DCM Series Trust
DCM GROWTH FUND
Supplement dated May 17, 2000
to
Prospectus dated October 15, 1999
Effective June 1, 2000, the DCM Growth Fund will impose a redemption
fee equal to 1.00% of the value of Fund shares redeemed within six
months of purchase. The references to a redemption fee in the Fee
Table on page 7 and under the heading "Shareholder Transaction
Expenses" on page 8 of the Prospectus are revised accordingly.
The expense table on page 8 is also revised as follows:
1 Year $178 3 Years $551
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THE DCM GROWTH FUND
A SERIES OF THE
DCM SERIES TRUST
STATEMENT OF ADDITIONAL INFORMATION
October 15, 1999
AS SUPPLEMENTED
May 17, 2000
This Statement of Additional Information is not a prospectus and should
be read in conjunction with the Prospectus for the DCM Growth Fund dated October
15, 1999, as amended from time to time, a copy of which may be obtained without
charge by calling 1-888-878-2696 or writing to American Data Services, Inc.,
Hauppauge Corporate Center, 150 Motor Parkway, Hauppauge, NY 11788-0132.
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TABLE OF CONTENTS
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INTRODUCTION.............................................................. 1
INVESTMENT OBJECTIVE AND POLICIES......................................... 1
TYPES OF SECURITIES AND INVESTMENT TECHNIQUES............................. 3
TRUSTEES AND OFFICERS..................................................... 24
COMPENSATION TABLE........................................................ 24
CONTROL PERSONS AND PRINCIPAL HOLDERS OF SHARES........................... 25
INVESTMENT ADVISORY AND OTHER SERVICES.................................... 25
SHAREHOLDER SERVICING AND DISTRIBUTION PLAN............................... 27
PORTFOLIO TRANSACTIONS AND ALLOCATION OF BROKERAGE........................ 29
PERFORMANCE INFORMATION................................................... 31
TAX STATUS................................................................ 33
NET ASSET VALUE........................................................... 38
CAPITAL STRUCTURE......................................................... 39
SHAREHOLDER AND TRUSTEE LIABILITY......................................... 40
HOW TO BUY AND SELL SHARES................................................ 41
SERVICE PROVIDERS......................................................... 42
FINANCIAL STATEMENTS...................................................... F-1
APPENDIX - A: GLOSSARY OF INVESTMENT TERMS................................ A-1
APPENDIX - B: RATINGS OF INVESTMENT SECURITIES............................ B-1
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INTRODUCTION
The DCM Growth Fund ("Fund") is a series of the DCM Series Trust (the
"Trust"), an open-end management investment company offering redeemable shares
of beneficial interest. The Trust is a Massachusetts business trust formed on
August 5, 1999. As of the date of this Statement of Additional Information
("SAI"), the Fund is the only series of the Trust.
INVESTMENT OBJECTIVE AND POLICIES
The Fund is a non-diversified fund that seeks long-term growth of
capital.
FUNDAMENTAL INVESTMENT RESTRICTIONS
The Fund is subject to certain fundamental policies and restrictions
that may not be changed without shareholder approval. Shareholder approval means
approval by the lesser of (i) more than 50% of the outstanding voting securities
of the Trust, or (ii) 67% or more of the voting securities present at a meeting
if the holders of more than 50% of the outstanding voting securities of the
Trust are present or represented by proxy. As fundamental policies, the Fund may
not:
(1) Invest 25% or more of the value of its total assets in
any particular industry (other than U.S. government
securities).
(2) Invest directly in real estate; however, the Fund may
own debt or equity securities issued by companies
engaged in those businesses.
(3) Purchase or sell physical commodities other than foreign
currencies unless acquired as a result of ownership of
securities (but this limitation shall not prevent the
Fund from purchasing or selling options, futures, swaps
and forward contracts or from investing in securities or
other instruments backed by physical commodities).
(4) Lend any security or make any other loan if, as a
result, more than 25% of the Fund's total assets would
be lent to other parties (but this limitation does not
apply to purchases of commercial paper, debt securities
or repurchase agreements).
(5) Act as an underwriter of securities issued by others,
except to the extent that the Fund may be deemed an
underwriter in connection with the disposition of
portfolio securities of the Fund.
(6) Issue senior securities, except as permitted under the
Investment Company Act of 1940, as amended (the "1940
Act").
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(7) Borrow money, except that the Fund may borrow money for
temporary or emergency purposes (not for leveraging or
investment) in an amount not exceeding 33 1/3% of the
value of its total assets (including the amount
borrowed) less liabilities (other than borrowings). If
borrowings exceed 33 1/3% of the value of the Fund's
total assets by reason of a decline in net assets, the
Fund will reduce its borrowings within three days to the
extent necessary to comply with the 33 1/3% limitation.
This policy shall not prohibit reverse repurchase
agreements, deposits of assets to margin or guarantee
positions in futures, options, swaps or forward
contracts, or the segregation of assets in connection
with such contracts. The Fund will not purchase
securities while its borrowings exceed 5% of the Fund's
total assets.
In addition, as a fundamental policy, the Fund may not own more than
10% of the outstanding voting securities of any one issuer and, as to 50% of the
value of its total assets, purchase the securities of any one issuer (except
cash items and "government securities" as defined under the 1940 Act), if
immediately after and as a result of such purchase, the value of the holdings of
the Fund in the securities of such issuer exceeds 5% of the value of the Fund's
total assets.
ADDITIONAL INVESTMENT RESTRICTIONS
The Trustees have adopted additional investment restrictions for the
Fund. These restrictions are operating policies of the Fund and may be changed
by the Trustees without shareholder approval. The additional investment
restrictions adopted by the Trustees to date include the following:
(a) The Fund will not (i) enter into any futures contracts and related
options for purposes other than bona fide hedging transactions within the
meaning of Commodity Futures Trading Commission ("CFTC") regulations if the
aggregate initial margin and premiums required to establish positions in futures
contracts and related options that do not fall within the definition of bona
fide hedging transactions will exceed 5% of the fair market value of the Fund's
net assets, after taking into account unrealized profits and unrealized losses
on any such contracts it has entered into; and (ii) enter into any futures
contracts if the aggregate amount of the Fund's commitments under outstanding
futures contracts positions would exceed the market value of its total assets.
(b) The Fund does not currently intend to sell securities short, unless
it owns or has the right to obtain securities equivalent in kind and amount to
the securities sold short without the payment of any additional consideration
therefor, and provided that transactions in futures, options, swaps and forward
contracts are not deemed to constitute selling securities short.
(c) The Fund does not currently intend to purchase securities on
margin, except that the Fund may obtain such short-term credits as are necessary
for the clearance of transactions,
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and provided that margin payments and other deposits in connection with
transactions in futures, options, swaps and forward contracts shall not be
deemed to constitute purchasing securities on margin.
(d) The Fund may not mortgage or pledge any securities owned or held by
the Fund in amounts that exceed, in the aggregate, 15% of the Fund's net asset
value, provided that this limitation does not apply to reverse repurchase
agreements, deposits of assets to margin, guaranteed positions in futures,
options, swaps or forward contracts, or the segregation of assets in connection
with such contracts.
(e) The Fund does not currently intend to purchase any securities or
enter into a repurchase agreement if, as a result, more than 15% of its net
assets would be invested in repurchase agreements not entitling the holder to
payment of principal and interest within seven days and in securities that are
illiquid by virtue of legal or contractual restrictions on resale or the absence
of a readily available market. The Trustees, or the Fund's investment adviser
acting pursuant to authority delegated by the Trustees, may determine that a
readily available market exists for securities eligible for resale pursuant to
Rule 144A under the Securities Act of 1933, as amended, ("Rule 144A
Securities"), or any successor to such rule, and Section 4(2) commercial paper
issued in reliance on Section 4(2) of the Securities Act of 1933, as amended,
("Section 4(2) Commercial Paper"). Accordingly, such securities may not be
subject to the foregoing limitation.
(f) The Fund may not invest in companies for the purpose of exercising
control of management.
For purposes of the Fund's investing in a particular industry, the Fund
will rely primarily on industry classifications as published by Bloomberg L.P.
To the extent that Bloomberg L.P. classifications are so broad that the primary
economic characteristics in a single-class are materially different, the Fund
may further classify issuers in accordance with industry classifications as
published by the Securities and Exchange Commission ("SEC").
Except as otherwise noted herein and in the Fund's Prospectus, the
Fund's investment objectives and policies may be changed by a vote of the
Trustees without a vote of shareholders.
TYPES OF SECURITIES AND INVESTMENT TECHNIQUES
ILLIQUID INVESTMENTS
The Fund may invest up to 15% of its net assets in illiquid securities,
for which there is a limited trading market and for which a low trading volume
of a particular security may result in abrupt and erratic price movements. The
Fund may be unable to dispose of its holdings in illiquid securities at
acceptable prices and may have to dispose of such securities over extended
periods of time. Derby Capital Management, the Fund's investment adviser (the
"Adviser") will
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take reasonable steps to bring the Fund into compliance with this policy if the
level of illiquid investments were to exceed 15%. The Fund may invest in (i)
securities that are sold in private placement transactions between their issuers
and their purchasers and that are neither listed on an exchange nor traded
over-the-counter, and (ii) securities that are sold in transactions between
qualified institutional buyers pursuant to Rule 144A under the Securities Act of
1933, as amended (the "1933 Act"). Such securities are subject to contractual or
legal restrictions on subsequent transfer. As a result of the absence of a
public trading market, such restricted securities may in turn be less liquid and
more difficult to value than publicly traded securities. Although these
securities may be resold in privately negotiated transactions, the prices
realized from the sales could, due to illiquidity, be less than those originally
paid by the Fund or less than their fair value and in some instances, it may be
difficult to locate any purchaser. In addition, issuers whose securities are not
publicly traded may not be subject to the disclosure and other investor
protection requirements that may be applicable if their securities were publicly
traded. If any privately placed or Rule 144A Securities held by the Fund are
required to be registered under the securities laws of one or more jurisdictions
before being resold, the Fund may be required to bear the expenses of
registration. Securities which are freely tradable under Rule 144A may be
treated as liquid if the Trustees of the Fund are satisfied that there is
sufficient trading activity and reliable price information. Investing in Rule
144A Securities could have the effect of increasing the level of illiquidity of
the Fund's portfolio to the extent that qualified institutional buyers become,
for a time, uninterested in purchasing such 144A Securities.
See Appendix A for risks associated with certain other investments.
The Trustees have authorized the Adviser to make liquidity
determinations with respect to its securities, including Rule 144A Securities
and Section 4(2) Commercial Paper. Under the guidelines established by the
Trustees, the Adviser will consider the following factors: (1) the frequency of
trades and quoted prices for the security; (2) the number of dealers willing to
purchase or sell the security and the number of other potential purchasers; (3)
the willingness of dealers to undertake to make a market in the security; and
(4) the nature of the security and the nature of marketplace trades, including
the time needed to dispose of the security, the method of soliciting offers and
the mechanics of the transfer. In the case of Section 4(2) Commercial Paper, the
Adviser will also consider whether the paper is traded flat or in default as to
principal and interest and any ratings of the paper by a nationally recognized
statistical rating organization ("NRSRO"). A foreign security that may be freely
traded on or through the facilities of an offshore exchange or other established
offshore securities market is not deemed to be a restricted security subject to
these procedures.
ZERO COUPON, STEP COUPON SECURITIES AND PAY-IN-KIND
The Fund may invest up to 5% of its assets in zero coupon, pay-in-kind
and step coupon securities. Zero coupon bonds are issued and traded at a
discount from their face value and they do not entitle the holder to any
periodic payment of interest prior to maturity. Step coupon bonds trade at a
discount from their face value and pay coupon interest. The coupon rate is low
for an initial period and then increases to a higher coupon rate thereafter. The
discount from the face
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amount or par value depends on the time remaining until cash payments begin,
prevailing interest rates, liquidity of the security and the perceived credit
quality of the issuer. Pay-in-kind bonds normally give the issuer an option to
pay cash at a coupon payment date or give the holder of the security a similar
bond with the same coupon rate and a face value equal to the amount of the
coupon payment that would have been made.
Current federal income tax law requires holders of zero coupon
securities and step coupon securities to report the portion of the original
issue discount on such securities that accrues during a given year as interest
income, even though the holders receive no cash payments of interest during the
year. As a "regulated investment company" under the Internal Revenue Code of
1986, as amended, and the regulations thereunder (the "Code"), the Fund must
distribute its investment company taxable income, including the original issue
discount accrued on zero coupon or step coupon bonds to its shareholders.
Because the Fund will not receive cash payments on a current basis in respect of
accrued original issue discount payments, in some years the fund may have to
distribute cash obtained from other sources in order to satisfy the distribution
requirements under the code. The Fund might obtain such cash from selling other
portfolio holdings which might cause the Fund to incur capital gains or losses
on the sale. Additionally, these actions are likely to reduce the assets to
which Fund expenses could be allocated and to reduce the rate of return for the
Fund. In some circumstances, such sales might be necessary in order to satisfy
cash distribution requirements even though investment considerations might
otherwise make it undesirable for the Fund to sell the securities at the time.
Generally, the market prices of zero coupon, step coupon and
pay-in-kind securities are more volatile than the prices of securities that pay
interest periodically and in cash and are likely to respond to changes in
interest rates to a greater degree than other types of debt securities having
similar maturities and credit quality.
