be entitled to share,
pro rata, in any assets of the Fund after discharge of all liabilities and
payment of the expenses of liquidation.
INVESTMENT MANAGEMENT ARRANGEMENTS
LSA Asset Management LLC, the Manager, located at 3100 Sanders Road,
Northbrook, Illinois 60062, serves as the investment adviser to the Trust and,
accordingly, as investment manager to each of the Funds. The Manager is a wholly
owned subsidiary of Allstate Life. Allstate Life and its subsidiaries are wholly
owned subsidiaries of Allstate Insurance Company. Allstate Insurance Company is
the second largest property/casualty writer in the U.S. Allstate Insurance
Company is a wholly owned subsidiary of the Allstate Corporation. Allstate Life,
incorporated in 1957 in Illinois, has established a record of financial strength
that has consistently resulted in superior ratings. A.M. Best Company assigns an
A+ (Superior) to Allstate Life. Standard & Poor's Insurance Rating Services
assigns an AA+ (Very Strong) financial strength rating and Moody's Investors
Service, Inc. assigns an Aa2 (Excellent) financial strength rating to Allstate
Life.
The Manager provides investment management services to each Fund
pursuant to an Investment Management Agreement with the Trust (the "Management
Agreement"). The services provided by the Manager consist of, among other
things, directing and supervising each Adviser, reviewing and evaluating the
performance of each Adviser and determining whether any Adviser
B-27
<PAGE>
should be replaced. The Manager and its affiliates will furnish all facilities
and personnel necessary in connection with providing these services. The
Management Agreement, after being initially approved, continues in force for two
years; thereafter it will continue in effect if such continuance is specifically
approved, at least annually, at a meeting called for the purpose of voting on
the Management Agreement, by the Trustees and by a majority of the Board members
who are not parties to the Management Agreement or interested persons of any
such party. The Manager pays all fees of the Advisers. The Advisers serve as
independent contractors of the Manager.
The Management Agreement is terminable, with respect to a Fund, without
penalty, on not more than 60 days' nor less than 30 days' written notice by: (1)
the Trust when authorized either by (a) in the case of a Fund, a majority vote
of the Fund's shareholders or (b) a vote of a majority of the Board; or (2) the
Manager. The Management Agreement will automatically terminate in the event of
its assignment. The Management Agreement provides that neither the Manager nor
its personnel shall be liable for any error of judgment or mistake of law or for
any loss arising out of any investment or for any act or omission in its
services to the Funds, except for willful misfeasance, bad faith or gross
negligence or reckless disregard of its or their obligations and duties under
the Management Agreement.
The Trust's Prospectus contains a description of fees payable to the
Manager for services under the Management Agreement. The Manager, not any Fund,
pays the fees of the Advisers.
THE ADVISERS
The Manager has entered into an advisory agreement for each Fund
pursuant to which the Manager has appointed an Adviser to carry out the
day-to-day investment and reinvestment of the assets of the relevant Fund. Under
the direction of the Manager, and, ultimately, of the Board, each Adviser is
responsible for making all of the day-to-day investment decisions for the
respective Fund (or portion of a Fund) in accordance with the Fund's investment
objective, guidelines and policies.
The Manager pays each Adviser a fee for its services from the Manager's
own resources. A Fund pays no additional management fees for the services of the
Advisers. Each Adviser furnishes at its own expense all facilities and personnel
necessary in connection with providing these services.
Goldman Sachs Asset Management ("GSAM") is a separate operating
division of Goldman, Sachs & Co. ("Goldman Sachs"). GSAM serves as the
investment adviser to the Growth Equity Fund. Goldman Sachs provides a wide
range of fully discretionary investment advisory services including
quantitatively driven and actively managed U.S. and international equity
portfolios, U.S. and global fixed income portfolios, commodity and currency
products, and money markets. The Goldman Sachs Group, L.P., which controls GSAM,
has merged into The Goldman Sachs Group Inc. as a result of an initial public
offering.
Salomon Brothers Asset Management Inc ("SBAM") serves as the investment
adviser to the Value Equity Fund. Together with its affiliates, SBAM manages a
wide spectrum of equity and fixed income products for both institutional and
private investors, including corporations, pension funds, public funds, central
banks, insurance companies, supranational
B-28
<PAGE>
organizations, endowments and foundations. SBAM is an indirect, wholly owned
subsidiary of Citigroup Inc.
J.P. Morgan Investment Management Inc. ("JPMIM"), 522 Fifth Avenue, New
York, New York 10036, serves as the Adviser to the Disciplined Equity Fund.
JPMIM is a wholly owned subsidiary of J.P. Morgan & Co. Incorporated. JPMIM
manages employee benefit funds of corporations, labor unions and state and local
governments and the accounts of other institutional investors, including
investment companies.
Morgan Stanley Asset Management ("MSAM"), with principal offices at
1221 Avenue of the Americas, New York, New York 10020, serves as the adviser to
the Focused Equity Fund. MSAM conducts a worldwide portfolio management business
and provides a broad range of portfolio management services to customers in the
United States and abroad. Morgan Stanley Dean Witter & Co. ("MSDW") is the
direct parent of MSAM. MSDW is a preeminent global financial services firm that
maintains leading market positions in each of its three primary businesses:
securities, asset management and credit services.
OpCap Advisors ("OpCap"), One World Financial Center, New York, New
York 10281, serves as the Adviser to the Balanced Fund. OpCap is a majority
owned subsidiary of Oppenheimer Capital. Oppenheimer Capital and OpCap are
indirect, wholly owned subsidiaries of PIMCO Advisors L.P. ("PIMCO Advisors").
PIMCO Advisors has two general partners: PIMCO Partners, G.P., a California
general partnership, and PIMCO Advisors Holdings L.P., an NYSE-listed Delaware
limited partnership of which PIMCO Partners, GP is the sole general partner.
Colin Glinsman is the portfolio manager for the Balanced Fund. Mr. Glinsman is
the chief investment officer and a managing director of Oppenheimer Capital and
has been a securities analyst with Oppenheimer Capital since 1989.
