LEGG MASON INVESTMENT TRUST, INC.
Legg Mason Opportunity Trust
PRIMARY CLASS SHARES and NAVIGATOR CLASS SHARES
STATEMENT OF ADDITIONAL INFORMATION
June 12, 2000
(revised June 23, 2000)
This Statement of Additional Information is not a prospectus and
should be read in conjunction with the Prospectus for Primary Class shares
(dated December 23, 1999) or for Navigator Class shares (dated June 12, 2000)
which have been filed with the U.S. Securities and Exchange Commission ("SEC").
Copies of the Prospectuses are available without charge from the fund's
distributor, Legg Mason Wood Walker, Incorporated ("Legg Mason"), at
1-800-822-5544.
Legg Mason Wood Walker,
Incorporated
100 Light Street
P.O. Box 1476
Baltimore, Maryland 21203-1476
(410)539-0000 (800)822-5544
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TABLE OF CONTENTS
Page
DESCRIPTION OF THE FUND.......................................................3
FUND POLICIES.................................................................3
INVESTMENT STRATEGIES AND RISKS...............................................4
ADDITIONAL TAX INFORMATION...................................................19
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION...............................23
VALUATION OF FUND SHARES.....................................................24
PERFORMANCE INFORMATION......................................................25
TAX-DEFERRED RETIREMENT PLANS - PRIMARY SHARES...............................26
MANAGEMENT OF THE FUND.......................................................28
THE FUND'S INVESTMENT ADVISER/MANAGER........................................30
PORTFOLIO TRANSACTIONS AND BROKERAGE.........................................32
THE FUND'S DISTRIBUTOR.......................................................33
CAPITAL STOCK INFORMATION....................................................35
THE FUND'S CUSTODIAN AND TRANSFER AND DIVIDEND-DISBURSING AGENT..............35
THE FUND'S LEGAL COUNSEL.....................................................35
THE FUND'S INDEPENDENT ACCOUNTANTS...........................................35
FINANCIAL STATEMENTS.........................................................36
Appendix A...................................................................37
No person has been authorized to give any information or to make any
representations not contained in the Prospectuses or this Statement of
Additional Information in connection with the offerings made by the Prospectuses
and, if given or made, such information or representations must not be relied
upon as having been authorized by the fund or its distributor. The Prospectuses
and this Statement of Additional Information do not constitute offerings by the
fund or by the distributor in any jurisdiction in which such offerings may not
lawfully be made.
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DESCRIPTION OF THE FUND
Legg Mason Investment Trust, Inc. ("Investment Trust" or
"Corporation") is an open-end series investment company that was established as
a Maryland corporation on October 8, 1999. Legg Mason Opportunity Trust
("Opportunity Trust") is the sole non-diversified series of Investment Trust.
FUND POLICIES
Opportunity Trust's investment objective is long-term growth of
capital.
In addition to the investment objective of the fund described in the
Prospectuses, the fund has adopted the following fundamental investment
limitations that cannot be changed except by vote of its shareholders.
The fund may not:
1. Borrow money, except that the fund may borrow money in an amount
not exceeding 331/3% of its total assets (including the amount borrowed) less
liabilities (other than borrowings);
2. Purchase or sell physical commodities; however, this policy shall
not prevent the fund from purchasing and selling foreign currency, futures
contracts, options, forward contracts, swaps, caps, floors, collars and other
financial instruments;
3. Engage in the business of underwriting the securities of other
issuers, except insofar as the fund may be deemed an underwriter under the
Securities Act of 1933, as amended, in disposing of a portfolio security;
4. Lend any security or make any other loan if, as a result, more
than 331/3% of its total assets would be lent to other parties, but this
limitation does not apply to the purchase of debt securities or to repurchase
agreements;
5. Purchase or sell real estate unless acquired as a result of
ownership of securities or other instruments (but this shall not prevent the
fund from investing in securities or other instruments backed by real estate or
securities of companies engaged in the real estate business);
6. Issue senior securities, except as permitted under the Investment
Company Act of 1940, as amended ("1940 Act"); or
7. Purchase any security if, as a result thereof, 25% or more of its
total assets would be invested in the securities of issuers having their
principal business activities in the same industry. This limitation does not
apply to securities issued or guaranteed by the U.S. Government, its agencies or
instrumentalities and repurchase agreements with respect thereto.
The foregoing fundamental limitations and the investment objective
may be changed by "the vote of a majority of the outstanding voting securities"
of the fund, a term defined in the 1940 Act to mean the vote (a) of 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 fund are present, or (b) of more
than 50% of the outstanding voting securities of the fund, whichever is less.
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The following are some of the non-fundamental limitations that the
fund currently observes. The fund may not:
1. Buy securities on "margin," except for short-term credits
necessary for clearance of portfolio transactions and except that the fund may
make margin deposits in connection with the use of futures contracts, options,
forward contracts, swaps, caps, floors, collars, and other financial
instruments;
2. Make short sales of securities or maintain a short position if,
when added together, more than 100% of the value of the fund's net assets would
be (a) deposited as collateral for the obligation to replace securities borrowed
to effect short sales, and (b) allocated to segregated accounts in connection
with short sales. Short sales "against the box" are not subject to this
limitation; or
3. Acquire additional securities if its borrowings exceed 5% of its
total assets.
The fund is a non-diversified fund; however, the fund intends to
qualify as a regulated investment company ("RIC") under the Internal Revenue
Code of 1986, as amended ("Code"), which requires that, among other things, at
the close of each quarter of the fund's taxable year (1) with respect to 50% of
its total assets, no more than 5% of its total assets may be invested in the
securities of any one issuer and (2) no more than 25% of the value of its total
assets may be invested in the securities of a single issuer. These limits do not
apply to U.S. Government securities and investment company securities or
securities of other RICs.
Except as otherwise stated, if a fundamental or non-fundamental
percentage limitation is complied with at the time an investment is made, a
later increase or decrease in percentage resulting from a change in value of
portfolio securities, in the net asset value of the fund, or in the number of
securities an issuer has outstanding, will not be considered to be outside the
limitation. The fund will monitor the level of borrowing and illiquid securities
in its portfolio and will make necessary adjustments to maintain required asset
coverage and adequate liquidity. The fund may borrow money for any legal purpose
to the extent consistent with its policy to limit borrowing to an amount not
exceeding 331/3% of its total assets (including the amount borrowed) less
liabilities (other than borrowing).
Unless otherwise stated, the investment policies and limitations are
not fundamental, and can be changed by the Board of Directors without
shareholder approval.
INVESTMENT STRATEGIES AND RISKS
This section supplements the information in the Prospectuses
concerning the investments the fund may make and the techniques it may use. The
fund, unless otherwise stated, may employ several investment strategies,
including but not limited to:
Illiquid and Restricted Investments
-----------------------------------
The fund may invest up to 15% of its net assets in illiquid
investments. For this purpose, "illiquid investments" are those that cannot be
disposed of within seven days for approximately the price at which the fund
values the security. Illiquid investments include repurchase agreements with
terms of greater than seven days, restricted investments other than those the
adviser has determined are liquid pursuant to guidelines established by the
Corporation's Board of Directors, securities involved in swap, cap, floor, and
collar transactions, and over-the-counter ("OTC") options and their underlying
collateral.
Restricted securities may be sold only in privately negotiated
transactions, pursuant to a registration statement filed under the Securities
Act of 1933, as amended, or pursuant to an exemption from registration. The fund
may be required to pay part or all of the costs of such registration, and a
considerable period may elapse between the time a decision is made to sell a
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restricted security and the time the registration statement becomes effective.
Judgment plays a greater role in valuing illiquid securities than those for
which a more active market exists.
SEC regulations permit the sale of certain restricted securities to
qualified institutional buyers. The investment adviser to the fund, acting
pursuant to guidelines established by the Corporation's Board of Directors, may
determine that certain restricted securities qualified for trading on this newly
developing market are liquid. If the market does not develop as anticipated, or
if qualified institutional buyers become uninterested for a time, restricted
securities in the fund's portfolio may adversely affect the fund's liquidity.
The assets used as cover for OTC options written by the fund will be
considered illiquid unless the OTC options are sold to qualified dealers who
agree that the fund may repurchase any OTC option it writes at a maximum price
to be calculated by a formula set forth in the option agreement. The cover for
an OTC option written subject to this procedure would be considered illiquid
only to the extent that the maximum repurchase price under the formula exceeds
the intrinsic value of the option.
Senior Securities
-----------------
The 1940 Act prohibits the issuance of senior securities by a
registered open-end fund with one exception. The fund may borrow from banks
provided that immediately after any such borrowing there is an asset coverage of
at least 300% for all borrowings of the fund. Borrowing for temporary purposes
only and in an amount not exceeding 5% of the value of the total assets of the
fund at the time the borrowing is made is not deemed to be an issuance of a
senior security.
There are various investment techniques which may give rise to an
obligation of the fund to pay in the future about which the Commission has
stated it would not raise senior security concerns, provided the fund maintains
segregated assets in an amount that covers the future payment obligation. Such
investment techniques include, among other things, when-issued securities,
futures and forward contracts, short options positions, and repurchase
agreements.
Foreign Securities
------------------
The fund may invest in foreign securities. Investment in foreign
securities presents certain risks, including those resulting from fluctuations
in currency exchange rates, revaluation of currencies, future political and
economic developments and the possible imposition of currency exchange blockages
or other foreign governmental laws or restrictions, reduced availability of
public information concerning issuers, and the fact that foreign issuers are not
generally subject to uniform accounting, auditing and financial reporting
standards or other regulatory practices and requirements comparable to those
applicable to domestic issuers. These risks are intensified when investing in
countries with developing economies and securities markets, also known as
"emerging markets." Moreover, securities of many foreign issuers may be less
liquid and their prices more volatile than those of comparable domestic issuers.
In addition, with respect to certain foreign countries, there is the possibility
of expropriation, confiscatory taxation, withholding taxes and limitations on
the use or removal of funds or other assets.
The costs associated with investment in foreign issuers, including
withholding taxes, brokerage commissions and custodial fees, are higher than
those associated with investment in domestic issuers. In addition, foreign
securities transactions may be subject to difficulties associated with the
settlement of such transactions. Delays in settlement could result in temporary
periods when assets of the fund are uninvested and no return is earned thereon.
The inability of the fund to make intended security purchases due to settlement
problems could cause it to miss attractive investment opportunities. Inability
to dispose of a portfolio security due to settlement problems 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 liability to the purchaser.
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Since the fund may invest in securities denominated in currencies
other than the U.S. dollar and may hold foreign currencies, the fund may be
affected favorably or unfavorably by exchange control regulations or changes in
the exchange rates between such currencies and the U.S. dollar. Changes in the
currency exchange rates may influence the value of the fund's shares, and also
may affect the value of dividends and interest earned by the fund and gains and
losses realized by the fund. Exchange rates are determined by the forces of
supply and demand in the foreign exchange markets. These forces are affected by
the international balance of payments, other economic and financial conditions,
government intervention, speculation and other factors.
In addition to purchasing foreign securities, the fund may invest in
American Depository Receipts ("ADRs"). Generally, ADRs, in registered form, are
denominated in U.S. dollars and are designed for use in the domestic market.
Usually issued by a U.S. bank or trust company, ADRs are receipts that
demonstrate ownership of the underlying securities. For purposes of the fund's
investment policies and limitations, ADRs are considered to have the same
classification as the securities underlying them. ADRs may be sponsored or
unsponsored; issuers of securities underlying unsponsored ADRs are not
contractually obligated to disclose material information in the U.S.
Accordingly, there may be less information available about such issuers than
there is with respect to domestic companies and issuers of securities underlying
sponsored ADRs. The fund may also invest in Global Depository Receipts ("GDRs"),
which are receipts, often denominated in U.S. dollars, issued by either a U.S.
or non-U.S. bank evidencing its ownership of the underlying foreign securities.
Although not a fundamental policy subject to shareholder vote, the
adviser currently anticipates the fund will invest no more than 49% of its total
assets in foreign securities either directly or through ADRs or GDRs.
Debt Securities
---------------
The fund may invest in the debt securities of governmental or
corporate issuers. Corporate debt securities may pay fixed or variable rates of
interest. These securities may be convertible into preferred or common equity,
or may be bought as part of a unit containing common stock.
The prices of debt securities fluctuate in response to perceptions
of the issuer's creditworthiness and also tend to vary inversely with market
interest rates. The value of such securities is likely to decline in times of
rising interest rates. Conversely, when rates fall, the value of these
investments is likely to rise. The longer the time to maturity the greater are
such variations.
Debt securities and securities convertible into common stock need
not necessarily be of a certain grade as determined by rating agencies such as
Standard & Poor's ("S&P") or Moody's Investors Service, Inc. ("Moody's");
however, the fund's adviser does consider such ratings in determining whether
the security is an appropriate investment for the fund. Generally, debt
securities rated below BBB by S&P, or below Baa by Moody's, and unrated
securities of comparable quality, offer a higher current yield than that
provided by higher grade issues, but also involve higher risks (debt securities
rated below investment grade are commonly referred to as junk bonds). However,
debt securities, regardless of their ratings, generally have a higher priority
in the issuer's capital structure than do equity securities.
The ratings of S&P and Moody's represent the opinions of those
agencies. Such ratings are relative and subjective, and are not absolute
standards of quality. Unrated debt securities are not necessarily of lower
quality than rated securities, but they may not be attractive to as many buyers.
A description of the ratings assigned to corporate debt obligations by S&P and
Moody's is included in Appendix A.
In addition to ratings assigned to individual bond issues, the
adviser will analyze interest rate trends and developments that may affect
individual issuers, including factors such as liquidity, profitability and asset
quality. The yields on bonds and other debt securities in which the fund invests
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are dependent on a variety of factors, including general money market
conditions, general conditions in the bond market, the financial conditions of
the issuer, the size of the offering, the maturity of the obligation and its
rating. There may be a wide variation in the quality of bonds, both within a
particular classification and between classifications. A bond issuer's
obligations are subject to the provisions of bankruptcy, insolvency and other
laws affecting the rights and remedies of bond holders or other creditors of an
issuer; litigation or other conditions may also adversely affect the power or
ability of bond issuers to meet their obligations for the payment of principal
and interest. Regardless of rating levels, all debt securities considered for
purchase (whether rated or unrated) are analyzed by the fund's adviser to
determine, to the extent possible, that the planned investment is sound.
