NATIONS FUNDS TRUST
STATEMENT OF ADDITIONAL INFORMATION
Nations High Yield Bond Fund
Nations Kansas Municipal Income Fund
Nations MidCap Index Fund
PRIMARY A, INVESTOR A, INVESTOR B AND INVESTOR C SHARES
March 16, 2000
This Statement of Additional Information ("SAI") provides supplementary
information pertaining to the classes of shares representing interests in the
above listed series of Nations Funds Trust (individually, a "Fund" and
collectively, the "Funds"). This SAI is not a prospectus, and should be read
only in conjunction with the current prospectuses for the aforementioned Funds
related to the class of shares in which one is interested, dated February 14,
2000 for Nations High Yield Bond Fund and March 15, 2000 for Nations Kansas
Municipal Income Fund and Nations MidCap Index Fund (each a "Prospectus"). All
terms used in this SAI that are defined in the Prospectuses will have the same
meanings assigned in the Prospectuses. Copies of the Prospectuses may be
obtained without charge by writing Nations Funds Trust, c/o Stephens Inc., One
Bank of America Plaza, 33rd Floor, Charlotte, North Carolina 28255, or by
calling Nations Funds Trust at (800) 321-7854.
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TABLE OF CONTENTS
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HISTORY OF NATIONS FUNDS TRUST............................................................... 1
DESCRIPTION OF THE TRUST AND THE INVESTMENTS AND RISKS
OF ITS FUNDS ................................................................................ 1
General............................................................................... 1
Investment Limitations ............................................................... 2
The Funds' Fundamental Policy Restrictions............................................ 2
The Funds' Non-Fundamental Policy Restrictions........................................ 3
Permissible Fund Investments.......................................................... 4
Asset-Backed Securities............................................................... 5
Borrowings............................................................................ 9
Commercial Instruments................................................................ 9
Combined Transactions................................................................. 10
Convertible Securities................................................................ 10
Corporate Debt Securities............................................................. 11
Custodial Receipts.................................................................... 11
Currency Swaps........................................................................ 11
Delayed Delivery Transactions......................................................... 12
Dollar Roll Transactions ............................................................. 12
Equity Swap Contracts ................................................................ 12
Foreign Currency Transactions ........................................................ 13
Futures, Options and Other Derivative Instruments..................................... 14
Guaranteed Investment Contracts....................................................... 28
Insured Municipal Securities ......................................................... 28
Interest Rate Transactions ........................................................... 28
Lower Rated (or High Yield) Debt Securities........................................... 29
Municipal Securities ................................................................. 30
Options on Currencies................................................................. 35
Other Investment Companies............................................................ 35
Participation Interests and Company Receipts.......................................... 35
Real Estate Investment Trusts......................................................... 35
Repurchase Agreements ................................................................ 36
Reverse Repurchase Agreements ........................................................ 36
Securities Lending.................................................................... 36
Short Sales........................................................................... 36
Special Situations.................................................................... 37
Standard & Poor's Depositary Receipts................................................. 37
Stand-by Commitments ................................................................. 37
Stripped Securities................................................................... 38
U.S. and Foreign Bank Obligations..................................................... 38
U.S. Government Obligations........................................................... 39
Use of Segregated and Other Special Accounts.......................................... 39
Variable and Floating Rate Instruments ............................................... 40
Warrants.............................................................................. 40
When-Issued Purchases and Forward Commitments ....................................... 41
Portfolio Turnover.................................................................... 41
Investment Risks and Considerations................................................... 41
MANAGEMENT OF THE TRUST...................................................................... 43
Nations Funds Retirement Plan......................................................... 47
Nations Funds Deferred Compensation Plan.............................................. 47
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Shareholder and Trustee Liability..................................................... 48
INVESTMENT ADVISORY, ADMINISTRATION, CUSTODY,
TRANSFER AGENCY, OTHER SERVICE PROVIDERS, SHAREHOLDER SERVICING AND
DISTRIBUTION AGREEMENTS ..................................................................... 49
Investment Adviser and Sub-Advisers................................................... 49
Co-Administrators and Sub-Administrator............................................... 50
Distribution Plans and Shareholder Servicing Arrangements for
Primary A Shares.................................................................. 51
Investor A Shares ................................................................ 51
Investor B Shares................................................................. 51
Investor C Shares................................................................. 52
Information Applicable to Investor A, Investor B, Investor C Plans................ 52
Expenses.......................................................................... 53
Transfer Agents and Custodians........................................................ 54
Distributor........................................................................... 55
Independent Accountants and Reports................................................... 55
Counsel............................................................................... 55
FUND TRANSACTIONS AND BROKERAGE.............................................................. 55
General Brokerage Policy.............................................................. 55
Section 28(e) Standards............................................................... 57
DESCRIPTION OF SHARES........................................................................ 58
Description of Shares of the Trust.................................................... 58
Net Asset Value Determination......................................................... 59
ADDITIONAL INFORMATION CONCERNING TAXES...................................................... 60
General............................................................................... 60
Excise Tax ........................................................................... 60
Investment through Master Portfolios.................................................. 61
Taxation of Fund/Master Portfolios Investments........................................ 61
Foreign Taxes ........................................................................ 62
Capital Gain Distributions............................................................ 62
Disposition of Fund Shares............................................................ 63
Federal Income Tax Rates.............................................................. 63
Corporate Shareholders................................................................ 63
Foreign Shareholders.................................................................. 63
Backup Withholding.................................................................... 64
Special Tax Considerations Pertaining to the Kansas Fund ............................. 64
Other Matters......................................................................... 64
ADDITIONAL INFORMATION ON PERFORMANCE........................................................ 64
Yield Calculations.................................................................... 67
Total Return Calculations............................................................. 69
MISCELLANEOUS ............................................................................... 71
Certain Significant Shareholders...................................................... 71
SCHEDULE A - Description of Ratings........................................................... A-1
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HISTORY OF NATIONS FUNDS TRUST
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Nations Funds Trust (the "Trust") is an open-end registered investment
company in the Nations Funds family of mutual funds (the "Nations Funds
Family"), which in addition to the Trust, consists of Nations Fund Trust,
Nations Fund, Inc., Nations Reserves, Nations LifeGoal Funds, Inc., Nations
Annuity Trust and Nations Master Investment Trust. The Nations Funds Family
currently has more than 70 distinct investment portfolios and total assets in
excess of $70 billion.
The Trust was organized as a Delaware business trust on October 22,
1999. It has a fiscal year end of March 31st.
DESCRIPTION OF THE TRUST AND
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THE INVESTMENTS AND RISKS OF ITS FUNDS
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GENERAL.
The Trust currently consists of three different investment portfolios.
This SAI pertains to the:
>> Primary A Shares of the Nations High Yield Bond Fund (the
"High Yield Fund"), Nations Kansas Municipal Income Fund (the
"Kansas Fund") and the Nations MidCap Index Fund (the "MidCap
Index Fund");
>> Investor A Shares of the High Yield Fund, the Kansas Fund and
the MidCap Index Fund; and
>> Investor B Shares and Investor C Shares of the High Yield
Fund and the Kansas Fund.
All of the Funds of the Trust are diversified, with the exception of
the Kansas Fund.
The High Yield Fund is sometimes referred to herein as the "Feeder
Fund." The Feeder Fund seeks to achieve its investment objective by investing
substantially all of its assets in a diversified investment portfolio having the
same investment objective as the corresponding master portfolio (the "Master
Portfolio") of Nations Master Investment Trust ("NMIT"), an open-end management
investment company. The High Yield Fund invests substantially all of its assets
in Nations High Yield Bond Master Portfolio (the "High Yield Master Portfolio").
Each share of the Trust is without par value, represents an equal
proportionate interest in the related fund with other shares of the same class,
and is entitled to such dividends and distributions out of the income earned on
the assets belonging to such fund as are declared in the discretion of the
Trust's Board of Trustees. The Trust's Declaration of Trust authorizes the Board
of Trustees to classify or reclassify any class of shares into one or more
series of shares.
Shareholders are entitled to one vote for each full share held and a
proportionate fractional vote for each fractional share held. Shareholders of
each Fund of the Trust will vote in the aggregate and not by fund, and
shareholders of each fund will vote in the aggregate and not by class except as
otherwise expressly required by law or when the Board of Trustees determines
that the matter to be voted on affects only the interests of shareholders of a
particular fund or class. See the discussion on Investment Limitations and
Description of Shares for examples of when the Investment Company Act of 1940
(the "1940 Act") requires voting by fund.
As of the date of the SAI set forth on the cover page, Bank of America,
N.A. ("Bank of America") and its affiliates possessed or shared power to dispose
or vote with respect to more than 25% of the outstanding shares of the Trust and
therefore could be considered to be a controlling person of the Trust for
purposes of the 1940 Act. For more detailed information concerning the
percentage of each class or series of shares over which Bank of America and its
affiliates possessed or shared power to dispose or vote as of a certain date,
see the discussion on Certain Record Holders.
The Trust does not presently intend to hold annual meetings except as
required by the 1940 Act.
Banc of America Advisors, Inc. ("BAAI") is the investment adviser to
the Funds, except the Feeder Fund. BAAI is the investment adviser to the Master
Portfolio. Banc of America Capital Management, Inc. ("BACAP") is the investment
sub-adviser to the MidCap Index Fund and the Kansas Fund. MacKay Shields LLC
("MacKay
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Shields") is the investment sub-adviser to the High Yield Master
Portfolio. As used herein the term "Adviser" shall mean BAAI, BACAP and/or
MacKay Shields as the context may require.
This SAI is intended to furnish prospective investors with additional
information concerning the Trust and the Funds. Some of the information required
to be in this SAI is also included in the Funds' current Prospectuses.
Additionally, the Prospectuses and this SAI omit certain information contained
in the registration statement filed with the SEC. Copies of the registration
statement, including items omitted from the Prospectuses and this SAI, may be
obtained from the SEC on its website (www.sec.gov) or by visiting the public
reading room of the SEC as is discussed in the Prospectuses. No investment in
the Funds' Shares should be made without first reading the related Prospectuses.
INVESTMENT LIMITATIONS
Information concerning each Fund's investment objective is set forth in
each of the Prospectuses. There can be no assurance that a Fund will achieve its
investment objective. The features of the Funds' principal investment strategies
and the principal risks associated with those investment strategies also are
discussed in the Prospectuses.
The fundamental and non-fundamental investment restrictions applicable
to the Funds' investment programs are set forth below. The investment
limitations that are matters of fundamental policy may not be changed without
the affirmative vote of a Fund's shareholders. The investment limitations that
are matters of non-fundamental policy may be changed without the affirmative
vote of a Fund's shareholders.
In addition to the policies outlined below, each Fund is seeking or has
obtained permission from the SEC to borrow money from or lend money to other
funds of the Trust, and to other investment companies that permit such
transactions, and for which BAAI serves as investment adviser.
The Funds' Fundamental Policy Restrictions
------------------------------------------
Each Fund may not:
1. Underwrite any issue of securities within the meaning of the 1933 Act
except when it might technically be deemed to be an underwriter either
(a) in connection with the disposition of a portfolio security, or (b)
in connection with the purchase of securities directly from the issuer
thereof in accordance with its investment objective. This restriction
shall not limit the Fund's ability to invest in securities issued by
other registered investment companies.
2. Purchase or sell real estate, except a Fund may purchase securities of
issuers which deal or invest in real estate and may purchase securities
which are secured by real estate or interests in real estate.
3. Purchase or sell commodities, except that a Fund may to the extent
consistent with its investment objective, invest in securities of
companies that purchase or sell commodities or which invest in such
programs, and purchase and sell options, forward contracts, futures
contracts, and options on futures contracts. This limitation does not
apply to foreign currency transactions including without limitation
forward currency contracts.
4. Purchase any securities which would cause 25% or more of the value of
its total assets at the time of purchase to be invested in the
securities of one or more issuers conducting their principal business
activities in the same industry, provided that: (a) there is no
limitation with respect to obligations issued or guaranteed by the U.S.
Government, any state or territory of the United States, or any of
their agencies, instrumentalities or political subdivisions, and (b)
notwithstanding this limitation or any other fundamental investment
limitation, assets may be invested in the securities of one or more
management investment companies to the extent permitted by the 1940
Act, the rules and regulations thereunder and any exemptive relief
obtained by the Funds.
5. Make loans, except to the extent permitted by the 1940 Act, the rules
and regulations thereunder and any exemptive relief obtained by the
Funds.
6. Borrow money or issue senior securities except to the extent permitted
by the 1940 Act, the rules and regulations thereunder and any exemptive
relief obtained by the Funds.
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7. Except for the Kansas Fund, purchase securities (except securities
issued or guaranteed by the U.S. Government, its agencies or
instrumentalities) of any one issuer if, as a result, more than 5% of
its total assets will be invested in the securities of such issuer or
it would own more than 10% of the voting securities of such issuer,
except that (a) up to 25% of its total assets may be invested without
regard to these limitations and (b) a Fund's assets may be invested in
the securities of one or more management investment companies to the
extent permitted by the 1940 Act, the rules and regulations thereunder
and any exemptive relief obtained by the Funds.
The Funds' Non-Fundamental Policy Restrictions
- ----------------------------------------------
Each Fund may:
1. Invest in shares of other open-end management investment companies,
subject to the limitations of the 1940 Act, the rules thereunder, and
any orders obtained thereunder now or in the future. Funds in a
master/feeder structure generally invest in the securities of one or
more open-end management investment companies pursuant to various
provisions of the 1940 Act.
2. Not invest or hold more than 15% (10% in the case of a money market
fund) of the Fund's net assets in illiquid securities. For this
purpose, illiquid securities include, among others, (a) securities that
are illiquid by virtue of the absence of a readily available market or
legal or contractual restrictions on resale, (b) fixed time deposits
that are subject to withdrawal penalties and that have maturities of
more than seven days, and (c) repurchase agreements not terminable
within seven days.
3. Invest in futures or options contracts regulated by the CFTC for (i)
bona fide hedging purposes within the meaning of the rules of the CFTC
and (ii) for other purposes if, as a result, no more than 5% of a
Fund's net assets would be invested in initial margin and premiums
(excluding amounts "in-the-money") required to establish the contracts.
A Fund (i) will not hedge more than 50% of its total assets by selling
futures contracts, buying put options, and writing call options (so
called "short positions"), (ii) will not buy futures contracts or write
put options whose underlying value exceeds 25% of the Fund's total
assets, and (iii) will not buy call options with a value exceeding 5%
of the Fund's total assets.
4. Lend securities from its portfolio to brokers, dealers and financial
institutions, in amounts not to exceed (in the aggregate) one-third of
the Fund's total assets. Any such loans of portfolio securities will be
fully collateralized based on values that are marked to market daily.
5. Not make investments for the purpose of exercising control of
management. (Investments by the Fund in entities created under the laws
of foreign countries solely to facilitate investment in securities in
that country will not be deemed the making of investments for the
purpose of exercising control.)
6. Not sell securities short, unless it owns or has the right to obtain
securities equivalent in kind and amount to the securities sold short
(short sales "against the box"), and provided that transactions in
futures contracts and options are not deemed to constitute selling
securities short.
7. The Kansas Fund may not purchase securities of any one issuer (other
than U.S. Government Obligations) if, immediately after such purchase,
more than 25% of the value of a Fund's total assets would be invested
in the securities of one issuer, and with respect to 50% of such Fund's
total assets, more than 5% of its assets would be invested in the
securities of one issuer.
For purposes of the foregoing limitations, any limitation that involves
a maximum percentage shall not be considered violated unless an excess over the
percentage occurs immediately after, and is caused by, an acquisition or
encumbrance of securities or assets of, or borrowings on behalf of, a Fund.
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PERMISSIBLE FUND INVESTMENTS
In addition to the principal investment strategies for each Fund, which
are outlined in the Funds' prospectuses, each Fund also may invest in other
types of securities in percentages of less than 10% of its total assets (unless
otherwise indicated, E.G., most Funds may invest in money market instruments
without limit during temporary defensive periods). These types of securities are
listed below for each portfolio and then are described in more detail after this
sub-section.
High Yield Fund: In addition to the types of securities described in
its Prospectuses, the Master Portfolio (in which the Fund invests all of its
assets) may invest in: debt securities, which include all types of debt
obligations of both domestic and foreign issuers, such as bonds, debentures,
notes, equipment lease certificates, equipment trust certificates, conditional
sales contracts, commercial paper and U.S. government securities (including
obligations, such as repurchase agreements, secured by such instruments). The
debt securities in which the Master Portfolio invests may be in non-dollar
denominated foreign currency and may include debt issued by countries or
corporations located in emerging market countries. The Master Portfolio may
invest in participation interests in loans. Such participation interests, which
may take the form of interests in, or assignments of, loans, are acquired from
banks which have made loans or are members of lending syndicates. The Master
Portfolio's investments in loan participation interests will be subject to its
limitation on investments in illiquid securities and, to the extent applicable,
its limitation on investments in securities rated below investment grade.
Kansas Fund: In addition to the types of securities described in its
Prospectuses, the Fund may invest in: certain specified derivative securities,
including interest rate swaps, caps and floors for hedging purposes;
exchange-traded options; over-the-counter options executed with primary dealers,
including long term calls and puts and covered calls; and U.S. and foreign
exchange-traded financial futures and options thereon approved by the CFTC for
market exposure risk management. The Fund also may lend its portfolio securities
to qualified institutional investors and may invest in repurchase agreements,
restricted, private placement and other illiquid securities. Additionally, the
Fund may purchase securities issued by other investment companies, consistent
with the its investment objective, investment strategies and policies. The Fund
also may invest in instruments issued by trusts or certain partnerships
including pass-through certificates representing participations in, or debt
instruments backed by, the securities and other assets owned by such issuers.
MidCap Index Fund: In addition to the types of securities described in
its Prospectuses, the Fund may invest in: high-quality short-term debt
securities and money market instruments to meet redemption requests. If the
Adviser believes that market conditions warrant a temporary defensive posture,
the Fund may invest without limitation in high-quality short-term debt
securities and money market instruments, domestic and foreign commercial paper,
certificates of deposit, bankers' acceptances and time deposits, U.S. Government
Obligations and repurchase agreements. The Fund also may invest in certain
specified derivative securities including: exchange-traded options;
over-the-counter options executed with primary dealers, including long calls and
puts and covered calls to enhance return; and U.S. exchange-traded financial
futures approved by the CFTC and options thereon for market exposure risk
management. The Fund may lend its securities to qualified institutional
investors and may invest in repurchase agreements, restricted, private placement
and other illiquid securities. The Fund also may invest in Standard & Poor's
Depositary Receipts ("SPDRs"). In addition, the Funds may invest in other
securities issued by other investment companies, consistent with the Fund's
investment objective and policies.
In addition, when consistent with the Fund's investment objective, the
Adviser will employ various techniques to manage capital gain distributions.
These techniques include utilizing a share identification methodology whereby
the Fund will specifically identify each lot of shares of Fund securities that
it holds, which will allow the Fund to sell first those specific shares with the
highest tax basis in order to reduce the amount of recognized capital gains as
compared with a sale of identical Fund securities, if any, with a lower tax
basis. The Fund will sell first those shares with the highest tax basis only
when it is in the best interest of the Fund to do so, and reserves the right to
sell other shares when appropriate. In addition, the Fund may, at times, sell
Fund securities in order to realize capital losses. Such capital losses would be
used to offset realized capital gains thereby reducing capital gain
distributions. Additionally, the Adviser will, consistent with the Fund
construction process discussed above, employ a low Fund turnover strategy
designed to defer the realization of capital gains.
The Fund incurs transaction (brokerage) costs in connection with the
purchase and sale of Fund securities. For some funds, these costs can have a
material negative impact on performance. With respect thereto, the Adviser will
attempt to minimize these transaction costs by utilizing program trades and
computerized exchanges called
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"crossing networks" which allow institutions to execute trades at the midpoint
of the bid/ask spread and at a reduced commission rate.
Additionally, the Fund may purchase securities issued by other
investment companies, consistent with the its investment objective, investment
strategies and policies. The Fund also may invest in instruments issued by
trusts or certain partnerships including pass-through certificates representing
participations in, or debt instruments backed by, the securities and other
assets owned by such issuers.
Additional information on the particular types of securities in which
certain Funds may invest in is set forth below.
ASSET-BACKED SECURITIES
IN GENERAL. Certain Funds may purchase asset-backed securities arise
through the grouping by governmental, government-related, and private
organizations of loans, receivables, or other assets originated by various
lenders. Asset-backed securities consist of both mortgage- and
non-mortgage-backed securities. Interests in pools of these assets may differ
from other forms of debt securities, which normally provide for periodic payment
of interest in fixed amounts with principal paid at maturity or specified call
dates. Conversely, asset-backed securities provide periodic payments which may
consist of both interest and principal payments.
The life of an asset-backed security varies depending upon the rate of
the prepayment of the underlying debt instruments. The rate of such prepayments
will be a function of current market interest rates, and other economic and
demographic factors. For example, falling interest rates generally result in an
increase in the rate of prepayments of mortgage loans while rising interest
rates generally decrease the rate of prepayments. An acceleration in prepayments
in response to sharply falling interest rates will shorten the security's
average maturity and limit the potential appreciation in the security's value
relative to a conventional debt security. Consequently, asset-backed securities
may not be as effective in locking in high, long-term yields. Conversely, in
periods of sharply rising rates, prepayments are generally slow, increasing the
security's average life and its potential for price depreciation.
MORTGAGE-BACKED SECURITIES. Mortgage-backed securities represent an
ownership interest in a pool of mortgage loans.
Mortgage pass-through securities may represent participation interests
in pools of residential mortgage loans originated by U.S. Governmental or
private lenders and guaranteed, to the extent provided in such securities, by
the U.S. Government or one of its agencies, authorities or instrumentalities.
Such securities, which are ownership interests in the underlying mortgage loans,
differ from conventional debt securities, which provide for periodic payment of
interest in fixed amounts (usually semi-annually) and principal payments at
maturity or on specified call dates. Mortgage pass-through securities provide
for monthly payments that are a "pass-through" of the monthly interest and
principal payments (including any prepayments) made by the individual borrowers
on the pooled mortgage loans, net of any fees paid to the guarantor of such
securities and the servicer of the underlying mortgage loans.
The guaranteed mortgage pass-through securities in which a Fund may
invest may include those issued or guaranteed by Government National Mortgage
Association ("Ginnie Mae" or "GNMA"), Federal National Mortgage Association
("Fannie Mae" or "FNMA") or Federal Home Loan Mortgage Corporation ("Freddie
Mac" or "FHLMC"). Such Certificates are mortgage-backed securities which
represent a partial ownership interest in a pool of mortgage loans issued by
lenders such as mortgage bankers, commercial banks and savings and loan
associations. Such mortgage loans may have fixed or adjustable rates of
interest.