RS Investment Management, L.P. ("RSIM"), 388 Market Street, Suite 200,
San Francisco, California 99111, serves as the Adviser to the Emerging Growth
Equity Fund. RSIM commenced operations in March, 1993. RSIM is a wholly owned
subsidiary of RS Investment Management Co. LLC, a Delaware limited liability
company. James L. Callinan is responsible for managing the Emerging Growth
Equity Fund. Mr. Callinan also serves as portfolio manager of the RS Emerging
Growth Fund. From 1986 until June 1996, Mr. Callinan was employed by Putnam
Investments, where, beginning in June 1994, he served as portfolio manager of
the Putnam OTC Emerging Growth Domestic Equity Fund.
Organizational and portfolio manager information for each Adviser is
also provided in the Trust's prospectus.
FUND EXPENSES
Each Fund assumes and pays the following costs and expenses to the
extent they are not assumed by the Manager: interest; taxes, brokerage charges
(which may be paid to broker-dealers affiliated with the Manager or an Adviser);
costs of preparing, printing and filing any amendments or supplements to the
registration forms of each Fund and its securities; all federal and state
registration, qualification and filing costs and fees, issuance and redemption
expenses, transfer agency and dividend and distribution disbursing costs and
expenses; custodian fees and expenses; accounting, auditing and legal expenses;
fidelity bond and other insurance premiums; fees and salaries of trustees,
officers and employees (if any) of the Funds other than those who
B-29
<PAGE>
are also officers or employees of the Manager or its affiliates; industry
membership dues; all annual and semiannual reports and prospectuses mailed to
each Fund's shareholders as well as all quarterly, annual and any other periodic
report required to be filed with the SEC or with any state; any notices required
by a federal or state regulatory authority; and any proxy solicitation materials
directed to each Fund's shareholders as well as all printing, mailing and
tabulation costs incurred in connection therewith, and any expenses incurred in
connection with the holding of meetings of each Fund's shareholders, and other
miscellaneous expenses related directly to the Funds' operations and interest.
PORTFOLIO TRANSACTIONS AND BROKERAGE
The Funds have no obligation to deal with any dealer or group of
dealers in the execution of transactions in portfolio securities. Subject to any
policy established by the Manager and the Board, the Advisers are responsible
for making the day-to-day investment decisions for each Fund and the placing of
its portfolio transactions. In placing orders, it is the policy of each Fund to
obtain the most favorable net results, taking into account various factors,
including price, dealer spread or commission, if any, size of the transaction
and difficulty of execution. While the Advisers generally seek competitive
spreads or commissions, they may direct brokerage transactions to broker/dealers
who also sell variable annuity and variable life insurance contracts issued by
Allstate Life and its affiliates and the sale of such contracts may be taken
into account by the Manager and/or the Advisers when allocating brokerage
transactions. In addition, the Advisers may direct brokerage transactions to
broker-dealers with which they are affiliated subject to principles of best
execution and procedures established by the Board.
The Advisers will generally deal directly with the dealers who make a
market in the securities involved (unless better prices and execution are
available elsewhere) if the securities are traded primarily in the
over-the-counter market. Such dealers usually act as principals for their own
account. On occasion, securities may be purchased directly from the issuer.
Bonds and money market securities are generally traded on a net basis and do not
normally involve either brokerage commissions or transfer taxes.
While the Advisers seek to obtain the most favorable net results in
effecting transactions in a Fund's portfolio securities, dealers who provide
supplemental investment research to an Adviser may receive orders for
transactions for the Funds. Such supplemental research services ordinarily
consist of assessments and analyses of the business or prospects of a company,
industry, or economic sector. If, in the judgment of an Adviser, a Fund will
benefit by such supplemental research services, the Fund may pay spreads or
commissions to brokers or dealers furnishing such services which are in excess
of spreads or commissions which another broker or dealer may charge for the same
transaction. Information so received will be in addition to and not in lieu of
the services required to be performed under the Management Agreement or the
advisory agreements between the Manager and the Advisers. The expenses of the
Advisers will not necessarily be reduced as a result of the receipt of such
supplemental information. The Advisers may use such supplemental research in
providing investment advice to their client accounts other than those for which
the transactions are made. Similarly, the Funds may benefit from such research
obtained by the Advisers for portfolio transactions for other client accounts.
Investment decisions for the Funds will be made independently from
those of any other clients that may be (or in the future may be) managed by the
Manager, the Advisers or their affiliates. If, however, accounts managed by an
Adviser are simultaneously engaged in the
B-30
<PAGE>
purchase of the same security, then, pursuant to general authorization of the
Board and the Manager, available securities may be allocated to each Fund in a
manner an Adviser deems to be fair. Such allocation and pricing may affect the
amount of brokerage commissions paid by each Fund. In some cases, this system
might adversely affect the price paid by a Fund (for example, during periods of
rapidly rising or falling interest rates) or limit the size of the position
obtainable for a Fund (for example, in the case of a small issue).
Securities held by any Fund may also be held by other funds and other
clients for which the Advisers or their respective affiliates provide investment
advice. Because of different investment objectives or other factors, a
particular security may be bought by the Advisers for one or more clients when
one or more of the Advisers' clients are selling the same security. If purchases
or sales of securities arise for consideration at or about the same time for any
Fund or client accounts (including other funds) for which the Manager or an
Adviser acts as an investment adviser (including the Funds described herein),
transactions in such securities will be made, insofar as feasible, for the
respective Funds and other client accounts in a manner deemed equitable to all
and in accordance with procedures established by the Board. To the extent that
transactions on behalf of more than one client of the Advisers or their
respective affiliates during the same period may increase the demand for
securities being purchased or the supply of securities being sold, there may be
an adverse effect on price.