When-Issued Securities
----------------------
The fund may enter into commitments to purchase securities on a
when-issued basis. Such securities are often the most efficiently priced and
have the best liquidity in the bond market. When the fund purchases securities
on a when-issued basis, it assumes the risks of ownership at the time of the
purchase, not at the time of receipt. However, the fund does not have to pay for
the obligations until they are delivered to it. This is normally 7 to 15 days
later, but could be longer. Use of this practice would have a leveraging effect
on the fund. Typically, no interest accrues to the purchaser until the security
is delivered.
To meet its payment obligation under a when-issued commitment, the
fund will establish a segregated account with its custodian and maintain cash or
appropriate liquid assets, in an amount at least equal in value to the fund's
commitments to purchase when-issued securities.
The fund may sell the securities underlying a when-issued purchase,
which may result in capital gains or losses.
Preferred Stock
---------------
The fund may purchase preferred stock as a substitute for debt
securities of the same issuer when, in the opinion of the adviser, the preferred
stock is more attractively priced in light of the risks involved. Preferred
stock pays dividends at a specified rate and generally has preference over
common stock in the payment of dividends and the liquidation of the issuer's
assets but is junior to the debt securities of the issuer in those same
respects. Unlike interest payments on debt securities, dividends on preferred
stock are generally payable at the discretion of the issuer's board of
directors. Shareholders may suffer a loss of value if dividends are not paid.
The market prices of preferred stocks are subject to changes in interest rates
and are more sensitive to changes in the issuer's creditworthiness than are the
prices of debt securities.
Convertible Securities
----------------------
A convertible security is a bond, debenture, note, preferred stock
or other security that may be converted into or exchanged for a prescribed
amount of common stock of the same or a different issuer within a particular
period of time at a specified price or formula. A convertible security entitles
the holder to receive interest paid or accrued on debt or the dividend paid on
preferred stock until the convertible security matures or is redeemed, converted
or exchanged. Before conversion, convertible securities ordinarily provide a
stream of income with generally higher yields than those of common stocks of the
same or similar issuers, but lower than the yield of non-convertible debt.
Convertible securities are usually subordinated to comparable-tier
nonconvertible securities but rank senior to common stock in a corporation's
capital structure.
The value of a convertible security is a function of (1) its yield
in comparison with the yields of other securities of comparable maturity and
quality that do not have a conversion privilege and (2) its worth, at market
value, if converted into the underlying common stock. The price of a convertible
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security often reflects variations in the price of the underlying common stock
in a way that non-convertible debt does not. A convertible security may be
subject to redemption at the option of the issuer at a price established in the
convertible security's governing instrument, which may be less than the ultimate
conversion value.
Many convertible securities are rated below investment grade or, if
unrated, are considered of comparable quality.
If an investment grade security purchased by the fund is
subsequently given a rating below investment grade, the adviser will consider
that fact in determining whether to retain that security in the fund's
portfolio, but is not required to dispose of it.
Stripped Securities
-------------------
Stripped securities are created by separating bonds into their
principal and interest components and selling each piece separately (commonly
referred to as IOs, for "interest-only," and POs, for "principal-only").
Stripped securities are more volatile than other fixed income securities in
their response to changes in market interest rates. The value of some stripped
securities moves in the same direction as interest rates, further increasing
their volatility.
Zero Coupon Bonds
-----------------
Zero coupon bonds do not provide for cash interest payments but
instead are issued at a significant discount from face value. Each year, a
holder of such bonds must accrue a portion of the discount as income. Because
the fund is required to pay out substantially all of its income each year,
including income accrued on zero coupon bonds, the fund may have to sell other
holdings to raise cash necessary to make the payout. Because issuers of zero
coupon bonds do not make periodic interest payments, their prices can be very
volatile when market interest rates change.
Closed-end Investment Companies
-------------------------------
The fund may invest in the securities of closed-end investment
companies. Such investments may involve the payment of substantial premiums
above the net asset value of such issuers' portfolio securities, and the total
return on such investments will be reduced by the operating expenses and fees of
such investment companies, including advisory fees. The fund will invest in such
companies, when, in the adviser's judgment, the potential benefits of such
investment justify the payment of any applicable premium or sales charge.
Options, Futures and Other Strategies
-------------------------------------
General. The fund may invest in certain options, futures contracts
(sometimes referred to as "futures"), options on futures contracts, forward
currency contracts, swaps, caps, floors, collars, indexed securities and other
derivative instruments (collectively, "Financial Instruments") to attempt to
enhance its income or yield or to attempt to hedge its investments. The
strategies described below may be used in an attempt to manage the fund's
foreign currency exposure (including exposure to the Euro) as well as other
risks of the fund's investments that can affect its net asset value.
Generally, the fund may purchase and sell any type of Financial
Instrument. However, as an operating policy, the fund will only purchase or sell
a particular Financial Instrument if the fund is authorized to invest in the
type of asset by which the return on, or value of, the Financial Instrument is
primarily measured. Since the fund is authorized to invest in foreign
securities, it may purchase and sell foreign currency and Euro derivatives.
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Hedging strategies can be broadly categorized as "short hedges" and
"long hedges." A short hedge is a purchase or sale of a Financial Instrument
intended partially or fully to offset potential declines in the value of one or
more investments held in the fund's portfolio. Thus, in a short hedge the fund
takes a position in a Financial Instrument whose price is expected to move in
the opposite direction of the price of the investment being hedged.
Conversely, a long hedge is a purchase or sale of a Financial
Instrument intended partially or fully to offset potential increases in the
acquisition cost of one or more investments that the fund intends to acquire.
Thus, in a long hedge, the fund takes a position in a Financial Instrument whose
price is expected to move in the same direction as the price of the prospective
investment being hedged. A long hedge is sometimes referred to as an
anticipatory hedge. In an anticipatory hedge transaction, the fund does not own
a corresponding security and, therefore, the transaction does not relate to a
security the fund owns. Rather, it relates to a security that the fund intends
to acquire. If the fund does not complete the hedge by purchasing the security
it anticipated purchasing, the effect on the fund's portfolio is the same as if
the transaction were entered into for speculative purposes.
Financial Instruments on securities generally are used to attempt to
hedge against price movements in one or more particular securities positions
that the fund owns or intends to acquire. Financial Instruments on indices, in
contrast, generally are used to attempt to hedge against price movements in
market sectors in which the fund has invested or expects to invest. Financial
Instruments on debt securities may be used to hedge either individual securities
or broad debt market sectors.
The use of Financial Instruments is subject to applicable
regulations of the SEC, the several exchanges upon which they are traded and the
Commodity Futures Trading Commission (the "CFTC"). In addition, the fund's
ability to use Financial Instruments may be limited by tax considerations. See
"Additional Tax Information."
In addition to the instruments, strategies and risks described
below, the adviser expects to discover additional opportunities in connection
with Financial Instruments and other similar or related techniques. These new
opportunities may become available as the adviser develops new techniques, as
regulatory authorities broaden the range of permitted transactions and as new
Financial Instruments or other techniques are developed. The adviser may utilize
these opportunities to the extent that they are consistent with the fund's
investment objective and permitted by its investment limitations and applicable
regulatory authorities. The fund might not use any of these strategies, and
there can be no assurance that any strategy used will succeed. The fund's
Prospectuses or this Statement of Additional Information will be supplemented to
the extent that new products or techniques involve materially different risks
than those described below or in the Prospectuses.
Special Risks. The use of Financial Instruments involves special
considerations and risks, certain of which are described below. In general,
these techniques may increase the volatility of the fund and may involve a small
investment of cash relative to the magnitude of the risk assumed. Risks
pertaining to particular Financial Instruments are described in the sections
that follow.
(1) Successful use of most Financial Instruments depends upon the
adviser's ability to predict movements of the overall securities, currency and
interest rate markets, which requires different skills than predicting changes
in the prices of individual securities. There can be no assurance that any
particular strategy will succeed, and use of Financial Instruments could result
in a loss, regardless of whether the intent was to reduce risk or increase
return.
(2) There might be imperfect correlation, or even no correlation,
between price movements of a Financial Instrument and price movements of the
investments being hedged. For example, if the value of a Financial Instrument
used in a short hedge increased by less than the decline in value of the hedged
investment, the hedge would not be fully successful. Such a lack of correlation
might occur due to factors unrelated to the value of the investments being
hedged, such as speculative or other pressures on the markets in which Financial
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Instruments are traded. The effectiveness of hedges using Financial Instruments
on indices will depend on the degree of correlation between price movements in
the index and price movements in the securities being hedged.
Because there is a limited number of types of exchange-traded
options and futures contracts, it is likely that the standardized contracts
available will not match the fund's current or anticipated investments exactly.
The fund may invest in options and futures contracts based on securities with
different issuers, maturities or other characteristics from the securities in
which it typically invests, which involves a risk that the options or futures
position will not track the performance of the fund's other investments.
Options and futures prices can also diverge from the prices of their
underlying instruments, even if the underlying instruments match the fund's
investments well. Options and futures prices are affected by such factors as
current and anticipated short-term interest rates, changes in volatility of the
underlying instrument, and the time remaining until expiration of the contract,
which may not affect security prices the same way. Imperfect correlation may
also result from differing levels of demand in the options and futures markets
and the securities markets, from structural differences in how options and
futures and securities are traded, or from imposition of daily price fluctuation
limits or trading halts. The fund may purchase or sell options and futures
contracts with a greater or lesser value than the securities it wishes to hedge
or intends to purchase in order to attempt to compensate for differences in
volatility between the contract and the securities, although this may not be
successful in all cases. If price changes in the fund's options or futures
positions are poorly correlated with its other investments, the positions may
fail to produce anticipated gains or result in losses that are not offset by
gains in other investments.
(3) If successful, the above-discussed strategies can reduce risk of
loss by wholly or partially offsetting the negative effect of unfavorable price
movements. However, such strategies can also reduce opportunity for gain by
offsetting the positive effect of favorable price movements. For example, if the
fund entered into a short hedge because the adviser projected a decline in the
price of a security in the fund's portfolio, and the price of that security
increased instead, the gain from that increase might be wholly or partially
offset by a decline in the price of the Financial Instrument. Moreover, if the
price of the Financial Instrument declined by more than the increase in the
price of the security, the fund could suffer a loss. In either such case, the
fund would have been in a better position had it not attempted to hedge at all.
(4) As described below, the fund might be required to maintain
assets as "cover," maintain accounts or make margin payments when it takes
positions in Financial Instruments involving obligations to third parties (i.e.,
Financial Instruments other than purchased options). If the fund were unable to
close out its positions in such Financial Instruments, it might be required to
continue to maintain such assets or accounts or make such payments until the
position expired or matured. These requirements might impair the fund's ability
to sell a portfolio security or make an investment at a time when it would
otherwise be favorable to do so, or require that the fund sell a portfolio
security at a disadvantageous time.
(5) The fund's ability to close out a position in a Financial
Instrument prior to expiration or maturity depends on the existence of a liquid
secondary market or, in the absence of such a market, the ability and
willingness of the other party to the transaction (the "counterparty") to enter
into a transaction closing out the position. Therefore, there is no assurance
that any position can be closed out at a time and price that is favorable to the
fund.
Cover. Transactions using Financial Instruments, other than
purchased options, expose the fund to an obligation to another party. The fund
will not enter into any such transactions unless it owns either (1) an
offsetting ("covered") position in securities, currencies or other options,
futures contracts or forward contracts, or (2) cash and liquid assets with a
value, marked-to-market daily, sufficient to cover its potential obligations to
the extent not covered as provided in (1) above. The fund will comply with SEC
guidelines regarding cover for these instruments and will, if the guidelines so
require, set aside cash or liquid assets in an account with its custodian in the
prescribed amount as determined daily.
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Assets used as cover or held in an account cannot be sold while the
position in the corresponding Financial Instrument is open, unless they are
replaced with other appropriate assets. As a result, the commitment of a large
portion of the fund's assets to cover in accounts could impede portfolio
management or the fund's ability to meet redemption requests or other current
obligations.
Options. A call option gives the purchaser the right to buy, and
obligates the writer to sell, the underlying investment at the agreed-upon price
during the option period. A put option gives the purchaser the right to sell,
and obligates the writer to buy, the underlying investment at the agreed-upon
price during the option period. Purchasers of options pay an amount, known as a
premium, to the option writer in exchange for the right under the option
contract.
The purchase of call options can serve as a long hedge, and the
purchase of put options can serve as a short hedge. Writing put or call options
can enable the fund to enhance income or yield by reason of the premiums paid by
the purchasers of such options. However, if the market price of the security
underlying a put option declines to less than the exercise price of the option,
minus the premium received, the fund would expect to suffer a loss.
Writing call options can serve as a limited short hedge, because
declines in the value of the hedged investment would be offset to the extent of
the premium received for writing the option. However, if the security or
currency appreciates to a price higher than the exercise price of the call
option, it can be expected that the option will be exercised and the fund will
be obligated to sell the security or currency at less than its market value. If
the call option is an OTC option, the securities or other assets used as cover
would be considered illiquid to the extent described under "Illiquid and
Restricted Investments."
Writing put options can serve as a limited long hedge because
increases in the value of the hedged investment would be offset to the extent of
the premium received for writing the option. However, if the security or
currency depreciates to a price lower than the exercise price of the put option,
it can be expected that the put option will be exercised and the fund will be
obligated to purchase the security or currency at more than its market value. If
the put option is an OTC option, the securities or other assets used as cover
would be considered illiquid to the extent described under "Illiquid and
Restricted Investments."
The value of an option position will reflect, among other things,
the current market value of the underlying investment, the time remaining until
expiration, the relationship of the exercise price to the market price of the
underlying investment, the historical price volatility of the underlying
investment and general market conditions. Options that expire unexercised have
no value.