The average life of a mortgage-backed security is likely to be
substantially less than the original maturity of the mortgage pools underlying
the securities. Prepayments of principal by mortgagors and mortgage foreclosures
will usually result in the return of the greater part of principal invested far
in advance of the maturity of the mortgages in the pool.
The yield which will be earned on mortgage-backed securities may vary
from their coupon rates for the following reasons: (i) Certificates may be
issued at a premium or discount, rather than at par; (ii) Certificates may trade
in the secondary market at a premium or discount after issuance; (iii) interest
is earned and compounded monthly, which has the effect of raising the effective
yield earned on the Certificates; and (iv) the actual yield of each Certificate
is affected by the prepayment of mortgages included in the mortgage pool
underlying the Certificates and
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the rate at which principal so prepaid is reinvested. In addition, prepayment of
mortgages included in the mortgage pool underlying a GNMA Certificate purchased
at a premium may result in a loss to the Fund.
Mortgage-backed securities issued by private issuers, whether or not
such obligations are subject to guarantees by the private issuer, may entail
greater risk than obligations directly or indirectly guaranteed by the U.S.
Government.
Collateralized mortgage obligations or "CMOs" are debt obligations
collateralized by mortgage loans or mortgage pass-through securities (collateral
collectively hereinafter referred to as "Mortgage Assets"). Multi-class
pass-through securities are interests in a trust composed of Mortgage Assets and
all references herein to CMOs will include multi-class pass-through securities.
Payments of principal of and interest on the Mortgage Assets, and any
reinvestment income thereon, provide the funds to pay debt service on the CMOs
or make scheduled distribution on the multi-class pass-through securities.
Moreover, principal prepayments on the Mortgage Assets may cause the
CMOs to be retired substantially earlier than their stated maturities or final
distribution dates, resulting in a loss of all or part of the premium if any has
been paid. Interest is paid or accrues on all classes of the CMOs on a monthly,
quarterly or semiannual basis.
The principal and interest payments on the Mortgage Assets may be
allocated among the various classes of CMOs in several ways. Typically, payments
of principal, including any prepayments, on the underlying mortgages are applied
to the classes in the order of their respective stated maturities or final
distribution dates, so that no payment of principal is made on CMOs of a class
until all CMOs of other classes having earlier stated maturities or final
distribution dates have been paid in full.
Stripped mortgage-backed securities ("SMBS") are derivative multi-class
mortgage securities. A Fund will only invest in SMBS that are obligations backed
by the full faith and credit of the U.S. Government. SMBS are usually structured
with two classes that receive different proportions of the interest and
principal distributions from a pool of mortgage assets. A Fund will only invest
in SMBS whose mortgage assets are U.S. Government obligations.
A common type of SMBS will be structured so that one class receives
some of the interest and most of the principal from the mortgage assets, while
the other class receives most of the interest and the remainder of the
principal. If the underlying mortgage assets experience greater than anticipated
prepayments of principal, a Fund may fail to fully recoup its initial investment
in these securities. The market value of any class which consists primarily or
entirely of principal payments generally is unusually volatile in response to
changes in interest rates.
The average life of mortgage-backed securities varies with the
maturities of the underlying mortgage instruments. The average life is likely to
be substantially less than the original maturity of the mortgage pools
underlying the securities as the result of mortgage prepayments, mortgage
refinancings, or foreclosures. The rate of mortgage prepayments, and hence the
average life of the certificates, will be a function of the level of interest
rates, general economic conditions, the location and age of the mortgage and
other social and demographic conditions. Such prepayments are passed through to
the registered holder with the regular monthly payments of principal and
interest and have the effect of reducing future payments. Estimated average life
will be determined by the Adviser and used for the purpose of determining the
average weighted maturity and duration of the Funds.
ADDITIONAL INFORMATION ON MORTGAGE-BACKED SECURITIES.
----------------------------------------------------
Mortgage-backed securities represent an ownership interest in a pool of
residential mortgage loans. These securities are designed to provide monthly
payments of interest and principal to the investor. The mortgagor's monthly
payments to his/her lending institution are "passed-through" to an investor.
Most issuers or poolers provide guarantees of payments, regardless of whether or
not the mortgagor actually makes the payment. The guarantees made by issuers or
poolers are supported by various forms of credit collateral, guarantees or
insurance, including individual loan, title, pool and hazard insurance purchased
by the issuer. There can be no assurance that the private issuers or poolers can
meet their obligations under the policies. Mortgage-backed securities issued by
private issuers or poolers, whether or not such securities are subject to
guarantees, may entail greater risk than securities directly or indirectly
guaranteed by the U.S. Government.
Interests in pools of mortgage-backed securities differ from other
forms of debt securities, which normally provide for periodic payment of
interest in fixed amounts with principal payments at maturity or specified call
dates. Instead, these securities provide a monthly payment which consists of
both interest and principal payments. In effect, these payments are a
"pass-through" of the monthly payments made by the individual borrowers on their
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residential mortgage loans, net of any fees paid. Additional payments are caused
by repayments resulting from the sale of the underlying residential property,
refinancing or foreclosure net of fees or costs which may be incurred. Some
mortgage-backed securities are described as "modified pass-through." These
securities entitle the holders to receive all interest and principal payments
owed on the mortgages in the pool, net of certain fees, regardless of whether or
not the mortgagors actually make the payments.
Residential mortgage loans are pooled by the FHLMC. FHLMC is a
corporate instrumentality of the U.S. Government and was created by Congress in
1970 for the purpose of increasing the availability of mortgage credit for
residential housing. Its stock is owned by the twelve Federal Home Loan Banks.
FHLMC issues Participation Certificates ("PC's"), which represent interests in
mortgages from FHLMC's national portfolio. FHLMC guarantees the timely payment
of interest and ultimate collection of principal.
FNMA is a Government sponsored corporation owned entirely by private
stockholders. It is subject to general regulation by the Secretary of Housing
and Urban Development. FNMA purchases residential mortgages from a list of
approved sellers/servicers which include state and federally-chartered savings
and loan associations, mutual savings banks, commercial banks and credit unions
and mortgage bankers. Pass-through securities issued by FNMA are guaranteed as
to timely payment of principal and interest by FNMA.
The principal Government guarantor of mortgage-backed securities is the
GNMA. GNMA is a wholly-owned U.S. Government corporation within the Department
of Housing and Urban Development. GNMA is authorized to guarantee, with the full
faith and credit of the U.S. Government, the timely payment of principal and
interest on securities issued by approved institutions and backed by pools of
FHA-insured or VA-guaranteed mortgages.
Commercial banks, savings and loan institutions, private mortgage
insurance companies, mortgage bankers and other secondary market issuers also
create pass-through pools of conventional residential mortgage loans. Pools
created by such non-governmental issuers generally offer a higher rate of
interest than Government and Government-related pools because there are no
direct or indirect Government guarantees of payments in the former pools.
However, timely payment of interest and principal of these pools is supported by
various forms of insurance or guarantees, including individual loan, title, pool
and hazard insurance purchased by the issuer. The insurance and guarantees are
issued by Governmental entities, private insurers, and the mortgage poolers.
There can be no assurance that the private insurers or mortgage poolers can meet
their obligations under the policies.
The Fund expects that Governmental or private entities may create
mortgage loan pools offering pass-through investments in addition to those
described above. The mortgages underlying these securities may be alternative
mortgage instruments, that is, mortgage instruments whose principal or interest
payment may vary or whose terms to maturity may be shorter than previously
customary. As new types of mortgage-backed securities are developed and offered
to investors, certain Funds will, consistent with their investment objective and
policies, consider making investments in such new types of securities.
Underlying Mortgages
- --------------------
Pools consist of whole mortgage loans or participations in loans. The
majority of these loans are made to purchasers of 1-4 family homes. The terms
and characteristics of the mortgage instruments are generally uniform within a
pool but may vary among pools. For example, in addition to fixed-rate,
fixed-term mortgages, a Fund may purchase pools of variable-rate mortgages
(VRM), growing equity mortgages (GEM), graduated payment mortgages (GPM) and
other types where the principal and interest payment procedures vary. VRM's are
mortgages which reset the mortgage's interest rate periodically with changes in
open market interest rates. To the extent that the Fund is actually invested in
VRM's, the Fund's interest income will vary with changes in the applicable
interest rate on pools of VRM's. GPM and GEM pools maintain constant interest
rates, with varying levels of principal repayment over the life of the mortgage.
These different interest and principal payment procedures should not impact the
Fund's net asset value since the prices at which these securities are valued
will reflect the payment procedures.
All poolers apply standards for qualification to local lending
institutions which originate mortgages for the pools. Poolers also establish
credit standards and underwriting criteria for individual mortgages included in
the pools. In addition, some mortgages included in pools are insured through
private mortgage insurance companies.
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Average Life
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The average life of pass-through pools varies with the maturities of
the underlying mortgage instruments. In addition, a pool's term may be shortened
by unscheduled or early payments of principal and interest on the underlying
mortgages. The occurrence of mortgage prepayments is affected by factors
including the level of interest rates, general economic conditions, the location
and age of the mortgage, and other social and demographic conditions.
As prepayment rates of individual pools vary widely, it is not possible
to accurately predict the average life of a particular pool. For pools of
fixed-rated 30-year mortgages, common industry practice is to assume that
prepayments will result in a 12-year average life. Pools of mortgages with other
maturities or different characteristics will have varying assumptions for
average life.
Returns on Mortgage-Backed Securities
- -------------------------------------
Yields on mortgage-backed pass-through securities are typically quoted
based on the maturity of the underlying instruments and the associated average
life assumption. Actual prepayment experience may cause the yield to differ from
the assumed average life yield.
Reinvestment of prepayments may occur at higher or lower interest rates
than the original investment, thus affecting the yields of the Fund. The
compounding effect from reinvestments of monthly payments received by the Fund
will increase its yield to shareholders, compared to bonds that pay interest
semi-annually.
NON-MORTGAGE ASSET-BACKED SECURITIES. Non-mortgage asset-backed
securities include interests in pools of receivables, such as motor vehicle
installment purchase obligations and credit card receivables. Such securities
are generally issued as pass-through certificates, which represent undivided
fractional ownership interests in the underlying pools of assets. Such
securities also may be debt instruments, which are also known as collateralized
obligations and are generally issued as the debt of a special purpose entity
organized solely for the purpose of owning such assets and issuing such debt.
Such securities also may include instruments issued by certain trusts,
partnerships or other special purpose issuers, including pass-through
certificates representing participations in, or debt instruments backed by, the
securities and other assets owned by such issuers.
Non-mortgage-backed securities are not issued or guaranteed by the U.S.
Government or its agencies or instrumentalities; however, the payment of
principal and interest on such obligations may be guaranteed up to certain
amounts and for a certain time period by a letter of credit issued by a
financial institution (such as a bank or insurance company) unaffiliated with
the issuers of such securities.
The purchase of non-mortgage-backed securities raises considerations
peculiar to the financing of the instruments underlying such securities. For
example, most organizations that issue asset-backed securities relating to motor
vehicle installment purchase obligations perfect their interests in their
respective obligations only by filing a financing statement and by having the
servicer of the obligations, which is usually the originator, take custody
thereof. In such circumstances, if the servicer were to sell the same
obligations to another party, in violation of its duty not to do so, there is a
risk that such party could acquire an interest in the obligations superior to
that of the holders of the asset-backed securities. Also, although most such
obligations grant a security interest in the motor vehicle being financed, in
most states the security interest in a motor vehicle must be noted on the
certificate of title to perfect such security interest against competing claims
of other parties. Due to the larger number of vehicles involved, however, the
certificate of title to each vehicle financed, pursuant to the obligations
underlying the asset-backed securities, usually is not amended to reflect the
assignment of the seller's security interest for the benefit of the holders of
the asset-backed securities. Therefore, there is the possibility that recoveries
on repossessed collateral may not, in some cases, be available to support
payments on those securities. In addition, various state and Federal laws give
the motor vehicle owner the right to assert against the holder of the owner's
obligation certain defenses such owner would have against the seller of the
motor vehicle. The assertion of such defenses could reduce payments on the
related asset-backed securities. Insofar as credit card receivables are
concerned, credit card holders are entitled to the protection of a number of
state and Federal consumer credit laws, many of which give such holders the
right to set off certain amounts against balances owed on the credit card,
thereby reducing the amounts paid on such receivables. In addition, unlike most
other asset-backed securities, credit card receivables are unsecured obligations
of the card holder.
While the market for asset-backed securities is becoming increasingly
liquid, the market for mortgage-backed securities issued by certain private
organizations and non-mortgage-backed securities is not as well developed.
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As stated above, the Adviser intends to limit its purchases of mortgage-backed
securities issued by certain private organizations and non-mortgage-backed
securities to securities that are readily marketable at the time of purchase.
BORROWINGS
The registered investment companies in the Nations Funds Family
participate in an uncommitted line of credit provided by The Bank of New York
under a line of credit agreement (the "Agreement"). Advances under the Agreement
are taken primarily for temporary or emergency purposes, including the meeting
of redemption requests that otherwise might require the untimely disposition of
securities. Interest on borrowings is payable at the federal funds rate plus
.50% on an annualized basis. The Agreement requires, among other things, that
each participating Fund maintain a ratio of no less than 4 to 1 net assets (not
including funds borrowed pursuant to the Agreement) to the aggregate amount of
indebtedness pursuant to the Agreement. Specific borrowings by a Fund under the
Agreement over the last fiscal year, if any, can by found in the Funds' Annual
Reports which will be available once the Funds complete a fiscal year.
COMMERCIAL INSTRUMENTS
Certain Funds may purchase commercial instruments. Commercial
Instruments consist of short-term U.S. dollar-denominated obligations issued by
domestic corporations or issued in the U.S. by foreign corporations and foreign
commercial banks. The Prime Fund will limit purchases of commercial instruments
to instruments which: (a) if rated by at least two NRSROs are rated in the
highest rating category for short-term debt obligations given by such
organizations, or if only rated by one such organization, are rated in the
highest rating category for short-term debt obligations given by such
organization; or (b) if not rated, are (i) comparable in priority and security
to a class of short-term instruments of the same issuer that has such rating(s),
or (ii) of comparable quality to such instruments as determined by the Board on
the advice of the Adviser.
Investments by a Fund in commercial paper will consist of issues rated
in a manner consistent with such Fund's investment policies and objectives. In
addition, the Funds may acquire unrated commercial paper and corporate bonds
that are determined by the Adviser at the time of purchase to be of comparable
quality to rated instruments that may be acquired by such Funds as previously
described.
Variable-rate master demand notes are unsecured instruments that permit
the indebtedness thereunder to vary and provide for periodic adjustments in the
interest rate. While some of these notes are not rated by credit rating
agencies, issuers of variable rate master demand notes must satisfy the Adviser
that similar criteria to that set forth above with respect to the issuers of
commercial paper purchasable by the Prime Fund are met. Variable-rate
instruments acquired by a Fund will be rated at a level consistent with such
Fund's investment objective and policies of high quality as determined by a
major rating agency or, if not rated, will be of comparable quality as
determined by the Adviser. See also the discussion of variable- and
floating-rate instruments in this SAI.
Variable- and floating-rate instruments are unsecured instruments that
permit the indebtedness thereunder to vary. While there may be no active
secondary market with respect to a particular variable or floating rate
instrument purchased by a Fund, a Fund may, from time to time as specified in
the instrument, demand payment of the principal or may resell the instrument to
a third party. The absence of an active secondary market, however, could make it
difficult for a Fund to dispose of an instrument if the issuer defaulted on its
payment obligation or during periods when a Fund is not entitled to exercise its
demand rights, and a Fund could, for these or other reasons, suffer a loss. A
Fund may invest in variable and floating rate instruments only when the Adviser
deems the investment to involve minimal credit risk. If such instruments are not
rated, the Adviser will consider the earning power, cash flows, and other
liquidity ratios of the issuers of such instruments and will continuously
monitor their financial status to meet payment on demand. In determining average
weighted portfolio maturity, an instrument will be deemed to have a maturity
equal to the longer of the period remaining to the next interest rate adjustment
or the demand notice period specified in the instrument.
Certain Funds also may purchase short-term participation interests in
loans extended by banks to companies, provided that both such banks and such
companies meet the quality standards set forth above. In purchasing a loan
participation or assignment, the Fund acquires some or all of the interest of a
bank or other lending institution in a loan to a corporate borrower. Many such
loans are secured and most impose restrictive covenants which must be met by the
borrower and which are generally more stringent than the covenants available in
publicly traded debt securities. However, interests in some loans may not be
secured, and the Fund will be exposed to a risk of loss if the borrower
defaults. Loan participations also may be purchased by the Fund when the
borrowing company is already in default. In purchasing a loan participation, the
Fund may have less protection under the federal securities laws than it has in
purchasing traditional types of securities. The Fund's ability to assert its
rights against the borrower will also depend on the particular terms of the loan
agreement among the parties.
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COMBINED TRANSACTIONS
Certain Funds may enter into multiple transactions, including multiple
options transactions, multiple futures transactions, multiple forward foreign
currency exchange contracts and any combination of futures, options and forward
foreign currency exchange contracts ("component" transactions), instead of a
single transaction, as part of a single hedging strategy when, in the opinion of
the Adviser, it is in the best interest of a Fund to do so and where underlying
hedging strategies are permitted by a Fund's investment policies. A combined
transaction, while part of a single hedging strategy, may contain elements of
risk that are present in each of its component transactions.
CONVERTIBLE SECURITIES
Certain Funds may invest in convertible securities, such as bonds,
notes, debentures, preferred stocks and other securities that may be converted
into common stock. All convertible securities purchased by the Fund will be
rated in the top two categories by an NRSRO or, if unrated, determined by the
Adviser to be of comparable quality. Investments in convertible securities can
provide income through interest and dividend payments, as well as, an
opportunity for capital appreciation by virtue of their conversion or exchange
features.
The convertible securities in which a Fund may invest include
fixed-income and zero coupon debt securities, and preferred stock that may be
converted or exchanged at a stated or determinable exchange ratio into
underlying shares of common stock. The exchange ratio for any particular
convertible security may be adjusted from time to time due to stock splits,
dividends, spin-offs, other corporate distributions or scheduled changes in the
exchange ratio. Convertible debt securities and convertible preferred stocks,
until converted, have general characteristics similar to both debt and equity
securities. Although to a lesser extent than with debt securities, generally,
the market value of convertible securities tends to decline as interest rates
increase and, conversely, tends to increase as interest rates decline. In
addition, because of the conversion exchange feature, the market value of
convertible securities typically changes as the market value of the underlying
common stock changes, and, therefore, also tends to follow movements in the
general market for equity securities. A unique feature of convertible securities
is that as the market price of the underlying common stock declines, convertible
securities tend to trade increasingly on a yield basis, and so may not
experience market value declines to the same extent as the underlying common
stock. When the market price of the underlying common stock increases, the price
of a convertible security tends to rise as a reflection of the value of the
underlying common stock, although typically not as much as the price of the
underlying common stock. While no securities investments are without risk,
investments in convertible securities generally entail less risk than
investments in common stock of the same issuer.
As debt securities, convertible securities are investments which
provide for a stream of income or, in the case of zero coupon securities,
accretion of income with generally higher yields than common stocks. Of course,
like all debt securities, there can be no assurance of income or principal
payments because the issuers of the convertible securities may default on their
obligations. Convertible securities generally offer lower yields than
non-convertible securities of similar quality because of their conversion
exchange features. Convertible securities generally are subordinated to other
similar debt securities but not to non-convertible securities of the same
issuer. Convertible bonds, as corporate debt obligations, are senior in right of
payment to all equity securities, and convertible preferred stock is senior to
common stock, of the same issuer. However, convertible bonds and convertible
preferred stock typically have lower coupon rates than similar non-convertible
securities. Convertible securities may be issued as fixed income obligations
that pay current income or as zero coupon notes and bonds, including Liquid
Yield Option Notes ("LYONs"). Zero coupon securities pay no cash income and are
sold at substantial discounts from their value at maturity. When held to
maturity, their entire income, which consists of accretion of discount, comes
from the difference between the issue price and their value at maturity. Zero
coupon convertible securities offer the opportunity for capital appreciation
because increases (or decreases) in the market value of such securities closely
follow the movements in the market value of the underlying common stock. Zero
coupon convertible securities generally are expected to be less volatile than
the underlying common stocks because they usually are issued with short
maturities (15 years or less) and are issued with options and/or redemption
features exercisable by the holder of the obligation entitling the holder to
redeem the obligation and receive a defined cash payment.
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<PAGE>
CORPORATE DEBT SECURITIES
Certain Funds may invest in corporate debt securities of domestic
issuers of all types and maturities, such as bonds, debentures, notes and
commercial paper. Corporate debt securities may involve equity features, such as
conversion or exchange rights or warrants for the acquisition of stock of the
same or a different issuer, participation based on revenue, sales or profit, or
the purchase of common stock or warrants in a unit transaction (where corporate
debt obligations and common stock are offered as a unit). Each Fund may also
invest in corporate debt securities of foreign issuers.
The corporate debt securities in which the High Yield Master Portfolio
will invest will be rated BB or lower by Standard & Poor's Corporation ("S&P")
or Ba or below by Moody's Investors Services, Inc. ("Moody's").
The corporate debt securities in which the Kansas Fund or the MidCap
Index Fund will invest will be rated investment grade by at least one NRSRO
(E.G., BBB or above by S&P or Baa or above by Moody's. Commercial paper
purchased by the Kansas Fund or the MidCap Index Fund will be rated in the top
two categories by a NRSRO. Corporate debt securities that are not rated may be
purchased by such Funds if they are determined by the Adviser to be of
comparable quality, as described above, under the direction of the Board of
Trustees of the Trust. If the rating of any corporate debt security held by a
Fund falls below such ratings or if the Adviser determines that an unrated
corporate debt security is no longer of comparable quality, then such security
shall be disposed of in an orderly manner as quickly as possible. A description
of these ratings is attached as Schedule A to this Statement of Additional
Information.
CUSTODIAL RECEIPTS
Certain Funds may also acquire custodial receipts that evidence
ownership of future interest payments, principal payments or both on certain
U.S. Government notes or bonds. Such notes and bonds are held in custody by a
bank on behalf of the owners. These custodial receipts are known by various
names, including "Treasury Receipts," "Treasury Investors Growth Receipts" and
"Certificates of Accrual on Treasury Securities." Although custodial receipts
are not considered U.S. Government securities, they are indirectly issued or
guaranteed as to principal and interest by the U.S. Government, its agencies,
authorities or instrumentalities. Custodial receipts will be treated as illiquid
securities.