DETERMINATION OF NET ASSET VALUE
The net asset value of the shares of each Fund is based on the prices
of a Fund's underlying securities as of the close of trading of the New York
Stock Exchange (NYSE) on each day that the Exchange is open for business. The
NYSE usually closes at 4:00 p.m. Eastern Standard Time though it may close
earlier on any given day. The Funds will be closed for business and will not
price their shares on the following business holidays: New Year's Day, Martin
Luther King Day, Presidents' Day, Good Friday, Memorial Day, Independence Day,
Labor Day, Thanksgiving Day and Christmas Day.
Equity securities are valued at the last sales price reported on
principal securities exchanges (domestic or foreign). If no sale took place on
such day, then such securities are valued at the mean between the bid and asked
prices. Securities quoted in foreign currencies are translated into U.S. dollars
at the exchange rate at the end of the reporting period. Options are valued at
the last sales price; if no sales took place on such day, then options are
valued at the mean between the bid and asked prices. Securities for which market
quotations are not readily available and all other assets are valued in good
faith at fair value by, or under guidelines established by, the Funds' Board.
Short-term debt securities with a maturity of more than 60 days when
purchased are valued based on market quotations until the remaining days to
maturity become less than 61 days. From such time until maturity, the
investments are valued at amortized cost. Under the amortized cost method of
valuation, an instrument is valued at cost and the interest payable at maturity
upon the instrument is accrued as income, on a daily basis, over the remaining
life of the instrument. Neither the amount of daily income nor the net asset
value is affected by unrealized appreciation or depreciation of the Fund's
investments assuming the instrument's obligation is paid in full on maturity. In
periods of declining interest rates, the indicated daily yield on shares of the
portfolio computed using amortized cost may tend to be higher than a similar
computation made using a method of valuation based upon market prices and
estimates. In periods of rising
B-31
<PAGE>
interest rates, the indicated daily yield computed using amortized cost may tend
to be lower than a similar computation made using a method of valuation based
upon market prices and estimates. For all Funds, securities with remaining
maturities of less than 60 days are valued at amortized cost, which approximates
market value. Debt securities (other than short-term obligations) are valued on
the basis of valuations furnished by an unaffiliated pricing service which
determines valuations for normal institutional size trading units of debt
securities.
PURCHASE AND REDEMPTION OF SHARES
For information regarding the purchase of Fund shares, or how a
shareholder may have a Fund redeem his/her shares, see "Purchase and Redemption
of Fund Shares" in the Funds' Prospectus.
SUSPENSION OF REDEMPTIONS AND POSTPONEMENT OF PAYMENTS
A Fund may not suspend a shareholder's right of redemption, or postpone
payment for a redemption for more than seven days, unless the NYSE is closed for
other than customary weekends or holidays, or trading on the NYSE is restricted,
or for any period during which an emergency exists as a result of which: (1)
disposal by a Fund of securities owned by it is not reasonably practicable, or
(2) it is not reasonably practicable for a Fund to fairly determine the value of
its assets, or for such other periods as the SEC may permit for the protection
of investors.
INVESTMENT PERFORMANCE
STANDARDIZED AVERAGE ANNUAL TOTAL RETURN QUOTATIONS.
Average annual total return quotations for the Funds are computed by
finding the average annual compounded rates of return that would cause a
hypothetical investment made on the first day of a designated period to equal
the ending redeemable value of such hypothetical investment on the last day of
the designated period in accordance with the following formula:
P(1+T)n = ERV
Where:
P = a hypothetical initial payment of n = number of years
$1,000, less the maximum sales
load applicable to a Fund
T = average annual total return ERV = ending redeemable value
of the hypothetical $1,000 initial
payment made at the beginning
of the designated period
(or fractional portion thereof)
The computation above assumes that all dividends and distributions made
by a Fund are reinvested at net asset value during the designated period. The
average annual total return quotation is determined to the nearest 1/100 of 1%.
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One of the primary methods used to measure performance is "total
return." "Total return" will normally represent the percentage change in value
of a Fund, or of a hypothetical investment in a Fund, over any period up to the
lifetime of the class. Unless otherwise indicated, total return calculations
will assume the reinvestment of all dividends and capital gains distributions
and will be expressed as a percentage increase or decrease from an initial
value, for the entire period or for one or more specified periods within the
entire period.
Total return percentages for periods longer than one year will usually
be accompanied by total return percentages for each year within the period
and/or by the average annual compounded total return for the period. The income
and capital components of a given return may be separated and portrayed in a
variety of ways in order to illustrate their relative significance. Performance
may also be portrayed in terms of cash or investment values, without
percentages. Past performance cannot guarantee any particular future result. In
determining the average annual total return (calculated as provided above),
recurring fees, if any, that are charged to all shareholder accounts are taken
into consideration.
Each Fund's average annual total return quotations and yield quotations
as they may appear in the Prospectus, this SAI or in advertising are calculated
by standard methods prescribed by the SEC.
Each Fund may also publish its distribution rate and/or its effective
distribution rate. A Fund's distribution rate is computed by dividing the most
recent monthly distribution per share annualized, by the current net asset value
per share. A Fund's effective distribution rate is computed by dividing the
distribution rate by the ratio used to annualize the most recent monthly
distribution and reinvesting the resulting amount for a full year on the basis
of such ratio. The effective distribution rate will be higher than the
distribution rate because of the compounding effect of the assumed reinvestment.
A Fund's yield is calculated using a standardized formula (set forth below), the
income component of which is computed from the yields to maturity of all debt
obligations held by the Fund based on prescribed methods (with all purchase and
sales of securities during such period included in the income calculation on a
settlement date basis), whereas the distribution rate is based on a Fund's last
monthly distribution. A Fund's monthly distribution tends to be relatively
stable and may be more or less than the amount of net investment income and
short-term capital gain actually earned by the Fund during the month.
Other data that may be advertised or published about each Fund include
the average portfolio quality, the average portfolio maturity and the average
portfolio duration.
STANDARDIZED YIELD QUOTATIONS.