The fund may effectively terminate its right or obligation under an
option by entering into a closing transaction. For example, the fund may
terminate its obligation under a call or put option that it had written by
purchasing an identical call or put option; this is known as a closing purchase
transaction. Conversely, the fund may terminate a position in a put or call
option it had purchased by writing an identical put or call option; this is
known as a closing sale transaction. Closing transactions permit the fund to
realize profits or limit losses on an option position prior to its exercise or
expiration.
A type of put that the fund may purchase is an "optional delivery
standby commitment," which is entered into by parties selling debt securities to
the fund. An optional delivery standby commitment gives the fund the right to
sell the security back to the seller on specified terms. This right is provided
as an inducement to purchase the security.
Risks of Options on Securities. Options offer large amounts of
leverage, which will result in the fund's net asset value being more sensitive
to changes in the value of the related instrument. The fund may purchase or
write both exchange-traded and OTC options. Exchange-traded options in the
United States are issued by a clearing organization affiliated with the exchange
on which the option is listed that, in effect, guarantees completion of every
exchange-traded option transaction. In contrast, OTC options are contracts
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between the fund and its counterparty (usually a securities dealer or a bank)
with no clearing organization guarantee. Thus, when the fund purchases an OTC
option, it relies on the counterparty from whom it purchased the option to make
or take delivery of the underlying investment upon exercise of the option.
Failure by the counterparty to do so would result in the loss of any premium
paid by the fund as well as the loss of any expected benefit of the transaction.
The fund's ability to establish and close out positions in
exchange-listed options depends on the existence of a liquid market. However,
there can be no assurance that such a market will exist at any particular time.
Closing transactions can be made for OTC options only by negotiating directly
with the counterparty, or by a transaction in the secondary market if any such
market exists. There can be no assurance that the fund will in fact be able to
close out an OTC option position at a favorable price prior to expiration. In
the event of insolvency of the counterparty, the fund might be unable to close
out an OTC option position at any time prior to its expiration.
If the fund were unable to effect a closing transaction for an
option it had purchased, it would have to exercise the option to realize any
profit. The inability to enter into a closing purchase transaction for a covered
call option written by the fund could cause material losses because the fund
would be unable to sell the investment used as cover for the written option
until the option expires or is exercised.
Options on Indices. Puts and calls on indices are similar to puts
and calls on securities or futures contracts except that all settlements are in
cash and gain or loss depends on changes in the index in question rather than on
price movements in individual securities or futures contracts. When the fund
writes a call on an index, it receives a premium and agrees that, prior to the
expiration date, the purchaser of the call, upon exercise of the call, will
receive from the fund an amount of cash if the closing level of the index upon
which the call is based is greater than the exercise price of the call. The
amount of cash is equal to the difference between the closing price of the index
and the exercise price of the call times a specified multiple ("multiplier"),
which determines the total dollar value for each point of such difference. When
the fund buys a call on an index, it pays a premium and has the same rights as
to such call as are indicated above. When the fund buys a put on an index, it
pays a premium and has the right, prior to the expiration date, to require the
seller of the put, upon the fund's exercise of the put, to deliver to the fund
an amount of cash if the closing level of the index upon which the put is based
is less than the exercise price of the put, which amount of cash is determined
by the multiplier, as described above for calls. When the fund writes a put on
an index, it receives a premium and the purchaser of the put has the right,
prior to the expiration date, to require the fund to deliver to it an amount of
cash equal to the difference between the closing level of the index and exercise
price times the multiplier if the closing level is less than the exercise price.
Risks of Options on Indices. The risks of investment in options on
indices may be greater than options on securities. Because index options are
settled in cash, when the fund writes a call on an index it cannot provide in
advance for its potential settlement obligations by acquiring and holding the
underlying securities. The fund can offset some of the risk of writing a call
index option by holding a diversified portfolio of securities similar to those
on which the underlying index is based. However, the fund cannot, as a practical
matter, acquire and hold a portfolio containing exactly the same securities as
underlie the index and, as a result, bears a risk that the value of the
securities held will vary from the value of the index.
Even if the fund could assemble a portfolio that exactly reproduced
the composition of the underlying index, it still would not be fully covered
from a risk standpoint because of the "timing risk" inherent in writing index
options. When an index option is exercised, the amount of cash that the holder
is entitled to receive is determined by the difference between the exercise
price and the closing index level on the date when the option is exercised. As
with other kinds of options, the fund as the call writer will not learn that the
fund has been assigned until the next business day at the earliest. The time lag
between exercise and notice of assignment poses no risk for the writer of a
covered call on a specific underlying security, such as common stock, because
there the writer's obligation is to deliver the underlying security, not to pay
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its value as of a fixed time in the past. So long as the writer already owns the
underlying security, it can satisfy its settlement obligations by simply
delivering it, and the risk that its value may have declined since the exercise
date is borne by the exercising holder. In contrast, even if the writer of an
index call holds securities that exactly match the composition of the underlying
index, it will not be able to satisfy its assignment obligations by delivering
those securities against payment of the exercise price. Instead, it will be
required to pay cash in an amount based on the closing index value on the
exercise date. By the time it learns that it has been assigned, the index may
have declined, with a corresponding decline in the value of its portfolio. This
"timing risk" is an inherent limitation on the ability of index call writers to
cover their risk exposure by holding securities positions.
If the fund has purchased an index option and exercises it before
the closing index value for that day is available, it runs the risk that the
level of the underlying index may subsequently change. If such a change causes
the exercised option to fall out-of-the-money, the fund will be required to pay
the difference between the closing index value and the exercise price of the
option (times the applicable multiplier) to the assigned writer.
OTC Options. Unlike exchange-traded options, which are standardized
with respect to the underlying instrument, expiration date, contract size, and
strike price, the terms of OTC options (options not traded on exchanges)
generally are established through negotiation with the other party to the option
contract. While this type of arrangement allows the fund great flexibility to
tailor the option to its needs, OTC options generally involve greater risk than
exchange-traded options, which are guaranteed by the clearing organization of
the exchanges where they are traded.
Generally, OTC foreign currency options used by the fund are
European-style options. This means that the option is only exercisable
immediately prior to its expiration. This is in contrast to American-style
options, which are exercisable at any time prior to the expiration date of the
option.
Futures Contracts and Options on Futures Contracts. The purchase of
futures or call options on futures can serve as a long hedge, and the sale of
futures or the purchase of put options on futures can serve as a short hedge.
Writing call options on futures contracts can serve as a limited short hedge,
using a strategy similar to that used for writing call options on securities or
indices. Similarly, writing put options on futures contracts can serve as a
limited long hedge. Futures contracts and options on futures contracts can also
be purchased and sold to attempt to enhance income or yield.
In addition, futures strategies can be used to manage the average
duration of the fund's fixed-income portfolio. If the adviser wishes to shorten
the average duration of the fund's fixed-income portfolio, the fund may sell a
debt futures contract or a call option thereon, or purchase a put option on that
futures contract. If the adviser wishes to lengthen the average duration of the
fund's fixed-income portfolio, the fund may buy a debt futures contract or a
call option thereon, or sell a put option thereon.
No price is paid upon entering into a futures contract. Instead, at
the inception of a futures contract the fund is required to deposit "initial
margin" in an amount generally equal to 10% or less of the contract value.
Margin must also be deposited when writing a call or put option on a futures
contract, in accordance with applicable exchange rules. Unlike margin in
securities transactions, initial margin on futures contracts does not represent
a borrowing, but rather is in the nature of a performance bond or good-faith
deposit that is returned to the fund at the termination of the transaction if
all contractual obligations have been satisfied. Under certain circumstances,
such as periods of high volatility, the fund may be required by an exchange to
increase the level of its initial margin payment, and initial margin
requirements might be increased generally in the future by regulatory action.
Subsequent "variation margin" payments are made to and from the
futures broker daily as the value of the futures position varies, a process
known as "marking-to-market." Variation margin does not involve borrowing, but
rather represents a daily settlement of the fund's obligations to or from a
futures broker. When the fund purchases an option on a futures contract, the
premium paid plus transaction costs is all that is at risk. In contrast, when
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the fund purchases or sells a futures contract or writes a call or put option
thereon, it is subject to daily variation margin calls that could be substantial
in the event of adverse price movements. If the fund has insufficient cash to
meet daily variation margin requirements, it might need to sell securities at a
time when such sales are disadvantageous.
Purchasers and sellers of futures contracts and options on futures
can enter into offsetting closing transactions, similar to closing transactions
on options, by selling or purchasing, respectively, an instrument identical to
the instrument purchased or sold. Positions in futures and options on futures
may be closed only on an exchange or board of trade that provides a secondary
market. However, there can be no assurance that a liquid secondary market will
exist for a particular contract at a particular time. In such event, it may not
be possible to close a futures contract or options position.
Under certain circumstances, futures exchanges may establish daily
limits on the amount that the price of a futures contract or an option on a
futures contract can vary from the previous day's settlement price; once that
limit is reached, no trades may be made that day at a price beyond the limit.
Daily price limits do not limit potential losses because prices could move to
the daily limit for several consecutive days with little or no trading, thereby
preventing liquidation of unfavorable positions.
If the fund were unable to liquidate a futures contract or an option
on a futures position due to the absence of a liquid secondary market or the
imposition of price limits, it could incur substantial losses. The fund would
continue to be subject to market risk with respect to the position. In addition,
except in the case of purchased options, the fund would continue to be required
to make daily variation margin payments and might be required to maintain the
position being hedged by the future or option or to maintain cash or securities
in a segregated account.
Risks of Futures Contracts and Options Thereon. The ordinary spreads
between prices in the cash and futures markets (including the options on futures
market), due to differences in the natures of those markets, are subject to the
following factors, which may create distortions. First, all participants in the
futures market are subject to margin deposit and maintenance requirements.
Rather than meeting additional margin deposit requirements, investors may close
futures contracts through offsetting transactions, which could distort the
normal 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. To the extent participants
decide to make or take delivery, liquidity in the futures market could be
reduced, thus producing distortion. Third, from the point of view of
speculators, the 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 distortion, a correct forecast of general
interest rate, currency exchange rate or stock market trends by the adviser may
still not result in a successful transaction. The adviser may be incorrect in
its expectations as to the extent of various interest rate, currency exchange
rate or stock market movements or the time span within which the movements take
place.
Index Futures. The risk of imperfect correlation between movements
in the price of an index futures and movements in the price of the securities
that are the subject of the hedge increases as the composition of the fund's
portfolio diverges from the securities included in the applicable index. The
price of the index futures may move more than or less than the price of the
securities being hedged. If the price of the index futures moves less than the
price of the securities that are the subject of the hedge, the hedge will not be
fully effective but, if the price of the securities being hedged has moved in an
unfavorable direction, the fund would be in a better position than if it had not
hedged at all. If the price of the securities being hedged has moved in a
favorable direction, this advantage will be partially offset by the futures
contract. If the price of the futures contract moves more than the price of the
securities, the fund will experience either a loss or a gain on the futures
contract that will not be completely offset by movements in the price of the
securities that are the subject of the hedge. To compensate for the imperfect
correlation of movements in the price of the securities being hedged and
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movements in the price of the index futures, the fund may buy or sell index
futures in a greater dollar amount than the dollar amount of the securities
being hedged if the historical volatility of the prices of such securities being
hedged is more than the historical volatility of the prices of the securities
included in the index. It is also possible that, where the fund has sold index
futures contracts to hedge against decline in the market, the market may advance
and the value of the securities held in the portfolio may decline. If this
occurred, the fund would lose money on the futures contract and also experience
a decline in value of its portfolio securities. However, while this could occur
for a very brief period or to a very small degree, over time the value of a
diversified portfolio of securities will tend to move in the same direction as
the market indices on which the futures contracts are based.
Where index futures are purchased to hedge against a possible
increase in the price of securities before the fund is able to invest in them in
an orderly fashion, it is possible that the market may decline instead. If the
fund then concludes not to invest in them at that time because of concern as to
possible further market decline or for other reasons, it will realize a loss on
the futures contract that is not offset by a reduction in the price of the
securities it had anticipated purchasing.
To the extent that the fund enters into futures contracts, options
on futures contracts and options on foreign currencies traded on a
CFTC-regulated exchange, in each case that are not for bona fide hedging
purposes (as defined by the CFTC), the aggregate initial margin and premiums
required to establish these positions (excluding the amount by which options are
"in-the-money" at the time of purchase) may not exceed 5% of the liquidation
value of the fund's portfolio, after taking into account unrealized profits and
unrealized losses on any contracts the fund has entered into. (In general, a
call option on a futures contract is "in-the-money" if the value of the
underlying futures contract exceeds the strike, i.e., exercise, price of the
call; a put option on a futures contract is "in-the-money" if the value of the
underlying futures contract is exceeded by the strike price of the put.) This
policy does not limit to 5% the percentage of the fund's assets that are at risk
in futures contracts, options on futures contracts and currency options.
Foreign Currency Hedging Strategies -- Special Considerations. The
fund may use options and futures contracts on foreign currencies (including the
Euro), as described above, and forward currency contracts, as described below,
to attempt to hedge against movements in the values of the foreign currencies in
which the fund's securities are denominated or to attempt to enhance income or
yield. Currency hedges can protect against price movements in a security that
the fund owns or intends to acquire that are attributable to changes in the
value of the currency in which it is denominated. Such hedges do not, however,
protect against price movements in the securities that are attributable to other
causes.
The fund might seek to hedge against changes in the value of a
particular currency when no Financial Instruments on that currency are available
or such Financial Instruments are more expensive than certain other Financial
Instruments. In such cases, the fund may seek to hedge against price movements
in that currency by entering into transactions using Financial Instruments on
another currency or a basket of currencies, the value of which the adviser
believes will have a high degree of positive correlation to the value of the
currency being hedged. The risk that movements in the price of the Financial
Instrument will not correlate perfectly with movements in the price of the
currency subject to the hedging transaction is magnified when this strategy is
used.
The value of Financial Instruments on foreign currencies depends on
the value of the underlying currency relative to the U.S. dollar. Because
foreign currency transactions occurring in the interbank market might involve
substantially larger amounts than those involved in the use of such Financial
Instruments, the fund could be disadvantaged by having to deal in the odd lot
market (generally consisting of transactions of less than $1 million) for the
underlying foreign currencies at prices that are less favorable than for round
lots.