CURRENCY SWAPS
Certain Funds also may enter into currency swaps for hedging purposes
and to seek to increase total return. In as much as swaps are entered into for
good faith hedging purposes or are offset by a segregated account as described
below, the Fund and the Adviser believe that swaps do not constitute senior
securities as defined in the 1940 Act and, accordingly, will not treat them as
being subject to the Fund's borrowing restrictions. The net amount of the
excess, if any, of the Fund's obligations over its entitlement with respect to
each currency swap will be accrued on a daily basis and an amount of cash or
liquid high grade debt securities (I.E., securities rated in one of the top
three ratings categories by an NRSRO, or, if unrated, deemed by the Adviser to
be of comparable credit quality) having an aggregate net asset value at least
equal to such accrued excess will be maintained in a segregated account by the
Fund's custodian. The Fund will not enter into any currency swap unless the
credit quality of the unsecured senior debt or the claims-paying ability of the
other party thereto is considered to be investment grade by the Adviser.
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DELAYED DELIVERY TRANSACTIONS
In a delayed delivery transaction, the Fund relies on the other party
to complete the transaction. If the transaction is not completed, the Fund may
miss a price or yield considered to be advantageous. In delayed delivery
transactions, delivery of the securities occurs beyond normal settlement
periods, but a Fund would not pay for such securities or start earning interest
on them until they are delivered. However, when a Fund purchases securities on
such a delayed delivery basis, it immediately assumes the risk of ownership,
including the risk of price fluctuation. Failure by a counterparty to deliver a
security purchased on a delayed delivery basis may result in a loss or missed
opportunity to make an alternative investment. Depending upon market conditions,
a Fund's delayed delivery purchase commitments could cause its net asset value
to be more volatile, because such securities may increase the amount by which
the Fund's total assets, including the value of when-issued and delayed delivery
securities held by the Fund, exceed its net assets.
DOLLAR ROLL TRANSACTIONS
Certain Funds may enter into "dollar roll" transactions, which consist
of the sale by a Fund to a bank or broker/dealer (the "counterparty") of GNMA
certificates or other mortgage-backed securities together with a commitment to
purchase from the counterparty similar, but not identical, securities at a
future date, at the same price. The counterparty receives all principal and
interest payments, including prepayments, made on the security while it is the
holder. A Fund receives a fee from the counterparty as consideration for
entering into the commitment to purchase. Dollar rolls may be renewed over a
period of several months with a different repurchase price and a cash settlement
made at each renewal without physical delivery of securities. Moreover, the
transaction may be preceded by a firm commitment agreement pursuant to which the
Fund agrees to buy a security on a future date. If the broker/dealer to whom a
Fund sells the security becomes insolvent, the Fund's right to purchase or
repurchase the security may be restricted; the value of the security may change
adversely over the term of the dollar roll; the security that the Fund is
required to repurchase may be worth less than the security that the Fund
originally held, and the return earned by the Fund with the proceeds of a dollar
roll may not exceed transaction costs.
The entry into dollar rolls involves potential risks of loss that are
different from those related to the securities underlying the transactions. For
example, if the counterparty becomes insolvent, the Fund's right to purchase
from the counterparty might be restricted. Additionally, the value of such
securities may change adversely before the Fund is able to purchase them.
Similarly, the Fund may be required to purchase securities in connection with a
dollar roll at a higher price than may otherwise be available on the open
market. Since, as noted above, the counterparty is required to deliver a
similar, but not identical security to the Fund, the security that the Fund is
required to buy under the dollar roll may be worth less than an identical
security. Finally, there can be no assurance that the Fund's use of the cash
that it receives from a dollar roll will provide a return that exceeds borrowing
costs.
EQUITY SWAP CONTRACTS
Certain Funds may from time to time enter into equity swap contracts.
The counterparty to an equity swap contract will typically be a bank, investment
banking firm or broker/dealer. For example, the counterparty will generally
agree to pay a Fund the amount, if any, by which the notional amount of the
Equity Swap Contract would have increased in value had it been invested in the
stocks comprising the S&P 500 Index in proportion to the composition of the
Index, plus the dividends that would have been received on those stocks. A Fund
will agree to pay to the counterparty a floating rate of interest (typically the
London Inter Bank Offered Rate) on the notional amount of the Equity Swap
Contract plus the amount, if any, by which that notional amount would have
decreased in value had it been invested in such stocks. Therefore, the return to
a Fund on any Equity Swap Contract should be the gain or loss on the notional
amount plus dividends on the stocks comprising the S&P 500 Index less the
interest paid by the Fund on the notional amount. A Fund will only enter into
Equity Swap Contracts on a net basis, I.E., the two parties' obligations are
netted out, with the Fund paying or receiving, as the case may be, only the net
amount of any payments. Payments under the Equity Swap Contracts may be made at
the conclusion of the contract or periodically during its term.
If there is a default by the counterparty to an Equity Swap Contract, a
Fund will be limited to contractual remedies pursuant to the agreements related
to the transaction. There is no assurance that Equity Swap Contract
counterparties will be able to meet their obligations pursuant to Equity Swap
Contracts or that, in the event of default, a Fund will succeed in pursuing
contractual remedies. A Fund thus assumes the risk that it may be delayed in or
prevented from obtaining payments owed to it pursuant to Equity Swap Contracts.
A Fund will closely monitor the credit of Equity Swap Contract counterparties in
order to minimize this risk.
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Certain Funds may from time to time enter into the opposite side of
Equity Swap Contracts (I.E., where a Fund is obligated to pay the increase (net
of interest) or receive the decrease (plus interest) on the contract to reduce
the amount of the Fund's equity market exposure consistent with the Fund's
objective. These positions are sometimes referred to as Reverse Equity Swap
Contracts.
Equity Swap Contracts will not be used to leverage a Fund. A Fund will
not enter into any Equity Swap Contract or Reverse Equity Swap Contract unless,
at the time of entering into such transaction, the unsecured senior debt of the
counterparty is rated at least A by Moody's or S&P. Since the SEC considers
Equity Swap Contracts and Reverse Equity Swap Contracts to be illiquid
securities, a Fund will not invest in Equity Swap Contracts or Reverse Equity
Swap Contracts if the total value of such investments together with that of all
other illiquid securities which a Fund owns would exceed any limitation imposed
by the SEC Staff.
The Adviser does not believe that a Fund's obligations under Equity
Swap Contracts or Reverse Equity Swap Contracts are senior securities and,
accordingly, the Fund will not treat them as being subject to its borrowing
restrictions. However, the net amount of the excess, if any, of a Fund's
obligations over its respective entitlements with respect to each Equity Swap
Contract and each Reverse Equity Swap Contract will be accrued on a daily basis
and an amount of cash, U.S. Government securities or other liquid high quality
debt securities having an aggregate market value at least equal to the accrued
excess will be maintained in a segregated account by the Fund's custodian.
FOREIGN CURRENCY TRANSACTIONS
Certain Funds may invest in foreign currency transactions. Foreign
securities involve currency risks. The U.S. dollar value of a foreign security
tends to decrease when the value of the U.S. dollar rises against the foreign
currency in which the security is denominated, and tends to increase when the
value of the U.S. dollar falls against such currency. A Fund may purchase or
sell forward foreign currency exchange contracts ("forward contracts") to
attempt to minimize the risk to the Fund from adverse changes in the
relationship between the U.S. dollar and foreign currencies. A Fund may also
purchase and sell foreign currency futures contracts and related options (see
"Purchase and Sale of Currency Futures Contracts and Related Options"). A
forward contract is an obligation to purchase or sell a specific currency for an
agreed price at a future date that is individually negotiated and privately
traded by currency traders and their customers.
Forward foreign currency exchange contracts establish an exchange rate
at a future date. These contracts are transferable in the interbank market
conducted directly between currency traders (usually large commercial banks) and
their customers. A forward foreign currency exchange contract generally has no
deposit requirement, and is traded at a net price without commission. A Fund
will direct its custodian to segregate high grade liquid assets in an amount at
least equal to its obligations under each forward foreign currency exchange
contract. Neither spot transactions nor forward foreign currency exchange
contracts eliminate fluctuations in the prices of a Fund's portfolio securities
or in foreign exchange rates, or prevent loss if the prices of these securities
should decline.
A Fund may enter into a forward contract, for example, when it enters
into a contract for the purchase or sale of a security denominated in a foreign
currency in order to "lock in" the U.S. dollar price of the security (a
"transaction hedge"). In addition, when the Adviser believes that a foreign
currency may suffer a substantial decline against the U.S. dollar, it may enter
into a forward sale contract to sell an amount of that foreign currency
approximating the value of some or all of the Fund's securities denominated in
such foreign currency, or when the Adviser believes that the U.S. dollar may
suffer a substantial decline against the foreign currency, it may enter into a
forward purchase contract to buy that foreign currency for a fixed dollar amount
(a "position hedge").
A Fund may, however, enter into a forward contract to sell a different
foreign currency for a fixed U.S. dollar amount where the Adviser believes that
the U.S. dollar value of the currency to be sold pursuant to the forward
contract will fall whenever there is a decline in the U.S. dollar value of the
currency in which the fund securities are denominated (a "cross-hedge").
Foreign currency hedging transactions are an attempt to protect a Fund
against changes in foreign currency exchange rates between the trade and
settlement dates of specific securities transactions or changes in foreign
currency exchange rates that would adversely affect a portfolio position or an
anticipated portfolio position. Although these transactions tend to minimize the
risk of loss due to a decline in the value of the hedged currency, at the same
time they tend to limit any potential gain that might be realized should the
value of the hedged currency increase. The precise matching of the forward
contract amount and the value of the securities involved will not generally be
possible because the future value of these securities in foreign currencies will
change as a consequence of market movements in the value of those securities
between the date the forward contract is entered into and date it matures.
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The Fund's custodian will segregate cash, U.S. Government securities or
other high-quality debt securities having a value equal to the aggregate amount
of the Fund's commitments under forward contracts entered into with respect to
position hedges and cross-hedges. If the value of the segregated securities
declines, additional cash or securities will be segregated on a daily basis so
that the value of the segregated securities will equal the amount of the Fund's
commitments with respect to such contracts. As an alternative to segregating all
or part of such securities, the Fund may purchase a call option permitting the
Fund to purchase the amount of foreign currency being hedged by a forward sale
contract at a price no higher than the forward contract price or the Fund may
purchase a put option permitting the Fund to sell the amount of foreign currency
subject to a forward purchase contract at a price as high or higher than the
forward contract price.
The Funds are dollar-denominated mutual funds and therefore
consideration is given to hedging part or all of the portfolio back to U.S.
dollars from international currencies. All decisions to hedge are based upon an
analysis of the relative value of the U.S. dollar on an international purchasing
power parity basis (purchasing power parity is a method for determining the
relative purchasing power of different currencies by comparing the amount of
each currency required to purchase a typical bundle of goods and services to
domestic markets) and an estimation of short-term interest rate differentials
(which affect both the direction of currency movements and also the cost of
hedging).
For more information about the risks associated with foreign
investments see "Investment Risks."
FUTURES, OPTIONS AND OTHER DERIVATIVE INSTRUMENTS
FUTURES CONTRACTS IN GENERAL. A futures contract is an agreement
between two parties for the future delivery of fixed income securities or equity
securities or for the payment or acceptance of a cash settlement in the case of
futures contracts on an index of fixed income or equity securities. A "sale" of
a futures contract means the contractual obligation to deliver the securities at
a specified price on a specified date, or to make the cash settlement called for
by the contract. Futures contracts have been designed by exchanges which have
been designated "contract markets" by the CFTC and must be executed through a
brokerage firm, known as a futures commission merchant, which is a member of the
relevant contract market. Futures contracts trade on these markets, and the
exchanges, through their clearing organizations, guarantee that the contracts
will be performed as between the clearing members of the exchange. Presently,
futures contracts are based on such debt securities as long-term U.S. Treasury
Bonds, Treasury Notes, GNMA modified pass-through mortgage-backed securities,
three-month U.S. Treasury Bills, bank certificates of deposit, and on indices of
municipal, corporate and government bonds.
While futures contracts based on securities do provide for the delivery
and acceptance of securities, such deliveries and acceptances are seldom made.
Generally, a futures contract is terminated by entering into an offsetting
transaction. A Fund will incur brokerage fees when it purchases and sells
futures contracts. At the time such a purchase or sale is made, a Fund must
provide cash or money market securities as a deposit known as "margin." The
initial deposit required will vary, but may be as low as 2% or less of a
contract's face value. Daily thereafter, the futures contract is valued through
a process known as "marking to market," and a Fund that engages in futures
transactions may receive or be required to pay "variation margin" as the futures
contract becomes more or less valuable. At the time of delivery of securities
pursuant to a futures contract based on securities, adjustments are made to
recognize differences in value arising from the delivery of securities with a
different interest rate than the specific security that provides the standard
for the contract. In some (but not many) cases, securities called for by a
futures contract may not have been issued when the contract was written.
Futures contracts on indices of securities are settled through the
making and acceptance of cash settlements based on changes in value of the
underlying rate or index between the time the contract is entered into and the
time it is liquidated.
FUTURES CONTRACTS ON FIXED INCOME SECURITIES AND RELATED INDICES. As
noted in their respective Prospectuses, certain Funds may enter into
transactions in futures contracts for the purpose of hedging a relevant portion
of their portfolios. A Fund may enter into transactions in futures contracts
that are based on U.S. Government obligations, including any index of government
obligations that may be available for trading. Such transactions will be entered
into where movements in the value of the securities or index underlying a
futures contract can be expected to correlate closely with movements in the
value of securities held in a Fund. For example, a Fund may sell futures
contracts in anticipation of a general rise in the level of interest rates,
which would result in a decline in the value of its fixed income securities. If
the expected rise in interest rates occurs, the Fund may realize gains on its
futures position, which should offset all or part of the decline in value of
fixed income fund securities. A Fund could protect against such decline by
selling fixed income securities, but such a strategy would involve higher
transaction costs than the sale of futures contracts and, if interest rates
again declined, the Fund would be unable to take advantage of the resulting
market advance without purchases of additional securities.
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The purpose of the purchase or sale of a futures contract on government
securities and indices of government securities, in the case of the
above-referenced Funds, which hold or intend to acquire long-term debt
securities, is to protect a Fund from fluctuations in interest rates without
actually buying or selling long-term debt securities. For example, if long-term
bonds are held by a Fund, and interest rates were expected to increase, the Fund
might enter into futures contracts for the sale of debt securities. Such a sale
would have much the same effect as selling an equivalent value of the long-term
bonds held by the Fund. If interest rates did increase, the value of the debt
securities in the Fund would decline, but the value of the futures contracts to
the Fund would increase at approximately the same rate thereby keeping the net
asset value of the Fund from declining as much as it otherwise would have. When
a Fund is not fully invested and a decline in interest rates is anticipated,
which would increase the cost of fixed income securities that the Fund intends
to acquire, it may purchase futures contracts. In the event that the projected
decline in interest rates occurs, the increased cost of the securities acquired
by the Fund should be offset, in whole or part, by gains on the futures
contracts by entering into offsetting transactions on the contract market on
which the initial purchase was effected. In a substantial majority of
transactions involving futures contracts on fixed income securities, a Fund will
purchase the securities upon termination of the long futures positions, but
under unusual market conditions, a long futures position may be terminated
without a corresponding purchase of securities.
Similarly, when it is expected that interest rates may decline, futures
contracts on fixed income securities and indices of government securities may be
purchased for the purpose of hedging against anticipated purchases of long-term
bonds at higher prices. Since the fluctuations in the value of such futures
contracts should be similar to that of long-term bonds, a Fund could take
advantage of the anticipated rise in the value of long-term bonds without
actually buying them until the market had stabilized. At that time, the futures
contracts could be liquidated and the Fund's cash reserves could then be used to
buy long-term bonds in the cash market. Similar results could be accomplished by
selling bonds with long maturities and investing in bonds with short maturities
when interest rates are expected to increase. However, since the futures market
is more liquid than the cash market, the use of these futures contracts as an
investment technique allows a Fund to act in anticipation of such an interest
rate decline without having to sell its portfolio securities. To the extent a
Fund enters into futures contracts for this purpose, the segregated assets
maintained by a Fund will consist of cash, cash equivalents or high quality debt
securities of the Fund in an amount equal to the difference between the
fluctuating market value of such futures contract and the aggregate value of the
initial deposit and variation margin payments made by the Fund with respect to
such futures contracts.
STOCK INDEX FUTURES CONTRACTS. Certain Funds may sell stock index
futures contracts in order to offset a decrease in market value of its
securities that might otherwise result from a market decline. A Fund may do so
either to hedge the value of its portfolio as a whole, or to protect against
declines, occurring prior to sales of securities, in the value of securities to
be sold. Conversely, a Fund may purchase stock index futures contracts in order
to protect against anticipated increases in the cost of securities to be
acquired.
In addition, a Fund may utilize stock index futures contracts in
anticipation of changes in the composition of its portfolio. For example, in the
event that a Fund expects to narrow the range of industry groups represented in
its portfolio, it may, prior to making purchases of the actual securities,
establish a long futures position based on a more restricted index, such as an
index comprised of securities of a particular industry group. As such securities
are acquired, a Fund's futures positions would be closed out. A Fund may also
sell futures contracts in connection with this strategy, in order to protect
against the possibility that the value of the securities to be sold as part of
the restructuring of its portfolio will decline prior to the time of sale.
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OPTIONS ON FUTURES CONTRACTS. An option on a futures contract gives the
purchaser (the "holder") the right, but not the obligation, to purchase a
position in the underlying futures contract (I.E., a purchase of such futures
contract) in the case of an option to purchase (a "call" option), or a "short"
position in the underlying futures contract (I.E., a sale of such futures
contract) in the case of an option to sell (a "put" option), at a fixed price
(the "strike price") up to a stated expiration date. The holder pays a
non-refundable purchase price for the option, known as the "premium." The
maximum amount of risk the purchase of the option assumes is equal to the
premium plus related transaction costs, although this entire amount may be lost.
Upon exercise of the option by the holder, the exchange clearing corporation
establishes a corresponding long position in the case of a put option. In the
event that an option is exercised, the parties will be subject to all the risks
associated with the trading of futures contracts, such as payment of variation
margin deposits. In addition, the writer of an option on a futures contract,
unlike the holder, is subject to initial and variation margin requirements on
the option position.
OPTIONS ON FUTURES CONTRACTS ON FIXED INCOME SECURITIES AND RELATED
INDICES. Certain Funds may purchase put options on futures contracts in which
such Funds are permitted to invest for the purpose of hedging a relevant portion
of their portfolios against an anticipated decline in the values of portfolio
securities resulting from increases in interest rates, and may purchase call
options on such futures contracts as a hedge against an interest rate decline
when they are not fully invested. A Fund would write options on these futures
contracts primarily for the purpose of terminating existing positions.
OPTIONS ON STOCK INDEX FUTURES CONTRACTS, OPTIONS ON STOCK INDICES AND
OPTIONS ON EQUITY SECURITIES. Certain Funds may purchase put options on stock
index futures contracts, stock indices or equity securities for the purpose of
hedging the relevant portion of their portfolio securities against an
anticipated market-wide decline or against declines in the values of individual
portfolio securities, and they may purchase call options on such futures
contracts as a hedge against a market advance when they are not fully invested.
A Fund would write options on such futures contracts primarily for the purpose
of terminating existing positions. In general, options on stock indices will be
employed in lieu of options on stock index futures contracts only where they
present an opportunity to hedge at lower cost. With respect to options on equity
securities, a Fund may, under certain circumstances, purchase a combination of
call options on such securities and U.S. Treasury bills. The Adviser believes
that such a combination may more closely parallel movements in the value of the
security underlying the call option than would the option itself.
Further, while a Fund generally would not write options on individual
portfolio securities, it may do so under limited circumstances known as
"targeted sales" and "targeted buys," which involve the writing of call or put
options in an attempt to purchase or sell portfolio securities at specific
desired prices. A Fund would receive a fee, or a "premium," for the writing of
the option. For example, where the Fund seeks to sell portfolio securities at a
"targeted" price, it may write a call option at that price. In the event that
the market rises above the exercise price, it would receive its "targeted"
price, upon the exercise of the option, as well as the premium income. Also,
where it seeks to buy portfolio securities at a "targeted" price, it may write a
put option at that price for which it will receive the premium income. In the
event that the market declines below the exercise price, a Fund would pay its
"targeted" price upon the exercise of the option. In the event that the market
does not move in the direction or to the extent anticipated, however, the
targeted sale or buy might not be successful and a Fund could sustain a loss on
the transaction that may not be offset by the premium received. In addition, a
Fund may be required to forego the benefit of an intervening increase or decline
in value of the underlying security.
OPTIONS AND FUTURES STRATEGIES. The Adviser may seek to increase the
current return of certain Funds by writing covered call or put options. In
addition, through the writing and purchase of options and the purchase and sale
of U.S. and certain foreign stock index futures contracts, interest rate futures
contracts, foreign currency futures contracts and related options on such
futures contracts, the Adviser may at times seek to hedge against a decline in
the value of securities included in the Fund or an increase in the price of
securities that it plans to purchase for the Fund. Expenses and losses incurred
as a result of such hedging strategies will reduce the Fund's current return. A
Fund's investment in foreign stock index futures contracts and foreign interest
rate futures contracts, and related options on such futures contracts, are
limited to only those contracts and related options that have been approved by
the CFTC for investment by U.S. investors. Additionally, with respect to a
Fund's investment in foreign options, unless such options are specifically
authorized for investment by order of the CFTC or meet the definition of trade
options as set forth in CFTC Rule 32.4, a Fund will not make these investments.
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The ability of a Fund to engage in the options and futures strategies
described below will depend on the availability of liquid markets in such
instruments. Markets in options and futures with respect to stock indices,
foreign government securities and foreign currencies are relatively new and
still developing. It is impossible to predict the amount of trading interest
that may exist in various types of options or futures. Therefore, no assurance
can be given that a Fund will be able to utilize these instruments effectively
for the purposes stated below. Furthermore, a Fund's ability to engage in
options and futures transactions may be limited by tax considerations. Although
a Fund will only engage in options and futures transactions for limited
purposes, these activities will involve certain risks which are described below
under "Risk Factors Associated with Futures and Options Transactions." A Fund
will not engage in options and futures transactions for leveraging purposes.
WRITING COVERED OPTIONS ON SECURITIES. Certain Funds may write covered
call options and covered put options on securities in which it is permitted to
invest from time to time as the Adviser determines is appropriate in seeking to
attain its objective. Call options written by a Fund give the holder the right
to buy the underlying securities from a Fund at a stated exercise price; put
options give the holder the right to sell the underlying security to the Fund at
a stated price.