The yield of a Fund is computed by dividing the Fund's net investment
income per share during a base period of 30 days, or one month, by the maximum
offering price per share of the Fund on the last day of such base period in
accordance with the following formula:
2[(a-b)+1)6-1]
cd
Where:
a = net investment income earned c = the average daily number of
during the period attributable to shares of the subject class
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<PAGE>
the subject class outstanding during the period
that were entitled to receive
dividends
b = net expenses accrued for the d = the maximum offering price per
period attributable to the subject share of the subject
class
Net investment income will be determined in accordance with rules established by
the SEC.
NON-STANDARDIZED PERFORMANCE.
In addition, in order to more completely represent a Fund's performance
or more accurately compare such performance to other measures of investment
return, a Fund also may include in advertisements, sales literature and
shareholder reports other total return performance data ("Non-Standardized
Performance"). Non-Standardized Performance may be quoted for the same or
different periods as those for which Standardized Return data is quoted; it may
consist of an aggregate or average annual percentage rate of return, actual
year-by-year rates or any combination thereof. Non-Standardized Performance may
or may not take sales charges (if any) into account; performance data calculated
without taking the effect of sales charges into account will be higher than data
including the effect of such charges. All Non-Standardized Performance will be
advertised only if the standard performance data for the same period, as well as
for the required periods, is also presented.
GENERAL INFORMATION.
From time to time, the Funds may advertise their performance compared
to similar funds using certain unmanaged indices, reporting services and
publications.
The Standard & Poor's 500 Composite Stock Price Index is a well
diversified list of 500 companies representing the U.S. Stock Market. The Index
is a broad-based measurement of changes in stock-market conditions based on the
average performance of 500 widely held common stocks.
The Standard & Poor's MidCap 400 Index is designed to represent price
movements in the mid cap U.S. equity market. It contains companies chosen by the
Standard & Poor's Index Committee for their size, liquidity and industry
representation. None of the companies in the S&P 400 overlap with those in the
S&P 500 Index or the S&P 600 Index. Decisions about stocks to be included and
deleted are made by the Committee which meets on a regular basis. S&P 400 stocks
are market cap weighted; each stock influences the Index in proportion to its
relative market capitalization. The range of capitalization of companies in the
Index as of April 30, 1999 was $202 million to $14.4 billion. The inception year
of the S&P MidCap 400 Index is 1982. The Index is rebalanced as needed. S&P 400
companies which merge or are acquired are immediately replaced in the Index;
other companies are replaced when the Committee decides they are no longer
representative.
The Standard and Poor's Emerging Growth Domestic Equity 600 index is
designed to represent price movements in the Emerging Growth Domestic Equity
U.S. equity market. It contains companies chosen by the Standard & Poor's Index
Committee for their size, industry characteristics, and liquidity. None of the
companies in the S&P 600 overlap with the S&P 500
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<PAGE>
or the S&P 400 (MidCap Index). The S&P 600 is weighted by market capitalization.
REITs are not eligible for inclusion.
The NASDAQ Composite OTC Price Index is a market value-weighted and
unmanaged index showing the changes in the aggregate market value of
approximately 3,500 stocks.
The Lehman Government Bond Index is a measure of the market value of
all public obligations of the U.S. Treasury; all publicly issued debt of all
agencies of the U.S. Government and all quasi-federal corporations; and all
corporate debt guaranteed by the U.S. Government. Mortgage backed securities,
bonds and foreign targeted issues are not included in the Lehman Government Bond
Index.
The Lehman Government/Corporate Bond Index is a measure of the market
value of approximately 5,900 bonds with a face value currently in excess of $3.5
trillion. Issues must have at least one year to maturity and an outstanding par
value of at least $100 million for U.S. Government issues and $50 million for
all others.
The Russell 2000 Index represents the bottom two thirds of the largest
3000 publicly traded companies domiciled in the U.S. Russell uses total market
capitalization to sort its universe to determine the companies that are included
in the Index. Only common stocks are included in the Index. REITs are eligible
for inclusion.
The Russell 2500 Index is a market value-weighted, unmanaged index
showing total return (i.e., principal changes with income) in the aggregate
market value of 2,500 stocks of publicly traded companies domiciled in the
United States. The Index includes stocks traded on the New York Stock Exchange
and the American Stock Exchange as well as in the over-the-counter market.
The Morgan Stanley Capital International EAFE Index (the "EAFE Index")
is an unmanaged index, which includes over 1,000 companies representing the
stock markets of Europe, Australia, New Zealand and the Far East. The EAFE Index
is typically shown weighted by the market capitalization. However, EAFE is also
available weighted by Gross Domestic Product (GDP). These weights are modified
on July 1st of each year to reflect the prior year's GDP. Indices with dividends
reinvested constitute an estimate of total return arrived at by reinvesting one
twelfth of the month end yield at every month end.
The Lehman Brothers High Yield BB Index is a measure of the market
value of public debt issues with a minimum par value of $100 million and rated
Ba1-Ba3 by Moody's. All bonds within the index are U.S. dollar denominated,
non-convertible and have at least one year remaining to maturity.
In addition, from time to time in reports and promotions:
o a Fund's performance may be compared to other groups of
mutual funds tracked by: (a) Lipper Analytical Services, a
widely used independent research firm which ranks mutual
funds by overall performance, investment objectives, and
assets; (b) Morningstar, Inc., another widely used
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<PAGE>
independent research from which ranks mutual funds by
overall performance, investment objectives, and assets; or
(c) other financial or business publications, such as
Business Week, Money Magazine, Forbes and Barron's which
provide similar information;
o the Consumer Price Index (measure for inflation) may be used
to assess the real rate of return from an investment in the
Fund;
o other statistics such as GNP, and net import and export
figures derived from governmental publications, e.g., The
Survey of Current Business or other independent parties,
e.g., the Investment Company Institute, may be used to
illustrate investment attributes to a Fund or the general
economic, business, investment or financial environment in
which a Fund operates;
o various financial, economic and market statistics developed
by brokers, dealers and other persons may be used to
illustrate aspects of a Fund's performance;
o the effect of tax-deferred compounding on a Fund's
investment returns, or on returns in general, may be
illustrated by graphs, charts, etc. where such graphs or
charts would compare, at various points in time, the return
from an investment in a Fund (or returns in general) on a
tax-deferred basis (assuming reinvestment of capital gains
and dividends and assuming one or more tax rates) with the
return on a taxable basis; and
o the sectors or industries in which a Fund invests may be
compared to relevant indices or surveys (e.g., S&P Industry
Surveys) in order to evaluate a Fund's historical
performance or current or potential value with respect to
the particular industry or sector.