PASS-THROUGH SECURITIES
The Fund may invest up to 5% of its total assets in various types of
pass-through securities, such as mortgage-backed securities and asset-backed
securities. A pass-through security is a share or certificate of interest in a
pool of debt obligations that have been repackaged by an intermediary, such as a
bank or broker-dealer. The purchaser of a pass through security receives an
undivided interest in the underlying pool of securities. The issuers of the
underlying securities make interest and principal payments to the intermediary
which are passed through to purchasers, such as the Fund. The most common type
of pass-through securities are mortgage-backed securities. Government National
Mortgage Association ("GNMA") Certificates are mortgage-backed securities that
evidence an undivided interest in a pool of mortgage loans. GNMA Certificates
differ from bonds in that principal is paid back monthly by the borrowers over
the term of the loan rather than returned in a lump sum at maturity. The Fund
will generally purchase "modified pass-through" GNMA Certificates, which entitle
the holder to receive a share of all interest and principal payments paid and
owned on the mortgage pool, net of fees paid to the "issuer" and GNMA,
regardless of whether or not the mortgagor actually makes the
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payment. GNMA Certificates are backed as to the timely payment of principal and
interest by the full faith and credit of the U.S. government.
Freddie Mac issues two types of mortgage pass-through securities:
mortgage participation certificates ("PCs") and guaranteed mortgage certificates
("GMCs"). PCs resemble GNMA Certificates in that each PC represents a pro rata
share of all interest and principal payments made and owned on the underlying
pool. Freddie Mac guarantees timely payments of interest on PCs and the full
return of principal. GMCs also represent a pro rata interest in a pool of
mortgages. However, these instruments pay interest semiannually and return
principal once a year in guaranteed minimum payments. This type of security is
guaranteed by FHLMC as to timely payment of principal and interest but it is not
guaranteed by the full faith and credit of the U.S. government.
Fannie Mae issues guaranteed mortgage pass-through certificates
("Fannie Mae Certificates"). Fannie Mae Certificates resemble GNMA Certificates
in that each Fannie Mae Certificate represents a pro rata share of all interest
and principal payments made and owned on the underlying pool. This type of
security is guaranteed by Fannie Mae as to timely payment of principal and
interest but it is not guaranteed by the full faith and credit of the U.S.
government.
Except for GMCs, each of the mortgage-backed securities described above
is characterized by monthly payments to the holder, reflecting the monthly
payments made by the borrowers who received the underlying mortgage loans. The
payments to the security holders (such as the Fund), like the payments on the
underlying loans, represent both principal and interest. Although the underlying
mortgage loans are for a specified period of time, such as 20 or 30 years, the
borrowers can, and typically do, pay them off sooner. Thus, the security holders
frequently receive prepayments of principal in addition to the principal that is
part of the regular monthly payments. The portfolio manager will consider
estimated prepayment rates in calculating the average weighted maturity of the
Fund. A borrower is more likely to prepay a mortgage that bears a relatively
high rate of interest. This means that in times of declining interest rates,
higher yielding mortgage-backed securities held by the Fund might be converted
to cash and that the Fund would be forced to accept lower interest rates when
that cash is used to purchase additional securities in the mortgage-backed
securities sector or in other investment sectors. Additionally, prepayments
during such periods will limit the Fund's ability to participate in as large a
market gain as may be experienced with a comparable security not subject to
prepayment.
Asset-backed securities represent interests in pools of consumer loans
and are backed by paper or accounts receivables originated by banks, credit card
companies or other providers of credit. Generally, the originating bank or
credit provider is neither the obligor nor the guarantor of the security, and
interest and principal payments ultimately depend upon payment of the underlying
loans by individuals.
OTHER INCOME-PRODUCING SECURITIES
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Other types of income producing securities that the Fund may purchase
include, but are not limited to, the following types of securities:
Variable and Floating Rate Obligations. These types of securities are
relatively long-term instruments that often carry demand features permitting the
holder to demand payment of principal at any time or at specified intervals
prior to maturity.
Standby Commitments. These instruments, which are similar to a put,
give the Fund the option to obligate a broker, dealer or bank to repurchase a
security held by that Fund at a specified price.
Tender Option Bonds. Tender option bonds are relatively long-term bonds
that are coupled with the agreement of a third party (such as a broker, dealer
or bank) to grant the holders of such securities the option to tender the
securities to the institution at periodic intervals.
Inverse Floaters. Inverse floaters are debt instruments whose interest
bears an inverse relationship to the interest rate on another security. The Fund
will not invest more than 5% of its net assets in inverse floaters.
The Fund will purchase standby commitments, tender option bonds and
instruments with demand features primarily for the purpose of increasing the
liquidity of the portfolio.
FUTURES, OPTIONS AND OTHER DERIVATIVE INSTRUMENTS
Futures Contracts. The Fund may enter into contracts for the purchase
or sale for future delivery of fixed-income securities, foreign currencies or
contracts based on financial indices, including indices of U.S. government
securities, foreign government securities, equity or fixed-income securities.
U.S. futures contracts are traded on exchanges which have been designated
"contract markets" by the CFTC and must be executed through a futures commission
merchant ("FCM"), or brokerage firm, which is a member of the relevant contract
market. Through their clearing corporations, the exchanges guarantee performance
of the contracts as between the clearing members of the exchange.
The buyer or seller of a futures contract is not required to deliver or
pay for the underlying instrument unless the contract is held until the delivery
date. However, both the buyer and seller are required to deposit "initial
margin" for the benefit of the FCM when the contract is entered into. Initial
margin deposits are equal to a percentage of the contract's value, as set by the
exchange on which the contract is traded, and may be maintained in cash or
certain other liquid assets by the Fund's custodian for the benefit of the FCM.
Initial margin payments are similar to good faith deposits or performance bonds.
Unlike margin extended by a securities broker, initial margin payments do not
constitute purchasing securities on margin for purposes of the Fund's investment
limitations. If the value of either party's position declines, that party will
be required to make additional "variation margin" payments for the benefit of
the FCM to settle the change in value on a daily basis. The party that has a
gain may be entitled to receive all or a portion of
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this amount. In the event of the bankruptcy of the FCM that holds margin on
behalf of the Fund, the Fund may be entitled to return of margin owed to it only
in proportion to the amount received by the FCM's other customers. The Adviser
will attempt to minimize the risk by careful monitoring of the creditworthiness
of the FCMs with which the Fund does business and by depositing margin payments
in a segregated account with the Fund's custodian.
The Fund intends to comply with guidelines of eligibility for exclusion
from the definition of the term "commodity pool operator" adopted by the CFTC
and the National Futures Association, which regulate trading in the futures
markets. The Fund will use futures contracts and related options primarily for
bona fide hedging purposes within the meaning of CFTC regulations. To the extent
that the Fund holds positions in futures contracts and related options that do
not fall within the definition of bona fide hedging transactions, the aggregate
initial margin and premiums required to establish such positions will not exceed
5% of the fair market value of the Fund's net assets, after taking into account
unrealized profits and unrealized losses on any such contracts it has entered
into.
Although the Fund will segregate cash and liquid assets in an amount
sufficient to cover its open futures obligations, the segregated assets would be
available to the Fund immediately upon closing out the futures position, while
settlement of securities transactions could take several days. However, because
the Fund's cash that may otherwise be invested would be held uninvested or
invested in other liquid assets so long as the futures position remains open,
the Fund's return could be diminished due to the opportunity losses of foregoing
other potential investments.
The Fund's primary purpose in entering into futures contracts is to
protect it from fluctuations in the value of securities or interest rates
without actually buying or selling the underlying debt or equity security. For
example, if the Fund anticipates an increase in the price of stocks, and it
intends to purchase stocks at a later time, the Fund could enter into a futures
contract to purchase a stock index as a temporary substitute for stock
purchases. If an increase in the market occurs that influences the stock index
as anticipated, the value of the futures contracts will increase, thereby
serving as a hedge against the Fund not participating in a market advance. This
technique is sometimes known as an anticipatory hedge. To the extent the Fund
enters into futures contracts for this purpose, the segregated assets maintained
to cover the Fund's obligations with respect to the futures contracts will
consist of other liquid assets from its portfolio in an amount equal to the
difference between the contract price and the aggregate value of the initial and
variation margin payments made by the Fund with respect to the futures
contracts. Conversely, if the Fund holds stocks and seeks to protect itself from
a decrease in stock prices, the Fund might sell stock index futures contracts,
thereby hoping to offset the potential decline in the value of its portfolio
securities by a corresponding increase in the value of the futures contract
position. The Fund could protect against a decline in stock prices by selling
portfolio securities and investing in money market instruments, but the use of
futures contracts enables it to maintain a defensive position without having to
sell portfolio securities.
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If the Fund owns Treasury bonds and the portfolio manager expects
interest rates to increase, the Fund may take a short position in interest rate
futures contracts. Taking such a position would have much the same effect as the
Fund selling Treasury bonds in its portfolio. If interest rates increase as
anticipated, the value of the Treasury bonds would decline, but the value of the
Fund's interest rate futures contract would increase, thereby keeping the net
asset value of the Fund from declining as much as it may have otherwise. If, on
the other hand, the portfolio manager expects interest rates to decline, the
Fund may take a long position in interest rate futures contracts in anticipation
of later closing out the futures position and purchasing the bonds. Although the
Fund can accomplish similar results by buying securities with long maturities
and selling securities with short maturities, given the greater liquidity of the
futures market than the cash market, it may be possible to accomplish the same
result more easily and more quickly by using futures contracts as an investment
tool to reduce risk.
The ordinary spreads between prices in the cash and futures markets,
due to differences in the nature of those markets, are subject to distortions.
First, all participants in the futures market are subject to initial margin and
variation margin requirements. Rather than meeting additional variation margin
requirements, investors may close out futures contracts through offsetting
transactions which could distort the normal price relationship between the cash
and futures markets. Second, the liquidity of the futures market depends on
participants entering into offsetting transactions rather than making or taking
delivery of the instrument underlying a futures contract. To the extent
participants decide to make or take delivery, liquidity in the futures market
could be reduced and prices in the futures market distorted. Third, from the
point of view of speculators, the margin deposit requirements in the futures
market are less onerous than margin requirements in the securities market.
Therefore, increased participation by speculators in the futures market may
cause temporary price distortions. Due to the possibility of the foregoing
distortions, a correct forecast of general price trends by the portfolio manager
still may not result in a successful use of futures.
Futures contracts entail risks. Although the Fund believes that use of
such contracts will benefit the Fund, the Fund's overall performance could be
adversely affected by entering into such contracts if the portfolio manager's
investment judgment proves incorrect. For example, if the Fund has hedged
against the effects of a possible decrease in prices of securities held in its
portfolio and prices increase instead, the Fund will lose part or all of the
benefit of the increased value of these securities because of offsetting losses
in its futures positions. In addition, if the Fund has insufficient cash, it may
have to sell securities from its portfolio to meet daily variation margin
requirements. Those sales may be, but will not necessarily be, at increased
prices which reflect the rising market and may occur at a time when the sales
are disadvantageous to such Fund.
The prices of futures contracts depend primarily on the value of their
underlying instruments. Because there are a limited number of types of futures
contracts, it is possible that the standardized futures contracts available to
the Fund will not match exactly such Fund's current or potential investments.
The Fund may buy and sell futures contracts based on underlying instruments with
different characteristics from the securities in which it typically
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invests--for example, by hedging investments in portfolio securities with a
futures contract based on a broad index of securities--which involves a risk
that the futures position will not correlate precisely with the performance of
the Fund's investments.
Futures prices can also diverge from the prices of their underlying
instruments, even if the underlying instruments closely correlate with the
Fund's investments. Futures prices are affected by factors such as current and
anticipated short-term interest rates, changes in volatility of the underlying
instruments and the time remaining until expiration of the contract. Those
factors may affect securities prices differently from futures prices. Imperfect
correlations between the Fund's investments and its futures positions also may
result from differing levels of demand in the futures markets and the securities
markets, from structural differences in how futures and securities are traded,
and from imposition of daily price fluctuation limits for futures contracts. The
Fund may buy or sell futures contracts with a greater or lesser value than the
securities it wishes to hedge or is considering purchasing in order to attempt
to compensate for differences in historical volatility between the futures
contract and the securities, although this may not be successful in all cases.
If price changes in the Fund's futures positions are poorly correlated with its
other investments, its futures positions may fail to produce desired gains or
result in losses that are not offset by the gains in the Fund's other
investments.
Because futures contracts are generally settled within a day from the
date they are closed out, compared with a settlement period of three days for
some types of securities, the futures markets can provide superior liquidity to
the securities markets. Nevertheless, there is no assurance that a liquid
secondary market will exist for any particular futures contract at any
particular time. In addition, futures exchanges may establish daily price
fluctuation limits for futures contracts and may halt trading if a contract's
price moves upward or downward more than the limit in a given day. On volatile
trading days when the price fluctuation limit is reached, it may be impossible
for the Fund to enter into new positions or close out existing positions. If the
secondary market for a futures contract is not liquid because of price
fluctuation limits or otherwise, the Fund may not be able to promptly liquidate
unfavorable futures positions and potentially could be required to continue to
hold a futures position until the delivery date, regardless of changes in its
value. As a result, the Fund's access to other assets held to cover its futures
positions also could be impaired.