A Fund may write only covered options, which means that, so long as the
Fund is obligated as the writer of a call option, it will own the underlying
securities subject to the option (or comparable securities satisfying the cover
requirements of securities exchanges). In the case of put options, a Fund will
maintain in a separate account cash or short-term U.S. Government securities
with a value equal to or greater than the exercise price of the underlying
securities. A Fund may also write combinations of covered puts and calls on the
same underlying security.
A Fund will receive a premium from writing a put or call option, which
increases the Fund's return in the event the option expires unexercised or is
closed out at a profit. The amount of the premium will reflect, among other
things, the relationship of the market price of the underlying security to the
exercise price of the option, the term of the option and the volatility of the
market price of the underlying security. By writing a call option, a Fund limits
its opportunity to profit from any increase in the market value of the
underlying security above the exercise price of the option. By writing a put
option, the Fund assumes the risk that it may be required to purchase the
underlying security for an exercise price higher than its then current market
value, resulting in a potential capital loss if the purchase price exceeds the
market value plus the amount of the premium received, unless the security
subsequently appreciates in value.
A Fund may terminate an option that it has written prior to its
expiration by entering into a closing purchase transaction in which it purchases
an option having the same terms as the option written. A Fund will realize a
profit or loss from such transaction if the cost of such transaction is less or
more than the premium received from the writing of the option. In the case of a
put option, any loss so incurred may be partially or entirely offset by the
premium received from a simultaneous or subsequent sale of a different put
option. Because increases in the market price of a call option will generally
reflect increases in the market price of the underlying security, any loss
resulting from the repurchase of a call option is likely to be offset in whole
or in part by unrealized appreciation of the underlying security owned by a
Fund.
PURCHASING PUT AND CALL OPTIONS ON SECURITIES. A Fund may purchase put
options to protect its portfolio holdings in an underlying security against a
decline in market value. Such hedge protection is provided during the life of
the put option since a Fund, as holder of the put option, is able to sell the
underlying security at the put exercise price regardless of any decline in the
underlying security's market price. In order for a put option to be profitable,
the market price of the underlying security must decline sufficiently below the
exercise price to cover the premium and transaction costs. By using put options
in this manner, a Fund will reduce any profit it might otherwise have realized
in its underlying security by the premium paid for the put option and by
transaction costs.
A Fund may also purchase call options to hedge against an increase in
prices of securities that it wants ultimately to buy. Such hedge protection is
provided during the life of the call option since the Fund, as holder of the
call option, is able to buy the underlying security at the exercise price
regardless of any increase in the underlying security's market price. In order
for a call option to be profitable, the market price of the underlying security
must rise sufficiently above the exercise price to cover the premium and
transaction costs. By using call options in this manner, a Fund will reduce any
profit it might have realized had it bought the underlying security at the time
it purchased the call option by the premium paid for the call option and by
transaction costs.
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PURCHASE AND SALE OF OPTIONS AND FUTURES ON STOCK INDICES. A Fund may
purchase and sell options on non-U.S. stock indices and stock index futures as a
hedge against movements in the equity markets.
Options on stock indices are similar to options on specific securities
except that, rather than the right to take or make delivery of the specific
security at a specific price, an option on a stock index gives the holder the
right to receive, upon exercise of the option, an amount of cash if the closing
level of that stock index is greater than, in the case of a call, or less than,
in the case of a put, the exercise price of the option. This amount of cash is
equal to such difference between the closing price of the index and the exercise
price of the option expressed in dollars multiplied by a specified multiple. The
writer of the option is obligated, in return for the premium received, to make
delivery of this amount. Unlike options on specific securities, all settlements
of options on stock indices are in cash and gain or loss depends on general
movements in the stocks included in the index rather than price movements in
particular stocks. A stock index futures contract is an agreement in which one
party agrees to deliver to the other an amount of cash equal to a specific
amount multiplied by the difference between the value of a specific stock index
at the close of the last trading day of the contract and the price at which the
agreement is made. No physical delivery of securities is made.
If the Adviser expects general stock market prices to rise, a Fund
might purchase a call option on a stock index or a futures contract on that
index as a hedge against an increase in prices of particular equity securities
it wants ultimately to buy. If in fact the stock index does rise, the price of
the particular equity securities intended to be purchased may also increase, but
that increase would be offset in part by the increase in the value of a Fund's
index option or futures contract resulting from the increase in the index. If,
on the other hand, the Adviser expects general stock market prices to decline, a
Fund might purchase a put option or sell a futures contract on the index. If
that index does in fact decline, the value of some or all of the equity
securities in a Fund may also be expected to decline, but that decrease would be
offset in part by the increase in the value of the Fund's position in such put
option or futures contract.
PURCHASE AND SALE OF INTEREST RATE FUTURES. A Fund may purchase and
sell interest rate futures contracts on foreign government securities including,
but not limited to, debt securities of the governments and central banks of
France, Germany, Denmark and Japan for the purpose of hedging fixed income and
interest sensitive securities against the adverse effects of anticipated
movements in interest rates.
A Fund may sell interest rate futures contracts in anticipation of an
increase in the general level of interest rates. Generally, as interest rates
rise, the market value of the fixed income securities held by a Fund will fall,
thus reducing the net asset value of the Fund. This interest rate risk can be
reduced without employing futures as a hedge by selling long-term fixed income
securities and either reinvesting the proceeds in securities with shorter
maturities or by holding assets in cash. This strategy, however, entails
increased transaction costs to a Fund in the form of dealer spreads and
brokerage commissions.
The sale of interest rate futures contracts provides an alternative
means of hedging against rising interest rates. As rates increase, the value of
a Fund's short position in the futures contracts will also tend to increase,
thus offsetting all or a portion of the depreciation in the market value of a
Fund's investments that are being hedged. While a Fund will incur commission
expenses in selling and closing out futures positions (which is done by taking
an opposite position which operates to terminate the position in the futures
contract), commissions on futures transactions are lower than transaction costs
incurred in the purchase and sale of portfolio securities.
OPTIONS ON STOCK INDEX FUTURES CONTRACTS AND INTEREST RATE FUTURES
CONTRACTS. A Fund may purchase and write call and put options on non-U.S. stock
index and interest rate futures contracts. A Fund may use such options on
futures contracts in connection with its hedging strategies in lieu of
purchasing and writing options directly on the underlying securities or stock
indices or purchasing and selling the underlying futures. For example, a Fund
may purchase put options or write call options on stock index futures, or
interest rate futures, rather than selling futures contracts, in anticipation of
a decline in general stock market prices or rise in interest rates,
respectively, or purchase call options or write put options on stock index or
interest rate futures, rather than purchasing such futures, to hedge against
possible increases in the price of equity securities or debt securities,
respectively, which the Fund intends to purchase.
PURCHASE AND SALE OF CURRENCY FUTURES CONTRACTS AND RELATED OPTIONS. In
order to hedge its portfolio and to protect it against possible variations in
foreign exchange rates pending the settlement of securities transactions, a Fund
may buy or sell currency futures contracts and related options. If a fall in
exchange rates for a particular currency is anticipated, a Fund may sell a
currency futures contract or a call option thereon or purchase a put option on
such futures contract as a hedge. If it is anticipated that exchange rates will
rise, a Fund may purchase a currency futures contract or a call option thereon
or sell (write) a put option to protect against an increase in the price of
securities denominated in a particular currency a Fund intends to purchase.
These futures contracts and related options thereon will be used only as a hedge
against anticipated currency rate changes, and all options on currency futures
written by a Fund will be covered.
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A currency futures contract sale creates an obligation by a Fund, as
seller, to deliver the amount of currency called for in the contract at a
specified future time for a special price. A currency futures contract purchase
creates an obligation by a Fund, as purchaser, to take delivery of an amount of
currency at a specified future time at a specified price. Although the terms of
currency futures contracts specify actual delivery or receipt, in most instances
the contracts are closed out before the settlement date without the making or
taking of delivery of the currency. Closing out of a currency futures contract
is effected by entering into an offsetting purchase or sale transaction. Unlike
a currency futures contract, which requires the parties to buy and sell currency
on a set date, an option on a currency futures contract entitles its holder to
decide on or before a future date whether to enter into such a contract. If the
holder decides not to enter into the contract, the premium paid for the option
is fixed at the point of sale.
The Fund will write (sell) only covered put and call options on
currency futures. This means that a Fund will provide for its obligations upon
exercise of the option by segregating sufficient cash or short-term obligations
or by holding an offsetting position in the option or underlying currency
future, or a combination of the foregoing. A Fund will, so long as it is
obligated as the writer of a call option on currency futures, own on a
contract-for-contract basis an equal long position in currency futures with the
same delivery date or a call option on stock index futures with the difference,
if any, between the market value of the call written and the market value of the
call or long currency futures purchased maintained by a Fund in cash, Treasury
bills, or other high grade short-term obligations in a segregated account with
its custodian. If at the close of business on any day the market value of the
call purchased by a Fund falls below 100% of the market value of the call
written by the Fund, a Fund will so segregate an amount of cash, Treasury bills
or other high grade short-term obligations equal in value to the difference.
Alternatively, a Fund may cover the call option through segregating with the
custodian an amount of the particular foreign currency equal to the amount of
foreign currency per futures contract option times the number of options written
by a Fund. In the case of put options on currency futures written by the Fund,
the Fund will hold the aggregate exercise price in cash, Treasury bills, or
other high grade short-term obligations in a segregated account with its
custodian, or own put options on currency futures or short currency futures,
with the difference, if any, between the market value of the put written and the
market value of the puts purchased or the currency futures sold maintained by a
Fund in cash, Treasury bills or other high grade short-term obligations in a
segregated account with its custodian. If at the close of business on any day
the market value of the put options purchased or the currency futures by a Fund
falls below 100% of the market value of the put options written by the Fund, a
Fund will so segregate an amount of cash, Treasury bills or other high grade
short-term obligations equal in value to the difference.
If other methods of providing appropriate cover are developed, a Fund
reserves the right to employ them to the extent consistent with applicable
regulatory and exchange requirements. In connection with transactions in stock
index options, stock index futures, interest rate futures, foreign currency
futures and related options on such futures, a Fund will be required to deposit
as "initial margin" an amount of cash or short-term government securities equal
to from 5% to 8% of the contract amount. Thereafter, subsequent payments
(referred to as "variation margin") are made to and from the broker to reflect
changes in the value of the futures contract.
LIMITATIONS ON PURCHASE OF OPTIONS. The staff of the SEC has taken the
position that purchased over-the-counter options and assets used to cover
written over-the-counter options are illiquid and, therefore, together with
other illiquid securities, cannot exceed 15% of a Fund's assets. The Adviser
intends to limit a Fund's writing of over-the-counter options in accordance with
the following procedure. Each Fund intends to write over-the-counter options
only with primary U.S. Government securities dealers recognized by the Federal
Reserve Bank of New York. Also, the contracts which a Fund has in place with
such primary dealers will provide that the Fund has the absolute right to
repurchase an option it writes at any time at a price which represents the fair
market value, as determined in good faith through negotiation between the
parties, but which in no event will exceed a price determined pursuant to a
formula in the contract. Although the specific formula may vary between
contracts with different primary dealers, the formula will generally be based on
a multiple of the premium received by a Fund for writing the option, plus the
amount, if any, of the option's intrinsic value (I.E., the amount that the
option is in-the-money). The formula also may include a factor to account for
the difference between the price of the security and the strike price of the
option if the option is written out-of-the-money. A Fund will treat all or a
part of the formula price as illiquid for purposes of any limitation on illiquid
securities imposed by the SEC staff.
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Risk Factors Associated with Futures and Options Transactions
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The effective use of options and futures strategies depends on, among
other things, a Fund's ability to terminate options and futures positions at
times when its the Adviser deems it desirable to do so. Although a Fund will not
enter into an option or futures position unless the Adviser believes that a
liquid secondary market exists for such option or future, there is no assurance
that a Fund will be able to effect closing transactions at any particular time
or at an acceptable price. A Fund generally expects that its options and futures
transactions will be conducted on recognized U.S. and foreign securities and
commodity exchanges. In certain instances, however, a Fund may purchase and sell
options in the over-the-counter market. A Fund's ability to terminate option
positions established in the over-the-counter market may be more limited than in
the case of exchange-traded options and may also involve the risk that
securities dealers participating in such transactions would fail to meet their
obligations to the Fund.
Options and futures markets can be highly volatile and transactions of
this type carry a high risk of loss. Moreover, a relatively small adverse market
movement with respect to these types of transactions may result not only in loss
of the original investment but also in unquantifiable further loss exceeding any
margin deposited.
The use of options and futures involves the risk of imperfect
correlation between movements in options and futures prices and movements in the
price of securities which are the subject of the hedge. Such correlation,
particularly with respect to options on stock indices and stock index futures,
is imperfect, and such risk increases as the composition of a Fund diverges from
the composition of the relevant index. The successful use of these strategies
also depends on the ability of the Adviser to correctly forecast interest rate
movements, currency rate movements and general stock market price movements.
In addition to certain risk factors described above, the following sets
forth certain information regarding the potential risks associated with the
Funds' futures and options transactions.
RISK OF IMPERFECT CORRELATION. A Fund's ability effectively to hedge
all or a portion of its portfolio through transactions in futures, options on
futures or options on stock indices depends on the degree to which movements in
the value of the securities or index underlying such hedging instrument
correlate with movements in the value of the relevant portion of the Fund's
securities. If the values of the securities being hedged do not move in the same
amount or direction as the underlying security or index, the hedging strategy
for a Fund might not be successful and the Fund could sustain losses on its
hedging transactions which would not be offset by gains on its portfolio. It is
also possible that there may be a negative correlation between the security or
index underlying a futures or option contract and the portfolio securities being
hedged, which could result in losses both on the hedging transaction and the
fund securities. In such instances, a Fund's overall return could be less than
if the hedging transactions had not been undertaken. Stock index futures or
options based on a narrower index of securities may present greater risk than
options or futures based on a broad market index, as a narrower index is more
susceptible to rapid and extreme fluctuations resulting from changes in the
value of a small number of securities. A Fund would, however, effect
transactions in such futures or options only for hedging purposes.
The trading of futures and options on indices involves the additional
risk of imperfect correlation between movements in the futures or option price
and the value of the underlying index. The anticipated spread between the prices
may be distorted due to differences in the nature of the markets, such as
differences in margin requirements, the liquidity of such markets and the
participation of speculators in the futures and options market. The purchase of
an option on a futures contract also involves the risk that changes in the value
of underlying futures contract will not be fully reflected in the value of the
option purchased. The risk of imperfect correlation, however, generally tends to
diminish as the maturity date of the futures contract or termination date of the
option approaches. The risk incurred in purchasing an option on a futures
contract is limited to the amount of the premium plus related transaction costs,
although it may be necessary under certain circumstances to exercise the option
and enter into the underlying futures contract in order to realize a profit.
Under certain extreme market conditions, it is possible that a Fund will not be
able to establish hedging positions, or that any hedging strategy adopted will
be insufficient to completely protect the Fund.
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A Fund will purchase or sell futures contracts or options only if, in
the Adviser's judgment, there is expected to be a sufficient degree of
correlation between movements in the value of such instruments and changes in
the value of the relevant portion of the Fund's portfolio for the hedge to be
effective. There can be no assurance that the Adviser's judgment will be
accurate.
POTENTIAL LACK OF A LIQUID SECONDARY MARKET. The ordinary spreads
between prices in the cash and futures markets, due to differences in the
natures of those markets, are subject to distortions. First, all participants in
the futures market are subject to initial deposit and variation margin
requirements. This could require a Fund to post additional cash or cash
equivalents as the value of the position fluctuates. Further, rather than
meeting additional variation margin 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 or options market may be lacking. Prior to exercise or expiration, a
futures or option position may be terminated only by entering into a closing
purchase or sale transaction, which requires a secondary market on the exchange
on which the position was originally established. While a Fund will establish a
futures or option position only if there appears to be a liquid secondary market
therefor, there can be no assurance that such a market will exist for any
particular futures or option contract at any specific time. In such event, it
may not be possible to close out a position held by a Fund, which could require
the Fund to purchase or sell the instrument underlying the position, make or
receive a cash settlement, or meet ongoing variation margin requirements. The
inability to close out futures or option positions also could have an adverse
impact on a Fund's ability effectively to hedge its securities, or the relevant
portion thereof.
The liquidity of a secondary market in a futures contract or an option
on a futures contract may be adversely affected by "daily price fluctuation
limits" established by the exchanges, which limit the amount of fluctuation in
the price of a contract during a single trading day and prohibit trading beyond
such limits once they have been reached. The trading of futures and options
contracts also is subject to the risk of trading halts, suspensions, exchange or
clearing house equipment failures, government intervention, insolvency of the
brokerage firm or clearing house or other disruptions of normal trading
activity, which could at times make it difficult or impossible to liquidate
existing positions or to recover excess variation margin payments.
RISK OF PREDICTING INTEREST RATE MOVEMENTS. Investments in futures
contracts on fixed income securities and related indices involve the risk that
if the Adviser's investment judgment concerning the general direction of
interest rates is incorrect, a Fund's overall performance may be poorer than if
it had not entered into any such contract. For example, if a Fund has been
hedged against the possibility of an increase in interest rates which would
adversely affect the price of bonds held in its portfolio and interest rates
decrease instead, the Fund will lose part or all of the benefit of the increased
value of its bonds which have been hedged because it will have offsetting losses
in its futures positions. In addition, in such situations, if a Fund has
insufficient cash, it may have to sell bonds from its portfolio to meet daily
variation margin requirements, possibly at a time when it may be disadvantageous
to do so. Such sale of bonds may be, but will not necessarily be, at increased
prices which reflect the rising market.
TRADING AND POSITION LIMITS. Each contract market on which futures and
option contracts are traded has established a number of limitations governing
the maximum number of positions which may be held by a trader, whether acting
alone or in concert with others. The Adviser does not believe that these trading
and position limits will have an adverse impact on the hedging strategies
regarding the Funds' investments.
REGULATIONS ON THE USE OF FUTURES AND OPTIONS CONTRACTS. Regulations of
the CFTC require that the Funds enter into transactions in futures contracts and
options thereon for hedging purposes only, in order to assure that they are not
deemed to be a "commodity pool" under such regulations. In particular, CFTC
regulations require that all short futures positions be entered into for the
purpose of hedging the value of investment securities held by a Fund, and that
all long futures positions either constitute bona fide hedging transactions, as
defined in such regulations, or have a total value not in excess of an amount
determined by reference to certain cash and securities positions maintained for
the Fund, and accrued profits on such positions. In addition, a Fund may not
purchase or sell such instruments if, immediately thereafter, the sum of the
amount of initial margin deposits on its existing futures positions and premiums
paid for options on futures contracts would exceed 5% of the market value of the
Fund's total assets.
When a Fund purchases a futures contract, an amount of cash or cash
equivalents or high quality debt securities will be segregated with the Fund's
custodian so that the amount so segregated, plus the initial deposit and
variation margin held in the account of its broker, will at all times equal the
value of the futures contract, thereby insuring that the use of such futures is
unleveraged.
21
<PAGE>
The Funds' ability to engage in the hedging transactions described
herein may be limited by the current federal income tax requirement that a Fund
derive less than 30% of its gross income from the sale or other disposition of
stock or securities held for less than three months. The Funds may also further
limit their ability to engage in such transactions in response to the policies
and concerns of various Federal and state regulatory agencies. Such policies may
be changed by vote of the Board of Trustees.
Additional Information on Futures and Options
As stated in the Prospectus, each Non-Money Market Fund, may enter into
futures contracts and options for hedging purposes. Such transactions are
described in this Schedule. During the current fiscal year, each of these Funds
intends to limit its transactions in futures contracts and options so that not
more than 5% of the Fund's net assets are at risk. Furthermore, in no event
would any Fund purchase or sell futures contracts, or related options thereon,
for hedging purposes if, immediately thereafter, the aggregate initial margin
that is required to be posted by the Fund under the rules of the exchange on
which the futures contract (or futures option) is traded, plus any premiums paid
by the Fund on its open futures options positions, exceeds 5% of the Fund's
total assets, after taking into account any unrealized profits and unrealized
losses on the Fund's open contracts and excluding the amount that a futures
option is "in-the-money" at the time of purchase. (An option to buy a futures
contract is "in-the-money" if the value of the contract that is subject to the
option exceeds the exercise price; an option to sell a futures contract is
"in-the-money" if the exercise Price exceeds the value of the contract that is
subject of the option.)
I. Interest Rate Futures Contracts.
-------------------------------
Use of Interest Rate Futures Contracts. Bond prices are established in
both the cash market and the futures market. In the cash market, bonds are
purchased and sold with payment for the full purchase price of the bond being
made in cash, generally within five business days after the trade. In the
futures market, only a contract is made to purchase or sell a bond in the future
for a set price on a certain date. Historically, the prices for bonds
established in the futures market have tended to move generally in the aggregate
in concert with the cash market prices and have maintained fairly predictable
relationships. Accordingly, a Fund may use interest rate futures as a defense,
or hedge, against anticipated interest rate changes and not for speculation. As
described below, this would include the use of futures contract sales to protect
against expected increases in interest rates and futures contract purchases to
offset the impact of interest rate declines.
A Fund presently could accomplish a similar result to that which it
hopes to achieve through the use of futures contracts by selling bonds with long
maturities and investing in bonds with short maturities when interest rates are
expected to increase, or conversely, selling short-term bonds and investing in
long-term bonds when interest rates are expected to decline. However, because of
the liquidity that is often available in the futures market the protection is
more likely to be achieved, perhaps at a lower cost and without changing the
rate of interest being earned by the Fund, through using futures contracts.
Description of Interest Rates Futures Contracts. An interest rate
futures contract sale would create an obligation by a Fund, as seller, to
deliver the specific type of financial instrument called for in the contract at
a specific future time for a specified price. A futures contract purchase would
create an obligation by the Fund, as purchaser, to take delivery of the specific
type of financial instrument at a specific future time at a specific price. The
specific securities delivered or taken, respectively, at settlement date, would
not be determined until at or near that date. The determination would be in
accordance with the rules of the exchange on which the futures contract sale or
purchase was made.
Although interest rate futures contracts by their terms call for actual
delivery or acceptance of securities, in most cases the contracts are closed out
before the settlement date without the making or taking of delivery of
securities. Closing out a futures contract sale is effected by the Fund's
entering into a futures contract purchase for the same aggregate amount of the
specific type of financial instrument and the same delivery date. If the price
in the sale exceeds the price in the offsetting purchase, the Fund is paid the
difference and thus realizes a gain. If the offsetting purchase price exceeds
the sale price, the Fund pays the difference and realizes a loss. Similarly, the
closing out of a futures contract purchase is effected by the Fund's entering
into a futures contract sale. If the offsetting sale price exceeds the purchase
price, the Fund realizes a gain, and if the purchase price exceeds the
offsetting sale price, the Fund realizes a loss.