TAXES
Each Fund is treated as a separate entity for federal income tax
purposes. Each Fund intends to elect to be treated, and intends to qualify for
each taxable year, as a separate "regulated investment company" under Subchapter
M of the Internal Revenue Code (the "Code"). As such and by complying with the
applicable provisions of the Code regarding the sources of its income, the
timing of its distributions, and the diversification of its assets, each Fund
will not be subject to federal income tax on taxable income (including net
realized capital gains) which is distributed to shareholders in accordance with
the timing and other requirements of the Code.
Qualification of a Fund for treatment as a regulated investment company
under the Code requires, among other things, that (a) at least 90% of a Fund's
gross income for its taxable year, without offset for losses from the sale or
other disposition of stock or securities or other transactions, be derived from
interest, dividends, payments with respect to securities loans and gains from
the sale or other disposition of stock or securities or foreign currencies, or
other income (including but not limited to gains from options, futures, or
forward contracts) derived with respect to its business of investing in such
stock, securities or currencies; (b) each Fund distribute to its shareholders
for each taxable year (in compliance with certain timing requirements) as
dividends at least 90% of the sum of its taxable and any tax-exempt net
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<PAGE>
investment income, the excess of net short-term capital gain over net long-term
capital loss and any other net income for that year (except for the excess, if
any, of net long-term capital gain over net short-term capital loss, which need
not be distributed in order for the Fund to qualify as a regulated investment
company but is taxed to the Fund if it is not distributed); and (c) each Fund
diversify its assets so that, at the close of each quarter of its taxable year,
(i) at least 50% of the fair market value of its total (gross) assets is
comprised of cash, cash items, U.S. Government securities, securities of other
regulated investment companies and other securities limited in respect of any
one issuer to no more than 5% of the fair market value of the Fund's total
assets and 10% of the outstanding voting securities of such issuer and (ii) no
more than 25% of the fair market value of its total assets is invested in the
securities of any one issuer (other than U.S. Government securities and
securities of other regulated investment companies) or of two or more issuers
controlled by the Fund and engaged in the same, similar, or related trades or
businesses.
Each Fund also intends to comply with the separate diversification
requirements imposed by Section 817(h) of the Code and the regulations
thereunder on certain insurance company separate accounts. These requirements,
which are in addition to the diversification requirements imposed on a Fund by
the 1940 Act and Subchapter M of the Code, place certain limitations on assets
of each insurance company separate account used to fund variable contracts.
Because Section 817(h) and those regulations treat the assets of the Fund as
assets of the related separate account, these regulations are imposed on the
assets of a Fund. Specifically, the regulations provide that, after a one year
start-up period or except as permitted by the "safe harbor" described below, as
of the end of each calendar quarter or within 30 days thereafter no more than
55% of the total assets of a Fund may be represented by any one investment, no
more than 70% by any two investments, no more than 80% by any three investments
and no more than 90% by any four investments. For this purpose, all securities
of the same issuer are considered a single investment, and each U.S. Government
agency and instrumentality is considered a separate issuer. Section 817(h)
provides, as a safe harbor, that a separate account will be treated as being
adequately diversified if the diversification requirements under Subchapter M
are satisfied and no more than 55% of the value of the account's total assets is
attributable to cash and cash items (including receivables), U.S. Government
securities and securities of other regulated investment companies. Failure by a
Fund to both qualify as a regulated investment company and satisfy the Section
817(h) requirements would generally cause the variable contracts to lose their
favorable tax status and require a contract holder to include in ordinary income
any income accrued under the contracts for the current and all prior taxable
years. Under certain circumstances described in the applicable Treasury
regulations, inadvertent failure to satisfy the applicable diversification
requirements may be corrected, but such a correction would require a payment to
the Internal Revenue Service based on the tax contract holders would have
incurred if they were treated as receiving the income on the contract for the
period during which the diversification requirements were not satisfied. Any
such failure may also result in adverse tax consequences for the insurance
company issuing the contracts. Failure by a Fund to qualify as a regulated
investment company would also subject the Fund to federal and state income
taxation on all of its taxable income and gain, whether or not distributed to
shareholders.
Under certain circumstances, the Fund will be subject to a 4%
nondeductible federal excise tax on any amounts required to be but not
distributed under a prescribed formula. The formula requires that a Fund
distribute (or be deemed to have distributed) to its shareholders during each
calendar year at least 98% of the Fund's ordinary income for the calendar year,
at least 98% of the excess of its capital gains over its capital losses realized
during the one-year period ending on October 31 of such year, and any income or
gain (as so computed) from the
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<PAGE>
prior calendar year that was not distributed for such year and on which the Fund
paid no income tax. Each Fund intends generally to seek to avoid liability for
this tax.
Any dividend declared by a Fund in October, November or December as of
a record date in such a month and paid the following January will be treated for
federal income tax purposes as received by shareholders on December 31 of the
year in which it is declared.
If a Fund acquires any equity interest in certain foreign corporations
that receive at least 75% of their annual gross income from passive sources
(such as interest, dividends, certain rents and royalties, or capital gains) or
hold at least 50% of their assets in investments producing such passive income
("passive foreign investment companies"), that Fund could be subject to federal
income tax and additional interest charges on "excess distributions" received
from such companies or gain from the sale of stock in such companies, even if
all income or gain actually received by the Fund is timely distributed to its
shareholders. The Fund would not be able to pass through to its shareholders any
credit or deduction for such a tax. Certain elections may ameliorate these
adverse tax consequences, but any such election could require the applicable
Fund to recognize taxable income or gain (subject to tax distribution
requirements) without the concurrent receipt of cash. These investments could
also result in the treatment of associated capital gains as ordinary income. Any
Fund that is permitted to invest in foreign corporations may limit and/or manage
its holdings in passive foreign investment companies to minimize its tax
liability or maximize its return from these investments.