Options on Futures Contracts. The Fund may buy and write put and call
options on futures contracts. An option on a future gives the Fund the right
(but not the obligation) to buy or sell a futures contract at a specified price
on or before a specified date. The purchase of a call option on a futures
contract is similar in some respects to the purchase of a call option on an
individual security. Depending on the pricing of the option compared to either
the price of the futures contract upon which it is based or the price of the
underlying instrument, ownership of the option may or may not be less risky than
ownership of the futures contract or the underlying instrument. As with the
purchase of futures contracts, when the Fund is not fully invested it may buy a
call option on a futures contract to hedge against a market advance.
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The writing of a call option on a futures contract constitutes a
partial hedge against declining prices of the security or foreign currency which
is deliverable under, or of the index comprising, the futures contract. If the
futures' price at the expiration of the option is below the exercise price, the
Fund will retain the full amount of the option premium which provides a partial
hedge against any decline that may have occurred in the Fund's portfolio
holdings. The writing of a put option on a futures contract constitutes a
partial hedge against increasing prices of the security or foreign currency
which is deliverable under, or of the index comprising, the futures contract. If
the futures' price at expiration of the option is higher than the exercise
price, the Fund will retain the full amount of the option premium which provides
a partial hedge against any increase in the price of securities which the Fund
is considering buying. If a call or put option the Fund has written is
exercised, the Fund will incur a loss which will be reduced by the amount of the
premium it received. Depending on the degree of correlation between the change
in the value of its portfolio securities and changes in the value of the futures
positions, the Fund's losses from existing options on futures may to some extent
be reduced or increased by changes in the value of portfolio securities.
The purchase of a put option on a futures contract is similar in some
respects to the purchase of protective put options on portfolio securities. For
example, the Fund may buy a put option on a futures contract to hedge its
portfolio against the risk of falling prices or rising interest rates.
The amount of risk the Fund assumes when it buys an option on a futures
contract is the premium paid for the option plus related transaction costs. In
addition to the correlation risks discussed above, the purchase of an option
also entails the risk that changes in the value of the underlying futures
contract will not be fully reflected in the value of the options bought.
Forward Contracts. A forward contract is an agreement between two
parties in which one party is obligated to deliver a stated amount of a stated
asset at a specified time in the future and the other party is obligated to pay
a specified amount for the assets at the time of delivery. The Fund may enter
into forward contracts to purchase and sell government securities, equity or
income securities, foreign currencies or other financial instruments. Forward
contracts generally are traded in an interbank market conducted directly between
traders (usually large commercial banks) and their customers. Unlike futures
contracts, which are standardized contracts, forward contracts can be
specifically drawn to meet the needs of the parties that enter into them. The
parties to a forward contract may agree to offset or terminate the contract
before its maturity, or may hold the contract to maturity and complete the
contemplated exchange.
The Fund may enter into forward currency contracts with stated contract
values of up to the value of the Fund's assets. A forward currency contract is
an obligation to buy or sell an amount of a specified currency for an agreed
price (which may be in U.S. dollars or a foreign currency). The Fund will
exchange foreign currencies for U.S. dollars and for other foreign currencies in
the normal course of business and may buy and sell currencies through forward
currency contracts in order to fix a price for securities it has agreed to buy
or sell ("transaction hedge"). The Fund also may hedge some or all of its
investments denominated in a foreign
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currency or exposed to foreign currency fluctuations against a decline in the
value of that currency relative to the U.S. dollar by entering into forward
currency contracts to sell an amount of that currency (or a proxy currency whose
performance is expected to replicate or exceed the performance of that currency
relative to the U.S. dollar) approximating the value of some or all of its
portfolio securities denominated in that currency ("position hedge") or by
participating in options or futures contracts with respect to the currency. The
Fund also may enter into a forward currency contract with respect to a currency
where the Fund is considering the purchase or sale of investments denominated in
that currency but has not yet selected the specific investments ("anticipatory
hedge"). In any of these circumstances the Fund may, alternatively, enter into a
forward currency contract to purchase or sell one foreign currency for a second
currency that is expected to perform more favorably relative to the U.S. dollar
if the portfolio manager believes there is a reasonable degree of correlation
between movements in the two currencies ("cross-hedge").
These types of hedging minimize the effect of currency appreciation as
well as depreciation, but do not eliminate fluctuations in the underlying U.S.
dollar equivalent value of the proceeds of or rates of return on the Fund's
foreign currency denominated portfolio securities. The matching of the increase
in value of a forward contract and the decline in the U.S. dollar equivalent
value of the foreign currency denominated asset that is the subject of the hedge
generally will not be precise. Shifting the Fund's currency exposure from one
foreign currency to another removes the Fund's opportunity to profit from
increases in the value of the original currency and involves a risk of increased
losses to the Fund if its portfolio manager's projection of future exchange
rates is inaccurate. Proxy hedges and cross-hedges may result in losses if the
currency used to hedge does not perform similarly to the currency in which
hedged securities are denominated. Unforeseen changes in currency prices may
result in poorer overall performance for the Fund than if it had not entered
into such contracts.
The Fund will cover outstanding forward currency contracts by
maintaining liquid portfolio securities denominated in or whose value is tied
to, the currency underlying the forward contract or the currency being hedged.
To the extent that the Fund is not able to cover its forward currency positions
with underlying portfolio securities, the Fund's custodian will segregate cash
or other liquid assets having a value equal to the aggregate amount of such
Fund's commitments under forward contracts entered into with respect to position
hedges, cross-hedges and anticipatory hedges. If the value of the securities
used to cover a position or the value of segregated assets declines, the Fund
will find alternative cover or segregate additional cash or liquid assets on a
daily basis so that the value of the covered and segregated assets will be equal
to the amount of the Fund's commitments with respect to such contracts. As an
alternative to segregating assets, the Fund may buy call options permitting the
Fund to buy the amount of foreign currency being hedged by a forward sale
contract or the Fund may buy put options permitting it to sell the amount of
foreign currency subject to a forward buy contract.
While forward contracts are not currently regulated by the CFTC, the
CFTC may in the future assert authority to regulate forward contracts. In such
event, the Fund's ability to utilize forward contracts may be restricted. In
addition, the Fund may not always be able to enter into
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forward contracts at attractive prices and may be limited in its ability to use
these contracts to hedge Fund assets.
Options on Foreign Currencies. The Fund may buy and write options on
foreign currencies in a manner similar to that in which futures or forward
contracts on foreign currencies will be utilized. For example, a decline in the
U.S. dollar value of a foreign currency in which portfolio securities are
denominated will reduce the U.S. dollar value of such securities, even if their
value in the foreign currency remains constant. In order to protect against such
diminutions in the value of portfolio securities, the Fund may buy put options
on the foreign currency. If the value of the currency declines, the Fund will
have the right to sell such currency for a fixed amount in U.S. dollars, thereby
offsetting, in whole or in part, the adverse effect on its portfolio.
Conversely, when a rise in the U.S. dollar value of a currency in which
securities to be acquired are denominated is projected, thereby increasing the
cost of such securities, the Fund may buy call options on the foreign currency.
The purchase of such options could offset, at least partially, the effects of
the adverse movements in exchange rates. As in the case of other types of
options, however, the benefit to the Fund from purchases of foreign currency
options will be reduced by the amount of the premium and related transaction
costs. In addition, if currency exchange rates do not move in the direction or
to the extent desired, the Fund could sustain losses on transactions in foreign
currency options that would require the Fund to forego a portion or all of the
benefits of advantageous changes in those rates.
The Fund may also write options on foreign currencies. For example, to
hedge against a potential decline in the U.S. dollar value of foreign currency
denominated securities due to adverse fluctuations in exchange rates, the Fund
could, instead of purchasing a put option, write a call option on the relevant
currency. If the expected decline occurs, the option will most likely not be
exercised and the decline in value of portfolio securities will be offset by the
amount of the premium received.
Similarly, instead of purchasing a call option to hedge against a
potential increase in the U.S. dollar cost of securities to be acquired, the
Fund could write a put option on the relevant currency which, if rates move in
the manner projected, will expire unexercised and allow the Fund to hedge the
increased cost up to the amount of the premium. As in the case of other types of
options, however, the writing of a foreign currency option will constitute only
a partial hedge up to the amount of the premium. If exchange rates do not move
in the expected direction, the option may be exercised and the Fund would be
required to buy or sell the underlying currency at a loss which may not be
offset by the amount of the premium. Through the writing of options on foreign
currencies, the Fund also may lose all or a portion of the benefits which might
otherwise have been obtained from favorable movements in exchange rates.
The Fund may write covered call options on foreign currencies. A call
option written on a foreign currency by the Fund is "covered" if the Fund owns
the foreign currency underlying the call or has an absolute and immediate right
to acquire that foreign currency without additional cash consideration (or for
additional cash consideration held in a segregated account by its
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custodian) upon conversion or exchange of other foreign currencies held in its
portfolio. A call option is also covered if the Fund has a call on the same
foreign currency in the same principal amount as the call written if the
exercise price of the call held (i) is equal to or less than the exercise price
of the call written or (ii) is greater than the exercise price of the call
written, if the difference is maintained by the Fund in cash or other liquid
assets in a segregated account with the Fund's custodian.
The Fund also may write call options on foreign currencies for
cross-hedging purposes. A call option on a foreign currency is for cross-hedging
purposes if it is designed to provide a hedge against a decline due to an
adverse change in the exchange rate in the U.S. dollar value of a security which
the Fund owns or has the right to acquire and which is denominated in the
currency underlying the option. Call options on foreign currencies which are
entered into for cross-hedging purposes are not covered. However, in such
circumstances, the Fund will collateralize the option by segregating cash or
other liquid assets in an amount not less than the value of the underlying
foreign currency in U.S. dollars marked-to-market daily.
Options on Securities. The Fund may write covered put and call options
and buy put and call options on securities that are traded on United States and
foreign securities exchanges and over-the-counter. The Fund may write and buy
options on the same types of securities that the Fund may purchase directly.
A put option written by the Fund is "covered" if the Fund (i)
segregates cash not available for investment or other liquid assets with a value
equal to the exercise price of the put with the Fund's custodian or (ii) holds a
put on the same security and in the same principal amount as the put written and
the exercise price of the put held is equal to or greater than the exercise
price of the put written. The premium paid by the buyer of an option will
reflect, among other things, the relationship of the exercise price to the
market price and the volatility of the underlying security, the remaining term
of the option, supply and demand and interest rates.
A call option written by the Fund is "covered" if the Fund owns the
underlying security covered by the call or has an absolute and immediate right
to acquire that security without additional cash consideration (or for
additional cash consideration held in a segregated account by the Fund's
custodian) upon conversion or exchange of other securities held in its
portfolio. A call option is also deemed to be covered if the Fund holds a call
on the same security and in the same principal amount as the call written and
the exercise price of the call held (i) is equal to or less than the exercise
price of the call written or (ii) is greater than the exercise price of the call
written if the difference is maintained by the Fund in cash and other liquid
assets in a segregated account with its custodian.
The Fund also may write call options that are not covered for
cross-hedging purposes. The Fund collateralizes its obligation under a written
call option for cross-hedging purposes by segregating cash or other liquid
assets in an amount not less than the market value of the underlying security,
marked-to-market daily. The Fund would write a call option for cross-hedging
purposes, instead of writing a covered call option, when the premium to be
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received from the cross-hedge transaction would exceed that which would be
received from writing a covered call option and its portfolio manager believes
that writing the option would achieve the desired hedge.
The writer of an option may have no control over when the underlying
securities must be sold, in the case of a call option, or bought, in the case of
a put option, since with regard to certain options, the writer may be assigned
an exercise notice at any time prior to the termination of the obligation.
Whether or not an option expires unexercised, the writer retains the amount of
the premium. This amount, of course, may, in the case of a covered call option,
be offset by a decline in the market value of the underlying security during the
option period. If a call option is exercised, the writer experiences a profit or
loss from the sale of the underlying security. If a put option is exercised, the
writer must fulfill the obligation to buy the underlying security at the
exercise price, which will usually exceed the then-current market value of the
underlying security.
The writer of an option that wishes to terminate its obligation may
effect a "closing purchase transaction." This is accomplished by buying an
option of the same series as the option previously written. The effect of the
purchase is that the writer's position will be canceled by the clearing
corporation. However, a writer may not effect a closing purchase transaction
after being notified of the exercise of an option. Likewise, an investor who is
the holder of an option may liquidate its position by effecting a "closing sale
transaction." This is accomplished by selling an option of the same series as
the option previously bought. There is no guarantee that either a closing
purchase or a closing sale transaction can be effected.
In the case of a written call option, effecting a closing transaction
will permit the Fund to write another call option on the underlying security
with either a different exercise price or expiration date or both. In the case
of a written put option, such transaction will permit the Fund to write another
put option to the extent that the exercise price is secured by other liquid
assets. Effecting a closing transaction also will permit the Fund to use the
cash or proceeds from the concurrent sale of any securities subject to the
option for other investments. If the Fund desires to sell a particular security
from its portfolio on which it has written a call option, the Fund will effect a
closing transaction prior to or concurrent with the sale of the security.
The Fund will realize a profit from a closing transaction if the price
of the purchase transaction is less than the premium received from writing the
option or the price received from a sale transaction is more than the premium
paid to buy the option. The Fund will realize a loss from a closing transaction
if the price of the purchase transaction is more than the premium received from
writing the option or the price received from a sale transaction is a less than
the premium paid to buy the option. Because increases in the market of a call
option generally will reflect increases in the market price of the underlying
security, any loss resulting from the repurchase of a call option is likely to
be offset in whole or in part by appreciation of the underlying security owned
by the Fund.