Interest rate futures contracts are traded in an auction environment on
the floors of several exchanges - principally, the Chicago Board of Trade, the
Chicago Mercantile Exchange and the New York Futures Exchange. A Fund would deal
only in standardized contracts on recognized changes. Each exchange guarantees
performance under contract provisions through a clearing corporation, a
nonprofit organization managed by the exchange membership.
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<PAGE>
A public market now exists in futures contracts covering various
financial instruments including long-term United States Treasury Bonds and
Notes; GNMA modified pass-through mortgage-backed securities; three-month United
States Treasury Bills; and ninety-day commercial paper. The Funds may trade in
any futures contract for which there exists a public market, including, without
limitation, the foregoing instruments.
Examples of Futures Contract Sale. A Fund would engage in an interest
rate futures contract sale to maintain the income advantage from continued
holding of a long-term bond while endeavoring to avoid part or all of the loss
in market value that would otherwise accompany a decline in long-term securities
prices. Assume that the market value of a certain security in a Fund tends to
move in concert with the futures market prices of long-term United States
Treasury bonds ("Treasury Bonds"). The Adviser wishes to fix the current market
value of this portfolio security until some point in the future. Assume the
portfolio security has a market value of 100, and the Adviser believes that,
because of an anticipated rise in interest rates, the value will decline to 95.
The Fund might enter into futures contract sales of Treasury bonds for an
equivalent of 98. If the market value of the portfolio securities does indeed
decline from 100 to 95, the equivalent futures market price for the Treasury
bonds might also decline from 98 to 93.
In that case, the five-point loss in the market value of the portfolio
security would be offset by the five-point gain realized by closing out the
futures contract sale. Of course, the futures market price of Treasury bonds
might well decline to more than 93 or to less than 93 because of the imperfect
correlation between cash and futures prices mentioned below.
The Adviser could be wrong in its forecast of interest rates and the
equivalent futures market price could rise above 98. In this case, the market
value of the portfolio securities, including the portfolio security being
protected, would increase. The benefit of this increase would be reduced by the
loss realized on closing out the futures contract sale.
If interest rate levels did not change, the Fund in the above example
might incur a loss of 2 points (which might be reduced by an offsetting
transaction prior to the settlement date). In each transaction, transaction
expenses would also be incurred.
Examples of Future Contract Purchase. A Fund would engage in an
interest rate futures contract purchase when it is not fully invested in
long-term bonds but wishes to defer for a time the purchase of long-term bonds
in light of the availability of advantageous interim investments, E.G.,
shorter-term securities whose yields are greater than those available on
long-term bonds. The Fund's basic motivation would be to maintain for a time the
income advantage from investing in the short-term securities; the Fund would be
endeavoring at the same time to eliminate the effect of all or part of an
expected increase in market price of the long-term bonds that the Fund may
purchase.
For example, assume that the market price of a long-term bond that the
Fund may purchase, currently yielding 10%, tends to move in concert with futures
market prices of Treasury bonds. The Adviser wishes to fix the current market
price (and thus 10% yield) of the long-term bond until the time (four months
away in this example) when it may purchase the bond. Assume the long-term bond
has a market price of 100, and the Adviser believes that, because of an
anticipated fall in interest rates, the price will have risen to 105 (and the
yield will have dropped to about 9-1/2%) in four months. The Fund might enter
into futures contracts purchases of Treasury bonds for an equivalent price of
98. At the same time, the Fund would assign a pool of investments in short-term
securities that are either maturing in four months or earmarked for sale in four
months, for purchase of the long-term bond at an assumed market price of 100.
Assume these short-term securities are yielding 15%. If the market price of the
long-term bond does indeed rise from 100 to 105, the equivalent futures market
price for Treasury bonds might also rise from 98 to 103. In that case, the
5-point increase in the price that the Fund pays for the long-term bond would be
offset by the 5-point gain realized by closing out the futures contract
Purchase.
The Adviser could be wrong in its forecast of interest rates; long-term
interest rates might rise to above 10%; and the equivalent futures market price
could fall below 98. If short-term rates at the same time fall to 10% or below,
it is possible that the Fund would continue with its purchase program for
long-term bonds. The market price of available long-term bonds would have
decreased. The benefit of this price decrease, and thus yield increase, will be
reduced by the loss realized on closing out the futures contract purchase.
23
<PAGE>
If, however, short-term rates remained above available long-term rates,
it is possible that the Fund would discontinue its purchase program for
long-term bonds. The yield on short-term securities in the portfolio, including
those originally in the pool assigned to the particular long-term bond, would
remain higher than yields on long-term bonds. The benefit of this continued
incremental income will be reduced by the loss realized on closing out the
futures contract purchase.
In each transaction, expenses also would be incurred.
II. Index Futures Contracts.
------------------------
A stock or bond index assigns relative values to the stocks or bonds
included in the index, and the index fluctuates with changes in the market
values of the stocks or bonds included. Some stock index futures contracts are
based on broad market indices, such as the Standard & Poor's 500 or the New York
Stock Exchange Composite Index. In contract, certain exchanges offer futures
contracts on narrower market indices, such as the Standard & Poor's 100, the
Bond Buyer Municipal Bond Index, an index composed of 40 term revenue and
general obligation bonds, or indices based on an industry or market segment,
such as oil and gas stocks. Futures contracts are traded on organized exchanges
regulated by the Commodity Futures Trading Commission. Transactions on such
exchanges are cleared through a clearing corporation, which guarantees the
performance of the parties to each contract.
A Fund will sell index futures contracts in order to offset a decrease
in market value of its portfolio securities that might otherwise result from a
market decline. The Fund may do so either to hedge the value of its portfolio as
a whole, or to protect against declines, occurring prior to sales of securities,
in the value of the securities to be sold. Conversely, a Fund will purchase
index futures contracts in anticipation of purchases of securities. In a
substantial majority of these transactions, the Fund will purchase such
securities upon termination of the long futures position, but a long futures
position may be terminated without a corresponding purchase of securities.
In addition, a Fund may utilize index futures contracts in anticipation
of changes in the composition of its portfolio holdings. For example, in the
event that a Fund expects to narrow the range of industry groups represented in
its holdings it may, prior to making purchases of the actual securities,
establish a long futures position based on a more restricted index, such as an
index comprised of securities of a particular industry group. A Fund also may
sell futures contracts in connection with this strategy, in order to protect
against the possibility that the value of the securities to be sold as part of
the restructuring of the portfolio will decline prior to the time of sale.
The following are examples of transactions in stock index futures (net
of commissions and premiums, if any).
ANTICIPATORY PURCHASE HEDGE: Buy the Future
Hedge Objective: Protect Against Increasing Price
<TABLE>
<CAPTION>
Portfolio Futures
-Day Hedge is Placed
<S> <C> <C> <C>
Anticipate Buying $62,500 Buying 1 Index Futures at 125
Equity Portfolio Value of Futures = $62,500/Contract
-Day Hedge is Lifted-
Buy Equity Portfolio with Sell 1 Index Futures at 130
Actual Cost = $65,000 Value of Futures = $65,000/Contract
Increase in Purchase Gain on Futures = $2,500
Price = $2,500
24
<PAGE>
HEDGING A STOCK PORTFOLIO: Sell the Future Hedge
Objective: Protect Against Declining (Value of the Portfolio)
Factors
Value of Stock Portfolio = $1,000,000
Value of Futures Contract = 125 x $500 = $62,500
Portfolio Beta Relative to the Index - 1.0
Portfolio Futures
-Day Hedge is Placed
Anticipate Selling $1,000,000 Sell 16 Index Futures at 125
Equity Portfolio Value of Futures = $1,000,000
-Day Hedge is Lifted-
Equity Portfolio-Own Buy 16 Index Futures at 120
Stock with Value = $960,000 Value of Futures = $960,000
Loss in Portfolio Gain on Futures = $40,000
Value = $40 000
IF, HOWEVER, THE MARKET MOVED IN THE OPPOSITE DIRECTION, THAT IS, MARKET
VALUE DECREASED AND THE FUND HAD ENTERED INTO AN ANTICIPATORY PURCHASE HEDGE, OR
MARKET VALUE INCREASED AND THE FUND HAD HEDGED ITS STOCK PORTFOLIO, THE RESULTS
OF THE FUND'S TRANSACTIONS IN STOCK INDEX FUTURES WOULD BE AS SET FORTH BELOW.
ANTICIPATORY PURCHASE HEDGE: Buy the Future
Hedge Objective: Protect Against Increasing Price
Portfolio Futures
-Day Hedge is Placed
Anticipate Buying $62,500 Buying 1 Index Futures at 125
Equity Portfolio Value of Futures = $62,500/Contract
-Day Hedge is Lifted-
Buy Equity Portfolio with Sell 1 Index Futures at 120
Actual Cost = $60,000 Value of Futures = $60,000/Contract
Decrease in Purchase Loss on Futures = $2,500/Contract
Price = $2,500
HEDGING A STOCK PORTFOLIO: Sell the Future
Hedge Objective: Protect Against Declining
Value of the Portfolio
Factors
Value of Stock Portfolio = $1,000,000
Value of Futures Contract = 125 x $500 = $62,500
Portfolio Beta Relative to the Index - 1.0
Portfolio Futures
-Day Hedge is Placed
Anticipate Selling $1,000,000 Sell 16 Index Futures at 125
Equity Portfolio Value of Futures = $1,000,000
-Day Hedge is Lifted-
Equity Portfolio-Own Buy 16 Index Futures at 130
Stock with Value = $1,040,000 Value of Futures = $1,040,000
Gain in Portfolio = $40,000 Loss of Futures = $40,000
Value = $40 000
</TABLE>
25
<PAGE>
III. Margin Payments
---------------
Unlike when a Fund purchases or sells a security, no price is paid or
received by the Fund upon the purchase or sale of a futures contract. Initially,
the Fund will be required to deposit with the broker or in a segregated account
with the Fund's Custodian an amount of cash or cash equivalents, the value, of
which may vary but is generally equal to 10% or less of the value of the
contract. This amount is known as initial margin. The nature of initial margin
in futures transactions is different from that of margin in security
transactions in that futures contract margin does not involve the borrowing of
funds by the customer to finance the transactions. Rather, the initial margin is
in the nature of a performance bond or good faith deposit on the contract which
is returned to the Fund upon termination of the futures contract assuming all
contractual obligations have been satisfied. Subsequent payments, called
variation margin, to and from the broker, will be made on a daily basis as the
price of the underlying security or index fluctuates making the long and short
positions in the futures contract more or less valuable, a process known as
marking to the market. For example, when a Fund has purchased a futures contract
and the price of the contract has risen in response to a rise in the underlying
instruments, that position will have increased in value and the Fund will be
entitled to receive from the broker a variation margin payment equal to that
increase in value. Conversely, where a Fund has purchased a futures contract and
the price of the futures contract has declined in response to a decrease in the
underlying instruments, the position would be less valuable, the Fund would be
required to make a variation margin payment to the broker. At any time prior to
expiration of the futures contract, the Adviser may elect to close the position
by taking an opposite position, subject to the availability of a secondary
market, which will operate to terminate the Fund's position in the futures
contract. A final determination of variation margin is then made, additional
cash is required to be paid by or released to the Fund, and the Fund realizes a
loss or gain.
IV. Risks of Transactions in Futures Contracts
There are several risks in connection with the use of futures by a Fund
as a hedging device. One risk arises because of the imperfect correlation
between movements in the price of the future and movements in the price of the
securities which are the subject of the hedge. The price of the future may move
more than or less than the price of the securities being hedged. If the price of
the future moves less than the price of the securities which are the subject of
the hedge, the hedge will not be fully effective but, if the price of 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 advance will be partially
offset by the loss on the future. If the price of the future moves more than the
price of the hedged securities, the Fund involved will experience either a loss
or gain on the future which will not be completely offset by movements in the
price of the securities which are the subject of the hedge.
To compensate for the imperfect correlation of movements in the price
of securities being hedged and movements in the price of futures contracts, a
Fund may buy or sell futures contracts in a greater dollar amount than the
dollar amount of securities being hedged if the volatility over a particular
time period of the prices of such securities has been greater than the
volatility over such time period of the future, or if otherwise deemed to be
appropriate by the Adviser. Conversely, a Fund may buy or sell fewer futures
contracts if the volatility over a particular time period of the prices of the
securities being hedged is less than the volatility over such time period of the
futures contract being used, or if otherwise deemed to be appropriate by the
Adviser. It also is possible that, where a Fund has sold futures to hedge its
portfolio against a decline in the market, the market may advance, and the value
of securities held by the Fund may decline. If this occurred, the Fund would
lose money on the future and also experience a decline in value in its portfolio
securities.
Where futures are purchased to hedge against a possible increase in the
price of securities before a Fund is able to invest its cash (or cash
equivalents) in securities (or options) in an orderly fashion, it is possible
that the market may decline instead; if the Fund then concludes not to invest in
securities or options at that time because of concern as to possible further
market decline or for other reasons, the Fund will realize a loss on the futures
contract that is not offset by a reduction in the price of securities purchased.
In instances involving the purchase of futures contracts by a Fund, an
amount of cash and cash equivalents, equal to the market value of the futures
contracts, will be deposited in a segregated account with the Fund's Custodian
and/or in a margin account with a broker to collateralize the position and
thereby insure that the use of such futures is unleveraged.
In addition to the possibility that there may be an imperfect
correlation, or no correlation at all, between movements in the futures and the
securities being hedged, the price of futures may not correlate perfectly with
movement in the cash market due to certain market distortions. Rather than
meeting additional margin deposit requirements, investors may close futures
contracts through off-setting transactions which could distort the normal
relationship between the cash and futures markets. Second, with respect to
financial futures contracts, the liquidity of the futures market depends on
participants entering into off-setting 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 distortions. 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 also cause
temporary price distortions. Due to the possibility of Price distortion in the
futures market, and because of the imperfect correlation between the movements
in the cash market and movements in the price of futures, a correct forecast of
general market trends or interest rate movements by the Adviser still may not
result in a successful hedging transaction over a short time frame.
26
<PAGE>
Positions in futures may be closed out only on an exchange or board of
trade which provides a secondary market for such futures. Although the Funds
intend to purchase or sell futures only on exchanges or boards of trade where
there appear to be active secondary markets, there is no assurance that a liquid
secondary market on any exchange or board of trade will exist for any particular
contract or at any particular time. In such event, it may not be possible to
close a futures investment position, and in the event of adverse price
movements, a Fund would continue to be required to make daily cash payments of
variation margin. However, in the event futures contracts have been used to
hedge portfolio securities, such securities will not be sold until the futures
contract can be terminated. In such circumstances, an increase in the price of
the securities, if any, may partially or completely offset losses on the futures
contract. However, as described above, there is no guarantee that the price of
the securities will in fact correlate with the price movements in the futures
contract and thus provide an offset on a futures contract.
Further, it should be noted that the liquidity of a secondary market in
a futures contract may be adversely affected by "daily price fluctuation limits"
established by commodity exchanges which limit the amount of fluctuation in a
futures contract price during a single trading day. Once the daily limit has
been reached in the contract, no trades may be entered into at a price beyond
the limit, thus preventing the liquidation of open futures positions.
Successful use of futures by a Fund also is subject to the Adviser's
ability to predict correctly movements in the direction of the market. For
example, if a Fund has hedged against the possibility of a decline in the market
adversely affecting securities held in its portfolio and securities prices
increase instead, the Fund will lose part or all of the benefit to the increased
value of its securities which it has hedged because it will have offsetting
losses in its futures positions. In addition, in such situations, if the Fund
has insufficient cash, it may have to sell securities to meet daily variation
margin requirements. Such sales of securities may be, but will not necessarily
be, at increased prices which reflect the rising market. A Fund may have to sell
securities at a time when it may be disadvantageous to do so.
V. Options on Futures Contracts.
----------------------------
The Funds may purchase options on the futures contracts described
above. A futures option gives the holder, in return for the premium paid, the
right to buy (call) from or sell (put) to the writer of the option a futures
contract at a specified price at any time during the period of the option. Upon
exercise, the writer of the option is obligated to pay the difference between
the cash value of the futures contract and the exercise price. Like the buyer or
seller of a futures contract, the holder, or writer, of an option has the right
to terminate its position prior to the scheduled expiration of the option by
selling, or purchasing, an option of the same series, at which time the person
entering into the closing transaction will realize a gain or loss.
Investments in futures options involve some of the same considerations
that are involved in connection with investments in futures contracts (for
example, the existence of a liquid secondary market). In addition, the purchase
of an option also entails the risk that changes in the value of the underlying
futures contract will not be fully reflected in the value of the option
purchased. Depending on the pricing of the option compared to either the futures
contract upon which it is based, or upon the price of the securities being
hedged, an option may or may not be less risky than ownership of the futures
contract or such securities. In general, the market prices of options can be
expected to be more volatile than the market prices on the underlying futures
contract. Compared to the purchase or sale of futures contracts, however, the
purchase of call or put options on futures contracts may frequently involve less
potential risk to a Fund because the maximum amount at risk is the premium paid
for the options (plus transaction costs). Although permitted by their
fundamental investment policies, the Funds do not currently intend to write
future options, and will not do so in the future absent any necessary regulatory
approvals.
27
<PAGE>
Accounting Treatment.
--------------------
Accounting for futures contracts and options will be in accordance with
generally accepted accounting principles.
GUARANTEED INVESTMENT CONTRACTS
Guaranteed investment contracts, investment contracts or funding
agreements (each referred to as a "GIC") are investment instruments issued by
highly rated insurance companies. Pursuant to such contracts, a Fund may make
cash contributions to a deposit fund of the insurance company's general or
separate accounts. The insurance company then credits to a Fund guaranteed
interest. The insurance company may assess periodic charges against a GIC for
expense and service costs allocable to it, and the charges will be deducted from
the value of the deposit fund. The purchase price paid for a GIC generally
becomes part of the general assets of the issuer, and the contract is paid from
the general assets of the issuer.
A Fund will only purchase GICs from issuers which, at the time of
purchase, meet quality and credit standards established by the Adviser.
Generally, GICs are not assignable or transferable without the permission of the
issuing insurance companies, and an active secondary market in GICs does not
currently exist. Also, a Fund may not receive the principal amount of a GIC from
the insurance company on seven days' notice or less, at which point the GIC may
be considered to be an illiquid investment.
INSURED MUNICIPAL SECURITIES
Certain of the Municipal Securities held by the Funds may be insured at
the time of issuance as to the timely payment of principal and interest. The
insurance policies will usually be obtained by the issuer of the Municipal
Securities at the time of its original issuance. In the event that the issuer
defaults with respect to interest or principal payments, the insurer will be
notified and will be required to make payment to the bondholders. There is,
however, no guarantee that the insurer will meet its obligations. In addition,
such insurance will not protect against market fluctuations caused by changes in
interest rates and other factors.
INTEREST RATE TRANSACTIONS
Among the strategic transactions into which certain Funds may enter are
interest rate swaps and the purchase or sale of related caps and floors. The
Funds expect to enter into these transactions primarily to preserve a return or
spread on a particular investment or portion of its portfolio, to protect
against currency fluctuations, as a duration management technique or to protect
against any increase in the price of securities the Fund anticipates purchasing
at a later date. A Fund intends to use these transactions as hedges and not as
speculative investments and will not sell interest rate caps or floors where it
does not own securities or other instruments providing the income stream the
Fund may be obligated to pay. Interest rate swaps involve the exchange by a Fund
with another party of their respective commitments to pay or receive interest,
E.G. an exchange of floating rate payments for fixed rate payments with respect
to a notional amount of principal. A currency swap is an agreement to exchange
cash flows on a notional amount of two or more currencies based on the relative
value differential among them and an index swap is an agreement to swap cash
flows on a notional amount based on changes in the values of the reference
indices. The purchase of a cap entitles the purchaser to receive payments on a
notional principal amount from the party selling such floor to the extent that a
specified index falls below a predetermined interest rate or amount.
A Fund will usually enter into swaps on a net basis, I.E., the two
payment streams are netted out in a cash settlement on the payment date or dates
specified in the instrument, with the Fund receiving or paying, as the case may
be, only the net amount of the two payments. In as much as these swaps, caps and
floors are entered into for good faith hedging purposes, the Adviser and the
Fund believe such obligations do not constitute senior securities under the 1940
Act and, accordingly, will not treat them as being subject to its borrowing
restrictions. A Fund will not enter into any swap, cap and floor transaction
unless, at the time of entering into such transaction, the unsecured long-term
debt of the counterparty, combined with any credit enhancements, is rated at
least "A" by Standard & Poor's Corporation or Moody's Investors Service, Inc. or
has an equivalent rating from an NRSRO or is determined to be of equivalent
credit quality by the Adviser. If there is a default by the counterparty, the
Fund may have contractual remedies pursuant to the agreements related to the
transaction. The swap market has grown substantially in recent years with a
large number of banks and investment banking firms acting both as principals and
as agents utilizing standardized swap documentation. As a result, the swap
market has become relatively liquid. Caps and floors are more recent innovations
for which standardized documentation has not yet been fully developed and,
accordingly, they are less liquid than swaps.
28
<PAGE>
With respect to swaps, a Fund will accrue the net amount of the excess,
if any, of its obligations over its entitlements with respect to each swap on a
daily basis and will segregate an amount of cash or liquid high grade securities
having a value equal to the accrued excess. Caps and floors require segregation
of assets with a value equal to the Fund's net obligation, if any.
LOWER RATED (OR HIGH YIELD) DEBT SECURITIES
The yields on lower rated debt and comparable unrated fixed-income
securities generally are higher than the yields available on higher-rated
securities. However, investments in lower rated debt and comparable unrated
securities generally involve greater volatility of price and risk of loss of
income and principal, including the probability of default by or bankruptcy of
the issuers of such securities. Lower rated debt and comparable unrated
securities (a) will likely have some quality and protective characteristics
that, in the judgment of the rating organization, are outweighed by large
uncertainties or major risk exposures to adverse conditions and (b) are
predominantly speculative with respect to the issuer's capacity to pay interest
and repay principal in accordance with the terms of the obligation. Accordingly,
it is possible that these types of factors could, in certain instances, reduce
the value of securities held in a Fund's portfolio, with a commensurate effect
on the value of the Fund's shares. Therefore, an investment in the Fund should
not be considered as a complete investment program and may not be appropriate
for all investors.