Foreign exchange gains and losses realized by a Fund in connection with
certain transactions involving foreign currency-denominated debt securities,
certain foreign currency futures and options, foreign currency forward
contracts, foreign currencies, or payables or receivables denominated in a
foreign currency are subject to Section 988 of the Code. Section 988 generally
causes such gains and losses to be treated as ordinary income and losses and may
affect the amount, timing and character of distributions to shareholders. Any
such transactions that are not directly related to a Fund's investment in stock
or securities, possibly including speculative currency positions or currency
derivatives not used for hedging purposes, could under future Treasury
regulations produce income not among the types of "qualifying income" from which
the Fund must derive at least 90% of its annual gross income. Income for
investments in commodities, such as gold and certain related derivative
instruments, is also not treated as qualifying income under this test. If the
net foreign exchange loss for a year treated as ordinary loss under Section 988
were to exceed a Fund's investment company taxable income computed without
regard to such loss, the resulting overall ordinary loss for such year would not
be deductible by the Fund or shareholders in future years.
A Fund may be subject to withholding and other taxes imposed by foreign
countries with respect to its investments in foreign securities. Tax conventions
between certain countries and the U.S. may reduce or eliminate such taxes in
some cases.
Investments in debt obligation that are at risk of default may present
special tax issues. Tax rules may not be entirely clear about issues such as
when a Fund may cease to accrue interest, original issue discount, or market
discount, when and to what extent deductions may be taken for bad debts or
worthless securities, how payments received on obligations in default should be
allocated between principal and income, and whether exchanges of debt
obligations in a workout context are taxable. These and any other issues will be
addressed by a Fund, in the event it invests in such securities, in order to
seek to ensure that it distributes sufficient income to
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<PAGE>
preserve its status as a regulated investment company and does not become
subject to federal income or excise tax.
Each Fund that invests in certain pay in-kind securities ("PIKs") (debt
securities whose interest payments may be made either in cash or in-kind), zero
coupon securities, deferred payment securities, or certain increasing rate
securities (and, in general, any other securities with original issue discount
or with market discount if the Fund elects to include market discount in income
currently) must accrue income on such investments prior to the receipt of the
corresponding cash payments. However, each Fund must distribute, at least
annually, all or substantially all of its net income, including such accrued
income, to shareholders to qualify as a regulated investment company under the
Code and avoid federal income tax. Therefore, a Fund may have to dispose of its
portfolio securities under disadvantageous circumstances to generate cash, or
may have to leverage itself by borrowing the cash, to satisfy distribution
requirements.
Redemptions and exchanges of Fund shares are potentially taxable
transactions for shareholders that are subject to tax. Shareholders should
consult their own tax advisers to determine whether any particular transaction
in Fund shares is properly treated as a sale for tax purposes, as the following
discussion assumes, and to ascertain its tax consequences in their particular
circumstances. Any loss realized by a shareholder upon the redemption, exchange
or other disposition of shares with a tax holding period of six months or less
will be treated as a long-term capital loss to the extent of any amounts treated
as distribution of long-term capital gain with respect to such shares. Losses on
redemptions or other dispositions of shares may be disallowed under wash sale
rules in the event of other investments in the same Fund (including through
automatic reinvestment of dividends and distributions) within a period of 61
days beginning 30 days before and ending 30 days after a redemption or other
disposition of shares. In such a case, the disallowed portion of any loss would
be included in the federal tax basis of the shares acquired in the other
investments.
Limitations imposed by the Code on regulated investment companies like
the Fund may restrict a Fund's ability to enter into futures, options and
currency forward transactions.
Certain options, futures and forward foreign currency transactions
undertaken by a Fund may cause the Fund to recognize gains or losses from
marking to market even though its securities or other positions have not been
sold or terminated and affect the character as long-term or short-term (or, in
the case of certain currency forwards, options and futures, as ordinary income
or loss) and timing of some capital gains and losses realized by the Fund. Also,
certain of a Fund's losses on its transactions involving options, futures and
forward foreign currency contracts and/or offsetting or successor portfolio
positions may be deferred rather than being taken into account currently
calculating the Fund's taxable income or gains. These transactions may therefore
affect the amount, timing and character of a Fund's distributions to
shareholders. Certain of the applicable tax rules may be modified if the Fund is
eligible and chooses to make one or more of certain tax elections that may be
available. The Funds will take into account the special tax rules (including
consideration of available elections) applicable to options, futures or forward
contracts in order to minimize any potential adverse tax consequences.
The tax rules applicable to dollar rolls, currency swaps and interest
rate swaps, caps, floors and collars may be unclear in some respects, and the
Funds may be required to limit participation in such transactions in order to
qualify as regulated investment companies. Additionally, the Fund may be
required to recognize gain, but not loss, if any option, collar,
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<PAGE>
futures contract, swap, short sale or other transaction that is not subject to
the market-to-market rules is treated as a constructive sale of an appreciated
financial position in the Fund's portfolio under Section 1259 of the Code. The
Fund may have to sell portfolio securities under disadvantageous circumstances
to generate cash, or borrow cash, to satisfy these distribution requirements.
The foregoing discussion relates solely to U.S. federal income tax law
as applicable to the Funds and certain aspects of their distributions. The
discussion does not address special tax rules applicable to insurance companies.
CUSTODIAN, TRANSFER AGENT, FUND ACCOUNTANT AND ADMINISTRATOR
Investors Bank & Trust Company ("IBT"), 200 Clarendon Street, Boston,
Massachusetts 02116, provides the Funds with transfer agent, accounting,
administrative and custodial services. As such, IBT is responsible for, among
other things, processing purchase and redemption orders, calculating the Funds'
net asset values and safeguarding the Funds' assets.
INDEPENDENT AUDITORS
The financial statements of the Trust will be audited by Deloitte and
Touche LLP, Two Prudential Plaza, 180 North Stetson Avenue, Chicago, Illinois,
for the periods indicated in their report.