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An option position may be closed out only where a secondary market for
an option of the same series exists. If a secondary market does not exist, the
Fund may not be able to effect closing transactions in particular options and
the Fund would have to exercise the options in order to realize any profit. If
the Fund is unable to effect a closing purchase transaction in a secondary
market, it will not be able to sell the underlying security until the option
expires or it delivers the underlying security upon exercise. The absence of a
liquid secondary market may be due to the following: (i) insufficient trading
interest in certain options, (ii) restrictions imposed by a national securities
exchange ("Exchange") on which the option is traded on opening or closing
transactions or both, (iii) trading halts, suspensions or other restrictions
imposed with respect to particular classes or series of options or underlying
securities, (iv) unusual or unforeseen circumstances that interrupt normal
operations on an Exchange, (v) the facilities of an Exchange or of the Options
Clearing Corporation ("OCC") may not at all times be adequate to handle current
trading volume, or (vi) one or more Exchanges could, for economic or other
reasons, decide or be compelled at some future date to discontinue the trading
of options (or a particular class or series of options), in which event the
secondary market on that Exchange (or in that class or series of options) would
cease to exist, although outstanding options on that Exchange that had been
issued by the OCC as a result of trades on that Exchange would continue to be
exercisable in accordance with their terms.
The Fund may write options in connection with buy-and-write
transactions. In other words, the Fund may buy a security and then write a call
option against that security. The exercise price of such call will depend upon
the expected price movement of the underlying security. The exercise price of a
call option may be below ("in-the-money"), equal to ("at-the-money") or above
("out-of-the-money") the current value of the underlying security at the time
the option is written. Buy-and-write transactions using in-the-money call
options may be used when it is expected that the price of the underlying
security will remain flat or decline moderately during the option period.
Buy-and-write transactions using at-the-money call options may be used when it
is expected that the price of the underlying security will remain fixed or
advance moderately during the option period. Buy-and-write transactions using
out-of-the-money call options may be used when it is expected that the premiums
received from writing the call option plus the appreciation in the market price
of the underlying security up to the exercise price will be greater than the
appreciation in the price of the underlying security alone. If the call options
are exercised in such transactions, the Fund's maximum gain will be the premium
received by it for writing the option, adjusted upwards or downwards by the
difference between the Fund's purchase price of the security and the exercise
price. If the options are not exercised and the price of the underlying security
declines, the amount of such decline will be offset by the amount of premium
received.
The writing of covered put options is similar in terms of risk and
return characteristics to buy-and-write transactions. If the market price of the
underlying security rises or otherwise is above the exercise price, the put
option will expire worthless and the Fund's gain will be limited to the premium
received. If the market price of the underlying security declines or otherwise
is below the exercise price, the Fund may elect to close the position or take
delivery of the security
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at the exercise price and the Fund's return will be the premium received from
the put options minus the amount by which the market price of the security is
below the exercise price.
The Fund may buy put options to hedge against a decline in the value of
its portfolio. By using put options in this way, the Fund will reduce any profit
it might otherwise have realized in the underlying security by the amount of the
premium paid for the put option and by transaction costs.
The Fund may buy call options to hedge against an increase in the price
of securities that it may buy in the future. The premium paid for the call
option plus any transaction costs will reduce the benefit, if any, realized by
the Fund upon exercise of the option, and, unless the price of the underlying
security rises sufficiently, the option may expire worthless to the Fund.
Eurodollar Instruments. The Fund may make investments in Eurodollar
instruments. Eurodollar instruments are U.S. dollar-denominated futures
contracts or options thereon which are linked to the London Interbank Offered
Rate ("LIBOR"), although foreign currency-denominated instruments are available
from time to time. Eurodollar futures contracts enable purchasers to obtain a
fixed rate for the lending of funds and sellers to obtain a fixed rate for
borrowings. The Fund might use Eurodollar futures contracts and options thereon
to hedge against changes in LIBOR, to which many interest rate swaps and
fixed-income instruments are linked.
Swaps and Swap-related Products. The Fund may enter into interest rate
swaps, caps and floors on either an asset-based or liability-based basis,
depending upon whether it is hedging its assets or its liabilities, and will
usually enter into interest rate swaps on a net basis (i.e., the two payment
streams are netted out, with the 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 the Fund's obligations over its entitlement with respect to each interest
rate swap will be calculated on a daily basis and an amount of cash or other
liquid assets having an aggregate net asset value at least equal to the accrued
excess will be maintained in a segregated account by the Fund's custodian. If
the Fund enters into an interest rate swap on other than a net basis, it would
maintain a segregated account in the full amount accrued on a daily basis of its
obligations with respect to the swap. The Fund will not enter into any interest
rate swap, cap or floor transaction unless the unsecured senior debt or the
claims-paying ability of the other party thereto is rated in one of the three
highest rating categories of at least one NRSRO at the time of entering into
such transaction. The Adviser will monitor the creditworthiness of all
counterparties on an ongoing basis. If there is a default by the other party to
such a transaction, the Fund will have contractual remedies pursuant to the
agreements related to the transaction.
The swap market has grown substantially in recent years with a large
number of banks and investment banking firms acting both as principals and as
agents utilizing standardizing swap documentation. The Adviser has determined
that, as a result, the swap market has become relatively liquid. Caps and floors
are more recent innovations for which standardized documentation has not yet
been developed and, accordingly, they are less liquid than swaps. To
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the extent the Fund sells (i.e., writes) caps and floors, it will segregate cash
or other liquid assets having an aggregate net asset value at least equal to the
full amount accrued on a daily basis, of its obligations with respect to any
caps or floors.
There is no limit on the amount of interest rate swap transactions that
may be entered into by the Fund. These transactions may in some instances
involve the delivery of securities or other underlying assets by the Fund or its
counterparty to collateralize obligations under the swap. Under the
documentation currently used in those markets, the risk of loss with respect to
interest rate swaps is limited to the net amount of the payments that the Fund
is contractually obligated to make. If the other party to an interest rate swap
that is not collateralized defaults, the Fund would risk the loss of the net
amount of the payments that it contractually is entitled to receive. The Fund
may buy and sell (i.e., write) caps and floors without limitation, subject to
the segregation requirement described above.
Additional Risks of Options on Foreign Currencies, Forward Contracts
and Foreign Instruments. Unlike transactions entered into by the Fund in futures
contracts, options on foreign currencies and forward contracts are not traded on
contract markets regulated by the CFTC or (with the exception of certain foreign
currency options) by the SEC. Such instruments are traded through financial
institutions acting as market-makers, although foreign currency options are also
traded on certain Exchanges, such as the Philadelphia Stock Exchange and the
Chicago Board Options Exchange, subject to SEC regulation. Similarly, options on
currencies may be traded over-the-counter. In an over-the-counter trading
environment, many of the protections afforded to Exchange participants will not
be available. For example, there are no daily price fluctuation limits, and
adverse market movements could therefore continue to an unlimited extent over a
period of time. Although the buyer of an option cannot lose more than the amount
of the premium plus related transaction costs, this entire amount could be lost.
Moreover, an option writer and buyer or seller of futures or forward contracts
could lose amounts substantially in excess of any premium received or initial
margin or collateral posted due to the potential additional margin and
collateral requirements associated with such positions.
Options on foreign currencies traded on Exchanges are within the
jurisdiction of the SEC, as are other securities traded on Exchanges. As a
result, many of the protections provided to traders on organized Exchanges will
be available with respect to such transactions. In particular, all foreign
currency option positions entered into on an Exchange are cleared and guaranteed
by the OCC, thereby reducing the risk of counterparty default. Further, a liquid
secondary market in options traded on an Exchange may be more readily available
than in the over-the-counter market, potentially permitting the Fund to
liquidate open positions at a profit prior to exercise or expiration, or to
limit losses in the event of adverse market movements.
The purchase and sale of exchange-traded foreign currency options,
however, is subject to the risks of the availability of a liquid secondary
market described above, as well as the risks regarding adverse market movements,
margining of options written, the nature of the foreign currency market,
possible intervention by governmental authorities and the effects of other
political and economic events. In addition, exchange-traded options on foreign
currencies
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involve certain risks not presented by the over-the-counter market. For example,
exercise and settlement of such options must be made exclusively through the
OCC, which has established banking relationships in applicable foreign countries
for this purpose. As a result, the OCC may, if it determines that foreign
governmental restrictions or taxes would prevent the orderly settlement of
foreign currency option exercises, or would result in undue burdens on the OCC
or its clearing member, impose special procedures on exercise and settlement,
such as technical changes in the mechanics of delivery of currency, the fixing
of dollar settlement prices or prohibitions on exercise.
In addition, options on U.S. government securities, futures contracts,
options on futures contracts, forward contracts and options on foreign
currencies may be traded on foreign exchanges and over-the-counter in foreign
countries. Such transactions are subject to the risk of governmental actions
affecting trading in or the prices of foreign currencies or securities. The
value of such positions also could be adversely affected by (i) other complex
foreign political and economic factors, (ii) lesser availability than in the
United States of data on which to make trading decisions, (iii) delays in the
Fund's ability to act upon economic events occurring in foreign markets during
non-business hours in the United States, (iv) the imposition of different
exercise and settlement terms and procedures and margin requirements than in the
United States, and (v) low trading volume.
ADDITIONAL DERIVATIVE INSTRUMENT RISKS
Additional risks inherent in the use of derivative instruments include:
- the risk that interest rates, securities prices and currency markets
will not move in the direction that the portfolio manager
anticipates;
- imperfect correlation between the price of derivative instruments
and movement in the prices of the securities, interest rates or
currencies being hedged;
- the fact that skills needed to use these strategies are different
from those needed to select portfolio securities;
- inability to close out certain hedged positions to avoid adverse tax
consequences;
- the possible absence of a liquid secondary market for any particular
instrument and possible exchange-imposed price fluctuation limits,
either of which may make it difficult or impossible to close out a
position when desired;
- leverage risk, or the risk that adverse price movements in an
instrument can result in a loss substantially greater than the
Fund's initial investment in that instrument (in some cases, the
potential loss is unlimited); and
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- particularly in the case of privately negotiated instruments, the
risk that the counterparty will fail to perform its obligations,
which could leave the Fund worse off than if it had not entered into
the position.
Although the Fund believes the use of derivative instruments will benefit it,
the Fund's performance could be worse than if the Fund had not used such
instruments if the portfolio manager's judgment proves incorrect. When the Fund
invests in a derivative instrument, it may be required to segregate cash and
other liquid assets or certain portfolio securities with its custodian to
"cover" the Fund's position. Assets segregated or set aside generally may not be
disposed of so long as the Fund maintains the positions requiring segregation or
cover. Segregating assets could diminish the Fund's return due to the
opportunity losses of foregoing other potential investments with the segregated
assets.
SHORT SALES
The Fund may engage in "short sales against the box." This technique
involves selling either a security that the Fund owns, or a security equivalent
in kind and amount to the security sold short that the Fund has the right to
obtain, for delivery at a specified date in the future, without the payment of
additional cost. The Fund will enter into a short sale against the box to hedge
against anticipated declines in the market price of portfolio securities. If the
value of the securities sold short increases prior to the scheduled delivery
date, the Fund loses the opportunity to participate in the gain.
DEPOSITARY RECEIPTS
The Fund may invest in sponsored and unsponsored American Depositary
Receipts ("ADRs"), which are receipts issued by an American bank or trust
company evidencing ownership of underlying securities issued by a foreign
issuer. ADRs, in registered form, are designed for use in U.S. securities
markets. Unsponsored ADRs may be created without the participation of the
foreign issuer. Holders of these ADRs generally bear all the costs of the ADR
facility, whereas foreign issuers typically bear certain costs in a sponsored
ADR. The bank or trust company depositary of an unsponsored ADR may be under no
obligation to distribute shareholder communications received from the foreign
issuer or to pass through voting rights. The Fund may also invest in European
Depositary Receipts ("EDRs"), Global Depositary Receipts ("GDRs") and in other
similar instruments representing securities of foreign companies. EDRs are
receipts issued by a European financial institution evidencing an arrangement
similar to that of ADRs. EDRs, in bearer form, are designed for use in European
securities markets.
REPURCHASE AND REVERSE REPURCHASE AGREEMENTS
In a repurchase agreement, the Fund purchases a security and
simultaneously commits to resell that security to the seller at an agreed-upon
price on an agreed upon date within a number of days (usually not more than
seven) from the date of purchase. The resale price reflects the purchase price
plus an agreed-upon incremental amount that is unrelated to the coupon rate or
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maturity of the purchased security. A repurchase agreement involves the
obligation of the seller to pay the agreed-upon price, which obligation is in
effect secured by the value (at least equal to the amount of the agreed-upon
resale price and marked-to-market daily) of the underlying security or
"collateral." The Fund may engage in a repurchase agreement with respect to any
security in which it is authorized to invest. A risk associated with repurchase
agreements is the failure of the seller to repurchase the securities as agreed,
which may cause the Fund to suffer a loss if the market value of such securities
decline before they can be liquidated on the open market. In the event of
bankruptcy or insolvency of the seller, the Fund may encounter delays and incur
costs in liquidating the underlying security. Repurchase agreements that mature
in more than seven days will be subject to the 15% limit on illiquid
investments. While it is not possible to eliminate all risks from these
transactions, it is the policy of the Fund to limit repurchase agreements to
those parties whose creditworthiness has been reviewed and found satisfactory by
the Adviser.