The market prices of lower rated securities may fluctuate more than
higher rated securities and may decline significantly in periods of general
economic difficulty which may follow periods of rising interest rates. During an
economic downturn or a prolonged period of rising interest rates, the ability of
issuers of lower quality debt to service their payment obligations, meet
projected goals, or obtain additional financing may be impaired.
Since the risk of default is higher for lower rated securities, the
Adviser will try to minimize the risks inherent in investing in lower rated debt
securities by engaging in credit analysis, diversification, and attention to
current developments and trends affecting interest rates and economic
conditions. The Adviser will attempt to identify those issuers of high-yielding
securities whose financial condition is adequate to meet future obligations,
have improved, or are expected to improve in the future.
Unrated securities are not necessarily of lower quality than rated
securities, but they may not be attractive to as many buyers. Each Fund's
policies regarding lower rated debt securities are not fundamental and may be
changed at any time without shareholder approval.
While the market values of lower rated debt and comparable unrated
securities tend to react less to fluctuations in interest rate levels than the
market values of higher-rated securities, the market values of certain lower
rated debt and comparable unrated securities also tend to be more sensitive to
individual corporate developments and changes in economic conditions than
higher-rated securities. In addition, lower rated debt securities and comparable
unrated securities generally present a higher degree of credit risk. Issuers of
lower rated debt and comparable unrated securities often are highly leveraged
and may not have more traditional methods of financing available to them so that
their ability to service their debt obligations during an economic downturn or
during sustained periods of rising interest rates may be impaired. The risk of
loss due to default by such issuers is significantly greater because lower rated
debt and comparable unrated securities generally are unsecured and frequently
are subordinated to the prior payment of senior indebtedness. A Fund may incur
additional expenses to the extent that it is required to seek recovery upon a
default in the payment of principal or interest on its portfolio holdings. The
existence of limited markets for lower rated debt and comparable unrated
securities may diminish a Fund's ability to (a) obtain accurate market
quotations for purposes of valuing such securities and calculating its net asset
value and (b) sell the securities at fair value either to meet redemption
requests or to respond to changes in the economy or in financial markets.
Fixed-income securities, including lower rated debt securities and
comparable unrated securities, frequently have call or buy-back features that
permit their issuers to call or repurchase the securities from their holders,
such as a Fund. If an issuer exercises these rights during periods of declining
interest rates, a Fund may have to replace the security with a lower yielding
security, thus resulting in a decreased return to a Fund.
The market for certain lower rated debt and comparable unrated
securities is relatively new and has not weathered a major economic recession.
The effect that such a recession might have on such securities is not known. Any
such recession, however, could disrupt severely the market for such securities
and adversely affect the value of such securities. Any such economic downturn
also could adversely affect the ability of the issuers of such securities to
repay principal and pay interest thereon.
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<PAGE>
MUNICIPAL SECURITIES
GENERALLY. The two principal classifications of municipal securities
are "general obligation" securities and "revenue" securities. General obligation
securities are secured by the issuer's pledge of its full faith, credit, and
taxing power for the payment of principal and interest. Revenue securities are
payable only from the revenues derived from a particular facility or class of
facilities or, in some cases, from the proceeds of a special excise tax or other
specific revenue source such as the user of the facility being financed. Private
activity bonds held by a Fund are in most cases revenue securities and are not
payable from the unrestricted revenues of the issuer. Consequently, the credit
quality of private activity bonds is usually directly related to the credit
standing of the corporate user of the facility involved.
Municipal securities may include "moral obligation" bonds, which are
normally issued by special purpose public authorities. If the issuer of moral
obligation bonds is unable to meet its debt service obligations from current
revenues, it may draw on a reserve fund, the restoration of which is a moral
commitment but not a legal obligation of the state or municipality which created
the issuer.
Municipal securities may include variable- or floating- rate
instruments issued by industrial development authorities and other governmental
entities. While there may not be an active secondary market with respect to a
particular instrument purchased by a Fund, a Fund may demand payment of the
principal and accrued interest on the instrument or may resell it to a third
party as specified in the instruments. The absence of an active secondary
market, however, could make it difficult for a Fund to dispose of the instrument
if the issuer defaulted on its payment obligation or during periods the Fund is
not entitled to exercise its demand rights, and the Fund could, for these or
other reasons, suffer a loss.
Some of these instruments may be unrated, but unrated instruments
purchased by a Fund will be determined by the Adviser to be of comparable
quality at the time of purchase to instruments rated "high quality" by any major
rating service. Where necessary to ensure that an instrument is of comparable
"high quality," a Fund will require that an issuer's obligation to pay the
principal of the note may be backed by an unconditional bank letter or line of
credit, guarantee, or commitment to lend.
Municipal securities may include participations in privately arranged
loans to municipal borrowers, some of which may be referred to as "municipal
leases." Generally such loans are unrated, in which case they will be determined
by the Adviser to be of comparable quality at the time of purchase to rated
instruments that may be acquired by a Fund. Frequently, privately arranged loans
have variable interest rates and may be backed by a bank letter of credit. In
other cases, they may be unsecured or may be secured by assets not easily
liquidated. Moreover, such loans in most cases are not backed by the taxing
authority of the issuers and may have limited marketability or may be marketable
only by virtue of a provision requiring repayment following demand by the
lender. Such loans made by a Fund may have a demand provision permitting the
Fund to require payment within seven days. Participations in such loans,
however, may not have such a demand provision and may not be otherwise
marketable.
Although lease obligations do not constitute general obligations of the
municipality for which the municipality's taxing power is pledged, a lease
obligation is ordinarily backed by the municipality's covenant to budget for,
appropriate, and make the payments due under the lease obligation. However,
certain lease obligations contain "non-appropriation" clauses which provide that
the municipality has no obligation to make lease or installment purchase
payments in future years unless money is appropriated for such purpose on a
yearly basis. In addition to the "non-appropriation" risk, these securities
represent a relatively new type of financing that has not yet developed the
depth of marketability associated with more conventional bonds. In the case of a
"non-appropriation" lease, the Funds' ability to recover under the lease in the
event of non-appropriation or default will be limited solely to the repossession
of the leased property in the event foreclosure might prove difficult.
The Funds will not invest more than 5% of their total investment assets
in lease obligations that contain "non-appropriation" clauses where (1) the
nature of the leased equipment or property is such that its ownership or use is
essential to a governmental function of the municipality, (2) the lease payments
will commence amortization of principal at an early date resulting in an average
life of seven years or less for the lease obligation, (3) appropriate covenants
will be obtained from the municipal obligor prohibiting the substitution or
purchase of similar equipment if lease payments are not appropriated, (4) the
lease obligor has maintained good market acceptability in the past, (5) the
investment is of a size that will be attractive to institutional investors, and
(6) the underlying leased equipment has elements of probability and/or use that
enhance its marketability in the event foreclosure on the underlying equipment
were ever required. The Funds have not imposed any percentage limitations with
respect to their investment in lease obligations not subject to the
"non-appropriation" risk. To the extent municipal leases are illiquid, they will
be subject to each Fund's limitation on investments in illiquid securities.
Recovery of an investment in any such loan that is illiquid and payable on
demand may depend on the ability of the municipal borrower to meet an obligation
for full repayment of principal and payment of accrued interest within the
demand period, normally seven days or less (unless a Fund determines that a
particular loan issue, unlike most such loans, has a readily available market).
As it deems appropriate, the Adviser will establish procedures to monitor the
credit standing of each such municipal borrower, including its ability to meet
contractual payment obligations.
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In evaluating the credit quality of a municipal lease obligation and
determining whether such lease obligation will be considered "liquid," the
Adviser for each Fund will consider: (1) whether the lease can be canceled; (2)
what assurance there is that the assets represented by the lease can be sold;
(3) the strength of the lessee's general credit (E.G., its debt, administrative,
economic, and financial characteristics); (4) the likelihood that the
municipality will discontinue appropriating funding for the leased property
because the property is no longer deemed essential to the operations of the
municipality (E.G., the potential for an "event of non-appropriation"); and (5)
the legal recourse in the event of failure to appropriate.
Municipal securities may include units of participation in trusts
holding pools of tax-exempt leases. Municipal participation interests may be
purchased from financial institutions, and give the purchaser an undivided
interest in one or more underlying municipal security. To the extent that
municipal participation interests are considered to be "illiquid securities,"
such instruments are subject to each Fund's limitation on the purchase of
illiquid securities. Municipal leases and participating interests therein, which
may take the form of a lease or an installment sales contract, are issued by
state and local governments and authorities to acquire a wide variety of
equipment and facilities. Interest payments on qualifying leases are exempt from
Federal income taxes.
In addition, certain of the Funds may acquire "stand-by commitments"
from banks or broker/dealers with respect to municipal securities held in their
portfolios. Under a stand-by commitment, a dealer would agree to purchase at a
Fund's option specified Municipal Securities at a specified price. The Funds
will acquire stand-by commitments solely to facilitate portfolio liquidity and
do not intend to exercise their rights thereunder for trading purposes.
Although the Funds do not presently intend to do so on a regular basis,
each may invest more than 25% of its total assets in municipal securities the
interest on which is paid solely from revenues of similar projects if such
investment is deemed necessary or appropriate by the Adviser. To the extent that
more than 25% of a Fund's total assets are invested in Municipal Securities that
are payable from the revenues of similar projects, a Fund will be subject to the
peculiar risks presented by such projects to a greater extent than it would be
if its assets were not so concentrated.
There are, of course, variations in the quality of Municipal
Securities, both within a particular classification and between classifications,
and the yields on Municipal Securities depend upon a variety of factors,
including general money market conditions, the financial condition of the
issuer, general conditions of the municipal bond market, the size of a
particular offering, the maturity of the obligation, and the rating of the
issue. The ratings of NRSROs represent their opinions as to the quality of
Municipal Securities. It should be emphasized, however, that these ratings are
general and are not absolute standards of quality, and Municipal Securities with
the same maturity, interest rate, and rating may have different yields while
Municipal Securities of the same maturity and interest rate with different
ratings may have the same yield. Subsequent to its purchase by a Fund, an issue
of Municipal Securities may cease to be rated, or its rating may be reduced
below the minimum rating required for purchase by that Fund. The Adviser will
consider such an event in determining whether a Fund should continue to hold the
obligation.
Opinions relating to the validity of Municipal Securities and to the
exemption of interest thereon from regular Federal income tax or state income
tax are rendered by counsel to the issuer or bond counsel at the time of
issuance. Neither the Funds nor the Adviser will review the proceedings relating
to the issuance of Municipal Securities or the bases for opinions relating to
the validity of such issuance.
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<PAGE>
The payment of principal and interest on most securities purchased by a
Fund will depend upon the ability of the issuers to meet their obligations. Each
state, each of their political subdivisions, municipalities, and public
authorities, as well as the District of Columbia, Puerto Rico, Guam, and the
Virgin Islands are a separate "issuer" as that term is used in the Prospectuses
and this SAI. The non-governmental user of facilities financed by private
activity bonds is also considered to be an "issuer." An issuer's obligations
under its Municipal Securities are subject to the provisions of bankruptcy,
insolvency, and other laws affecting the rights and remedies of creditors, such
as the Federal Bankruptcy Code, and laws, if any, which may be enacted by
Federal or state legislatures extending the time for payment of principal or
interest, or both, or imposing other constraints upon enforcement of such
obligations or upon the ability of municipalities to levy taxes. The power or
ability of an issuer to meet its obligations for the payment of interest on and
principal of its Municipal Securities may be materially adversely affected by
litigation or other conditions.
Certain types of Municipal Securities (private activity bonds) have
been or are issued to obtain funds to provide, among other things, privately
operated housing facilities, pollution control facilities, convention or trade
show facilities, mass transit, airport, port or parking facilities, and certain
local facilities for water supply, gas, electricity, or sewage or solid waste
disposal. Private activity bonds are also issued for privately held or publicly
owned corporations in the financing of commercial or industrial facilities. Most
governments are authorized to issue private activity bonds for such purposes in
order to encourage corporations to locate within their communities. The
principal and interest on these obligations may be payable from the general
revenues of the users of such facilities.
From time to time, proposals have been introduced before Congress for
the purpose of restricting or eliminating the Federal income tax exemption for
interest on Municipal Securities. Moreover, with respect to Municipal Securities
issued by Kansas, the Trust cannot predict which legislation, if any, may be
proposed in the state legislature or which proposals, if any, might be enacted.
Such proposals, while pending or if enacted, might materially and adversely
affect the availability of Municipal Securities generally, or Kansas Municipal
Securities specifically, for investment by the Fund and the liquidity and value
of such portfolios. In such an event, a Fund impacted would re-evaluate its
investment objective and policies and consider possible changes in its structure
or possible dissolution.
Although the Kansas Fund invests primarily in Municipal Securities with
intermediate and long-term maturities, it may also purchase short-term General
Obligation Notes, Tax Anticipation Notes, Bond Anticipation Notes, Revenue
Anticipation Notes, Tax-Exempt Commercial Paper, Construction Loan Notes, and
other forms of short-term loans. Such instruments are issued with a short-term
maturity in anticipation of the receipt of tax funds, the proceeds of bond
placements, or other revenues. The Fund may also invest in long-term tax-exempt
instruments.
The following information as to certain Kansas State considerations is
given to investors in view of the Kansas Fund's policy of concentrating its
investments in Kansas issuers. Such information supplements the information in
the Prospectuses. It is derived from sources that are generally available to
investors and is believed to be accurate. Such information constitutes only a
brief summary, does not purport to be a complete description and is based on
information from official statements relating to securities offerings of Kansas
State issuers. Neither the Trust nor the Kansas Fund has independently verified
this information.
Kansas is a large but sparsely populated state in the central plains
region of the United States. Kansas' approximately 2.6 million people are
increasingly concentrated in several urban centers that are located in the
northeast and south central regions of the state. Kansas' economy is primarily
based on manufacturing, wholesale and retail trade, finance, construction and
agriculture. Kansas is a major producer of livestock and grain. Stability in
durable goods manufacturing, and in the service, construction and trade
industries has sustained steady economic growth in Kansas for the past several
years. Slower growth in jobs and personal income is forecast for Kansas through
the year 2000.
The University of Kansas Institute for Public Policy and Business
Research summarized its forecast for the Kansas economy through the year 2000 in
"The Outlook for Kansas and the Nation: 1999 Update and 2000 Forecast," KANSAS
BUSINESS REVIEW, 23, No. 1, pages 26 and 27, as follows:
A summary of the current forecast for Kansas is shown in the table
below. A prominent characteristic of the forecast is that in most
categories, and especially in job (non-farm wage and salary employment)
and personal income growth, the rates of increase appear to be slowing
significantly from the corresponding rates of increase in 1998. Jobs in
Kansas are expected to grow 2.2 percent in 1999 and 2.0 percent in
2000, compared to 3.5 percent in 1998. Personal income is expected to
grow 4.5 percent in 1999 and 4.3 percent in 2000, compared to 5.6
percent in 1998; real personal income (personal income corrected for
inflation) is expected to increase 3.0 percent in 1999 and 2.3 percent
in 2000, compared to 4.8 percent in 1998.
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While the comparisons of the forecast to 1998 are dramatic, it is
probably important to have some other basis of comparison in order to
bring the forecasted growth rates into sharper perspective. A useful
basis of comparison for this purpose is to compare the forecasted
growth rates to their averages during the 1990s, a period that has in
general seen the Kansas economy perform quite well. For example, the
average annual rate of job growth in Kansas during the 1990-1998 period
was just under 2.4 percent. The predicted increases of 2.2 percent in
1999 and 2.0 percent in 2000 are right in line with this longer-run
average.
The average rate of personal income growth during the 1990-1998 period
was just under 5.3 percent. Although the forecasted rates of personal
income growth (4.5 percent in 1999 and 4.3 percent in 2000) are nearly
a full percentage point less, this may be somewhat misleading given the
current period is one of very low inflation. A more meaningful
comparison will arise when we adjust for the changes in inflation rates
by looking at real personal income. The average annual rate of growth
of real personal income during the 1990-1998 period was just under 2.5
percent. Once again, we see that the predicted real personal income
increases of 3.0 percent in 1999 and 2.3 percent in 2000 are in line
with the average rate of increase from 1990 through 1998.
Looking at the unemployment rate forecast in table below also helps to
place the forecast in perspective. The unemployment rate in Kansas
averaged 3.8 percent in 1998. Strong economic growth throughout the
year brought the unemployment rate down as the year progressed, so that
1999 began with a lower unemployment rate than 1998 did. The predicted
unemployment rates of 3.4 percent for all of 1999 and 3.5 percent for
all of 2000 mean that the Kansas economy is expected to be strong
enough during these two years to keep the unemployment rate at the low
level at which it ended 1998.
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<TABLE>
<CAPTION>
THE KANSAS FORECAST - SUMMARY
1998 1999 2000
<S> <C> <C> <C>
Civilian Labor Force (thousands) 1411 1451 1483
PERCENT CHANGE 3.2 2.9 2.2
Employment (thousands) 1357 1401 1431
PERCENT CHANGE 3.2 3.3 2.1
Unemployment Rate 3.8 3.4 3.5
Nonfarm Wages & Salary Emp. (thousands) 1312 1341 1368
PERCENT CHANGE 3.5 2.2 2.0
Nominal Personal Income (mil. current $) 65855 68811 71777
PERCENT CHANGE 5.6 4.5 4.3
Real Personal Income (mil. of 1992$) 58432 60160 61550
PERCENT CHANGE 4.8 3.0 2.3
Source: Kansas Econometric Model, IPPBR University of
Kansas
PERCENT CHANGE is percent change from the pervious year.
</TABLE>
Evidence for slower growth of the Kansas economy in 1999 comes from the
job figures that are available for the first eight months of the year.
Although jobs increased 3.2 percent during the first quarter of 1999,
that rate of increase fell to 2.3 percent in the second quarter and 1.8
percent in the third quarter. Slower job growth is expected to continue
during the fourth quarter of 1999 and the first quarter of 2000 before
increasing during the last three quarters of the year. The most recent
figures available for Kansas personal income (5.6 percent increase
during the first quarter of 1999) are consistent with the first quarter
of job growth figures in suggesting that the state's economy carried
the momentum of 1998 through the first quarter of this year.
Two major sectors of the Kansas economy, manufacturing and services,
provide further evidence of the source of somewhat slower growth in
1999. Jobs in non-durable goods manufacturing decreased during the
second and third quarters of 1999, as job losses in the printing and
publishing sector continued to have a dampening effect. Job growth in
durable goods manufacturing, which was one of the bright spots in the
state economy during the last two years (6.7 percent job growth in 1997
and 5.5 percent job growth in 1998) was modest during the first quarter
of the year and leveled off during the second and third quarters. The
robust growth in durable goods manufacturing in 1997 and 1998 was
driven by the buildup in employment in the aircraft and parts sector.
Although the latter sector has continued to grow at a modest rate
during 1999, this rate has not been sufficient to drive overall durable
goods manufacturing growth to a high level.
The services sector, which accounts for more than a fourth of Kansas
employment and has consistently exhibited high employment growth rates
during the last 15 years, also exhibited slower employment growth
during the second and third quarters of 1999. Jobs in the sector grew
4.8 percent during the first quarter of the year, nearly matching
1998's 5.4 percent increase. However, the rate of job increase fell to
2.9 percent during the second quarter and 1.9 percent during the third
quarter. Slower job growth in services is expected to continue through
the first quarter of 2000 but is expected to pick up to above four
percent during the last half of the year.
BAAI believes that the information summarized above describes some of
the more significant matters relating to the Kansas Fund. The sources of the
information are the official statements of issuers located in the state, other
publicly available documents, and oral statements from various state agencies.
BAAI has not independently verified any of the information contained in the
official statements, other publicly available documents, or oral statements from
various state agencies.
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<PAGE>
OPTIONS ON CURRENCIES
Certain Funds may purchase and sell options on currencies to hedge the
value of securities the Fund holds or intends to buy. Options on foreign
currencies may be traded on U.S. and foreign exchanges or over-the-counter.
OTHER INVESTMENT COMPANIES
In seeking to attain their investment objectives, certain Funds may
invest in securities issued by other investment companies within the limits
prescribed by the 1940 Act, its rules and regulations and any exemptive relief
obtained by the Funds. Other than the Feeder Fund, which invests all of its
assets in a corresponding Master Portfolio, each Fund currently intends to limit
its investments so that, as determined immediately after a securities purchase
is made: (a) not more than 5% of the value of its total assets will be invested
in the securities of any one investment company; (b) not more than 10% of the
value of its total assets will be invested in the aggregate in securities of
investment companies as a group; and (c) not more than 3% of the outstanding
voting stock of any one investment company will be owned by the Fund or by the
Trust as a whole. As a shareholder of another investment company, a Fund would
bear, along with other shareholders, its pro rata portion of the other
investment company's expenses, including Advisory fees. These expenses would be
in addition to the Advisory and other expenses that a Fund bears in connection
with its own operations. The Adviser has agreed to remit to the respective
investing Fund fees payable to it under its respective Investment Advisory
Agreement with an affiliated money market Fund to the extent such fees are based
upon the investing Fund's assets invested in shares of the affiliated money
market Fund.
PARTICIPATION INTERESTS AND COMPANY RECEIPTS
Certain Funds may purchase from domestic financial institutions and
trusts created by such institutions participation interests and trust receipts
in high quality debt securities. A participation interest or receipt gives the
Fund an undivided interest in the security in the proportion that the Fund's
participation interest or receipt bears to the total principal amount of the
security. As to certain instruments for which the Fund will be able to demand
payment, the Fund intends to exercise its right to do so only upon a default
under the terms of the security, as needed to provide liquidity or to maintain
or improve the quality of its investment portfolio. It is possible that a
participation interest or trust receipt may be deemed to be an extension of
credit by the Fund to the issuing financial institution rather than to the
obligor of the underlying security and may not be directly entitled to the
protection of any collateral security provided by the obligor. In such event,
the ability of the Fund to obtain repayment could depend on the issuing
financial institution.
Participation interests and trust receipts may have fixed, floating or
variable rates of interest, and will have remaining maturities of thirteen
months or less (as defined by the SEC). If a participation interest or trust
receipt is unrated, the Adviser will have determined that the interest or
receipt is of comparable quality to those instruments in which the Fund may
invest pursuant to guidelines approved by the Board of Trustees. For certain
participation interests or trust receipts the Fund will have the right to demand
payment, on not more than 30 days' notice, for all or any part of the Fund's
participation interest or trust receipt in the securities involved, plus accrued
interest.