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There is no systematic reporting of last sale information for
foreign currencies or any regulatory requirement that quotations available
through dealers or other market sources be firm or revised on a timely basis.
Quotation information generally is representative of very large transactions in
the interbank market and thus might not reflect odd-lot transactions where rates
might be less favorable. The interbank market in foreign currencies is a global,
round-the-clock market. To the extent the U.S. options or futures markets are
closed while the markets for the underlying currencies remain open, significant
price and rate movements might take place in the underlying markets that cannot
be reflected in the markets for the Financial Instruments until they reopen.
Settlement of hedging transactions involving foreign currencies
might be required to take place within the country issuing the underlying
currency. Thus, the fund might be required to accept or make delivery of the
underlying foreign currency in accordance with any U.S. or foreign regulations
regarding the maintenance of foreign banking arrangements by U.S. residents and
might be required to pay any fees, taxes and charges associated with such
delivery assessed in the issuing country.
Forward Currency Contracts. The fund may enter into forward currency
contracts to purchase or sell foreign currencies for a fixed amount of U.S.
dollars or another foreign currency. A forward currency contract involves an
obligation to purchase or sell a specific currency at a future date, which may
be any fixed number of days (term) from the date of the forward currency
contract agreed upon by the parties, at a price set at the time of the forward
currency contract. These forward currency contracts are traded directly between
currency traders (usually large commercial banks) and their customers.
Such transactions may serve as long hedges; for example, the fund
may purchase a forward currency contract to lock in the U.S. dollar price of a
security denominated in a foreign currency that the fund intends to acquire.
Forward currency contract transactions may also serve as short hedges; for
example, the fund may sell a forward currency contract to lock in the U.S.
dollar equivalent of the proceeds from the anticipated sale of a security,
dividend or interest payment denominated in a foreign currency.
The fund may also use forward currency contracts to hedge against a
decline in the value of existing investments denominated in foreign currency.
For example, if the fund owned securities denominated in Euros, it could enter
into a forward currency contract to sell Euros in return for U.S. dollars to
hedge against possible declines in the Euro's value. Such a hedge, sometimes
referred to as a "position hedge," would tend to offset both positive and
negative currency fluctuations, but would not offset changes in security values
caused by other factors. The fund could also hedge the position by selling
another currency expected to perform similarly to the Euro. This type of hedge,
sometimes referred to as a "proxy hedge," could offer advantages in terms of
cost, yield or efficiency, but generally would not hedge currency exposure as
effectively as a simple hedge into U.S. dollars. Proxy hedges may result in
losses if the currency used to hedge does not perform similarly to the currency
in which the hedged securities are denominated.
The fund also may use forward currency contracts to attempt to
enhance income or yield. The fund could use forward currency contracts to
increase its exposure to foreign currencies that the adviser believes might rise
in value relative to the U.S. dollar, or shift its exposure to foreign currency
fluctuations from one country to another. For example, if the fund owned
securities denominated in a foreign currency and the adviser believed that
currency would decline relative to another currency, it might enter into a
forward currency contract to sell an appropriate amount of the first foreign
currency, with payment to be made in the second foreign currency.
The cost to the fund of engaging in forward currency contracts
varies with factors such as the currency involved, the length of the contract
period and the market conditions then prevailing. Because forward currency
contracts are usually entered into on a principal basis, no fees or commissions
are involved. When the fund enters into a forward currency contract, it relies
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on the counterparty to make or take delivery of the underlying currency at the
maturity of the contract. Failure by the counterparty to do so would result in
the loss of any expected benefit of the transaction.
As is the case with futures contracts, purchasers and sellers of
forward currency contracts can enter into offsetting closing transactions,
similar to closing transactions on futures contracts, by selling or purchasing,
respectively, an instrument identical to the instrument purchased or sold.
Secondary markets generally do not exist for forward currency contracts, with
the result that closing transactions generally can be made for forward currency
contracts only by negotiating directly with the counterparty. Thus, there can be
no assurance that the fund will in fact be able to close out a forward currency
contract at a favorable price prior to maturity. In addition, in the event of
insolvency of the counterparty, the fund might be unable to close out a forward
currency contract at any time prior to maturity. In either event, the fund would
continue to be subject to market risk with respect to the position, and would
continue to be required to maintain a position in securities denominated in the
foreign currency or to maintain cash or liquid assets in an account.
The precise matching of forward currency contract amounts and the
value of the securities involved generally will not be possible because the
value of such securities, measured in the foreign currency, will change after
the forward currency contract has been established. Thus, the fund might need to
purchase or sell foreign currencies in the spot (cash) market to the extent such
foreign currencies are not covered by forward currency contracts. The projection
of short-term currency market movements is extremely difficult, and the
successful execution of a short-term hedging strategy is highly uncertain.
Successful use of forward currency contracts depends on the
adviser's skill in analyzing and predicting currency values. Forward currency
contracts may substantially change the fund's exposure to changes in currency
exchange rates and could result in losses to the fund if currencies do not
perform as the adviser anticipates. There is no assurance that the adviser's use
of forward currency contracts will be advantageous to the fund or that the
adviser will hedge at an appropriate time.
Combined Positions. The fund may purchase and write options in
combination with each other, or in combination with futures or forward
contracts, to adjust the risk and return characteristics of its overall
position. For example, the fund may purchase a put option and write a call
option on the same underlying instrument, in order to construct a combined
position whose risk and return characteristics are similar to selling a futures
contract. Another possible combined position would involve writing a call option
at one strike price and buying a call option at a lower price, in order to
reduce the risk of the written call option in the event of a substantial price
increase. Because combined options positions involve multiple trades, they
result in higher transaction costs and may be more difficult to open and close
out.
Turnover. The fund's options and futures activities may affect its
turnover rate and brokerage commission payments. The exercise of calls or puts
written by the fund, and the sale or purchase of futures contracts, may cause it
to sell or purchase related investments, thus increasing its turnover rate. Once
the fund has received an exercise notice on an option it has written, it cannot
effect a closing transaction in order to terminate its obligation under the
option and must deliver or receive the underlying securities at the exercise
price. The exercise of puts purchased by the fund may also cause the sale of
related investments, also increasing turnover; although such exercise is within
the fund's control, holding a protective put might cause it to sell the related
investments for reasons that would not exist in the absence of the put. The fund
will pay a brokerage commission each time it buys or sells a put or call or
purchases or sells a futures contract. Such commissions may be higher than those
that would apply to direct purchases or sales.
Swaps, Caps, Floors, Collars. The fund may enter into swaps, caps,
floors, and collars to preserve a return or a spread on a particular investment
or portion of its portfolio, to protect against any increase in the price of
securities the fund anticipates purchasing at a later date or to attempt to
enhance yield. A swap involves the exchange by the fund with another party of
their respective commitments to pay or receive cash flows, e.g., an exchange of
floating rate payments for fixed-rate payments. The purchase of a cap entitles
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the purchaser, to the extent that a specified index exceeds a predetermined
value, to receive payments on a notional principal amount from the party selling
the cap. The purchase of a floor entitles the purchaser, to the extent that a
specified index falls below a predetermined value, to receive payments on a
notional principal amount from the party selling the floor. A collar combines
elements of buying a cap and selling a floor.
Swap agreements, including caps, floors, and collars, can be
individually negotiated and structured to include exposure to a variety of
different types of investments or market factors. Depending on their structure,
swap agreements may increase or decrease the overall volatility of the fund's
investments and its share price and yield because, and to the extent, these
agreements affect the fund's exposure to long- or short-term interest rates (in
the United States or abroad), foreign currency values, mortgage-backed security
values, corporate borrowing rates or other factors such as security prices or
inflation rates.
Swap agreements will tend to shift the fund's investment exposure
from one type of investment to another. For example, if the fund agrees to
exchange payments in U.S. dollars for payments in foreign currency, the swap
agreement would tend to decrease the fund's exposure to U.S. interest rates and
increase its exposure to foreign currency and interest rates. Caps and floors
have an effect similar to buying or writing options.
The creditworthiness of firms with which the fund enters into swaps,
caps, floors, or collars will be monitored by the adviser. If a firm's
creditworthiness declines, the value of the agreement would be likely to
decline, potentially resulting in losses. If a default occurs by the other party
to such transaction, the fund will have contractual remedies pursuant to the
agreements related to the transaction.
The net amount of the excess, if any, of the fund's obligations over
its entitlements with respect to each swap will be accrued on a daily basis and
an amount of cash or liquid assets having an aggregate net asset value at least
equal to the accrued excess will be maintained in an account with the fund's
custodian that satisfies the requirements of the 1940 Act. The fund will also
establish and maintain such accounts with respect to its total obligations under
any swaps that are not entered into on a net basis and with respect to any caps
or floors that are written by the fund. The adviser and the fund believe that
such obligations do not constitute senior securities under the 1940 Act and,
accordingly, will not treat them as being subject to the fund's borrowing
restrictions. The fund understands that the position of the SEC is that assets
involved in swap transactions are illiquid and are, therefore, subject to the
limitations on investing in illiquid investments. See "Illiquid and Restricted
Investments."
Indexed Securities
------------------
Indexed securities are securities whose prices are indexed to the
prices of other securities, securities indices, currencies, precious metals or
other commodities, or other financial indicators, subject to its operating
policy regarding derivative instruments. Indexed securities typically are debt
securities or deposits whose value at maturity and/or coupon rate is determined
by reference to a specific instrument or statistic. The performance of indexed
securities fluctuates (either directly or inversely, depending upon the
instrument) with the performance of the index, security, currency or other
instrument to which they are indexed and may also be influenced by interest rate
changes in the U.S. and abroad. At the same time, indexed securities are subject
to the credit risks associated with the issuer of the security, and their value
may substantially decline if the issuer's creditworthiness deteriorates. Indexed
securities may be more volatile than the underlying investments. Recent issuers
of indexed securities have included banks, corporations, and certain U.S.
Government agencies. The U.S. Treasury issues securities whose principal value
is indexed to the Consumer Price Index (known as "Treasury Inflation-Protection
Securities").
The fund will purchase indexed securities only of issuers that its
adviser determines present minimal credit risks and will monitor the issuer's
creditworthiness during the time the indexed security is held. The adviser will
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use its judgment in determining whether indexed securities should be treated as
short-term instruments, bonds, stock or as a separate asset class for purposes
of the fund's investment allocations, depending on the individual
characteristics of the securities. The fund currently does not intend to invest
more than 5% of its net assets in indexed securities. Indexed securities may
fluctuate according to multiple changes in the underlying instrument and, in
that respect, have a leverage-like effect on the fund.
Portfolio Lending
-----------------
The fund may lend portfolio securities to brokers or dealers in
corporate or government securities, banks or other recognized institutional
borrowers of securities, provided that cash or equivalent collateral, equal to
at least 100% of the market value of the securities loaned, is continuously
maintained by the borrower with the fund. During the time portfolio securities
are on loan, the borrower will pay the fund an amount equivalent to any
dividends or interest paid on such securities, and the fund may invest the cash
collateral and earn income, or it may receive an agreed upon amount of interest
income from the borrower who has delivered equivalent collateral. These loans
are subject to termination at the option of the fund or the borrower. The fund
may pay reasonable administrative and custodial fees in connection with a loan
and may pay a negotiated portion of the interest earned on the cash or
equivalent collateral to the borrower or placing broker. The fund does not have
the right to vote securities on loan, but would terminate the loan and regain
the right to vote if that were considered important with respect to the
investment. The risks of securities lending are similar to those of repurchase
agreements. The fund presently does not intend to lend more than 5% of its
portfolio securities at any given time.
Repurchase Agreements
---------------------
When cash is temporarily available, or for temporary defensive
purposes, the fund may invest without limit in repurchase agreements and money
market instruments, including high-quality short-term debt securities. A
repurchase agreement is an agreement under which either U.S. Government
obligations or other high-quality liquid debt securities are acquired from a
securities dealer or bank subject to resale at an agreed-upon price and date.
The securities are held for the fund by a custodian bank as collateral until
resold and will be supplemented by additional collateral if necessary to
maintain a total value equal to or in excess of the value of the repurchase
agreement. The fund bears a risk of loss in the event that the other party to a
repurchase agreement defaults on its obligations and the fund is delayed or
prevented from exercising its rights to dispose of the collateral securities,
which may decline in value in the interim. The fund will enter into repurchase
agreements only with financial institutions determined by the fund's adviser to
present minimal risk of default during the term of the agreement.
Repurchase agreements are usually for periods of one week or less,
but may be for longer periods. The fund will not enter into repurchase
agreements of more than seven days' duration if more than 15% of its net assets
would be invested in such agreements and other illiquid investments. To the
extent that proceeds from any sale upon a default of the obligation to
repurchase were less than the repurchase price, the fund might suffer a loss. If
bankruptcy proceedings are commenced with respect to the seller of the security,
realization upon the collateral by the fund could be delayed or limited.
When the fund enters into a repurchase agreement, it will obtain as
collateral from the other party securities equal in value to 102% of the amount
of the repurchase agreement (or 100%, if the securities obtained are U.S.
Treasury bills, notes or bonds). Such securities will be held by a custodian
bank or an approved securities depository or book-entry system.
ADDITIONAL TAX INFORMATION
The following is a general summary of certain federal tax
considerations affecting the fund and its shareholders. Investors are urged to
consult their own tax advisers for more detailed information and for information
regarding any federal, state or local taxes that might apply to them.