The Fund may use reverse repurchase agreements to provide cash to
satisfy unusually heavy redemption requests or for other temporary or emergency
purposes without the necessity of selling portfolio securities, or to earn
additional income on portfolio securities, such as Treasury bills or notes. In a
reverse repurchase agreement, the Fund sells a portfolio security to another
party, such as a bank or broker-dealer, in return for cash and agrees to
repurchase the instrument at a particular price and time. While a reverse
repurchase agreement is outstanding, the Fund will maintain cash and appropriate
liquid assets in a segregated custodial account to cover its obligation under
the agreement. The Fund will enter into reverse repurchase agreements only with
parties that the Adviser deems creditworthy. Using reverse repurchase agreements
to earn additional income involves the risk that the interest earned on the
invested proceeds is less than the expense of the reverse repurchase agreement
transaction. This technique may also have a leveraging effect on the Fund's
portfolio, although the Fund's intent to segregate assets in the amount of the
reverse repurchase agreement minimizes this effect.
HIGH-YIELD/HIGH-RISK SECURITIES
The Fund may invest up to 5% of its total assets in debt securities
that are rated below investment grade (i.e., securities rated BB or lower by
Standard & Poor's Ratings Services ("Standard & Poor's") or Ba or lower by
Moody's Investors Service, Inc. ("Moody's")). Lower-rated securities involve a
higher degree of credit risk, which is the risk that the issuer will not make
interest or principal payments when due. In the event of an unanticipated
default, the Fund would experience a reduction in its income, and could expect a
decline in the market value of the securities so affected. The Fund will not
purchase debt securities rated lower than "CCC-" by Standard & Poor's or "Caa"
by Moody's. The Fund may invest in unrated debt securities of foreign and
domestic issuers. Unrated debt, while not necessarily of lower quality than
rated securities, may not have as broad a market. Unrated debt securities will
be included in the stated limit for investments in high-yield investments by the
Fund unless the portfolio manager deems such securities to be the equivalent of
investment grade securities.
21
<PAGE>
Financial and Market Risks. Investments in high-yield/high risk
securities involve a high degree of financial and market risks that can result
in substantial or, at times, even total losses. High-yield securities are more
vulnerable to real or perceived economic changes, political changes or adverse
developments specific to the issuer. Issuers of such securities may have
substantial capital needs and may become involved in bankruptcy or
reorganization proceedings. Among the problems involved in investments in such
issuers is the fact that it may be difficult to obtain information about the
condition of such issuers. The market prices of such securities also are subject
to abrupt and erratic movements and above average price volatility, and the
spread between the bid and asked prices of such securities may be greater than
normally expected.
Disposition of High Yield/High Risk Securities. Although the Fund
generally will purchase securities for which the portfolio manager expects an
active market to be maintained, high-yield/high-risk securities may be less
actively traded than other securities and it may be difficult to dispose of
substantial holdings of such securities at prevailing market prices. The Fund
will limit holdings of any securities to amounts that the portfolio manager
believes could be readily sold, and holdings of such securities would, in any
event, be limited so as not to limit the Fund's ability to readily dispose of
securities to meet redemptions.
Credit Risk. The value of lower quality securities generally is more
dependent on the ability of the issuer to meet interest and principal payments
than is the case for higher quality securities. Conversely, the value of higher
quality securities may be more sensitive to interest rate movements than lower
quality securities. Issuers of high-yield securities may not be as strong
financially as those issuing bonds with higher credit ratings. Investments in
such companies are considered to be more speculative than higher quality
investments.
GENERAL CHARACTERISTICS OF FOREIGN SECURITIES
Foreign securities involve certain inherent risks that are different
from those of domestic issuers, including political or economic instability of
the issuer or the country of issue, diplomatic developments which could affect
U.S. investments in those countries, changes in foreign currency and exchange
rates and the possibility of adverse changes in investment or exchange control
regulations. As a result of these and other factors, foreign securities
purchased by the Fund may be subject to greater price fluctuation than
securities of U.S. companies.
Most foreign stock markets are not as large or liquid as in the United
States, fixed commissions on foreign stock exchanges are generally higher than
the negotiated commissions on U.S. exchanges, and there is generally less
government supervision and regulation of foreign stock exchanges, brokers and
companies than in the United States. Investors should recognize that foreign
markets have different clearance and settlement procedures and in certain
markets there have been times when settlements have been unable to keep pace
with the volume of securities transactions, making it difficult to conduct such
transactions. Delays in settlement could result in temporary periods when assets
of the Fund is uninvested and no return is earned thereon. The inability of the
Fund to make intended security purchases due to settlement problems could cause
the Fund to miss investment opportunities. Inability to dispose of portfolio
22
<PAGE>
securities due to settlement problems either could result in losses to the Fund
due to subsequent declines in value of the portfolio security or, if the Fund
has entered into a contract to sell the security, could result in a possible
liability to the purchaser. Payment for securities without delivery may be
required in certain foreign markets. Further, the Fund may encounter
difficulties or be unable to pursue legal remedies and obtain judgments in
foreign courts. Foreign governments can also levy confiscatory taxes,
expropriate assets, and limit repatriations of assets. Typically, there is less
publicly available information about a foreign company than about a U.S.
company, and foreign companies may be subject to less stringent reserve,
auditing and reporting requirements. It may be more difficult for the Fund's
agents to keep currently informed about corporate actions such as stock
dividends or other matters which may affect the prices of portfolio securities.
Communications between the United States and foreign countries may be less
reliable than within the United States, thus increasing the risk of delayed
settlements of portfolio transactions or loss of certificates for portfolio
securities. Individual foreign economies may differ favorably or unfavorably
from the U.S. economy in such respects as growth of gross national product, rate
of inflation, capital reinvestment, resource self-sufficiency and balance of
payments position.
Because investments in foreign securities will usually involve
currencies of foreign countries, and because the Fund may hold foreign
currencies, the value of the assets of the Fund as measured in U.S. dollars may
be affected favorably or unfavorably by changes in foreign currency exchange
rates and exchange control regulations, and the Fund may incur costs in
connection with conversions between various currencies. Although the Fund values
assets daily in terms of U.S. dollars, it does not intend to convert its
holdings of foreign currencies into U.S. dollars on a daily basis. The Fund will
do so from time to time, and investors should be aware of the costs of currency
conversion. Although foreign exchange dealers do not charge a fee for
conversion, they do realize a profit based on the difference (the "spread")
between the prices at which they are buying and selling various currencies.
Thus, a dealer may offer to sell a foreign currency to the Fund at one rate,
while offering a lesser rate of exchange should the Fund desire to resell that
currency to the dealer. The Fund will conduct its foreign currency exchange
transactions either on a spot (i.e., cash) basis at the spot rate prevailing in
the foreign currency exchange market, or through entering into forward foreign
currency exchange contracts or purchasing or writing put or call options on
foreign currencies.
INVESTMENTS IN THE SHARES OF OTHER INVESTMENT COMPANIES
To a limited extent, the Fund may purchase securities of other
investment companies. The Adviser does not expect the Fund to invest more than
10% of its total assets in shares issued by other investment companies and, in
no instance, will such investments exceed the levels permitted under the 1940
Act. The Adviser anticipates investing in shares of other investment companies
primarily as a means to invest cash in funds consisting of short-term money
market instruments and U.S. government securities. To the extent that the Fund
invests in other investment companies, the Fund may incur duplicate investment
advisory and other fees.
23
<PAGE>
TRUSTEES AND OFFICERS
The business and affairs of the Fund are managed under the direction of
the Board of Trustees. The Trustees and Officers of the Fund and their principal
occupations during the past five years are set forth below.
<TABLE>
<CAPTION>
POSITIONS HELD PRINCIPAL OCCUPATIONS
NAME, ADDRESS AND AGE WITH THE FUND DURING THE PAST FIVE YEARS
- - --------------------- ------------- --------------------------
<S> <C> <C>
Mark Alan Derby, 39 Trustee and President Vice President, Derby and
7 Wells Avenue Company, Inc.
Newton, MA 02459
Jonathan Jay Derby, 35 Trustee and Vice President Vice President and Legal
7 Wells Avenue counsel, Derby and
Newton, MA 02459 Company, Inc.
Stuart N. Cole, Esq., 39 Trustee Partner in the law firm of
1172 Beacon Street Barr & Cole, Chief Executive
Newton, MA 02461 Officer of County Mortgage
Trust, Partner and founder
of H&S Investments, President of
Washington Realty, Inc.
Ronald L. Cooper, D.M.D., 51 Trustee Partner of Cooper and Spiller,
22 Wabanaki Way P.C. Board member, Massachusetts
Andover, MA 01810 Dental Society Board of
Legislation. Past president,
Second New England Study Club
of Dentistry. Member, the
Massachusetts Dental Society.
Stephen Dephoure, 57 Trustee Managed D4 Film Studios, Inc.
749 Charles River Street for over 27 years. Principal
Needham, MA 02492 of Dephoure & Company.
</TABLE>
COMPENSATION TABLE
The Trust pays no salaries or compensation to any of its officers. The
Fund will pay an annual trustee's fee of $2,000 to each Trustee who is not
affiliated with the Adviser or American Data Services, Inc. The following table
estimates the amount of compensation to be paid by the Trust during its fiscal
year ended December 31, 1999 to the persons who are to serve as Trustees during
such period:
<TABLE>
<CAPTION>
PENSION OR TOTAL COMPENSATION
ESTIMATED RETIREMENT BENEFITS ESTIMATED ANNUAL FROM THE TRUST AND
NAME OF PERSON AND COMPENSATION ACCRUED AS PART OF BENEFITS UPON FUND COMPLEX PAID
POSITION FROM THE TRUST* FUND EXPENSES RETIREMENT TO TRUSTEE
-------- -------------- ------------- ---------- ----------
<S> <C> <C> <C> <C>
Mark A. Derby $ 0 None None $ 0
Trustee,
Vice-President
Jonathan J. Derby $ 0 None None $ 0
Trustee,
Vice-President
Stuart N. Cole, Esq. $ 2,000 None None $2,000
Trustee
Ronald L. Cooper D.M.D. $ 2,000 None None $2,000
Trustee
Stephen Dephoure $ 2,000 None None $2,000
Trustee
</TABLE>
- - ----------------------
* The estimated compensation information is furnished for the fiscal year
ended December 31, 1999.
24
<PAGE>
CONTROL PERSONS AND PRINCIPAL HOLDERS OF SHARES
As of October 12, 1999, Derby Capital Management owns 100% of the
initial outstanding shares of the Fund, and no officer or Trustee of the Trust
directly owns any shares of the Fund.
INVESTMENT ADVISORY AND OTHER SERVICES
Investment Advisory Agreement. The Adviser of the Fund is Derby Capital
Management. Under the terms of the Advisory Agreement, the Adviser furnishes
overall investment management for the Fund, provides research and credit
analysis, oversees the purchase and sales of portfolio securities, maintains
books and records with respect to the Fund's securities transactions and
provides periodic and special reports to the Board of Trustees as required.
For the advisory services provided and expenses assumed by it, the
Adviser has agreed to a fee from the Fund, computed daily and payable monthly,
at an annual rate of 1.00% of average daily net assets.
The Investment Advisory Agreement, which was approved by the
shareholders of the Trust, will continue in effect for a period of two years
from its effective date, unless a period of shorter duration is agreed to by the
Trust and the Adviser. If not sooner terminated, the Advisory Agreement will
continue in effect for successive one year periods thereafter, provided that
each continuance is specifically approved annually by (a) the vote of a majority
of the Board of Trustees who are not parties to the Advisory Agreement or
interested persons (as defined in the 1940 Act), cast in person at a meeting
called for the purpose of voting on approval, and (b) either (i) the vote of a
majority of the outstanding voting securities of the Fund, or (ii) the vote of a
majority of the Board of Trustees. The Advisory Agreement is terminable by vote
of the Board of Trustees, by the holders of a majority of the outstanding voting
securities of the Fund, at any time without penalty, on 60 days' written notice
to the Adviser. The Adviser may also terminate its advisory relationship with
the Fund without penalty on 90 days' written notice to the Trust. The Advisory
Agreement terminates automatically in the event of its assignment (as defined in
the 1940 Act).
ADMINISTRATOR
The Administrator for the Fund is American Data Services, Inc. (the
"Administrator"), which has its principal office at The Hauppauge Corporate
Center, 150 Motor Parkway, Hauppauge, New York 11788, and is primarily in the
business of providing administrative, fund accounting and stock transfer
services to retail and institutional mutual funds through its offices in New
York, Denver and Los Angeles.
25
<PAGE>
Pursuant to an Administrative Service Agreement with the Fund, the
Administrator provides all administrative services necessary for the Fund,
subject to the supervision of the Board of Trustees.
The Administrative Service Agreement is terminable by the Board of
Trustees of the Fund or the Administrator on sixty days' written notice and may
be assigned provided the non-assigning party provides prior written consent. The
Agreement shall remain in effect for two years from the date of its initial
approval, and subject to annual approval of the Board of Trustees for one-year
periods thereafter. The Agreement provides that in the absence of willful
misfeasance, bad faith or gross negligence on the part of the Administrator or
reckless disregard of its obligations thereunder, the Administrator shall not be
liable for any action or failure to act in accordance with its duties
thereunder.