REAL ESTATE INVESTMENT TRUSTS
A real estate investment trust ("REIT") is a managed portfolio of real
estate investments which may include office buildings, apartment complexes,
hotels and shopping malls. An equity REIT holds equity positions in real estate,
and it seeks to provide its shareholders with income from the leasing of its
properties, and with capital gains from any sales of properties. A mortgage REIT
specializes in lending money to developers of properties, and passes any
interest income it may earn to its shareholders.
REITs may be affected by changes in the value of the underlying
property owned or financed by the REIT, while Mortgage REITs also may be
affected by the quality of credit extended. Both equity and mortgage REITs are
dependent upon management skill and may not be diversified. REITs also may be
subject to heavy cash flow dependency, defaults by borrowers, self-liquidation,
and the possibility of failing to qualify for tax-free pass-through of income
under the Internal Revenue Code of 1986, as amended.
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<PAGE>
REPURCHASE AGREEMENTS
The repurchase price under any repurchase agreements described in the
Prospectuses generally equals the price paid by a Fund plus interest negotiated
on the basis of current short-term rates (which may be more or less than the
rate on the securities underlying the repurchase agreement). Securities subject
to repurchase agreements will be held by the Trust's custodian in a segregated
account or in the Federal Reserve/Treasury book-entry system. Repurchase
agreements are considered to be loans by the Trust under the 1940 Act.
REVERSE REPURCHASE AGREEMENTS
At the time a Fund enters into a reverse repurchase agreement, it may
establish a segregated account with its custodian bank in which it will maintain
cash, U.S. Government securities or other liquid high grade debt obligations
equal in value to its obligations in respect of reverse repurchase agreements.
Reverse repurchase agreements involve the risk that the market value of the
securities the Funds are obligated to repurchase under the agreement may decline
below the repurchase price. In the event the buyer of securities under a reverse
repurchase agreement files for bankruptcy or becomes insolvent, the Funds' use
of proceeds of the agreement may be restricted pending a determination by the
other party, or its trustee or receiver, whether to enforce the Funds'
obligation to repurchase the securities. Reverse repurchase agreements are
speculative techniques involving leverage, and are subject to asset coverage
requirements if the Funds do not establish and maintain a segregated account (as
described above). In addition, some or all of the proceeds received by a Fund
from the sale of a portfolio instrument may be applied to the purchase of a
repurchase agreement. To the extent the proceeds are used in this fashion and a
common broker/dealer is the counterparty on both the reverse repurchase
agreement and the repurchase agreement, the arrangement might be recharacterized
as a swap transaction. Under the requirements of the 1940 Act, the Funds are
required to maintain an asset coverage (including the proceeds of the
borrowings) of at least 300% of all borrowings. Depending on market conditions,
the Funds' asset coverage and other factors at the time of a reverse repurchase,
the Funds may not establish a segregated account when the Adviser believes it is
not in the best interests of the Funds to do so. In this case, such reverse
repurchase agreements will be considered borrowings subject to the asset
coverage described above.
SECURITIES LENDING
To increase return on portfolio securities, certain Funds may lend
their portfolio securities to broker/dealers and other institutional investors
pursuant to agreements requiring that the loans be continuously secured by
collateral equal at all times in value to at least the market value of the
securities loaned. Collateral for such loans may include cash, securities of the
U.S. Government, its agencies or instrumentalities, an irrevocable letter of
credit issued by (i) a U.S. bank that has total assets exceeding $1 billion and
that is a member of the Federal Deposit Insurance Corporation, or (ii) a foreign
bank that is one of the 75 largest foreign commercial banks in terms of total
assets, or any combination thereof. Such loans will not be made if, as a result,
the aggregate of all outstanding loans of the Fund involved exceeds 33% of the
value of its total assets which may include cash collateral received for
securities loaned. There may be risks of delay in receiving additional
collateral or in recovering the securities loaned or even a loss of rights in
the collateral should the borrower of the securities fail financially. However,
loans are made only to borrowers deemed by the Adviser to be of good standing
and when, in its judgment, the income to be earned from the loan justifies the
attendant risks. Pursuant to the securities loan agreement a Fund is able to
terminate the securities loan upon notice of not more than five business days
and thereby secure the return to the Fund of securities identical to the
transferred securities upon termination of the loan.
SHORT SALES
Certain Funds may from time to time enter into short sales
transactions. A Fund will not make short sales of securities nor maintain a
short position unless at all times when a short position is open, such Fund owns
an equal amount of such securities or securities convertible into or
exchangeable, without payment of any further consideration, for securities of
the same issue as, and equal in amount to, the securities sold short. This is a
technique known as selling short "against the box." Such short sales will be
used by a Fund for the purpose of deferring recognition of gain or loss for
federal income tax purposes.
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SPECIAL SITUATIONS
Certain Funds may invest in "special situations." A special situation
arises when, in the opinion of the Adviser, the securities of a particular
company will, within a reasonably estimable period of time, be accorded market
recognition at an appreciated value solely by reason of a development applicable
to that company, and regardless of general business conditions or movements of
the market as a whole. Developments creating special situations might include,
among others: liquidations, reorganizations, recapitalizations, mergers,
material litigation, technical breakthroughs and new management or management
policies. Although large and well known companies may be involved, special
situations more often involve comparatively small or unseasoned companies.
Investments in unseasoned companies and special situations often involve much
greater risk than is inherent in ordinary investment securities.
STANDARD & POOR'S DEPOSITARY RECEIPTS ("SPDRS")
Certain Funds may purchase Standard & Poor's Depositary Receipts, or
SPDRs, which are interests in a unit investment trust holding a portfolio of
securities linked to the S&P 500 Index. Because a unit investment trust is an
investment company under the 1940 Act, a Fund's investments in SPDRs are subject
to the limitations set forth in Section 12(d)(1)(A) of the 1940 Act.
SPDRs closely track the underlying portfolio of securities, trade like
a share of common stock and pay periodic dividends proportionate to those paid
by the portfolio of stocks that comprise the S&P 500 Index. As a holder of
interests in a unit investment trust, a Fund would indirectly bear its ratable
share of that unit investment trust's expenses. At the same time the Fund would
continue to pay its own management and advisory fees and other expenses, as a
result of which the Fund and its shareholders in effect will be absorbing
duplicate levels of fees with respect to investments in such unit investment
trusts.
SPDRs are subject to the risks of an investment in a broadly based
portfolio of large-capitalization common stocks, including the risk that the
general level of stock prices may decline, thereby adversely affecting the value
of such investment. In addition, because individual investments in SPDRs are not
redeemable, except upon termination of the unit investment trust, the liquidity
of small holdings of SPDRs will depend upon the existence of a secondary market.
Large holdings of SPDRs are called "creation unit size" and are redeemable in
kind only and are not redeemable for cash from the unit investment trust. The
price of SPDRs is derived and based upon the securities held by the unit
investment trust. Accordingly, the level of risk involved in the purchase or
sale of a SPDR is similar to the risk involved in the purchase or sale of
traditional common stock, with the exception that the pricing mechanism for
SPDRs is based on a basket of stocks. Disruptions in the markets for the
securities underlying SPDRs purchased or sold by a Fund could result in losses
on SPDRs.
STAND-BY COMMITMENTS
Certain Funds may acquire "stand-by commitments" with respect to
Municipal Securities held in their portfolios. Under a "stand-by commitment," a
dealer agrees to purchase from a Fund, at a Fund's option, specified Municipal
Securities at a specified price. Stand-by commitments are exercisable by a Fund
at any time before the maturity of the underlying Municipal Securities, and may
be sold, transferred, or assigned by a Fund only with the underlying
instruments.
The amount payable to a tax-free bond fund, such as the Kansas Fund,
upon its exercise of a stand-by commitment will normally be (i) the Fund's
acquisition cost of the Municipal Securities (excluding any accrued interest
which a the Fund paid on their acquisition), less any amortized market premium
or plus any amortized market or original issue discount during the period a Fund
owned the securities, plus (ii) all interest accrued on the securities since the
last interest payment date during that period. Under normal market conditions,
in determining net asset value a Fund values the underlying Municipal Securities
on an amortized cost basis. Accordingly, the amount payable by a dealer upon
exercise of a stand-by commitment will normally be substantially the same as the
portfolio value of the underlying Municipal Securities.
A Fund's right to exercise stand-by commitments will be unconditional
and unqualified. A stand-by commitment will not be transferable by a Fund,
although the Fund could sell the underlying Municipal Securities to a third
party at any time. Until a Fund exercises its stand-by commitment, it owns the
securities in its portfolio which are subject to the stand-by commitment.
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The Funds expect that stand-by commitments will generally be available
without the payment of any direct or indirect consideration. However, if
necessary or advisable, a Fund may pay for a stand-by commitment either
separately in cash or by paying a higher price for the security being acquired
which will be subject to the commitment (thus reducing the yield to maturity
otherwise available for the same security). When a Fund pays any consideration
directly or indirectly for a stand-by commitment, its cost will be reflected as
unrealized depreciation for the period during which the commitment is held by
that Fund.
Each Fund intends to enter into stand-by commitments only with banks
and broker/dealers which, in the Adviser's opinion, present minimal credit
risks. In evaluating the credit worthiness of the issuer of a stand-by
commitment, the Adviser will review periodically the issuer's assets,
liabilities, contingent claims, and other relevant financial information.
The Funds would acquire stand-by commitments solely to facilitate
portfolio liquidity and do not intend to exercise their rights thereunder for
trading purposes. Stand-by commitments acquired by a Fund will be valued at zero
in determining net asset value. A Fund's reliance upon the credit of these
dealers, banks, and broker/dealers will be secured by the value of the
underlying Municipal Securities that are subject to the commitment. Thus, the
risk of loss to the Fund in connection with a "stand-by commitment" will not be
qualitatively different from the risk of loss faced by a person that is holding
securities pending settlement after having agreed to sell the securities in the
ordinary course of business.
STRIPPED SECURITIES
Certain Funds may purchase stripped securities issued or guaranteed by
the U.S. Government, where the principal and interest components are traded
independently under the Separate Trading of Registered Interest and Principal of
Securities program ("STRIPS"). Under STRIPS, the principal and interest
components are individually numbered and separately issued by the U.S. Treasury
at the request of depository financial institutions, which then trade the
component parts independently.
In addition, the Fund may purchase stripped mortgage-backed securities
("SMBS") issued by the U.S. Government (or a U.S. Government agency or
instrumentality) or by private issuers such as banks and other institutions. If
the underlying obligations experience greater than anticipated prepayments of
principal, the Fund may fail to fully recover its initial investment. The market
value of the class consisting entirely of principal payments can be extremely
volatile in response to changes in interest rates. The yields on a class of SMBS
that receives all or most of the interest are generally higher than prevailing
market yields on other mortgage-backed obligations because their cash flow
patterns are also volatile and there is a greater risk that the initial
investment will not be full recovered. SMBS issued by the U.S. Government (or a
U.S. Government agency or instrumentality) may be considered liquid under
guidelines established by the Trust's Board of Trustees if they can be disposed
of promptly in the ordinary course of business at a value reasonably close to
that used in the calculation of the Fund's per share net asset value.
Although stripped securities may not pay interest to holders prior to
maturity, Federal income tax regulations require a Fund to recognize as interest
income a portion of the bond's discount each year. This income must then be
distributed to shareholders along with other income earned by the Fund. To the
extent that any shareholders in the Fund elect to receive their dividends in
cash rather than reinvest such dividends in additional Fund shares, cash to make
these distributions will have to be provided from the assets of the Fund or
other sources such as proceeds of sales of Fund shares and/or sales of portfolio
securities. In such cases, the Fund will not be able to purchase additional
income producing securities with cash used to make such distributions and its
current income may ultimately be reduced as a result.
U.S. AND FOREIGN BANK OBLIGATIONS
These obligations include negotiable certificates of deposit, banker's
acceptances and fixed time deposits. Each Fund limits its investments in
domestic bank obligations to banks having total assets in excess of $1 billion
and subject to regulation by the U.S. Government. Each Fund may also invest in
certificates of deposit issued by members of the Federal Deposit Insurance
Corporation ("FDIC") having total assets of less than $1 billion, provided that
the Fund will at no time own more than $100,000 principal amount of certificates
of deposit (or any higher principal amount which in the future may be fully
covered by FDIC insurance) of any one of those issuers. Fixed time deposits are
obligations which are payable at a stated maturity date and bear a fixed rate of
interest. Generally, fixed time deposits may be withdrawn on demand by a Fund,
but they may be subject to early withdrawal penalties which vary depending upon
market conditions and the remaining maturity of the obligation. Although fixed
time deposits do not have a market, there are no contractual restrictions on a
Fund's right to transfer a beneficial interest in the deposit to a third party.
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Each Fund limits any investments in foreign bank obligations (I.E.,
obligations of foreign branches and subsidiaries of domestic banks, and domestic
and foreign branches and agencies of foreign banks) to obligations of banks
which at the time of investment are branches or subsidiaries of domestic banks
which meet the criteria in the preceding paragraphs or are branches or agencies
of foreign banks which (i) have more than $10 billion, or the equivalent in
other currencies, in total assets; (ii) in terms of assets are among the 75
largest foreign banks in the world; (iii) have branches or agencies in the
United States; and (iv) in the opinion of the Adviser, pursuant to the
established by the Board of Trustees of the Trust, are of an investment quality
comparable to obligations of domestic banks which may be purchased by a Fund.
These obligations may be general obligations of the parent bank in addition to
the issuing branch or subsidiary, but the parent bank's obligations may be
limited by the terms of the specific obligation or by governmental regulation.
Each Fund also limits its investments in foreign bank obligations to banks,
branches and subsidiaries located in Western Europe (United Kingdom, France,
Germany, Belgium, The Netherlands, Italy and Switzerland), Scandinavia (Denmark
and Sweden), Australia, Japan, the Cayman Islands, the Bahamas and Canada. Each
Fund will limit its investment in securities of foreign banks to not more than
20% of total assets at the time of investment.
Each Fund may also make interest-bearing savings deposits in commercial
and savings banks in amounts not in excess of 5% of the total assets of the
Fund.
U.S. GOVERNMENT OBLIGATIONS
Each Fund may invest in U.S. Government obligations. Examples of the
types of U.S. Government obligations that may be held by the Funds include, in
addition to U.S. Treasury bonds, notes and bills, the obligations of the Federal
Home Loan Banks, Federal Farm Credit Banks, Federal Land Banks, Federal Housing
Administration, Farmers Home Administration, Export-Import Bank of the United
States, Small Business Administration, Government National Mortgage Association,
Federal National Mortgage Association, General Services Administration, Student
Loan Marketing Association, Central Bank for Cooperatives, Federal Home Loan
Mortgage Corporation, Federal Intermediate Credit Banks, Tennessee Valley
Authority, Resolution Funding Corporation and Maritime Administration.
Obligations guaranteed as to principal or interest by the U.S. Government, its
agencies, authorities or instrumentalities are deemed to include: (a) securities
for which the payment of principal and interest is backed by an irrevocable
letter of credit issued by the U.S. Government, its agencies, authorities or
instrumentalities and (b) participations in loans made to foreign governments or
their agencies that are so guaranteed. The secondary market for certain of these
participations is limited. If such participations are illiquid they will not be
purchased.
U.S. Government obligations include principal and interest components
of securities issued or guaranteed by the U.S. Treasury if the components are
traded independently under the Separate Trading of Registered Interest and
Principal of Securities program. Obligations issued or guaranteed as to
principal or interest by the U.S. Government, its agencies, authorities or
instrumentalities may also be acquired in the form of custodial receipts. These
receipts evidence ownership of future interest payments, principal payments or
both on certain notes or bonds issued by the U.S. Government, its agencies,
authorities or instrumentalities.
USE OF SEGREGATED AND OTHER SPECIAL ACCOUNTS
Options, futures and forward foreign currency contracts that obligate a
Fund to provide cash, securities or currencies to complete such transactions
will entail that Fund to either segregate assets in an account with, or on the
books of, the Trust's custodian, or otherwise "covering" the transaction as
described below. For example, a call option written by a Fund will require the
Fund to hold the securities subject to the call (or securities convertible into
the needed securities without additional consideration) or liquid assets
sufficient to meet the obligation by purchasing and delivering the securities if
the call is exercised. A call option written on an index will require that Fund
to have portfolio securities that correlate with the index. A put option written
by a Fund also will require that Fund to have available assets sufficient to
purchase the securities the Fund would be obligated to buy if the put is
exercised.
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A forward foreign currency contract that obligates a Fund to provide
currencies will require the Fund to hold currencies or liquid securities
denominated in a foreign currency which will equal the Fund's obligations. Such
a contract requiring the purchase of currencies also requires segregation.
Unless a segregated account consists of the securities, cash or
currencies that are the subject of the obligation, a Fund will hold cash, U.S.
Government securities and other high grade liquid debt obligations in a
segregated account. These assets cannot be transferred while the obligation is
outstanding unless replaced with other suitable assets. In the case of an
index-based transaction, a Fund could own securities substantially replicating
the movement of the particular index.
In the case of a futures contract, a Fund must deposit initial margin
and variation margin, as often as daily, if the position moves adversely,
sufficient to meet its obligation to purchase or provide securities or
currencies, or to pay the amount owed at the expiration of an index-based
futures contract. Similarly, options on futures contracts require a Fund to
deposit margin to the extent necessary to meet the Fund's commitments.
In lieu of such assets, such transactions may be covered by other means
consistent with applicable regulatory policies. A Fund may enter into
off-setting transactions so that its combined position, coupled with any
segregated assets, equals its net outstanding obligation in related options and
hedging transactions. For example, a Fund could purchase a put option if the
strike price of that option is the same or higher than the strike price of a put
option sold by that Fund. Moreover, instead of segregating assets if a Fund held
a futures or forward contract, it could purchase a put option on the same
futures or forward contract with a strike price as high or higher than the price
of the contract held. Of course, the off-setting transaction must terminate at
the time of or after the primary transaction.
VARIABLE- AND FLOATING-RATE INSTRUMENTS
Certain Funds may purchase variable-rate and floating rate obligations.
If such instrument is not rated, the Adviser will consider the earning power,
cash flows, and other liquidity ratios of the issuers and guarantors of such
obligations and, if the obligation is subject to a demand feature, will monitor
their financial status to meet payment on demand. In determining average
weighted portfolio maturity, a variable-rate demand instrument issued or
guaranteed by the U.S. Government or an agency or instrumentality thereof will
be deemed to have a maturity equal to the period remaining until the obligations
next interest rate adjustment. Other variable-rate obligations will be deemed to
have a maturity equal to the longer of the period remaining to the next interest
rate adjustment or the time a Fund can recover payment of principal as specified
in the instrument.
Variable-rate demand notes held by a Money Market Fund may have
maturities of more than 397 days, provided (i) the Fund is entitled to payment
principal on not more than 30 days' notice, or at specified intervals not
exceeding 397 days (upon not more than 30 days' notice), and (ii) the rate of
interest on such note is adjusted automatically at periodic intervals which may
extend up to 397 days.
The variable- and-floating rate demand instruments that the Funds may
purchase include participations in Municipal Securities purchased from and owned
by financial institutions, primarily banks. Participation interests provide a
Fund with a specified undivided interest (up to 100%) in the underlying
obligation and the right to demand payment of the unpaid principal balance plus
accrued interest on the participation interest from the institution upon a
specified number of days' notice, not to exceed 30 days. Each participation
interest is backed by an irrevocable letter of credit or guarantee of a bank
that the Adviser has determined meets the prescribed quality standards for the
Funds. The bank typically retains fees out of the interest paid on the
obligation for servicing the obligation, providing the letter of credit, and
issuing the repurchase commitment.
WARRANTS
Certain Funds are permitted to invest in warrants. Warrants are
privileges issued by corporations enabling the owner to subscribe to and
purchase a specified number of shares of the corporation at a specified price
during a specified period of time. The prices of warrants do not necessarily
correlate with the prices of the underlying securities. The purchase of warrants
involves the risk that the purchaser could lose the purchase value of the
warrant if the right to subscribe to additional shares is not exercised prior to
the warrant's expiration. Also, the purchase of warrants involves the risk that
the effective price paid for the warrant added to the subscription price of the
related security may exceed the value of the subscribed security's market price
such as when there is no movement in the level of the underlying security.
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WHEN-ISSUED PURCHASES AND FORWARD COMMITMENTS
A Fund may agree to purchase securities on a when-issued basis or enter
into a forward commitment to purchase securities. When a Fund engages in these
transactions, its custodian will segregate cash, U.S. Government securities or
other high quality debt obligations equal to the amount of the commitment.
Normally, the custodian will segregate portfolio securities to satisfy a
purchase commitment, and in such a case a Fund may be required subsequently to
segregate additional assets in order to ensure that the value of the segregated
assets remains equal to the amount of the Fund's commitment. Because a Fund will
segregate cash or liquid assets to satisfy its purchase commitments in the
manner described, the Fund's liquidity and ability to manage its portfolio might
be adversely affected in the event its commitments to purchase when-issued
securities ever exceeded 25% of the value of its assets. In the case of a
forward commitment to sell portfolio securities, the Fund's custodian will hold
the portfolio securities themselves in a segregated account while the commitment
is outstanding.
A Fund will make commitments to purchase securities on a when-issued
basis or to purchase or sell securities on a forward commitment basis only with
the intention of completing the transaction and actually purchasing or selling
the securities. If deemed advisable as a matter of investment strategy, however,
a Fund may dispose of or renegotiate a commitment after it is entered into, and
may sell securities it has committed to purchase before those securities are
delivered to the Fund on the settlement date. In these cases the Fund may
realize a capital gain or loss.
When a Fund engages in when-issued and forward commitment transactions,
it relies on the other party to consummate the trade. Failure of such party to
do so may result in the Fund's incurring a loss or missing an opportunity to
obtain a price considered to be advantageous.
The value of the securities underlying a when-issued purchase or a
forward commitment to purchase securities, and any subsequent fluctuations in
their value, is taken into account when determining the net asset value of a
Fund starting on the date the Fund agrees to purchase the securities. The Fund
does not earn dividends on the securities it has committed to purchase until
they are paid for and delivered on the settlement date. When the Fund makes a
forward commitment to sell securities it owns, the proceeds to be received upon
settlement are included in the Fund's assets. Fluctuations in the value of the
underlying securities are not reflected in the Fund's net asset value as long as
the commitment remains in effect.
PORTFOLIO TURNOVER
Generally, the Equity Funds will purchase portfolio securities for
capital appreciation or investment income, or both, and not for short-term
trading profits. If a Fund's annual portfolio turnover rate exceeds 100%, it may
result in higher brokerage costs and possible tax consequences for the Portfolio
and its shareholders. For the Funds' portfolio turnover rates, see the
"Financial Highlights" in the Prospectus.