19
<PAGE>
General
-------
To qualify for treatment as a RIC under the Code, the fund must
distribute annually to its shareholders at least 90% of its investment company
taxable income (generally, net investment income plus any net short-term capital
gain and net gains from certain foreign currency transactions) ("Distribution
Requirement") and must meet several additional requirements. These requirements
include the following: (1) the fund must derive at least 90% of its gross income
each taxable year from dividends, interest, payments with respect to securities
loans and gains from the sale or other disposition of securities or foreign
currencies, or other income (including gains from options, futures or forward
currency contracts) derived with respect to its business of investing in
securities or foreign currencies ("Income Requirement"); (2) at the close of
each quarter of the fund's taxable year, at least 50% of the value of its total
assets must be represented by cash and cash items, U.S. Government securities,
securities of other RICs and other securities, with those other securities
limited, in respect of any one issuer, to an amount that does not exceed 5% of
the value of the fund's total assets and that does not represent more than 10%
of the issuer's outstanding voting securities; and (3) at the close of each
quarter of the fund's taxable year, not more than 25% of the value of its total
assets may be invested in the securities (other than U.S. Government securities
or the securities of other RICs) of any one issuer.
By qualifying for treatment as a RIC, the fund (but not its
shareholders) will be relieved of federal income tax on the part of the
investment company taxable income and net capital gain (i.e., the excess of net
long-term capital gain over net short-term capital loss) that it distributes to
its shareholders. If the fund failed to qualify for treatment as a RIC for any
taxable year, (1) it would be taxed at corporate rates on the full amount of its
taxable income for that year without being able to deduct the distributions it
makes to its shareholders and (2) the shareholders would treat all those
distributions, including distributions of net capital gain, as dividends (that
is, ordinary income) to the extent of the fund's earnings and profits. In
addition, the fund could be required to recognize unrealized gains, pay
substantial taxes and interest and make substantial distributions before
requalifying for RIC treatment.
The fund will be subject to a nondeductible 4% excise tax ("Excise
Tax") to the extent it fails to distribute by the end of any calendar year
substantially all of its ordinary income for that year and capital gain net
income for the one-year period ending on October 31 of that year, plus certain
other amounts.
Dividends and Other Distributions
---------------------------------
Dividends and other distributions declared by the fund in December
of any year and payable to its shareholders of record on a date in that month
will be deemed to have been paid by the fund and received by the shareholders on
December 31 if the distributions are paid by the fund during the following
January. Accordingly, those distributions will be taxed to shareholders for the
year in which that December 31 falls.
A portion of the dividends from the fund's investment company
taxable income (whether paid in cash or reinvested in fund shares) may be
eligible for the dividends-received deduction allowed to corporations. The
eligible portion may not exceed the aggregate dividends received by the fund for
the taxable year from domestic corporations. However, dividends received by a
corporate shareholder and deducted by it pursuant to the dividends-received
deduction are subject indirectly to the federal alternative minimum tax.
Distributions of net capital gain made by the fund do not qualify for the
dividends-received deduction.
If fund shares are sold at a loss after being held for six months or
less, the loss will be treated as a long-term, instead of a short-term, capital
loss to the extent of any capital gain distributions received on those shares.
Investors also should be aware that if shares are purchased shortly before the
record date for a dividend or other distribution, the shareholder will pay full
price for the shares and receive some portion of the price back as a taxable
distribution.
20
<PAGE>
Passive Foreign Investment Companies
------------------------------------
The fund may invest in the stock of "passive foreign investment
companies" ("PFICs"). A PFIC is any foreign corporation (with certain
exceptions) that, in general, meets either of the following tests: (1) at least
75% of its gross income is passive or (2) an average of at least 50% of its
assets produce, or are held for the production of, passive income. Under certain
circumstances, the fund will be subject to federal income tax on a portion of
any "excess distribution" received on the stock of a PFIC or of any gain on
disposition of that stock (collectively "PFIC income"), plus interest thereon,
even if the fund distributes the PFIC income as a taxable dividend to its
shareholders. The balance of the PFIC income will be included in the fund's
investment company taxable income and, accordingly, will not be taxable to it to
the extent it distributes that income to its shareholders.
If the fund invests in a PFIC and elects to treat the PFIC as a
"qualified electing fund" ("QEF"), then in lieu of the foregoing tax and
interest obligation, the fund would be required to include in income each year
its pro rata share of the QEF's annual ordinary earnings and net capital gain --
which the fund probably would have to distribute to satisfy the Distribution
Requirement and avoid imposition of the Excise Tax -- even if the QEF did not
distribute those earnings and gain to the fund. In most instances it will be
very difficult, if not impossible, to make this election because of certain
requirements thereof.
The fund may elect to "mark-to-market" its stock in any PFIC.
"Marking-to-market," in this context, means including in ordinary income each
taxable year the excess, if any, of the fair market value of the stock over the
fund's adjusted basis therein as of the end of that year. Pursuant to the
election, the fund also would be allowed to deduct (as an ordinary, not capital,
loss) the excess, if any, of its adjusted basis in PFIC stock over the fair
market value thereof as of the taxable year-end, but only to the extent of any
net mark-to-market gains with respect to that stock included in income by the
fund for prior taxable years under the election. The fund's adjusted basis in
each PFIC's stock subject to the election would be adjusted to reflect the
amounts of income included and deductions taken thereunder.
Options, Futures, Forward Currency Contracts and Foreign Currencies
-------------------------------------------------------------------
The use of hedging instruments, such as writing (selling) and
purchasing options and futures contracts and entering into forward currency
contracts, involves complex rules that will determine for income tax purposes
the amount, character and timing of recognition of the gains and losses the fund
realizes in connection therewith. Gains from the disposition of foreign
currencies (except certain gains that may be excluded by future regulations) --
and gains from options, futures and forward currency contracts derived by the
fund with respect to its business of investing in securities or foreign
currencies -- will be treated as qualifying income under the Income Requirement.
Certain futures and foreign currency contracts in which the fund may
invest will be subject to section 1256 of the Code ("section 1256 contracts").
Any section 1256 contracts the fund holds at the end of each taxable year, other
than contracts with respect to which the fund has made a "mixed straddle
election," must be "marked-to-market" (that is, treated as having been sold at
that time for their fair market value), with the result that unrealized gains or
losses will be treated as though they were realized. Sixty percent of any net
gain or loss recognized on these deemed sales, and 60% of any net realized gain
or loss on section 1256 contracts actually sold by the fund during the year will
be treated as long-term capital gain or loss, and the balance will be treated as
short-term capital gain or loss. Section 1256 contracts also may be
marked-to-market for purposes of the Excise Tax. These rules may operate to
increase the amount that the fund must distribute to satisfy the Distribution
Requirement (i.e., with respect to the portion treated as short-term capital
gain), which will be taxable to the shareholders as ordinary income, and to
increase the net capital gain the fund recognizes, without in either case
increasing the cash available to the fund. The fund may elect to exclude certain
transactions from the operation of section 1256, although doing so may have the
effect of increasing the relative proportion of net short-term capital gain
(taxable as ordinary income) and thus increasing the amount of dividends that
must be distributed.
21
<PAGE>
When a covered call option written (sold) by the fund expires, it
will realize a short-term capital gain equal to the amount of the premium it
received for writing the option. When the fund terminates its obligations under
such an option by entering into a closing transaction, it will realize a
short-term capital gain (or loss), depending on whether the cost of the closing
transaction is less than (or exceeds) the premium received when the option was
written. When a covered call option written by the fund is exercised, it will be
treated as having sold the underlying security, producing long-term or
short-term capital gain or loss, depending on the holding period of the
underlying security and whether the sum of the option price received on the
exercise plus the premium received when the option was written exceeds or is
less than the basis of the underlying security.
Code section 1092 (dealing with straddles) also may affect the
taxation of Financial Instruments in which the fund may invest. Section 1092
defines a "straddle" as offsetting positions with respect to personal property;
for these purposes, options, futures, and forward currency contracts are
personal property. Under section 1092, any loss from the disposition of a
position in a straddle generally may be deducted only to the extent the loss
exceeds the unrealized gain on the offsetting position(s) of the straddle; in
addition, these rules may apply to postpone the recognition of loss that
otherwise would be recognized under the mark-to-market rules discussed above.
The regulations under section 1092 also provide certain "wash sale" rules, which
apply to transactions where a position is sold at a loss and a new offsetting
position is acquired within a prescribed period, and "short sale" rules
applicable to straddles. If the fund makes certain elections, the amount,
character, and timing of recognition of gains and losses from the affected
straddle positions would be determined under rules that vary according to the
elections made. Because only a few of the regulations implementing the straddle
rules have been promulgated, the tax consequences to the fund of straddle
transactions are not entirely clear.
Other
-----
Dividends and interest received by the fund, and gains realized
thereby, may be subject to income, withholding or other taxes imposed by foreign
countries and U.S. possessions that would reduce the total return on its
securities. Tax conventions between certain countries and the United States may
reduce or eliminate these foreign taxes, however, and many foreign countries do
not impose taxes on capital gains in respect of investments by foreign
investors.
If the fund has an "appreciated financial position" -- generally, an
interest (including an interest through an option, futures or forward currency
contract or short sale) with respect to any stock, debt instrument (other than
"straight debt") or partnership interest the fair market value of which exceeds
its adjusted basis -- and enters into a "constructive sale" of the position, the
fund will be treated as having made an actual sale thereof, with the result that
the gain will be recognized at that time. A constructive sale generally consists
of a short sale, an offsetting notional principal contract or a futures or
forward currency contract entered into by the fund or a related person with
respect to the same or substantially identical property. In addition, if the
appreciated financial position is itself a short sale or such a contract,
acquisition of the underlying property or substantially identical property will
be deemed a constructive sale. The foregoing will not apply, however, to any
transaction during any taxable year that otherwise would be treated as a
constructive sale if the transaction is closed within 30 days after the end of
that year and the fund holds the appreciated financial position unhedged for 60
days after that closing (i.e., at no time during that 60-day period is the
fund's risk of loss regarding that position reduced by reason of certain
specified transactions with respect to substantially identical or related
property, such as having an option to sell, being contractually obligated to
sell, making a short sale, or granting an option to buy substantially identical
stock or securities).
To the extent the fund recognizes income from a "conversion
transaction," as defined in section 1258 of the Code, all or part of the gain
from the disposition or other termination of a position held as part of the
conversion transaction may be recharacterized as ordinary income. A conversion
transaction generally consists of two or more positions taken with regard to the
same or similar property, where (1) substantially all of the taxpayer's return
is attributable to the time value of its net investment in the transaction and
22
<PAGE>
(2) the transaction satisfies any of the following criteria: (a) the transaction
consists of the acquisition of property by the taxpayer and a substantially
contemporaneous agreement to sell the same or substantially identical property
in the future; (b) the transaction is a straddle, within the meaning of section
1092 of the Code (see above); (c) the transaction is one that was marketed or
sold to the taxpayer on the basis that it would have the economic
characteristics of a loan but the interest-like return would be taxed as capital
gain; or (d) the transaction is described as a conversion transaction in future
regulations.
ADDITIONAL PURCHASE AND REDEMPTION INFORMATION
The fund offers two classes of shares known as Primary Class shares
and Navigator Class shares. Other classes of shares may be offered in the
future. Primary Class shares are available from Legg Mason, certain of its
affiliates, and unaffiliated entities having an agreement with Legg Mason.
Navigator Class shares are of the fund are currently offered for sale only to:
any qualified retirement plan of Legg Mason, Inc. or of any of its affiliates;
and employees of LMFA and spouses and children of such persons ("LMFA" Staff").
Primary Class shares are available to all other investors.
Transfer of Funds from Financial Institutions
---------------------------------------------
Investors in Primary Class shares and LMFA Staff investing in
Navigator Class shares may also buy shares through a plan permitting transfers
of funds from a financial institution. Certain financial institutions may allow
the investor, on a pre-authorized basis, to have $50 or more automatically
transferred monthly for investment in shares of the fund to:
Legg Mason Wood Walker, Incorporated
Funds Processing
P.O. Box 1476
Baltimore, Maryland 21203-1476
If the investor's check is not honored by the institution it is drawn on, the
investor may be subject to extra charges in order to cover collection costs.
These charges may be deducted from the investor's shareholder account.
Systematic Withdrawal Plan
--------------------------
Investors in Primary Class shares and LMFA Staff investing in
Navigator Class shares with a net asset value of $5,000 or more may elect to
make systematic withdrawals of a minimum of $50 on a monthly basis. The amounts
paid to you each month are obtained by redeeming sufficient shares from your
account to provide the withdrawal amount that you have specified. The Systematic
Withdrawal Plan is not currently available for shares held in an Individual
Retirement Account ("IRA"), Simplified Employee Pension Plan ("SEP"), Savings
Incentive Match Plan for Employees ("SIMPLE") or other qualified retirement
plan. You may change the monthly amount to be paid to you without charge not
more than once a year by notifying Legg Mason or the affiliate with which you
have an account. Redemptions will be made at the Primary Class shares' or
Navigator Class shares', whichever is applicable, net asset value per share
determined as of the close of regular trading of the New York Stock Exchange
("Exchange") (normally 4:00 p.m., eastern time) ("close of the Exchange") on the
first day of each month. If the Exchange is not open for business on that day,
the shares will be redeemed at the per share net asset value determined as of
the close of regular trading of the Exchange on the preceding business day. The
check for the withdrawal payment will usually be mailed to you on the next
business day following redemption. If you elect to participate in the Systematic
Withdrawal Plan, dividends and other distributions on all shares in your Primary
Class shares or Navigator Class shares account must be automatically reinvested
in Primary Class shares or Navigator Class shares, respectively. You may
terminate the Systematic Withdrawal Plan at any time without charge or penalty.
The fund, its transfer agent, and Legg Mason also reserve the right to modify or
terminate the Systematic Withdrawal Plan at any time.
23
<PAGE>
Withdrawal payments are treated as a sale of shares rather than as a
dividend or other distribution. These payments are taxable to the extent that
the total amount of the payments exceeds the tax basis of the shares sold. If
the periodic withdrawals exceed reinvested dividends and distributions, the
amount of your original investment may be correspondingly reduced.
Ordinarily, you should not purchase additional shares of the fund if
you maintain a Systematic Withdrawal Plan, because you may incur tax liabilities
in connection with such purchases and withdrawals. The fund will not knowingly
accept purchase orders from you for additional shares if you maintain a
Systematic Withdrawal Plan unless your purchase is equal to at least one year's
scheduled withdrawals. In addition, if you maintain a Systematic Withdrawal Plan
you may not make periodic investments under the Future First Systematic
Investment Plan.