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<PAGE>
APPENDIX A
Description of S & P, Moody's, Fitch and Duff ratings:
S & P
Bond Ratings
AAA
Bonds rated AAA have the highest rating assigned by the S & P. Capacity
to pay interest and repay principal is extremely strong.
AA
Bonds rated AA have a very strong capacity to pay interest and repay
principal.
A
Bonds rated A have a strong capacity to pay interest and repay
principal although they are somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than obligations in higher
rated categories.
BBB
Bonds rated BBB are regarded as having an adequate capacity to pay
interest and repay principal. Whereas they normally exhibit adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
bonds in this category than bonds in higher rated categories.
BB
Bonds rated BB have less near-term vulnerability to default than other
speculative grade debt. However, they face major ongoing uncertainties or
exposure to adverse business, financial or economic conditions which could lead
to inadequate capacity to meet timely interest and principal payments.
B
Bonds rated B have a greater vulnerability to default but presently
have the capacity to meet interest payments and principal repayments. Adverse
business, financial or economic conditions would likely impair capacity or
willingness to pay interest and repay principal.
CCC
<PAGE>
Bonds rated CCC have a current identifiable vulnerability to default
and are dependent upon favorable business, financial and economic conditions to
meet timely payments of interest and repayment of principal. In the event of
adverse business, financial or economic conditions, they are not likely to have
the capacity to pay interest and repay principal.
CC
The rating CC is typically applied to debt subordinated to senior debt
which is assigned an actual or implied CCC rating.
C
The rating C is typically applied to debt subordinated to senior debt
which is assigned an actual or implied CCC- debt rating.
D
Bonds rated D are in default, and payment of interest and/or repayment
of principal is in arrears.
S & P's letter ratings may be modified by the addition of a plus (+) or
a minus (-) sign designation, which is used to show relative standing within the
major rating categories, except in the AAA (Prime Grade) category.
Commercial Paper Rating
An S & P commercial paper rating is a current assessment of the
likelihood of timely payment of debt having an original maturity of no more than
365 days. Issues assigned an A rating are regarded as having the greatest
capacity for timely payment. Issues in this category are delineated with the
numbers 1, 2 and 3 to indicate the relative degree of safety.
A-1
This designation indicates that the degree of safety regarding timely
payment is either overwhelming or very strong. Those issues determined to
possess overwhelming safety characteristics are denoted with a plus (+)
designation.
A-2
Capacity for timely payment on issues with this designation is
strong. However, the relative degree of safety is not as high as for issues
designated
A-3
<PAGE>
Issues carrying this designation have a satisfactory capacity for
timely payment. They are, however, somewhat more vulnerable to the adverse
effects of changes in circumstances than obligations carrying the higher
designations.
B
Issues carrying this designation are regarded as having only
speculative capacity for timely repayment.
C
This designation is assigned to short-term obligations with doubtful
capacity for payment.
D
Issues carrying this designation are in default, and payment of
interest and/or repayment of principal is in arrears.
Moody's
Bond Ratings
Aaa
Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and generally are referred to as
"gilt edge." Interest payments are protected by a large or by an exceptionally
stable margin and principal is secure. While the various protective elements are
likely to change, such changes as can be visualized are most unlikely to impair
the fundamentally strong position of such issues.
Aa
Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what generally are known as
high grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in Aaa securities or fluctuation of protective
elements may be of greater amplitude or there may be other elements present
which make the long-term risks appear somewhat larger than in Aaa securities.
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 sometime in the future.
<PAGE>
Baa
Bonds which are rated Baa are considered as medium grade obligations,
i.e., they are neither highly protected nor poorly secured. Interest payments
and principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
Ba
Bonds which are rated Ba are judged to have speculative elements; their
future cannot be considered as well assured. Often the protection of interest
and principal payments may be very moderate and, therefore, 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 present 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 the numerical modifiers 1, 2 and 3 to show relative
standing within the major rating categories, except in the Aaa category and in
the categories below B. The modifier 1 indicates a ranking for the security in
the higher end of a rating category; the modifier 2 indicates a mid-range
ranking; and the modifier 3 indicates a ranking in the lower end of a rating
category.
Commercial Paper Rating
<PAGE>
The rating Prime-1 (P-1) is the highest commercial paper rating
assigned by Moody's. Issuers of P-1 paper must have a superior capacity for
repayment of short-term promissory obligations, and ordinarily will be evidenced
by leading market positions in well established industries, high rates of return
on funds employed, conservative capitalization structures with moderate reliance
on debt and ample asset protection, broad margins in earnings coverage of fixed
financial charges and high internal cash generation, and well established access
to a range of financial markets and assured sources of alternate liquidity.
Issuers (or related supporting institutions) rated Prime-2 (P-2) have a
strong capacity for repayment of short-term promissory obligations. This
ordinarily will be evidenced by many of the characteristics cited above but to a
lesser degree. Earnings trends and coverage ratios, while sound, will be subject
to more variation. Capitalization characteristics, while still appropriate, may
be more affected by external conditions. Ample alternate liquidity is
maintained.
Issuers (or related supporting institutions) rated Prime-3 (P-3) have
an acceptable capacity for repayment of short-term promissory obligations. The
effect of industry characteristics and market composition may be more
pronounced. Variability in earnings and profitability may result in changes in
the level of debt protection measurements and the requirements for relatively
high financial leverage. Adequate alternate liquidity is maintained.
Issuers (or related supporting institutions) rated Not Prime do not
fall within any of the Prime rating categories.
Fitch
Bond Rating
The ratings represent Fitch's assessment of the issuer's ability to
meet the obligations of specific debt issue or class of debt. The ratings take
into consideration special features of the issue, its relationship to other
obligations of the issuer, the current financial condition and operative
performance of the issuer and of any guarantor, as well as the political and
economic environment that might affect the issuer's future financial strength
and credit quality.