Under the Administrative Service Agreement, the Administrator provides
all administrative services, including, without limitation: (i) services of
persons competent to perform such administrative and clerical functions as are
necessary to provide effective administration of the Fund; (ii) overseeing the
performance of administrative and professional services to the Fund by others,
including the Fund's custodian; (iii) preparing, but not paying for, the
periodic updating of the Fund's Registration Statement, Prospectus and SAI in
conjunction with Fund counsel, including the printing of such documents for the
purpose of filings with the SEC and state securities administrators, preparing
the Fund's tax returns, and preparing reports to the Fund's shareholders and the
SEC; (iv) preparing in conjunction with Fund counsel, but not paying for, all
filings under the securities or "Blue Sky" laws of such states or countries as
are designated by the distributor, which may be required to register or qualify,
or continue the registration or qualification, of the Fund and/or its shares
under such laws; (v) preparing notices and agendas for meetings of the Board of
Trustees and minutes of such meetings in all matters required by the 1940 Act to
be acted upon by the Board; and (vi) monitoring daily and periodic compliance
with respect to all requirements and restrictions of the 1940 Act, the Code and
the Prospectus.
The Administrator, pursuant to the Administrative Service Agreement,
provides the Fund with all accounting services, including, without limitation:
(i) daily computation of net asset value; (ii) maintenance of security ledgers
and books and records as required by the 1940 Act; (iii) production of the
Fund's listing of portfolio securities and general ledger reports; (iv)
reconciliation of accounting records; (v) calculation of yield and total return
for the Fund; (vi) maintaining certain books and records described in Rule 31a-1
under the 1940 Act, and reconciling account information and balances among the
Fund's custodian and Adviser; and (vii) monitoring and evaluating daily income
and expense accruals, and sales and redemptions of shares of the Fund.
26
<PAGE>
ADMINISTRATOR'S FEES
For the services rendered to the Fund by the Administrator, the Fund
pays the Administrator a monthly fee based on the Fund's average net assets. The
Fund also pays the Administrator for any out-of-pocket expenses.
In return for providing the Fund with all accounting related services,
the Fund pays the Administrator a monthly fee based on the Fund's average net
assets, plus any out-of-pocket expenses for such services.
CUSTODIAN, TRANSFER AGENT AND DIVIDEND AGENT
Firstar Bank, National Association (the "Custodian") serves as
custodian for the Fund's cash and securities. Pursuant to a Custody Agreement,
it is responsible for maintaining the books and records of the Fund's portfolio
securities and cash. The Custodian does not assist in, and is not responsible
for, investment decisions involving assets of the Fund. American Data Services,
Inc., the Administrator, also acts as the Fund's transfer and dividend agent.
DISTRIBUTION AGREEMENT
Pursuant to an Underwriting Agreement, ADS Distributors, Inc. (the
"Distributor") has agreed to act as the principal underwriter for the Fund in
the sale and distribution to the public of shares of the Fund, either through
dealers or otherwise. The Distributor has agreed to offer such shares for sale
at all times when such shares are available for sale and may lawfully be offered
for sale and sold.
PLAN OF DISTRIBUTION
The Fund has adopted a Plan of Distribution (the "Plan"), which was
reviewed and approved by a majority of the disinterested Trustees of the Fund,
pursuant to Rule 12b-1 under the 1940 Act (the "Rule"). The Rule provides that
an investment company which bears any direct or indirect expense of distributing
its shares must do so only in accordance with a plan permitted by the Rule. The
Plan provides that the Fund will reimburse the Distributor for certain expenses
and costs incurred in connection with providing marketing and promotional
support to the Fund, shareholder servicing and maintaining shareholder accounts,
to compensate parties with which it has written agreements and whose clients own
shares of the Fund for providing servicing to their clients ("shareholder
servicing") and financial institutions with which it has written agreements and
whose clients are Fund shareholders (each a "broker-dealer") for providing
distribution assistance and promotional support to the Fund, which is subject to
a maximum of 0.25% per annum of the Fund's average daily net assets. Fees paid
under the Plan may not be waived for individual shareholders.
27
<PAGE>
Each shareholder servicing agent and broker-dealer will, as agent for
its customers, among other things: answer customer inquiries regarding account
status and history, the manner in which purchases and redemptions of shares of
the Fund may be effected and certain other matters pertaining to the Fund;
assist shareholders in designating and changing dividend options, account
designations and addresses; provide necessary personnel and facilities to
establish and maintain shareholder accounts and records; assist in processing
purchase and redemption transactions; arrange for the wiring of funds; transmit
and receive funds in connection with customer orders to purchase or redeem
shares; verify and guarantee shareholder signatures in connection with
redemption orders and transfers and changes in shareholder designated accounts;
furnish quarterly and year-end statements and confirmations within five business
days after activity in the account; transmit to shareholders of the Fund proxy
statements, annual reports, updated prospectuses and other communications;
receive, tabulate and transmit proxies executed by shareholders with respect to
meetings of shareholders of the Fund; and provide such other related services as
the Fund or a shareholder may request.
The Plan, the shareholder servicing agreements and the form of
distribution agreement each provide that the Adviser or the Distributor may make
payments from time to time from their own resources which may include the
advisory fee and the asset based sales charges and past profits for the
following purposes: (i) to defray the costs of and to compensate others,
including financial intermediaries with whom the Distributor has entered into
written agreements, for performing shareholder servicing and related
administrative functions of the Fund; to compensate certain financial
intermediaries for providing assistance in distributing Fund shares; (ii) to pay
the costs of printing and distributing the Fund's Prospectus to prospective
investors; and (iii) to defray the cost of the preparation and printing of
brochures and other promotional materials, mailings to prospective shareholders,
advertising, and other promotional activities, including the salaries and/or
commissions of sales personnel in connection with the distribution of the Fund's
shares. The Distributor will determine the amount of such payments made pursuant
to the Plan with the shareholder servicing agents and broker-dealers with whom
it has contracted, provided that such payments made pursuant to the Plan will
not increase the amount which the Fund is required to pay the Distributor for
any fiscal year under the shareholder servicing agreements or otherwise.
Shareholder servicing agents and broker-dealers may charge investors a
fee in connection with their use of specialized purchase and redemption
procedures offered to investors by the shareholder servicing agents and
broker-dealers. In addition, shareholder servicing agents and broker-dealers
offering purchase and redemption procedures similar to those offered to
shareholders who invest in the Fund directly may impose charges, limitations,
minimums and restrictions in addition to or different from those applicable to
shareholders who invest in the Fund directly. Accordingly, the net yield to
investors who invest through shareholder servicing agents and broker-dealers may
be less than realized by investing in the Fund directly. An investor should read
the Prospectus in conjunction with the materials provided by the shareholder
servicing agent and broker-dealer describing the procedures under which Fund
shares may be purchased and redeemed through the shareholder servicing agent and
broker-dealer.
28
<PAGE>
In accordance with the Rule, the Plan provides that all written
agreements relating to the Plan entered into by the Fund, the Distributor or the
Adviser, and the shareholder servicing agents, broker-dealers, or other
organizations, must be in a form satisfactory to the Board of Trustees. In
addition, the Plan requires the Fund and the Distributor to prepare, at least
quarterly, written reports setting forth all amounts expended for distribution
purposes by the Fund and the Distributor pursuant to the Plan and identifying
the distribution activities for which those expenditures were made for review by
the Board of Trustees.
OTHER EXPENSES
The Fund pays certain operating expenses that are not assumed by the
Adviser, the Administrator or any of their respective affiliates. These
expenses, together with fees paid to the Adviser, the Administrator, the
Distributor and the Transfer Agent, are deducted from income of the Fund before
dividends are paid. These expenses include, but are not limited to,
organizational costs, fees and expenses of officers and Trustees who are not
affiliated with the Adviser, the Administrator or any of their respective
affiliates, taxes, interest, legal fees, custodian fees, audit fees, brokerage
fees and commissions, fees and expenses of registering and qualifying the Fund
and its shares for distribution under federal and state securities laws, the
expenses of reports to shareholders, shareholders' meetings and proxy
solicitations.
PORTFOLIO TRANSACTIONS AND ALLOCATION OF BROKERAGE
The Fund's assets are invested by the Adviser in a manner consistent
with its investment objectives, policies, and restrictions and with any
instructions the Board of Trustees may issue from time to time. Within this
framework, the Adviser is responsible for making all determinations as to the
purchase and sale of portfolio securities and for taking all steps necessary to
implement securities transactions on behalf of the Fund.
U.S. Government securities generally are traded in the over-the-counter
market through broker-dealers. A broker-dealer is a securities firm or bank that
makes a market for securities by offering to buy at one price and sell at a
slightly higher price. The difference between the prices is known as a spread.
In placing orders for the purchase and sale of portfolio securities for
the Fund, the Adviser will use its best efforts to obtain the best possible
price and execution and will otherwise place orders with broker-dealers subject
to and in accordance with any instructions the Board of Trustees may issue from
time to time. The Adviser will select broker-dealers including, the Distributor,
to execute portfolio transactions on behalf of the Fund primarily on the basis
of best price and execution.
Transactions on U.S. stock exchanges, commodities markets and futures
markets and other agency transactions involve the payment by the Fund of
negotiated brokerage commissions. Such commissions vary among different brokers.
A particular broker may charge
29
<PAGE>
different commissions according to such factors as the difficulty and size of
the transaction. Transactions in foreign investments often involve the payment
of fixed brokerage commissions, which may be higher than those in the United
States. There is generally no stated commission in the case of securities traded
in the over-the-counter markets, but the price paid by the Fund usually includes
an undisclosed dealer commission or mark-up. In underwritten offerings, the
price paid by the Fund includes a disclosed, fixed commission or discount
retained by the underwriter or dealer.
It has for many years been a common practice in the investment advisory
business for advisers of investment companies and other institutional investors
to receive brokerage and research services (as defined in the Securities
Exchange Act of 1934, as amended (the "1934 Act")) from broker-dealers that
execute portfolio transactions for the clients of such advisers and from third
parties with which such broker-dealers have arrangements. Consistent with this
practice, the Adviser may receive brokerage and research services and other
similar services from many broker-dealers with which the Adviser may place the
Fund's portfolio transactions and from third parties with which these
broker-dealers have arrangements. These services include such matters as general
economic and market reviews, industry and company reviews, evaluations of
investments, recommendations as to the purchase and sale of investments,
newspapers, magazines, pricing services, quotation services, news services and
personal computers utilized by the Adviser. Where the services referred to above
are not used exclusively by the Adviser for research purposes, the Adviser,
based upon its own allocations of expected use, bears that portion of the cost
of these services which directly relates to their non-research use. Some of
these services are of value to the Adviser and its affiliates in advising
various of its clients (including the Fund), although not all of these services
are necessarily useful and of value in managing the Fund. The management fee
paid by the Fund is not reduced because the Adviser and its affiliates receive
these services even though the Adviser might otherwise be required to purchase
some of these services for cash.
As permitted by Section 28(e) of the 1934 Act, the Adviser may cause
the Fund to pay a broker-dealer which provides "brokerage and research services"
(as defined in the 1934 Act) to the Adviser an amount of disclosed commission
for effecting securities transactions on stock exchanges and other transactions
for the Fund on an agency basis in excess of the commission which another
broker-dealer would have charged for effecting that transaction. The Adviser's
authority to cause the Fund to pay any such greater commissions is also subject
to such policies as the Trustees may adopt from time to time. The Adviser does
not currently intend to cause the Fund to make such payments. It is the position
of the staff of the SEC that Section 28(e) does not apply to the payment of such
greater commissions in "principal" transactions. Accordingly, the Adviser will
use its best effort to obtain the most favorable price and execution available
with respect to such transactions, as described above.
Consistent with the Conduct Rules of the National Association of
Securities Dealers, Inc. and subject to seeking the most favorable price and
execution available and such other policies
30
<PAGE>
as the Trustees may determine, the Adviser may consider sales of shares of the
Fund as a factor in the selection of broker-dealers to execute portfolio
transactions for the Fund.
PERFORMANCE INFORMATION
From time to time, quotations of the Fund's performance may be included
in advertisements, sales literature or reports to shareholders or prospective
investors. These performance figures are calculated in the following manner.
AVERAGE ANNUAL TOTAL RETURN
Average annual total return is the average annual compounded rate of
return for periods of one year, five years and ten years, all ended on the last
day of a recent calendar quarter. Average annual total return quotations reflect
changes in the price of the Fund's shares and assume that all dividends and
capital gains distributions during the respective periods were reinvested in
Fund shares. Average annual total return is calculated by computing the average
annual compounded rates of return of a hypothetical investment over such
periods, according to the following formula (average annual total return is then
expressed as a percentage):
1/n
-----
T = (ERV/P)-1
Where:
T = average annual total return
P = a hypothetical initial investment of $1,000
n = number of years
ERV = ending redeemable value: ERV is the value, at the end of
the applicable period, of a hypothetical $1,000 investment
made at the beginning of the applicable period.
It should be noted that average annual total return is based on
historical earnings and is not intended to indicate future performance. Average
annual total return for the Fund will vary based on changes in market conditions
and the level of the Fund's expenses.
In connection with communicating its average annual total return to
current or prospective shareholders, the Fund also may compare these figures to
the performance of other mutual funds tracked by mutual fund rating services or
to unmanaged indices which may assume reinvestment of dividends but generally do
not reflect deductions for administrative and management costs.
31
<PAGE>
COMPARISON OF PORTFOLIO PERFORMANCE
Comparison of the quoted non-standardized performance of various
investments is valid only if performance is calculated in the same manner. Since
there are different methods of calculating performance, investors should
consider the effect of the methods used to calculate performance when comparing
performance of the Fund with performance quoted with respect to other investment
companies or types of investments.