Other Information Regarding Redemption
--------------------------------------
The fund reserves the right to modify or terminate the wire or
telephone redemption services described in the Prospectuses at any time.
The date of payment for redemption may not be postponed for more
than seven days, and the right of redemption may not be suspended by the fund or
its distributor except (i) for any period during which the Exchange is closed
(other than for customary weekend and holiday closings), (ii) when trading in
markets the fund normally utilizes is restricted, or an emergency, as defined by
rules and regulations of the SEC, exists, making disposal of the fund's
investments or determination of its net asset value not reasonably practicable,
or (iii) for such other periods as the SEC by regulation or order may permit for
protection of the fund's shareholders. In the case of any such suspension, you
may either withdraw your request for redemption or receive payment based upon
the net asset value next determined after the suspension is lifted.
The fund reserves the right, under certain conditions, to honor any
request for redemption by making payment in whole or in part in securities
valued in the same way as they would be valued for purposes of computing the
fund's net asset value per share. If payment is made in securities, a
shareholder should expect to incur brokerage expenses in converting those
securities into cash and will be subject to fluctuation in the market price of
those securities until they are sold. The fund does not redeem "in kind" under
normal circumstances, but would do so where the adviser determines that it would
be in the best interests of the fund's shareholders as a whole.
VALUATION OF FUND SHARES
Net asset value of a fund share is determined daily for each class
as of the close of the Exchange, on every day the Exchange is open, by dividing
the value of the total assets attributable to that class, less liabilities
attributable to that class, by the number of shares of that class outstanding.
Pricing will not be done on days when the Exchange is closed. The Exchange
currently observes the following holidays: New Year's Day, Presidents' Day,
Martin Luther King, Jr. Day, Good Friday, Memorial Day, Independence Day, Labor
Day, Thanksgiving Day, and Christmas Day. As described in the Prospectuses,
securities for which market quotations are readily available are valued at
current market value. Securities traded on an exchange or the NASDAQ Stock
Market securities are normally valued at last sale prices. Other
over-the-counter securities, and securities traded on exchanges for which there
is no sale on a particular day (including debt securities), are valued at the
mean of latest closing bid and asked prices. Securities with remaining
maturities of 60 days or less are valued at amortized cost. Securities and other
assets quoted in foreign currencies will be valued in U.S. dollars based on the
currency exchange rates prevailing at the time of the valuation. All other
securities are valued at fair value as determined by or under the direction of
the Corporation's Board of Directors. Premiums received on the sale of call
options are included in the net asset value of each class, and the current
market value of options sold by the fund will be subtracted from net assets of
each class.
24
<PAGE>
PERFORMANCE INFORMATION
Total Return Calculations
-------------------------
Average annual total return quotes used in the fund's advertising
and other promotional materials ("Performance Advertisements") are calculated
separately for each class according to the following formula:
P(1+T)n = ERV
where: P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years
ERV = ending redeemable value of a
hypothetical $1,000 payment made at
the beginning of that period
Under the foregoing formula, the time periods used in Performance
Advertisements will be based on rolling calendar quarters, updated at least to
the last day of the most recent quarter prior to submission of the Performance
Advertisements for publication. Total return, or "T" in the formula above, is
computed by finding the average annual change in the value of an initial $1,000
investment over the period. In calculating the ending redeemable value, all
dividends and other distributions by the fund are assumed to have been
reinvested at net asset value on the reinvestment dates during the period.
From time to time the fund may compare the performance of a class to
the performance of other investment companies, groups of investment companies,
various market indices, the features or performance of alternative investments,
in advertisements, sales literature, and reports to shareholders. One such
market index is the S&P 500, a widely recognized, unmanaged index composed of
the capitalization-weighted average of the prices of 500 of the largest publicly
traded stocks in the U.S. The S&P 500 includes reinvestment of all dividends. It
takes no account of the costs of investing or the tax consequences of
distributions. The fund invests in many securities that are not included in the
S&P 500. The fund may also include calculations, such as hypothetical
compounding examples or tax-free compounding examples, which describe
hypothetical investment results in such communications. Such performance
examples will be based on an express set of assumptions that are not indicative
of the performance of the fund.
From time to time, the total return of the fund may be quoted in
advertisements, shareholder reports, or other communications to shareholders.
The fund may also cite rankings and ratings, and compare the return
of a class with data published by Lipper Analytical Services, Inc. ("Lipper"),
CDA Investment Technologies, Inc., Wiesenberger Investment Company Services,
Value Line, Morningstar, and other services or publications that monitor,
compare and/or rank the performance of investment companies. The fund may also
refer in such materials to mutual fund performance rankings, ratings,
comparisons with funds having similar investment objectives, and other mutual
funds reported in independent periodicals, including, but not limited to,
FINANCIAL WORLD, MONEY Magazine, FORBES, BUSINESS WEEK, BARRON'S, FORTUNE, THE
KIPLINGER LETTERS, THE WALL STREET JOURNAL, and THE NEW YORK TIMES.
The fund may compare the investment return of a class to the return
on certificates of deposit and other forms of bank deposits, and may quote from
organizations that track the rates offered on such deposits. Bank deposits are
insured by an agency of the federal government up to specified limits. In
contrast, fund shares are not insured, the value of fund shares may fluctuate,
and an investor's shares, when redeemed, may be worth more or less than the
investor originally paid for them. Unlike the interest paid on many certificates
of deposit, which remains at a specified rate for a specified period of time,
the return of each class of shares will vary.
25
<PAGE>
Fund advertisements may reference the history of the distributor and
its affiliates, the education, experience, investment philosophy and strategy of
the portfolio manager, and the fact that the portfolio manager engages in
certain approaches to investing.
In advertising, the fund may illustrate hypothetical investment
plans designed to help investors meet long-term financial goals, such as saving
for a child's college education or for retirement. Sources such as the Internal
Revenue Service, the Social Security Administration, the Consumer Price Index
and Chase Global Data and Research may supply data concerning interest rates,
college tuitions, the rate of inflation, Social Security benefits, mortality
statistics and other relevant information. The fund may use other recognized
sources as they become available.
The fund may use data prepared by independent third parties such as
Ibbotson Associates and Frontier Analytics, Inc. to compare the returns of
various capital markets and to show the value of a hypothetical investment in a
capital market. Typically, different indices are used to calculate the
performance of common stocks, corporate and government bonds and Treasury bills.
The fund may illustrate and compare the historical volatility of
different portfolio compositions where the performance of stocks is represented
by the performance of an appropriate market index, such as the S&P 500 and the
performance of bonds is represented by a nationally recognized bond index, such
as the Lehman Brothers Long-Term Government Bond Index.
The fund may also include in advertising biographical information on
key investment and managerial personnel.
The fund may advertise examples of the potential benefits of
periodic investment plans, such as dollar cost averaging, a long-term investment
technique designed to lower average cost per share. Under such a plan, an
investor invests in a mutual fund at regular intervals a fixed dollar amount
thereby purchasing more shares when prices are low and fewer shares when prices
are high. Although such a plan does not guarantee profit or guard against loss
in declining markets, the average cost per share could be lower than if a fixed
number of shares were purchased at the same intervals. Investors should consider
their ability to purchase shares through periods of low price levels.
The fund may discuss Legg Mason's tradition of service. Since 1899,
Legg Mason and its affiliated companies have helped investors meet their
specific investment goals and have provided a full spectrum of financial
services. Legg Mason affiliates serve as investment advisers for private
accounts and mutual funds with assets of approximately $94.6 billion as of
September 30, 1999.
In advertising, the fund may discuss the advantages of saving
through tax-deferred retirement plans or accounts, including the advantages and
disadvantages of "rolling over" a distribution from a retirement plan into an
IRA, factors to consider in determining whether you qualify for such a rollover,
and the other options available. These discussions may include graphs or other
illustrations that compare the growth of a hypothetical tax-deferred investment
to the after-tax growth of a taxable investment.
TAX-DEFERRED RETIREMENT PLANS
In general, income earned through the investment of assets of IRAs
and qualified retirement plans is not taxed to their beneficiaries until the
income is distributed to them. Investors who are considering establishing an IRA
or a SEP, SIMPLE, or other qualified retirement plan should consult their
attorneys or other tax advisers with respect to individual tax questions. The
option of investing in IRAs and those plans with respect through regular payroll
deductions may be arranged with a Legg Mason or affiliated financial adviser and
your employer. Additional information with respect to IRAs and these plans is
available upon request from any Financial Adviser or Service Provider.
26
<PAGE>
Traditional IRA. Certain investors may obtain tax advantages by
establishing an IRA. Specifically, except as noted below, if neither you nor
your spouse is an active participant in a qualified employer or government
retirement plan, or if either you or your spouse is an active participant and
your adjusted gross income does not exceed a certain level, then each of you may
deduct cash contributions made to an IRA in an amount for each taxable year not
exceeding the lesser of 100% of your earned income or $2,000. However, a married
investor who is not an active participant in such a plan and files a joint
income tax return with his or her spouse (and their combined adjusted gross
income does not exceed $150,000) is not affected by the spouse's active
participant status. In addition, if your spouse is not employed and you file a
joint return, you may establish a separate IRA for your spouse and contribute up
to a total of $4,000 to the two IRAs, provided that the contribution to either
does not exceed $2,000. If your employer's plan qualifies as a SIMPLE, permits
voluntary contributions and meets certain other requirements, you may make
voluntary contributions to that plan that are treated as deductible IRA
contributions.
Even if you are not in one of the categories described in the
preceding paragraph, you may find it advantageous to invest through
non-deductible IRA contributions, up to certain limits, because all dividends
and other distributions on your fund shares are then not immediately taxable to
you or the IRA; they become taxable only when distributed to you. To avoid
penalties, your interest in an IRA must be distributed, or start to be
distributed, to you not later than April 1 following the calendar year in which
you attain age 70 1/2. Distributions made before age 59 1/2, in addition to
being taxable, generally are subject to a penalty equal to 10% of the
distribution, except in the case of death or disability, where the distribution
is rolled over into another qualified plan or certain other situations.
Roth IRA. A shareholder whose adjusted gross income (or combined
adjusted gross income with his or her spouse) does not exceed certain levels may
establish and contribute up to $2,000 per tax year to a Roth IRA. In addition,
for a shareholder whose adjusted gross income does not exceed $100,000 (or is
not married filing a separate return), certain distributions from traditional
IRAs may be rolled over to a Roth IRA and any of the shareholder's traditional
IRAs may be converted to a Roth IRA; these rollover distributions and
conversions are, however, subject to federal income tax.
Contributions to a Roth IRA are not deductible; however, earnings
accumulate tax-free in a Roth IRA, and withdrawals of earnings are not subject
to federal income tax if the account has been held for at least five years (or
in the case of earnings attributable to rollover contributions from or
conversions of a traditional IRA, the rollover or conversion occurred more than
five years before the withdrawal) and the account holder has reached age 59 1/2
(or certain other conditions apply).
Education IRA. Although not technically for retirement savings, an
Education IRA provides a vehicle for saving for a child's higher education. An
Education IRA may be established for the benefit of any minor, and any person
whose adjusted gross income does not exceed certain levels may contribute to an
Education IRA, provided that no more than the maximum amount allowable ($500)
may be contributed for any year to Education IRAs for the same beneficiary.
Contributions are not deductible and may not be made after the beneficiary
reaches age 18; however, earnings accumulate tax-free, and withdrawals are not
subject to tax if used to pay the qualified higher education expenses of the
beneficiary (or transferred to an Education IRA of a qualified family member).
Simplified Employee Pension Plan -- SEP
---------------------------------------
Legg Mason makes available to corporate and other employers a SEP
for investment in Primary Class shares.
Savings Incentive Match Plan for Employees -- SIMPLE
----------------------------------------------------
An employer with no more than 100 employees that does not maintain
another retirement plan instead may establish a SIMPLE either as separate IRAs
27
<PAGE>
or as part of a Code section 401(k) plan. A SIMPLE, which is not subject to the
complicated nondiscrimination rules that generally apply to qualified retirement
plans, will allow certain employees to make elective contributions of up to
$6,000 per year and will require the employer to make either matching
contributions up to 3% of each such employee's salary or a 2% nonelective
contribution.
Withholding at the rate of 20% is required for federal income tax
purposes on certain distributions (excluding, for example, certain periodic
payments) from the foregoing retirement plans (except IRAs and SEPs), unless the
recipient transfers the distribution directly to an "eligible retirement plan"
(including IRAs and other qualified plans) that accepts those distributions.
Other distributions generally are subject to regular wage withholding at the
rate of 10% (depending on the type and amount of the distribution), unless the
recipient elects not to have any withholding apply. Primary Class share
investors should consult their plan administrator or tax adviser for further
information.
MANAGEMENT OF THE FUND
The Corporation's officers are responsible for the operation of the
Corporation under the direction of the Board of Directors. The officers and
directors of the Corporation, their dates of birth, and their principal
occupations during the past five years are set forth below. An asterisk (*)
indicates officers and/or directors who are "interested persons" of the fund as
defined by the 1940 Act. The business address of each director and officer is
100 Light Street, Baltimore, Maryland 21202, unless otherwise indicated.
JOHN F. CURLEY, JR.* [7/24/39], Chairman of the Board and Director;
President and/or Chairman of the Board and Director/Trustee of all Legg Mason
retail funds. Retired: Vice Chairman and Director of Legg Mason, Inc. and Legg
Mason Wood Walker, Inc. Formerly: Director of LMFA and Western Asset Management
Company (each a registered investment adviser); Officer and/or Director of
various other affiliates of Legg Mason, Inc.
NELSON A. DIAZ [5/23/47], Director; One Logan Square, Philadelphia,
PA. Partner, Blank Rome Comisky, & McCauley LLP since 1997; Trustee of Temple
University and of Philadelphia Museum of Art; Board member of U.S. Hispanic
Leadership Institute, Democratic National Committee, and National Association
for Hispanic Elderly; Director/Trustee of all Legg Mason retail funds except
Legg Mason Income Trust, Inc. and Legg Mason Tax Exempt Trust, Inc. Formerly:
General Counsel, United States Department of Housing and Urban Development
(1993-1997).