AAA
Bonds rated AAA are considered to be investment grade and of the
highest credit quality. The obligor has an exceptionally strong ability to pay
interest and repay principal, which is unlikely to be affected by reasonably
foreseeable events.
AA
Bonds rated AA are considered to be investment grade and of very high
credit quality. The obligor's ability to pay interest and repay principal is
very strong, although not quite as strong as bonds rated AAA. Because bonds
rated in the AAA and AA categories are not
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significantly vulnerable to foreseeable future developments, short-term debt of
these issuers is generally rated F1+.
A
Bonds rated A are considered to be investment grade and of high credit
quality. The obligor's ability to pay interest and repay principal is considered
to be strong, but may be more vulnerable to adverse changes in economic
conditions and circumstances than bonds with higher ratings.
BBB
Bonds rated BBB are considered to be investment grade and of
satisfactory credit quality. The obligor's ability to pay interest and repay
principal is considered adequate. Adverse changes in economic conditions and
circumstances, however, are more likely to have an adverse impact on these
bonds, and therefore, impair timely payment. The likelihood that the ratings of
these bonds will fall below investment grade is higher than for bonds with
higher ratings.
BB
Bonds rated BB are considered speculative. The obligor's ability to pay
interest and repay principal may be affected over time by adverse economic
changes. However, business and financial alternatives can be identified which
could assist the obligor in satisfying its debt service requirements.
B
Bonds rated B are considered highly speculative. While bonds in this
class are currently meeting debt service requirements, the probability of
continued timely payment of principal and interest reflects the obligor's
limited margin of safety and the need for reasonable business and economic
activity throughout the life of the issue.
CCC
Bonds rated CCC have certain identifiable characteristics, which, if
not remedied, may lead to default. The ability to meet obligations requires an
advantageous business and economic environment.
CC
Bonds rated CC are minimally protected. Default in payment of interest
and/or principal seems probable over time.
C
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Bonds rated C are in imminent default in payment of interest or
principal.
DDD, DD and D
Bonds rated DDD, DD and D are in actual default of interest and/or
principal payments. Such bonds are extremely speculative and should be valued on
the basis of their ultimate recovery value in liquidation or reorganization of
the obligor. DDD represents the highest potential for recovery on these bonds
and D represents the lowest potential for recovery.
Plus (+) and minus (-) signs are used with a rating symbol to indicate
the relative position of a credit within the rating category. Plus and minus
signs, however, are not used in the AAA category covering 12-36 months.
Short-Term Ratings
Fitch's short-term ratings apply to debt obligations that are payable
on demand or have original maturities of up to three years, including commercial
paper, certificates of deposit, medium-term notes, and municipal and investment
notes.
Although the credit analysis is similar to Fitch's bond rating
analysis, the short-term rating places greater emphasis than bond ratings on the
existence of liquidity necessary to meet the issuer's obligations in a timely
manner.
F-1+
Exceptionally Strong Credit Quality. Issues assigned this rating are
regarded as having the strongest degree of assurance for timely payment.
F-1
Very Strong Credit Quality. Issues assigned this rating reflect an
assurance of timely payment only slightly less in degree than issues rated F-1+.
F-2
Good Credit Quality. Issues carrying this rating have a satisfactory
degree of assurance for timely payments, but the margin of safety is not as
great as the F-1+ and F-1 categories.
F-3
Fair Credit Quality. Issues assigned this rating have characteristics
suggesting that the degree of assurance for timely payment is adequate; however,
near-term adverse changes could cause these securities to be rated below
investment grade.
F-S
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Weak Credit Quality. Issues assigned this rating have characteristics
suggesting a minimal degree of assurance for timely payment and are vulnerable
to near-term adverse changes in financial and economic conditions.
D
Default. Issues assigned this rating are in actual or imminent payment
default.
Duff
Bond Ratings
AAA
Bonds rated AAA are considered highest credit quality. The risk factors
are negligible, being only slightly more than for risk-free U.S. Treasury debt.
AA
Bonds rated AA are considered high credit quality. Protection factors
are strong. Risk is modest but may vary slightly from time to time because of
economic conditions.
A
Bonds rated A have protection factors which are average but adequate.
However, factors are more variable and greater in periods of economic stress.
BBB
Bonds rated BBB are considered to have below average protection factors
but still considered sufficient for prudent investment. There may be
considerable variability in risk for bonds in this category during economic
cycles.
BB
Bonds rated BB are below investment grade but are deemed by Duff as
likely to meet obligations when due. Present or prospective financial protection
factors fluctuate according to industry conditions or company fortunes. Overall
quality may move up or down frequently within the category.
B
Bonds rated B are below investment grade and possess the risk that
obligations will not be met when due. Financial protection factors will
fluctuate widely according to economic
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cycles, industry conditions and/or company fortunes. Potential exists for
frequent changes in quality rating within this category or into a higher or
lower quality rating grade.
CCC
Bonds rated CCC are well below investment grade securities. Such bonds
may be in default or have considerable uncertainty as to timely payment of
interest, preferred dividends and/or principal. Protection factors are narrow
and risk can be substantial with unfavorable economic or industry conditions
and/or with unfavorable company developments.
DD
Defaulted debt obligations. Issuer has failed to meet scheduled
principal and/or interest payments.
Plus (+) and minus (-) signs are used with a rating symbol (except AAA)
to indicate the relative position of a credit within the rating category.
Commercial Paper Rating
The rating Duff-1 is the highest commercial paper rating assigned by
Duff. Paper rated Duff-1 is regarded as having very high certainty of timely
payment with excellent liquidity factors which are supported by ample asset
protection. Risk factors are minor. Paper rated Duff-2 is regarded as having
good certainty of timely payment, good access to capital markets and sound
liquidity factors and company fundamentals. Risk factors are small. Paper rated
Duff-3 is regarded as having satisfactory liquidity and other protection
factors. Risk factors are larger and subject to more variation. Nevertheless,
timely payment is expected. Paper rated Duff-4 is regarded as having 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. Paper rated Duff-5 is in default. The issuer has
failed to meet scheduled principal and/or interest payments.