In connection with communicating its performance to current or
prospective shareholders, the Fund also may compare these figures to the
performance of unmanaged indices which may assume reinvestment of dividends or
interest but generally do not reflect deductions for administrative and
management costs. Examples include, but are not limited to the Dow Jones
Industrial Average, the Consumer Price Index, Standard & Poor's 500 Composite
Stock Price Index (S&P 500), the NASDAQ OTC Composite Index, the NASDAQ
Industrials Index, and the Russell 2000 Index.
From time to time, in advertising, marketing and other Fund literature,
the performance of the Fund may be compared to the performance of broad groups
of mutual funds with similar investment goals, as tracked by independent
organizations such as Investment Company Data, Inc., Lipper Analytical Services,
Inc., CDA Investment Technologies, Inc., Morningstar, Inc., Value Line Mutual
Fund Survey and other independent organizations. When these organizations'
tracking results are used, the Fund will be compared to the appropriate fund
category, that is, by fund objective and portfolio holdings or the appropriate
volatility grouping, where volatility is a measure of the Fund's risk. From time
to time, the average price-earnings ratio and other attributes of the Fund's or
the model portfolio's securities, may be compared to the average price-earnings
ratio and other attributes of the securities that comprise the S&P 500 Index.
Statistical and other information, as provided by the Social Security
Administration, may be used in marketing materials pertaining to retirement
planning in order to estimate future payouts of social security benefits.
Estimates may be used on demographic and economic data.
Marketing and other Fund literature may include a description of the
potential risks and rewards associated with an investment in the Fund. The
description may include a "risk/return spectrum" which compares the Fund to
broad categories of funds, such as money market, bond or equity funds, in terms
of potential risks and returns. Money market funds are designed to maintain a
constant $1.00 share price and have a fluctuating yield. Share price, yield and
total return of a bond fund will fluctuate. The share price and return of an
equity fund also will fluctuate. The description may also compare the Fund to
bank products, such as certificates of deposit. Unlike mutual funds,
certificates of deposit are insured up to $100,000 by the U.S.
government and offer a fixed rate of return.
Risk/return spectrums also may depict funds that invest in both
domestic and foreign securities or a combination of bond and equity securities.
32
<PAGE>
The investment return and principal value of an investment in the Fund
will fluctuate so that an investor's shares, when redeemed, may be worth more or
less than their original cost.
TAX STATUS
The Fund intends to qualify as a regulated investment company under
Subchapter M of the Code. Accordingly, the Fund generally must, among other
things, (a) derive in each taxable year at least 90% of its gross income from
dividends, interest, payments with respect to certain securities loans, and
gains from the sale or other disposition of stock, securities or foreign
currencies, or other income derived with respect to its business of investing in
such stock, securities or currencies; and (b) diversify its holdings so that, at
the end of each fiscal quarter, (i) at least 50% of the market value of its
assets is represented by cash, U.S. Government securities, the securities of
other regulated investment companies and other securities, with such other
securities limited, in respect of any one issuer, to an amount not greater than
5% of the value of the Fund's total assets and 10% of the outstanding voting
securities of such issuer, and (ii) not more than 25% of the value of its total
assets is invested in the securities of any one issuer (other than U.S.
Government securities and the securities of other regulated investment
companies).
As a regulated investment company, the Fund generally will not be
subject to U.S. federal income tax on income and gains that it distributes to
shareholders, if at least 90% of the Fund's investment company taxable income
(which includes, among other items, dividends, interest and the excess of any
net short-term capital gains over net long-term capital losses) for the taxable
year is distributed. The Fund intends to distribute substantially all of such
income.
Amounts not distributed on a timely basis in accordance with a calendar
year distribution requirement are subject to a nondeductible 4% excise tax at
the Fund level. To avoid the tax, the Fund must distribute during each calendar
year an amount equal to the sum of (1) at least 98% of its ordinary income (not
taking into account any capital gains or losses) for the calendar year, (2) at
least 98% of its capital gains in excess of its capital losses (adjusted for
certain ordinary losses) for a one-year period generally ending on October 31 of
the calendar year, and (3) all ordinary income and capital gains for previous
years that were not distributed during such years. To avoid application of the
excise tax, the Fund intends to make distributions in accordance with the
calendar year distribution requirement. A distribution will be treated as paid
on December 31 of the current calendar year if it is declared by the Fund in
October, November or December of that year with a record date in such a month
and paid by the Fund during January of the following year. Such distributions
will be taxable to shareholders in the calendar year in which the distributions
are declared, rather than the calendar year in which the distributions are
received.
Original Issue Discount. Certain debt securities acquired by the Fund
may be treated as debt securities that were originally issued at a discount.
Original issue discount can generally be defined as the difference between the
price at which a security was issued and its stated redemption price at
maturity. Although no cash income is actually received by the Fund, original
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issue discount that accrues on a debt security in a given year generally is
treated for federal income tax purposes as interest and, therefore, such income
would be subject to the distribution requirements applicable to regulated
investment companies.
Some debt securities may be purchased by the Fund at a discount that
exceeds the original issue discount on such debt securities, if any. This
additional discount represents market discount for federal income tax purposes.
The gain realized on the disposition of any taxable debt security having market
discount generally will be treated as ordinary income to the extent it does not
exceed the accrued market discount on such debt security. Generally, market
discount accrues on a daily basis for each day the debt security is held by the
Fund at a constant rate over the time remaining to the debt security's maturity
or, at the election of the Fund, at a constant yield to maturity which takes
into account the semi-annual compounding of interest.
Options, Futures and Foreign Currency Forward Contracts; Straddles. The
Fund's transactions in foreign currencies, forward contracts, options and
futures contracts (including options and futures contracts on foreign
currencies) will be subject to special provisions of the Code that, among other
things, may affect the character of gains and losses realized by the Fund (i.e.,
may affect whether gains or losses are ordinary or capital), accelerate
recognition of income to the Fund, defer Fund losses, and affect the
determination of whether capital gains and losses are characterized as long-term
or short-term capital gains or losses. These rules could therefore, in turn,
affect the character, amount, and timing of distributions to shareholders. These
provisions also may require the Fund to mark-to-market certain types of the
positions in its portfolio (i.e., treat them as if they were closed out), which
may cause the Fund to recognize income without receiving cash with which to make
distributions in amounts necessary to satisfy its distribution requirements for
relief from income and excise taxes. The Fund will monitor its transactions and
may make such tax elections as Fund management deems appropriate with respect to
foreign currency, options, futures contracts, forward contracts, or hedged
investments. The Fund's status as a regulated investment company may limit its
transactions involving foreign currency, futures, options, and forward
contracts.
Certain transactions undertaken by the Fund may result in "straddles"
for federal income tax purposes. The straddle rules may affect the character of
gains (or losses) realized by the Fund, and losses realized by the Fund on
positions that are part of a straddle may be deferred under the straddle rules,
rather than being taken into account in calculating the taxable income for the
taxable year in which the losses are realized. In addition, certain carrying
charges (including interest expense) associated with positions in a straddle may
be required to be capitalized rather than deducted currently. Certain elections
that the Fund may make with respect to its straddle positions may also affect
the amount, character and timing of the recognition of gains or losses from the
affected positions.
Under certain circumstances, the Fund may recognize gain from a
constructive sale of an "appreciated financial position" it holds if it enters
into a short sale, forward contract or other transaction that substantially
reduces the risk of loss with respect to the appreciated position. In that
event, the Fund would be treated as if it had sold and immediately repurchased
the property
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and would be taxed on any gain (but not loss) from the constructive sale. The
character of gain from a constructive sale would depend upon the Fund's holding
period in the property. Loss from a constructive sale would be recognized when
the property was subsequently disposed of, and its character would depend on the
Fund's holding period and the application of various loss deferral provisions of
the Code. Constructive sale treatment does not apply to transactions closed in
the 90-day period ending with the 30th day after the close of the taxable year,
if certain conditions are met.
Currency Fluctuations--"Section 988" Gains or Losses. The Fund will
maintain accounts and calculate income by reference to the U.S. dollar for U.S.
federal income tax purposes. Some of the Fund's investments will be maintained
and income therefrom calculated by reference to certain foreign currencies, and
such calculations will not necessarily correspond to the Fund's distributable
income and capital gains for U.S. federal income tax purposes as a result of
fluctuations in currency exchange rates. Furthermore, exchange control
regulations may restrict the ability of the Fund to repatriate investment income
or the proceeds of sales of securities. These restrictions and limitations may
limit the Fund's ability to make sufficient distributions to satisfy the 90%
distribution requirement for qualification as a regulated investment company.
Even if a fund so qualified, these restrictions could inhibit its ability to
distribute all of its income in order to be fully relieved of tax liability.
Gains or losses attributable to fluctuations in exchange rates which
occur between the time the Fund accrues income or other receivables (including
dividends) or accrues expenses or other liabilities denominated in a foreign
currency and the time the Fund actually collects such receivables or pays such
liabilities generally are treated as ordinary income or ordinary loss.
Similarly, on disposition of some investments, including debt securities and
certain forward contracts denominated in a foreign currency, gains or losses
attributable to fluctuations in the value of the foreign currency between the
date of the acquisition of the security or other instrument and the date of
disposition also are treated as ordinary gain or loss. These gains and losses,
referred to under the Code as "section 988" gains or losses, increase or
decrease the amount of the Fund's investment company taxable income available to
be distributed to its shareholders as ordinary income. If section 988 losses
exceed other investment company taxable income during a taxable year, the Fund
would not be able to make any ordinary dividend distributions, or distributions
made before the losses were realized would be recharacterized as a return of
capital to shareholders, or, in some cases, as capital gain, rather than as an
ordinary dividend.
Passive Foreign Investment Companies. The Fund may invest in shares of
foreign corporations which may be classified under the Code as passive foreign
investment companies ("PFICs"). In general, a foreign corporation is classified
as a PFIC if at least one-half of its assets constitute investment-type assets,
or 75% or more of its gross income is investment-type income. If the Fund
receives a so-called "excess distribution" with respect to PFIC stock, the Fund
itself may be subject to a tax on a portion of the excess distribution, whether
or not the corresponding income is distributed by the Fund to shareholders. In
general, under the PFIC rules, an excess distribution is treated as having been
realized ratably over the period during which the Fund held
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the PFIC shares. The Fund itself will be subject to tax on the portion, if any,
of an excess distribution that is so allocated to prior Fund taxable years and
an interest factor will be added to the tax, as if the tax had been payable in
such prior taxable years. Certain distributions from a PFIC as well as gain from
the sale of PFIC shares are treated as excess distributions. Excess
distributions are characterized as ordinary income even though, absent
application of the PFIC rules, certain distributions might have been classified
as capital gain.
The Fund may be eligible to elect alternative tax treatment with
respect to PFIC shares. Under an election that currently is available in some
circumstances, the Fund generally would be required to include in its gross
income its share of the earnings of a PFIC on a current basis, regardless of
whether distributions were received from the PFIC in a given year. If this
election were made, the special rules, discussed above, relating to the taxation
of excess distributions, would not apply. In addition, another election would
involve marking to market the Fund's PFIC shares at the end of each taxable
year, with the result that unrealized gains would be treated as though they were
realized and reported as ordinary income. Any mark-to-market losses and any loss
from an actual disposition of Fund shares would be deductible as ordinary losses
to the extent of any net mark-to-market gains included in income in prior years.
Because the application of the PFIC rules may affect, among other
things, the character of gains, the amount of gain or loss and the timing of the
recognition of income with respect to PFIC shares, as well as subject the Fund
itself to tax on certain income from PFIC shares, the amount that must be
distributed to shareholders, and which will be taxed to shareholders as ordinary
income or long-term capital gains, may be increased or decreased substantially
as compared to a fund that did not invest in PFIC shares.
Distributions. Distributions of investment company taxable income are
taxable to a U.S. shareholder as ordinary income, whether paid in cash or
shares. Dividends paid by the Fund to a corporate shareholder, to the extent
such dividends are attributable to dividends received from U.S. corporations by
the Fund, may qualify for the dividends received deduction. However, the revised
alternative minimum tax applicable to corporations may reduce the value of the
dividends received deduction. Distributions of net capital gains (the excess of
net long-term capital gains over net short-term capital losses), if any,
designated by the Fund as capital gain dividends, are taxable to shareholders at
the applicable mid-term or long-term capital gains rate, whether paid in cash or
in shares, regardless of how long the shareholder has held the Fund's shares,
and they are not eligible for the dividends received deduction. Shareholders
will be notified annually as to the U.S. federal tax status of distributions,
and shareholders receiving distributions in the form of newly issued shares will
receive a report as to the net asset value of the shares received.
If the net asset value of shares is reduced below a shareholder's cost
as a result of a distribution by the Fund, such distribution generally will be
taxable even though it represents a return of invested capital. Investors should
be careful to consider the tax implications of buying shares of the Fund just
prior to a distribution. The price of shares purchased at this time may
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reflect the amount of the forthcoming distribution. Those purchasing just prior
to a distribution will receive a distribution which generally will be taxable to
them.