RICHARD G. GILMORE [6/9/27], Director; 10310 Tamo Shanter Place,
Bradenton, Florida. Independent Consultant. Director of CSS Industries, Inc.
(diversified holding company whose subsidiaries are engaged in the manufacture
and sale of decorative paper products, business forms, and specialty metal
packaging); Director of PECO Energy Company (formerly Philadelphia Electric
Company); Director/Trustee of all Legg Mason retail funds. Formerly: Senior Vice
President and Chief Financial Officer of Philadelphia Electric Company (now PECO
Energy Company); Executive Vice President and Treasurer, Girard Bank, and Vice
President of its parent holding company, the Girard Company; and Director of
Finance, City of Philadelphia.
ARNOLD L. LEHMAN [7/18/44], Director; The Brooklyn Museum of Art,
200 Eastern Parkway, Brooklyn, New York. Director of the Brooklyn Museum of Art;
Director/Trustee of all Legg Mason retail funds. Formerly: Director of the
Baltimore Museum of Art.
JILL E. McGOVERN [8/29/44], Director; 400 Seventh Street NW,
Washington, DC. Chief Executive Officer of the Marrow Foundation.
Director/Trustee of all Legg Mason retail funds. Formerly: Executive Director of
the Baltimore International Festival (January 1991 - March 1993); and Senior
Assistant to the President of The Johns Hopkins University (1986-1991).
28
<PAGE>
JENNIFER W. MURPHY* [12/18/64], President and Director; Senior Vice
President of LMFA; employee of Legg Mason since 1995. Formerly: strategy
consultant with Corporate Decisions, Inc. (1992-1995).
G. PETER O'BRIEN [10/13/45], Director; Trustee of Colgate
University; Director/Trustee of all Legg Mason retail funds except Legg Mason
Income Trust, Inc. and Legg Mason Tax Exempt Trust, Inc. Retired: Managing
Director/Equity Capital Markets Group of Merrill Lynch & Co. (1971-1999).
T.A. RODGERS [10/22/34], Director; 2901 Boston Street, Baltimore,
Maryland. Principal, T.A. Rodgers & Associates (management consulting);
Director/Trustee of all Legg Mason retail funds. Formerly: Director and Vice
President of Corporate Development, Polk Audio, Inc. (manufacturer of audio
components).
EDWARD A. TABER, III* [8/25/43], Director; Senior Executive Vice
President of Legg Mason, Inc. and Legg Mason Wood Walker, Inc.; Vice Chairman
and Director of LMFA and Director of Western Asset Management Company (each a
registered investment adviser); President and/or Director/Trustee of all Legg
Mason retail funds except Legg Mason Tax Exempt Trust. Formerly: Executive Vice
President of T. Rowe Price-Fleming International, Inc. (1986-1992) and Director
of the Taxable Fixed Income Division at T. Rowe Price Associates, Inc.
(1973-1992).
The executive officers of the Corporation, other than those who also
serve as directors, are:
MARIE K. KARPINSKI* [1/1/49], Vice President and Treasurer;
Treasurer of LMFA; Vice President and Treasurer of all Legg Mason retail funds.
PATRICIA A. MAXEY* [7/10/67], Secretary; Secretary of Legg Mason
Cash Reserve Trust; employee of Legg Mason since November 1999. Formerly:
Employee of Select Appointments International, Inc. (1998-1999) and Fidelity
Investments (1995-1997).
WM. SHANE HUGHES* [4/24/68], Assistant Secretary and Assistant
Treasurer; employee of Legg Mason since May 1997. Formerly: Senior Associate of
C.W. Amos and Co. (a regional public accounting firm).
The Nominating Committee of the Board of Directors is responsible
for the selection and nomination of disinterested directors. The committee is
composed of Messrs. Gilmore, Lehman, Rodgers, and O'Brien, and Dr. McGovern.
Officers and directors of the Corporation who are "interested
persons" of the Corporation receive no salary or fees from the Corporation. Each
director of the Corporation who is not an interested person of the Corporation
("Independent Directors") receives an annual retainer and a per meeting fee
based on the average net assets of the fund at December 31 of the previous year.
As of March 20, 2000, the directors and officers of the Corporation
beneficially owned less than 1% of the Fund's outstanding shares.
As of February 29, 2000, no person is known by the fund to own
beneficially and/or of record 5% or more of any class of the fund's outstanding
shares.
The following table provides certain information relating to the
compensation of the Corporation's directors. The fund has no retirement plan for
its directors.
29
<PAGE>
COMPENSATION TABLE
--------------------------------------------------------------------------------
Total Compensation From
Name of Person and Aggregate Compensation Fund and Fund Complex
Position From Fund* Paid to Directors**
--------------------------------------------------------------------------------
John F. Curley, Jr. -
Chairman of the Board None None
and Director
--------------------------------------------------------------------------------
Jennifer W. Murphy -
President and Director None None
--------------------------------------------------------------------------------
Edward A. Taber, III -
Director None None
--------------------------------------------------------------------------------
Nelson A. Diaz -
Director*** $1,200 None
--------------------------------------------------------------------------------
Richard G. Gilmore -
Director $1,200 $41,100
--------------------------------------------------------------------------------
Arnold L. Lehman -
Director $1,200 $41,100
--------------------------------------------------------------------------------
Jill E. McGovern - Director $1,200 $41,100
--------------------------------------------------------------------------------
T.A. Rodgers - Director $1,200 $41,100
--------------------------------------------------------------------------------
G. Peter O'Brien - Director $1,200 $15,000
--------------------------------------------------------------------------------
* Represents estimated compensation that will be paid to each director
during the first full fiscal year of operations.
** Represents aggregate compensation paid to each director during the
calendar year ended December 31, 1999. There are twelve open-end
investment companies in the Legg Mason Complex (with a total of
twenty-four funds).
*** Mr. Diaz was elected to the Board on February 10, 2000.
THE FUND'S INVESTMENT ADVISER/MANAGER
LMM, a Delaware limited liability company located at 100 Light
Street, Baltimore, Maryland 21202, is 50% owned by Legg Mason, Inc. and 50%
owned, directly or indirectly, by William H. Miller, III. LMM serves as the
fund's investment adviser and manager under a Management Agreement ("Management
Agreement"). LMFA, a Maryland corporation located at 100 Light Street,
Baltimore, Maryland 21202, is a wholly-owned subsidiary of Legg Mason, Inc. LMFA
serves as sub-manager to the fund under a Sub-Management Agreement
("Sub-Management Agreement"). Legg Mason, Inc. is a financial services holding
company.
The Management Agreement provides that, subject to overall direction
by the fund's Board of Directors, LMM manages or oversees the investment and
30
<PAGE>
other affairs of the fund. LMM is responsible for managing the fund consistent
with the fund's investment objective and policies described in its Prospectuses
and this Statement of Additional Information. The Management Agreement further
provides that LMM is responsible, subject to the general supervision of the
Corporation's Board of Directors, for the actual management of the fund's
assets, including responsibility for making decisions and placing orders to buy,
sell or hold a particular security.
LMM receives for its services to the fund a management fee,
calculated daily and payable monthly. LMM receives from Opportunity Trust a
management fee at an annual rate of 1.00% of the average daily net assets of the
fund up to $100 million and 0.75% of its average daily net assets in excess of
$100 million. LMM has agreed to waive its fees for Opportunity Trust for
expenses related to Primary Class shares (exclusive of taxes, interest,
brokerage and extraordinary expenses) in excess of 1.99% of average net assets
attributable to the shares until December 31, 2000. The fund has agreed to pay
the manager for waived fees and reimbursed expenses provided that payment does
not cause the fund's annual operating expenses to exceed 1.99% of the average
net assets of the Primary Class shares and the payment is made within three
years after the year in which the manager earned the fee or incurred the
expense.
For the period December 30, 1999 (commencement of operations) to
December 31, 1999, LMM waived $1,451 in management fees for the fund under the
Management Agreement. For the same period, the fund paid management fees of
$2,177.
The Sub-Management Agreement provides that LMFA is obligated to
perform certain advisory and administrative services for the fund. Regarding
advisory services, LMFA will regularly provide investment research, advice,
management and supervision; otherwise assist in determining from time to time
what securities will be purchased, retained or sold by the fund; and implement
decisions to purchase, retain or sell securities made on behalf of the fund, all
subject to the supervision of LMM and the general supervision of the
Corporation's Board of Directors. LMFA will also place orders for the fund
either directly with the issuer or with any broker or dealer; provide advice and
recommendations with respect to other aspects of the business and affairs of the
fund; and perform such other functions of management and supervision as may be
directed by the Board of Directors of the Corporation and LMM.
Regarding administrative services, LMFA will (a) furnish the fund
with office space and executive and other personnel necessary for the operation
of the fund; (b) supervise all aspects of the fund's operations; (c) bear the
expense of certain informational and purchase and redemption services to the
fund's shareholders; (d) arrange, but not pay for, the periodic updating of
prospectuses, proxy material, tax returns and reports to shareholders and state
and federal regulatory agencies; and (e) report regularly to the fund's officers
and directors. LMFA and its affiliates pay all compensation of directors and
officers of the fund who are officers, directors or employees of LMFA. The fund
pays all of its expenses which are not expressly assumed by LMFA. These expenses
include, among others, interest expense, taxes, brokerage fees and commissions,
expenses of preparing and setting in type prospectuses, proxy statements and
reports to shareholders and of printing and distributing them to existing
shareholders, custodian charges, transfer agency fees, distribution fees to the
fund's distributor, compensation of the independent directors, organizational
expenses, legal and audit expenses, insurance expense, shareholder meetings,
proxy solicitations, expenses of registering and qualifying fund shares for sale
under federal and state law, governmental fees, and expenses incurred in
connection with membership in investment company organizations. The fund also is
liable for such nonrecurring expenses as may arise, including litigation to
which the fund may be a party. The fund may also have an obligation to indemnify
its directors and officers with respect to litigation.
For LMFA's services to the fund, LMM (not the fund) pays LMFA a fee,
calculated daily and payable monthly, of 0.10% of the average daily net assets
of the fund up to $100 million and 0.05% of the average daily net assets of the
fund in excess of $100 million.
31
<PAGE>
For the period December 30, 1999 (commencement of operations) to
December 31, 1999, LMFA received $363 for its services to the fund.
Under the Management Agreement and Sub-Management Agreement, LMM and
LMFA will not be liable for any error of judgment or mistake of law or for any
loss by the fund in connection with the performance of the Management Agreement
or the Sub-Management Agreement, except a loss resulting from a breach of
fiduciary duty with respect to the receipt of compensation for services or a
loss resulting from willful misfeasance, bad faith or gross negligence on its
part in the performance of its duties or from reckless disregard of its
obligations or duties under the respective agreement.
The Management Agreement and Sub-Management Agreement each terminate
automatically upon assignment and are terminable at any time without penalty by
vote of the fund's Board of Directors, by vote of a majority of the fund's
outstanding voting securities, or by LMM and LMFA, on not less than 60 days'
notice to the other party to the agreement, and may be terminated immediately
upon the mutual written consent of all parties to the agreement.
To mitigate the possibility that the fund will be affected by
personal trading of employees, the Corporation, LMM, LMFA, and Legg Mason have
adopted policies that restrict securities trading in the personal accounts of
portfolio managers and others who normally come into advance possession of
information on portfolio transactions. These policies comply, in all material
respects, with the recommendations of the Investment Company Institute.
PORTFOLIO TRANSACTIONS AND BROKERAGE
Under the Management Agreement with the fund, the fund's adviser is
responsible for the execution of the fund's portfolio transactions and must seek
the most favorable price and execution for such transactions, subject to the
possible payment, as described below, of higher brokerage commissions to brokers
who provide research and analysis. The fund may not always pay the lowest
commission or spread available. Rather, in placing orders for the fund the
fund's adviser also takes into account such factors as size of the order,
difficulty of execution, efficiency of the executing broker's facilities
(including the services described below), and any risk assumed by the executing
broker.
Consistent with the policy of most favorable price and execution,
the fund's adviser may give consideration to research, statistical and other
services furnished by brokers or dealers to the fund's adviser for its use, may
place orders with brokers who provide supplemental investment and market
research and securities and economic analysis and may pay to these brokers a
higher brokerage commission than may be charged by other brokers. Such services
include, without limitation, advice as to the value of securities; the
advisability of investing in, purchasing, or selling securities; advice as to
the availability of securities or of purchasers or sellers of securities; and
furnishing analyses and reports concerning issuers, industries, securities,
economic factors and trends, portfolio strategy and the performance of accounts.
On any given trade, the choice of broker may be made by either LMM or LMFA. Such
research and analysis may be useful to either the fund's adviser or sub-adviser
in connection with services to clients other than the fund whose brokerage
generated the service. LMM's and LMFA's fee is not reduced by reason of its
receiving such brokerage and research services.
From time to time the fund may use Legg Mason as broker for agency
transactions in listed and over-the-counter securities at commission rates and
under circumstances consistent with the policy of best execution. Commissions
paid to Legg Mason will not exceed "usual and customary brokerage commissions."
Rule 17e-1 under the 1940 Act defines "usual and customary" commissions to
include amounts which are "reasonable and fair compared to the commission, fee
or other remuneration received by other brokers in connection with comparable
transactions involving similar securities being purchased or sold on a
securities exchange during a comparable period of time." In the over-the-counter
market, the fund generally deals with responsible primary market-makers unless a
more favorable execution can otherwise be obtained.
32
<PAGE>
The fund commenced investment operations on December 30, 1999, and
paid no brokerage commissions for the fiscal year ended December 31, 1999.
Except as permitted by SEC rules or orders, the fund may not buy
securities from, or sell securities to, Legg Mason or its affiliated persons as
principal. The fund's Board of Directors has adopted procedures in conformity
with Rule 10f-3 under the 1940 Act whereby the fund may purchase securities that
are offered in certain underwritings in which Legg Mason or any of its
affiliated persons is a participant. These procedures, among other things, limit
the fund's investment in the amount of securities of any class of securities
offered in an underwriting in which Legg Mason or any of its affiliated persons
is a participant so that the fund, together with all other registered investment
companies having the same adviser, may not purchase more than 25% of the
principal amount of the offering of such class. In addition, the fund may not
purchase securities during the existence of an underwriting if Legg Mason is the
sole underwriter for those securities.
Section 11(a) of the Securities Exchange Act of 1934 prohibits Legg
Mason from executing transactions on an exchange for its affiliates, such as the
fund, unless the affiliate expressly consents by written contract. The fund's
Management Agreement expressly provides such consent.
Investment decisions for the fund are made independently from those
of other funds and accounts advised by LMM or LMFA. However, the same security
may be held in the portfolios of more than one fund or account. When two or more
accounts simultaneously engage in the purchase or sale of the same security, the
prices and amounts will be equitably allocated to each account. In some cases,
this procedure may adversely affect the price or quantity of the security
available to a particular account. In other cases, however, an account's ability
to participate in large-volume transactions may produce better executions and
prices.
THE FUND'S DISTRIBUTOR
Legg Mason acts as distributor of the fund's shares pursuant to an
Underwriting Agreement with the fund. The Underwriting Agreement obligates Legg
Mason to promote the sale of fund shares and to pay certain expenses in
connection with its distribution efforts, including expenses for the printing
and distribution of prospectuses and periodic reports used in connection with
the offering to prospective investors (after the prospectuses and reports have
been prepared, set in type and mailed to existing shareholders at the fund's
expense), and for supplementary sales literature and advertising costs.
Under the Underwriting Agreement, the fund has the non-exclusive
right to use the name "Legg Mason" until that agreement is terminated, or until
the right is withdrawn in writing by Legg Mason.
The Primary Class shares are subject to a deferred sales charge
payable to Legg Mason if they are redeemed within 12 months of purchase. This
deferred sales charge is not applicable where the investor's broker-dealer of
record notifies the distributor prior to the time of investment that the
broker-dealer waives the payment otherwise payable to it. Except as specifically
provided for in the fund's Prospectuses, for purposes of exchange privileges,
the fund is not considered a Legg Mason fund.
The fund has adopted a Distribution and Shareholder Services Plan
("Plan") which, among other things, permits the fund to pay Legg Mason fees for
its services related to sales and distribution of Primary Class shares and the
provision of ongoing services to Primary Class shareholders. Payments are made
only from assets attributable to Primary Class shares. Under the Plan, the
aggregate fees may not exceed 1.00% of the fund's annual average daily net
assets attributable to Primary Class shares. Distribution activities for which
such payments may be made include, but are not limited to, compensation to
persons who engage in or support distribution and redemption of shares, printing
of prospectuses and reports for persons other than existing shareholders,
advertising, preparation and distribution of sales literature, overhead, travel
and telephone expenses, all with respect to Primary Class shares only.
33
<PAGE>
The Plan was adopted, as required by Rule 12b-1 under the 1940 Act,
by a vote of the Board of Directors, including a majority of the directors who
are not "interested persons" of the Corporation as that term is defined in the
1940 Act, and who have no direct or indirect financial interest in the operation
of the Plan or the Underwriting Agreement ("12b-1 Directors"). In approving the
establishment of the Plan, in accordance with the requirements of Rule 12b-1,
the directors determined that there was a reasonable likelihood that the Plan
would benefit the fund and its Primary Class shareholders. The directors
considered, among other things, the extent to which the potential benefits of
the Plan to the fund's Primary Class shareholders could offset the costs of the
Plan; the likelihood that the Plan would succeed in producing such potential
benefits; the merits of certain possible alternatives to the Plan; and the
extent to which the retention of assets and additional sales of the fund's
Primary Class shares would be likely to maintain or increase the amount of
compensation paid by the fund to LMM and LMFA.
In considering the costs of the Plan, the directors gave particular
attention to the fact that any payments made by the fund to Legg Mason under the
Plan would increase the fund's level of expenses in the amount of such payments.
Further, the directors recognized that LMM and LMFA would earn greater
management fees if the fund's assets were increased, because such fees are
calculated as a percentage of the fund's assets and thus would increase if net
assets increase. The directors further recognized that there can be no assurance
that any of the potential benefits described below would be achieved if the Plan
was implemented.
Among the potential benefits of the Plan, the directors noted that
the payment of commissions and service fees to Legg Mason and its investment
executives could motivate them to improve their sales efforts with respect to
the fund's Primary Class shares and to maintain and enhance the level of
services they provide to the fund's Primary Class shareholders. These efforts,
in turn, could lead to increased sales and reduced redemptions, eventually
enabling the fund to achieve economies of scale and lower per share operating
expenses. Any reduction in such expenses would serve to offset, at least in
part, the additional expenses incurred by the fund in connection with its Plan.
Furthermore, the investment management of the fund could be enhanced, as net
inflows of cash from new sales might enable its portfolio manager to take
advantage of attractive investment opportunities, and reduced redemptions could
eliminate the potential need to liquidate attractive securities positions in
order to raise the funds necessary to meet the redemption requests.
As compensation for its services and expenses, Legg Mason receives
from the fund an annual distribution fee equivalent to 0.75% of its average
daily net assets attributable to Primary Class shares and a service fee
equivalent to 0.25% of its average daily net assets attributable to Primary
Class shares in accordance with the Plan. All distribution and service fees are
calculated daily and paid monthly.
The Plan will continue in effect only so long as it is approved at
least annually by the vote of a majority of the 12b-1 Directors, cast in person
at a meeting called for the purpose of voting on the Plan. The Plan may be
terminated by a vote of a majority of the 12b-1 Directors or by a vote of a
majority of the outstanding voting Primary Class shares. Any change in the Plan
that would materially increase the distribution cost to the fund requires
shareholder approval; otherwise the Plan may be amended by the directors,
including a majority of the 12b-1 Directors, as previously described.
In accordance with Rule 12b-1, the Plan provides that Legg Mason
will submit to the fund's Board of Directors, and the directors will review, at
least quarterly, a written report of any amounts expended pursuant to the Plan
and the purposes for which expenditures were made. In addition, as long as the
Plan is in effect, the selection and nomination of candidates for Independent
Director will be committed to the discretion of the Independent Directors.
34
<PAGE>
For the period December 30, 1999 (commencement of operations) to
December 31, 1999, Legg Mason incurred the following expenses in connection with
distribution and shareholder services:
Compensation to Sales Personnel $2,685
Other $943
-----
Total $3,628
The amounts in "Other" reflect the allocation of certain items of
overhead, using assumptions believed by Legg Mason to be reasonable.
CAPITAL STOCK INFORMATION
The Articles of Incorporation of the Corporation authorize issuance
of 400 million shares of common stock, par value $0.001 per share, of Legg Mason
Opportunity Trust. The fund has three authorized classes of shares: Class A
shares, Primary Class shares, and Navigator Class shares. Class A shares are not
being offered at this time.
Each share in the fund is entitled to one vote for the election of
directors and any other matter submitted to a vote of fund shareholders.
Fractional shares have fractional voting rights. Voting rights are not
cumulative. All shares in the fund are fully paid and nonassessable and have no
preemptive or conversion rights.
Shareholder meetings will not be held except where the Investment
Company Act of 1940 requires a shareholder vote on certain matters (including
the election of directors, approval of an advisory contract, and certain
amendments to the plan of distribution pursuant to Rule 12b-1), at the request
of 25% or more of the shares entitled to vote as set forth in the bylaws of Legg
Mason Investment Trust, Inc. or as the Board of Directors from time to time
deems appropriate.
THE FUND'S CUSTODIAN AND TRANSFER AND DIVIDEND-DISBURSING AGENT
State Street Bank and Trust Company ("State Street"), P.O. Box 1713,
Boston, Massachusetts 02105, serves as custodian of the fund's assets. Boston
Financial Data Services ("BFDS"), P.O. Box 953, Boston, Massachusetts 02103, as
agent for State Street, serves as transfer and dividend-disbursing agent, and
administrator of various shareholder services. Legg Mason assists BFDS with
certain of its duties as transfer agent and receives compensation from BFDS for
its services. Shareholders who request an historical transcript of their account
will be charged a fee based upon the number of years researched. The fund
reserves the right, upon 60 days' written notice, to make other charges to
investors to cover administrative costs.
THE FUND'S LEGAL COUNSEL
Kirkpatrick & Lockhart LLP, 1800 Massachusetts Ave., N.W.,
Washington, D.C. 20036, serves as counsel to the fund.
THE FUND'S INDEPENDENT ACCOUNTANTS
Ernst & Young LLP, Two Commerce Square, 2001 Market Street,
Philadelphia, PA 19103, serves as independent auditors for Opportunity Trust.
35
<PAGE>
FINANCIAL STATEMENTS
The Statement of Assets and Liabilities as of December 31, 1999; the
Statements of Operations, Changes in Net Assets, and Financial Highlights for
the period ended December 31, 1999; the Notes to Financial Statements and the
Report of the Independent Auditors, each with respect to Opportunity Trust, are
included in the December 31, 1999, annual report, and are hereby incorporated by
reference in this Statement of Additional Information.
36
<PAGE>
Appendix A
RATINGS OF SECURITIES
Description of Moody's Investors Service, Inc. ("Moody's") corporate bond
ratings:
--------------------------------------------------------------------------------
Aaa-Bonds which are rated Aaa are judged to be of the best quality.
They carry the smallest degree of investment risk and are generally referred to
as "gilt edge". Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized are
most unlikely to impair the fundamentally strong position of such issues.
Aa -Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known as
high grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in Aaa securities or fluctuation of protective
elements may be of greater amplitude or there may be other elements present
which make the long-term risk appear somewhat larger than in Aaa securities.
A-Bonds which are rated A possess many favorable investment
attributes and are to be considered as upper-medium-grade obligations. Factors
giving security to principal and interest are considered adequate but elements
may be present which suggest a susceptibility to impairment some time in the
future.
Baa-Bonds which are rated Baa are considered medium-grade
obligations, i.e., they are neither highly protected nor poorly secured.
Interest payments and principal security appear adequate for the present but
certain protective elements may be lacking or may be characteristically
unreliable over any great length of time. Such bonds lack outstanding investment
characteristics and in fact have speculative characteristics as well.
Ba-Bonds which are rated Ba are judged to have speculative elements;
their future cannot be considered as well-assured. Often the protection of
interest and principal payments may be very moderate and thereby not well
safeguarded during both good and bad times over the future. Uncertainty of
position characterizes bonds in this class.
B- Bonds which are rated B generally lack characteristics of the
desirable investment. Assurance of interest and principal payments or of
maintenance of other terms of the contract over any long period of time may be
small.
Caa-Bonds which are rated Caa are of poor standing. Such issues may
be in default or there may be present elements of danger with respect to
principal or interest.
Ca- Bonds which are rated Ca represent obligations which are
speculative in a high degree. Such issues are often in default or have other
marked shortcomings.
C-Bonds which are rated C are the lowest rated class of bonds and
issues so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
37
<PAGE>
Description of Standard & Poor's ("S&P") corporate bond ratings:
----------------------------------------------------------------
AAA-An obligation rated AAA has the highest rating assigned by S&P.
The obligor's capacity to meet its financial commitment on the obligation is
extremely strong.
AA -An obligation rated AA differs from the highest rated
obligations only in small degree. The obligor's capacity to meet its financial
commitment on the obligation is very strong.
A-An obligation rated A is somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than obligations in
higher rated categories. However, the obligor's capacity to meet its financial
commitment on the obligation is still strong.
BBB-An obligation rated BBB exhibits adequate protection parameters.
However, adverse economic conditions or changing circumstances are more likely
to lead to a weakened capacity of the obligor to meet its financial commitment
on the obligation. Obligations rated BB, B, CCC, CC, and C are regarded as
having significant speculative characteristics. BB indicates the least degree of
speculation and C the highest. While such obligations will likely have some
quality and protective characteristics, these may be outweighed by large
uncertainties or major exposures to adverse conditions.
BB-An obligation rated BB is less vulnerable to nonpayment than
other speculative issues. However, it faces major ongoing uncertainties or
exposure to adverse business, financial, or economic conditions which could lead
to the obligor's inadequate capacity to meet its financial commitment on the
obligation.
B-An obligation rated B is more vulnerable to nonpayment than
obligations rated BB, but the obligor currently has the capacity to meet its
financial commitment on the obligation. Adverse business, financial, or economic
conditions will likely impair the obligor's capacity or willingness to meet its
financial commitment on the obligation.
CCC-An obligation rated CCC is currently vulnerable to nonpayment,
and is dependent upon favorable business, financial, and economic conditions for
the obligor to meet its financial commitment on the obligation. In the event of
adverse business, financial, or economic conditions, the obligor is not likely
to have the capacity to meet its financial commitment on the obligation.
CC-An obligation rated CC is currently highly vulnerable to
nonpayment.
C-A subordinated debt or preferred stock obligation rated C is
currently highly vulnerable to nonpayment. The C rating may be used to cover a
situation where a bankruptcy petition has been filed or similar action has been
taken, but payments on this obligation are being continued. A C also will be
assigned to a preferred stock issue in arrears on dividends or sinking fund
payments but that is currently paying.
D-An obligation rated D is in payment default. The D rating category
is used when payments on an obligation are not made on the date due even if the
applicable grace period has not expired, unless S&P believes that such payments
will be made during such grace period. The D rating also will be used upon the
filing of a bankruptcy petition or the taking of a similar action if payments on
an obligation are jeopardized.
Plus (+) or minus (-)-The ratings from AA to CCC may be modified by
the addition of a plus or minus sign to show relative standing within the major
rating categories.
r-This symbol is attached to the ratings of instruments with
significant noncredit risks. It highlights risks to principal or volatility of
expected returns which are not addressed in the credit rating. Examples include:
obligations linked or indexed to equities, currencies, or commodities;
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obligations exposed to severe prepayment risk-such as interest-only or
principal-only mortgage securities; and obligations with unusually risky
interest terms, such as inverse floaters.
N.R.-This indicates that no rating has been requested, that there is
insufficient information on which to base a rating, or that S&P does not rate a
particular obligation as a matter of policy.
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