Disposition of Shares. Upon a redemption, sale or exchange of shares of
the Fund, a shareholder will realize a taxable gain or loss depending upon the
amount realized and the shareholder's basis in the shares. A gain or loss will
be treated as capital gain or loss if the shares are capital assets in the
shareholder's hands and generally will be long-term or short-term, depending
upon the shareholder's holding period for the shares. Any loss realized on a
redemption, sale or exchange will be disallowed to the extent the shares
disposed of are replaced (including through reinvestment of dividends) within a
period of 61 days beginning 30 days before and ending 30 days after the shares
are disposed of. In such a case, the basis of the shares acquired will be
adjusted to reflect the disallowed loss. Any loss realized by a shareholder on
the disposition of the Fund's shares held by the shareholder for six months or
less will be treated for tax purposes as a long-term capital loss to the extent
of any distributions of capital gain dividends received or treated as having
been received by the shareholder with respect to such shares.
Backup Withholding. The Fund will be required to report to the Internal
Revenue Service (the "IRS") all distributions and gross proceeds from the
redemption of the Fund's shares, except in the case of certain exempt
shareholders. All distributions and proceeds from the redemption of the Fund's
shares will be subject to withholding of federal income tax at a rate of 31%
("backup withholding") in the case of non-exempt shareholders if (1) the
shareholder fails to furnish the Fund with and to certify the shareholder's
correct taxpayer identification number or social security number, (2) the IRS
notifies the shareholder or the Fund that the shareholder has failed to report
properly certain interest and dividend income to the IRS and to respond to
notices to that effect, or (3) when required to do so, the shareholder fails to
certify that he or she is not subject to backup withholding. If the withholding
provisions are applicable, any such distributions or proceeds, whether
reinvested in additional shares or taken in cash, will be reduced by the amounts
required to be withheld.
Other Taxation. Distributions may also be subject to additional state,
local and foreign taxes depending on each shareholder's particular situation.
Non-U.S. shareholders may be subject to U.S. tax rules that differ significantly
from those summarized above. This discussion does not address all of the tax
consequences applicable to the Fund or shareholders, and shareholders are
advised to consult their own tax advisers with respect to the particular tax
consequences to them of an investment in the Fund.
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NET ASSET VALUE
Shares are purchased at their net asset value per share. The Fund
calculates its net asset value (NAV) as follows:
NAV = (Value of Fund Assets) - (Fund Liabilities)
---------------------------------------------
Number of Outstanding Shares
Net asset value is determined as of the end of trading hours on the NYSE
(currently 4:00 p.m. New York City time) on days that the NYSE is open.
A security listed or traded on a recognized stock exchange or quoted on
NASDAQ is valued at its last sale price prior to the time when assets are valued
on the principal exchange on which the security is traded or on NASDAQ. If no
sale is reported at that time the most current bid price will be used. All other
securities for which over-the-counter market quotations are readily available
are valued at the most current bid price. Where quotations are not readily
available, the Fund's investments are valued at fair value as determined by
management and approved in good faith by the Trustees pursuant to guidelines
adopted by the Fund. Debt securities which will mature in more than 60 days are
valued at prices furnished by a pricing service approved by the Trustees subject
to review and determination of the appropriate price by the Adviser, whenever a
furnished price is significantly different from the previous day's furnished
price. Securities which will mature in 60 days or less are valued at amortized
cost, which approximates market value.
Generally, trading in foreign securities, as well as U.S. Government
securities and certain cash equivalents and repurchase agreements, is
substantially completed each day at various times prior to the close of the
NYSE. The values of such securities used in computing the net asset value of the
shares of the Fund is determined as of such times. Foreign currency exchange
rates are also generally determined prior to the close of the NYSE.
Occasionally, events affecting the value of such securities and such exchange
rates may occur between the times at which they are determined and at the close
of the NYSE, which will not be reflected in the computation of net asset value.
If during such periods, events occur which materially affect the value of such
securities, the securities will be valued at their fair market value as
determined by management and approved in good faith by the Trustees.
For purposes of determining the net asset value per share of the Fund,
all assets and liabilities initially expressed in foreign currencies will be
converted into United States dollars at the mean between the bid and offer
prices of such currencies against United States dollars furnished by a pricing
service approved by the Trustees.
CAPITAL STRUCTURE
The Trust's Declaration of Trust permits the Board of Trustees to
authorize the issuance of an unlimited number of full and fractional shares of
beneficial interest which may be divided
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into such separate series as the Trustees may establish. Currently, the Trust
consists of only one series. The Trustees may, however, establish additional
series of shares, and may divide or combine the shares into a greater or lesser
number of shares without thereby changing the proportionate beneficial interests
in the Trust. The Declaration of Trust further authorizes the Trustees to
classify or reclassify any series of the shares into one or more classes. Each
share of the Fund represents an equal proportionate interest in the assets of
the Fund. Upon liquidation of the Trust, shareholders of the Fund are entitled
to share pro rata in the Fund's net assets allocable to such class available for
distribution to shareholders. The Trust reserves the right to create and issue
additional series or classes of shares, in which case the shares of each class
of a series would participate equally in the earnings, dividends and assets
allocable to that class of the particular series.
Rule 18f-2 under the 1940 Act provides that any matter required to be
submitted by the provisions of the 1940 Act or applicable state law, or
otherwise, to the holders of the outstanding voting securities of an investment
company such as the Trust shall not be deemed to have been effectively acted
upon unless approved by the holders of a majority of the outstanding shares of
each class or series affected by such matter. Rule 18f-2 further provides that a
class or series shall be deemed to be affected by a matter unless the interests
of each class or series in the matter are substantially identical or the matter
does not affect any interest of such class or series. However, Rule 18f-2
exempts the selection of independent public accountants, the approval of
principal distribution contracts and the election of trustees from the separate
voting requirements of Rule 18f-2.
The Trust is not required to hold annual meetings of shareholders and
does not intend to hold such meetings. In the event that a meeting of
shareholders is held, each share of the Trust will be entitled, as determined by
the Trustees, either to one vote for each share or to one vote for each dollar
of net asset value represented by such shares on all matters presented to
shareholders including the elections of Trustees (this method of voting being
referred to as "dollar based voting"). However, to the extent required by the
1940 Act or otherwise determined by the Trustees, series and classes of the
Trust will vote separately from each other. Shareholders of the Trust do not
have cumulative voting rights in the election of Trustees. Meetings of
shareholders of the Trust, or any series or class thereof, may be called by the
Trustees, certain officers or upon the written request of holders of 10% or more
of the shares entitled to vote at such meetings. The shareholders of the Trust
will have voting rights only with respect to the limited number of matters
specified in the Declaration of Trust and such other matters as the Trustees may
determine or may be required by law.
The Declaration of Trust provides for indemnification of Trustees and
officers of the Trust unless the recipient is adjudicated (i) to be liable by
reason of willful misfeasance, bad faith, gross negligence or reckless disregard
of the duties involved in the conduct of such person's office or (ii) not to
have acted in good faith in the reasonable belief that such person's actions
were in the best interest of the Trust. The Declaration of Trust provides that,
if any shareholder or former shareholder of any series is held personally liable
solely by reason of being or having been a shareholder and not because of the
shareholder's acts or omissions or for
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some other reason, the shareholder or former shareholder (or heirs, executors,
administrators, legal representatives or general successors) shall be held
harmless from and indemnified against all loss and expense arising from such
liability.
The Declaration of Trust permits the termination of the Trust or of any
series or class of the Trust (i) by a majority of the affected shareholders at a
meeting of shareholders of the Trust, series or class; or (ii) by a majority of
the Trustees without shareholder approval if the Trustees determine that such
action is in the best interest of the Trust or its shareholders.
The Declaration of Trust authorizes the Trustees, with shareholder
approval to cause the Trust, or any series thereof, to merge or consolidate with
any corporation, association, trust or other organization or sell or exchange
all or substantially all of the property belonging to the Trust or any series
thereof. In addition, the Trustees, without shareholder approval, may adopt a
master-feeder structure by investing all or a portion of the assets of a series
of the Trust in the securities of another open-end investment company.
The Declaration of Trust permits the Trustees to amend the Declaration
of Trust without a shareholder vote. However, shareholders of the Trust have the
right to vote on any amendment (i) that would affect the voting rights of
shareholders; (ii) that is required by law to be approved by shareholders; (iii)
that would amend the voting provisions of the Declaration of Trust; or (iv) that
the Trustees determine to submit to shareholders.
SHAREHOLDER AND TRUSTEE LIABILITY
As a Massachusetts business trust, the Trust's operations are governed
by its Declaration of Trust dated August 5, 1999, a copy of which is on file
with the office of the Secretary of State of The Commonwealth of Massachusetts.
Theoretically, shareholders of a Massachusetts business trust may, under certain
circumstances, be held personally liable for the obligations of the Trust.
However, the Declaration of Trust contains an express disclaimer of shareholder
liability for acts or obligations of the Trust or any series of the Trust and
provides that notice of such disclaimer may be given in each agreement,
obligation or instrument entered into or executed by the Trust or its Trustees.
Moreover, the Declaration of Trust provides for the indemnification out of Trust
property of any shareholders held personally liable for any obligations of the
Trust or any series of the Trust. The Declaration of Trust also provides that
the Trust shall, upon request, assume the defense of any claim made against any
shareholder for any act or obligation of the Trust and satisfy any judgment
thereon. Thus, the risk of a shareholder incurring financial loss beyond his or
her investment because of shareholder liability would be limited to
circumstances in which the Trust itself will be unable to meet its obligations.
In light of the nature of the Trust's business and the nature and amount of its
assets, the possibility of the Trust's liabilities exceeding its assets, and
therefore a shareholder's risk of personal liability, is remote.
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The Declaration of Trust further provides that the Trust shall
indemnify each of its Trustees and officers against liabilities and expenses
reasonably incurred by them, in connection with, or arising out of, any action,
suit or proceeding, threatened against or otherwise involving such Trustee or
officer, directly or indirectly, by reason of being or having been a Trustee or
officer of the Trust. The Declaration of Trust does not authorize the Trust to
indemnify any Trustee or officer against any liability to which he or she would
otherwise be subject by reason of or for willful misfeasance, bad faith, gross
negligence or reckless disregard of such person's duties.
HOW TO BUY AND SELL SHARES
PURCHASE OF SHARES
Shares of the Fund may be purchased at the net asset value per share
next determined, after receipt of an order by the Fund's Transfer Agent in
proper form with accompanying check or other bank wire payment arrangements
satisfactory to the Fund. The Fund's minimum initial investment is $2,500
(except for retirement accounts for which the minimum initial investment is
$1,000 and for gifts to minors accounts for which the minimum initial investment
is $500) and the minimum subsequent investment is $100, $50 for gifts to minors
accounts and for automatic investment plan investments.
REDEMPTION OF SHARES
Redemption of shares, or payment for redemptions, may be suspended at
times (a) when the New York Stock Exchange is closed for other than customary
weekend or holiday closings, (b) when trading on said Exchange is restricted,
(c) when an emergency exists, as a result of which disposal by the Fund of
securities owned by it is not reasonably practicable, or it is not reasonably
practicable for the Fund fairly to determine the value of its net assets, or (d)
during any other period when the SEC, by order, so permits, provided that
applicable rules and regulations of the SEC shall govern as to whether the
conditions prescribed in (b) or (c) exist.
Shareholders who purchased shares through a broker-dealer may also
redeem such shares by written request to the Transfer Agent which shares are
held by the Transfer Agent at the address set forth in the Prospectus. To be
considered in "good order", written requests for redemption should indicate the
dollar amount or number of shares to be redeemed and refer to the shareholder's
Fund account number, including either the social security or tax identification
number. The request should be signed in exactly the same way the account is
registered. If there is more than one owner of the shares, all owners must sign.
If shares to be redeemed have a value of $50,000 or more or redemption proceeds
are to be paid to someone other than the shareholder at the shareholder's
address of record, the signature(s) must be guaranteed by an "eligible guarantor
institution," which includes a commercial bank that is a member of the Federal
Deposit Insurance Corporation, a trust company, a member firm of a domestic
stock exchange, a savings association or a credit union that is authorized by
its charter to provide a signature guarantee. The Transfer Agent may reject
redemption instructions if the guarantor is
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neither a member of nor a participant in a signature guarantee program.
Signature guarantees by notaries public are not acceptable. The purpose of a
signature guarantee is to protect shareholders against the possibility of fraud.
Further documentation will be requested from corporations, administrators,
executors, personal representatives, trustees and custodians. Redemption
requests given by facsimile will not be accepted. Unless other instructions are
given in proper form, a check for the proceeds of the redemption will be sent to
the shareholder's address of record.
Effective June 1, 2000, the Fund will impose a redemption fee equal to
1.00% of the value of Fund shares redeemed within six months of purchase.
Share purchases and redemptions are governed by Massachusetts law.
SERVICE PROVIDERS
INVESTMENT ADVISER
Derby Capital Management, 7 Wells Avenue, Newton, MA 02459
ADMINISTRATOR
American Data Services, Inc., Hauppauge Corporate Center, 150 Motor Parkway,
Hauppauge, NY 11788-0132
COUNSEL
Choate, Hall & Stewart, Exchange Place, 53 State Street, Boston, MA 02109
CUSTODIAN
Firstar Bank, National Association, 425 Walnut Street, Cincinnati, OH, 45202
INDEPENDENT ACCOUNTS
Vitale, Caturano and Company, 210 Commercial Street, Boston, MA, 02109
TRANSFER AND DIVIDEND DISBURSING AGENT
American Data Services, Inc., Hauppauge Corporate Center, 150 Motor Parkway,
Hauppauge, NY 11788-0132
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