INVESTMENT RISKS AND CONSIDERATIONS
In addition to the investment risks and considerations identified in
certain of the securities descriptions above, there are additional investment
risks and considerations associated with an investment in certain of the Funds.
Investments by a Fund in common stocks and other equity securities are
subject to stock market risks. The value of the stocks that the Fund holds, like
the broader stock market, may decline over short or even extended periods. The
U.S. stock market tends to be cyclical, with periods when stock prices generally
rise and periods when prices generally decline. As of the date of this SAI, the
stock market, as measured by the S&P 500 Index and other commonly used indexes,
was trading at or close to record levels. There can be no guarantee that these
levels will continue.
The Kansas Fund is a non-diversified fund, which means that it
typically invest in fewer issuers than diversified funds. Therefore,
appreciation or depreciation of an investment in a single issuer could have a
greater impact on the Fund's net asset value.
The value of a Fund's investments in debt securities, including U.S.
Government Obligations, will tend to decrease when interest rates rise and
increase when interest rates fall. In general, longer-term debt instruments tend
to fluctuate in value more than shorter-term debt instruments in response to
interest rate movements. In addition, debt securities that are not backed by the
United States Government are subject to credit risk, which is the risk that the
issuer may not be able to pay principal and/or interest when due. In addition,
obligations with the lowest investment grade rating (E.G., "BBB" by Standard &
Poor's Corporation ("S&P") or "Baa" by Moody's Investors Service, Inc.
("Moody's")) have speculative characteristics and changes in economic conditions
or other circumstances are more likely to lead to a weakened capacity to make
principal and interest payments than is the case with higher grade debt
obligations. Subsequent to its purchase by the Fund, an issue of securities may
cease to be rated or its rating may be reduced below the minimum rating required
for purchase by the Fund. The Adviser will consider such an event in determining
whether the Fund should continue to hold the obligation. Unrated obligations may
be acquired by the Fund if they are determined by the Adviser to be of
comparable quality at the time of purchase to rated obligations that may be
acquired.
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Certain of the Funds' investments constitute derivative securities,
which are securities whose value is derived, at least in part, from an
underlying index or reference rate. There are certain types of derivative
securities that can, under certain circumstances, significantly increase a
purchaser's exposure to market or other risks. The Adviser, however, only
purchases derivative securities in circumstances where it believes such
purchases are consistent with such Fund's investment objective and do not unduly
increase the Fund's exposure to market or other risks. For additional risk
information regarding the Funds' investments in particular instruments, see
"Appendix A -- Fund Securities."
MASTER FEEDER STRUCTURE. The Feeder Fund is an open-end mutual fund
that seeks to achieve its investment objectives by investing all of its
investable assets in a corresponding Master Portfolio which has the same
investment objective. The Feeder Fund may withdraw its investment in the Master
Portfolio at any time if the Board of Trustees of the Trust determines that it
is in the best interest of the Feeder Fund to do so. Upon such withdrawal, the
Board of Trustees would consider what action might be taken, including the
investment of all of the assets of the Fund in another pooled investment entity
having the same investment objective as the Feeder Fund or the hiring of an
investment adviser to manage the Feeder Fund's assets in accordance with its
investment policies.
The Master Portfolio is a separate series of Nations Master Investment
Trust (the "Master Trust"), which is organized as a business trust under the
laws of Delaware. The Feeder Fund and other entities that may investment in the
Master Portfolio from time to time (E.G., other investment companies and
commingled trust funds) will each be liable for all obligations of the Master
Portfolio. However, the risk of the Feeder Fund incurring financial loss on
account of such liability is limited to circumstances in which both inadequate
insurance exists and a Portfolio itself is unable to meet its obligations.
Accordingly, the Trust's Boards of Trustees believes that neither the Feeder
Fund nor its shareholders will be adversely affected by reason of the Feeder
Fund's investing in the Master Portfolio. As with any mutual fund, other
investors in the Master Portfolio could control the results of voting at the
Master Portfolio level in certain instances (E.G., a change in fundamental
policies by the Master Portfolio which was not approved by the Fund's
shareholders). This could result in the Feeder Fund's withdrawal of its
investment in the Master Portfolio. Further, the withdrawal of other entities
that may from time to time invest in the Master Portfolio could have an adverse
effect on the performance of such Master Portfolio and the corresponding Feeder
Fund, such as decreased economies of scale, and increased per share operating
expenses. In addition, the total withdrawal by another investment company as an
investor in the Master Portfolio will cause the such Master Portfolio to
terminate automatically in 120 days unless the Feeder Fund and any other
investors in the Master Portfolio unanimously agree to continue the business of
the Master Portfolio. If unanimous agreement is not reached to continue the
Master Portfolio, the Board of Trustees of the Trust would need to consider
alternative arrangements for the Feeder Fund, such as those described above.
When the Fund is required to vote as an interestholder of the Master Portfolio,
current regulations provide that in those circumstances the Feeder Fund may
either seek instructions from its security holders with regard to voting such
proxies and vote such proxies in accordance with such instructions or the Feeder
Fund may vote its shares in the Master Portfolio in the same proportion of all
other security holders in the Master Portfolio.
There may also be other investment companies through which you can
invest in the Master Portfolio which may have higher or lower fees and expense
than those of its corresponding Fund and which may therefore have different
performance results than the Feeder Fund.
SPECIAL RISK RELATING TO THE HIGH YIELD FUND/MASTER PORTFOLIO -- High
yield bonds may be more susceptible to real or perceived adverse economic and
competitive industry conditions than higher grade bonds. The prices of high
yield bonds have been found to be less sensitive to interest-rate changes than
more highly rated investments, but more sensitive to adverse economic downturns
or individual corporate developments. A projection of an economic downturn or of
a period of rising interest rates, for example, could cause a decline in high
yield bond prices because the advent of a recession could lessen the ability of
a highly leveraged company to make principal and interest payments on its debt
securities. Adverse publicity and investor perceptions, whether or not based on
fundamental analysis, may decrease the values and liquidity of high yield bonds,
especially in a thinly traded market. Legislation designed to limit the use of
high yield bonds in corporate transactions may have a material adverse effect on
a Fund's/Master Portfolio's net asset value and investment practices. In
addition, there may be special tax considerations associated with investing in
high yield bonds structured as zero coupon or payment-in-kind securities. A
Fund/Master Portfolio records the interest on these securities annually as
income even though it receives no cash interest until the security's maturity or
payment date. Also, distributions on account of such interest generally will be
taxable to shareholders even if the Fund/Master Portfolio does not distribute
cash to them. Therefore, in order to pay taxes on this interest, shareholders
may have to redeem some of their shares to pay the tax or the Fund/Master
Portfolio may have to sell some of its assets to reduce the Fund's/Master
Portfolio's assets and may thereby increase its expense ratio and decrease its
rate of return. The Sub-Adviser seeks to reduce risk through diversification,
credit analysis and attention to current developments and trends in both the
economy and financial markets. In addition, investments in foreign securities
may serve to provide further diversification.
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Because certain high yield debt instruments that the High Yield
Fund/Master Portfolio purchases may be instruments issued by foreign
governments, agencies, corporations or other entities of countries, some of
which may be considered emerging markets countries, there are certain additional
risks associated with such investments.
Investors should also understand and consider carefully the special
risks involved in foreign investing. Such risks include, but are not limited to:
(1) restrictions on foreign investment and repatriation of capital; (2)
fluctuations in currency exchange rates, which can significantly affect a
Fund's/Master Portfolio's share price; (3) costs of converting foreign currency
into U.S. dollars and U.S. dollars into foreign currencies; (4) greater price
volatility and less liquidity; (5) settlement practices, including delays, which
may differ from those customary in U.S. markets; (6) exposure to political and
economic risks, including the risk of nationalization, expropriation of assets
and war; (7) possible impositions of foreign taxes and exchange control and
currency restrictions; (8) lack of uniform accounting, auditing and financial
reporting standards; (9) less governmental supervision of securities markets,
brokers and issuers of securities; (10) less financial information available to
investors; and (11) difficulty in enforcing legal rights outside the United
States.
Certain of the risks associated with investments by the High Yield
Fund/Master Portfolio in foreign securities are heightened with respect to
investment in emerging markets countries. Political and economic structures in
many emerging market countries, especially those in Eastern Europe, the Pacific
Basin, and the Far East, may be undergoing significant evolution and rapid
development, and may lack the social, political and economic stability
characteristic of more developed countries. Investing in emerging markets
securities also involves risks which are in addition to the usual risks inherent
in foreign investments. For example, some emerging market countries may have
fixed or managed currencies that are not free-floating against the U.S. dollar.
Further, certain currencies may not be traded internationally and some countries
with emerging securities markets have sustained long periods of substantially
high inflation or rapid fluctuation in inflation rates which can have negative
effects on a country's economy or securities markets.
MANAGEMENT OF THE TRUST
-----------------------
The business and affairs of the Trust is managed under the direction of
its Board of Trustees. This SAI contains the names of and general background
information concerning each Trustee. The Trustees and executive officers of the
Trust and their principal occupations during the last five years are set forth
below. The address of each, unless otherwise indicated, is 111 Center Street,
Little Rock, Arkansas 72201. Those trustees who are "interested persons" of the
Trust (as defined in the 1940 Act) are indicated by an asterisk(*).
43
<PAGE>
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATIONS
DURING PAST 5 YEARS
POSITION WITH AND CURRENT
NAME, ADDRESS, AND AGE THE TRUST DIRECTORSHIPS
- ---------------------- --------- -------------
<S> <C> <C> <C>
Edmund L. Benson, III, 62 Trustee Director, President and Treasurer,
Saunders & Benson, Inc. Saunders & Benson, Inc. (Insurance),
1510 Willow Lawn Drive Insurance Managers, Inc.
Suite 216 (insurance); Trustee, Nations
Richmond, VA 23230 Reserves, Master Investment Trust,
Nations Annuity Trust and Nations
Fund Trust; Director, Nations Fund,
Inc., and Nations LifeGoal Funds,
Inc.; Director, Nations Fund
Portfolios, Inc. through August,
1999.
William P. Carmichael, 66 Trustee Trustee - 231 Funds (investment
Succession Fund company) from 1993 to 1995, Time
The Wrigley Building Horizon Fund (investment company)
400 North Michigan Avenue from 1995 to 1999, Pacific
Suite 1016 Innovations Trust (investment
Chicago, IL 60611 company) from 1997 to 1999, Nations
Annuity Trust (investment company)
since December 1999, Nations Master
Investment Trust (investment
company) since December 1999 and
Nations Funds Trust (investment
company) since December 1999;
Director- The Hain Food Group, Inc.
(specialty food products
distributor) until December 1998,
Cobra Electronics Corporation
(electronic equipment manufacturer),
Opta Food Ingredients, Inc. (food
ingredients manufacturer), Golden
Rule Insurance Company, Nations
LifeGoal Funds, Inc. (investment
company) since December 1999.
James Ermer, 56 Trustee Retired Executive Vice President,
11511 Compass Point Drive Corporate Development and Planning -
Ft. Myers, FL 33908 Land America (title insurance);
Senior Vice President, Finance - CSX
Corporation (transportation and
natural resources); Director -
National Mine Service (mining
supplies), Lawyers Title Corporation
(title insurance); Trustee, Nations
Reserves, Nations Fund Trust,
Nations Annuity Trust and Nations
Master Investment Trust; Director,
Nations Fund, Inc. and Nations
LifeGoal Funds, Inc.; Director,
Nations Fund Portfolios, Inc.
through August, 1999.
William H. Grigg, 66 Trustee Chairman Emeritus since July 1997,
Duke Power Co. Chairman and Chief Executive Officer
16092A Reap Road from April 1994 to July 1997 - Duke
Albermarle, NC 28001 Power Co.; Director - The Shaw
Group, Inc.; Director and Vice
Chairman, Aegis Insurance Services,
Ltd. (a mutual insurance company in
Bermuda); Trustee, Nations
Reserves, Nations Fund Trust,
Nations Annuity Trust and Nations
Master Investment Trust; Director,
Hatteras Income Securities, Inc.,
Nations Government Income Term Trust
2003, Inc., Nations Government
Income Term Trust 2004, Inc.,
Nations Balanced Target Maturity
Fund, Inc., Nations Fund, Inc. and
Nations LifeGoal Funds, Inc.;
Director, Nations Fund Portfolios,
Inc. through August, 1999.
44
<PAGE>
PRINCIPAL OCCUPATIONS
DURING PAST 5 YEARS
POSITION WITH AND CURRENT
NAME, ADDRESS, AND AGE THE TRUST DIRECTORSHIPS
- ---------------------- --------- -------------
Thomas F. Keller, 67 Trustee R.J. Reynolds Industries Professor
Fuqua School of Business of Business Administration and
P.O. Box 90120 Former Dean - Fuqua School of
Duke University Business, Duke University; Director
Durham, NC 27708 - LADD Furniture, Inc. (furniture),
Wendy's International, Inc.
(restaurant operating and
franchising), American Business
Products, Inc. (printing services),
Dimon, Inc. (tobacco), Biogen, Inc.
(pharmaceutical biotechnology);
Trustee, The Mentor Funds, Mentor
Institutional Trust, Cash Reserve
Trust, Nations Reserves, Nations
Fund Trust, Nations Annuity Trust
and Nations Master Investment Trust;
Director, Hatteras Income
Securities, Inc., Nations Government
Income Term Trust 2003, Inc.,
Nations Government Income Term Trust
2004, Inc., Nations Balanced Target
Maturity Fund, Inc. and Nations
LifeGoal Funds, Inc.; Director,
Nations Fund Portfolios, Inc.
through August, 1999.
Carl E. Mundy, Jr., 64 Trustee President and CEO - USO from May
USO World Headquarters 1996 to present; Commandant - United
Washington Navy Yard States Marine Corps from July 1991
Building 198 to July 1995; Director -
901 M Street, S.E. Shering-Plough (pharmaceuticals and
Washington, D.C. 20374-5096 health care products); General
Dynamics Corporation (defense
systems); Trustee, Nations Reserves,
Nations Fund Trust, Nations Annuity
Trust and Nations Master Investment
Trust; Director, Nations Fund, Inc.
and Nations LifeGoal Funds, Inc.;
Director, Nations Fund Portfolios,
Inc. through August, 1999.
Dr. Cornelius J. Pings, 70* Trustee President - Association of American
480 S. Orange Grove Blvd. Universities from February 1993 to
Pasadena, CA 91105 June 1998; Director - Farmers Group,
Inc. (insurance company), Nations
Fund, Inc. and Nations LifeGoal
Funds, Inc.; Trustee, Master
Investment Trust, Series I from 1995
to 1999, Master Investment Trust,
Series II from 1995 to 1997, Nations
Reserves, Nations Fund Trust,
Nations Annuity Trust and Nations
Master Investment Trust.;
Director/Trustee and Chairman -
Pacific Horizon Funds, Inc. and
Master Investment Trust, Series I,
from inception to May 1999;
Director - Time Horizon Funds and
Pacific Innovations Trust; Director,
Nations Fund Portfolios, Inc.
through August, 1999.
James B. Sommers*, 60 Trustee President - NationsBank Trust from
237 Cherokee Road January 1992 to September 1996;
Charlotte, NC 28207 Executive Vice President -
NationsBank Corporation from January
1992 to May 1997; Chairman - Central
Piedmont Community College
Foundation; Board of Commissioners,
Charlotte/ Mecklenberg Hospital
Authority; Director - Nations Fund,
Inc. and Nations LifeGoal Funds,
Inc.; Trustee, Central Piedmont
Community College; Mint Museum of
Art, Nations Reserves, Nations Fund
Trust, Nations Annuity Trust and
Nations Master Investment Trust;
Director, Nations Fund Portfolios,
Inc. through August, 1999.
45
<PAGE>
PRINCIPAL OCCUPATIONS
DURING PAST 5 YEARS
POSITION WITH AND CURRENT
NAME, ADDRESS, AND AGE THE TRUST DIRECTORSHIPS
- ---------------------- --------- -------------
A. Max Walker*, 77 President, Trustee and Independent Financial Consultant;
4580 Windsor Gate Court Chairman of the Board Director and Chairman of the Board -
Atlanta, GA 30342 Hatteras Income Securities, Inc.,
Nations Government Income Term Trust
2003, Inc., Nations Government
Income Term Trust 2004, Inc.,
Nations Balanced Target Maturity
Fund, Inc.; President, Director and
Chairman of the Board - Nations
Fund, Inc. and Nations LifeGoal
Funds, Inc.; President, Trustee and
Chairman of the Board - Nations
Reserves, Nations Fund Trust,
Nations Annuity Trust and Nations
Master Investment Trust; Director,
Nations Fund Portfolios, Inc.
through August, 1999.
Charles B. Walker, 60 Trustee Director-Ethyl Corporation (chemical
Albermarle Corporation manufacturing); Vice Chairman and
Vice Chairman and CFO Chief Financial Officer - Albemarle
330 South Fourth Street Corporation (chemical
Richmond, VA 23219 manufacturing); Director, Nations
Fund, Inc. and Nations LifeGoal
Funds, Inc.; Trustee, Nations
Reserves, Nations Fund Trust,
Nations Annuity Trust and Nations
Master Investment Trust; Director,
Nations Fund Portfolios, Inc.
through August, 1999.
Thomas S. Word, Jr.*, 61 Trustee Partner - McGuire, Woods, Battle &
McGuire, Woods, Battle & Boothe LLP Boothe LLP (law firm); Director -
One James Center Vaughan-Bassett Furniture Companies,
8th Floor Inc. (furniture), Nations Fund, Inc.
Richmond, VA 23219 and Nations LifeGoal Funds, Inc.;
Trustee, Nations Reserves, Nations
Fund Trust, Nations Annuity Trust
and Nations Master Investment Trust;
Director, Nations Fund Portfolios,
Inc. through August, 1999.
Richard H. Blank, Jr., 42 Secretary and Treasurer Senior Vice President since 1998,
Stephens Inc. Vice President from 1994 to 1998 and
111 Center Street Manager from 1990 to 1994 - Mutual
Little Rock, AR 72201 Fund Services, Stephens Inc.;
Secretary since September 1993 and
Treasurer since November 1998 -
Nations Fund, Inc., Nations LifeGoal
Funds, Inc., Nations Reserves,
Nations Fund Trust, Nations Annuity
Trust and Nations Master Investment
Trust.; Secretary and Treasurer,
Nations Fund Portfolios, Inc.
through August, 1999.
Michael W. Nolte, 38 Assistant Secretary Assistant Secretary - Nations Fund
Stephens Inc. Trust, Nations Fund, Inc., Nations
Reserves, Nations LifeGoal Funds,
Inc., Nations Annuity Trust and
Nations Master Investment Trust;
Assistant Secretary, Nations Fund
Portfolios, Inc. through August,
1999.
James E. Banks, 43 Assistant Secretary Assistant Secretary - Nations Fund
Stephens Inc. Trust, Nations Fund, Inc., Nations
Reserves, Nations LifeGoal Funds,
Inc., Nations Annuity Trust and
Nations Master Investment Trust; ;
Director, Nations Fund Portfolios,
Inc. through August, 1999.
</TABLE>
Each Trustee is a board member of the Trust, Nations Fund Trust,
Nations Fund, Inc., Nations Reserves, Nations Annuity Trust, Nations Master
Investment Trust and Nations LifeGoal Funds, Inc., each a registered investment
company that is part of the Nations Funds Family. Richard H. Blank, Jr., Michael
W. Nolte, and James E. Banks. Jr. also are officers of Trust, Nations Fund
Trust, Nations Fund, Inc., Nations Reserves, Nations Annuity Trust, Nations
Master Investment Trust and Nations LifeGoal Funds, Inc.
46
<PAGE>
The Trust and the Adviser have adopted codes of ethics which contain
policies on personal securities transactions by "access persons," including
portfolio managers and investment analysts. These policies substantially comply
in all material respects with the recommendations set forth in the May 9, 1994
Report of the Advisory Group on Personal Investing of the Investment Company
Institute. The Trust's Code of Ethics, among other things, prohibits each access
person of the Trust from purchasing or selling securities when such person knows
or should have known that, at the time of the transaction, the security (i) was
being considered for purchase or sale by a Fund, or (ii) was being purchased or
sold by a Fund. For purposes of the Code of Ethics, an access person means (i) a
trustee or officer of the Trust, (ii) any employee of the Trust (or any company
in a control relationship with the Trust) who, in the course of his/her regular
duties, obtains information about, or makes recommendations with respect to, the
purchase or sale of securities by the Trust, and (iii) any natural person in a
control relationship with the Trust who obtains information concerning
recommendations made to the Trust regarding the purchase or sale of securities.
Portfolio managers and other persons who assist in the investment process are
subject to additional restrictions, including a requirement that they disgorge
to the Trust any profits realized on short-term trading (I.E., the purchase/sale
or sale/purchase of securities within any 60-day period). The above restrictions
do not apply to purchases or sales of certain types of securities, including
mutual fund shares, money market instruments and certain U.S. Government
securities. To facilitate enforcement, the Code of Ethics generally requires
that the Trust's access persons, other than its "disinterested" directors or
trustees, submit reports to the Trust's designated compliance person regarding
transactions involving securities which are eligible for purchase by a Fund.
NATIONS FUNDS RETIREMENT PLAN
Under the terms of the Nations Funds Retirement Plan for Eligible
Directors/Trustees (the "Retirement Plan"), each Director/Trustee may be
entitled to certain benefits upon retirement from the Board of
Directors/Trustees. Pursuant to the Retirement Plan, the normal retirement date
is the date on which the eligible director/trustee has attained age 65 and has
completed at least five years of continuous service with one or more of the
open-end investment companies advised by the Adviser. If a director/trustee
retires before reaching age 65, no benefits are payable. Each eligible
director/trustee is entitled to receive an annual benefit from the Funds
commencing on the first day of the calendar quarter coincident with or next
following his date of retirement equal to 5% of the aggregate
director's/trustee's fees payable by the Funds during the calendar year in which
the director's/trustee's retirement occurs multiplied by the number of years of
service (not in excess of ten years of service) completed with respect to any of
the Funds. Such benefit is payable to each eligible director/trustee in
quarterly installments for a period of no more than five years. If an eligible
director/trustee's dies after attaining age 65, the director's/trustees
surviving spouse (if any) will be entitled to receive 50% of the benefits that
would have been paid (or would have continued to have been paid) to the
director/trustee if he had not died. The Retirement Plan is unfunded. The
benefits owed to each director/trustee are unsecured and subject to the general
creditors of the Funds.
NATIONS FUNDS DEFERRED COMPENSATION PLAN
Under the terms of the Nations Funds Deferred Compensation Plan for
Eligible Directors/Trustees (the "Deferred Compensation Plan"), each
director/trustee may elect, on an annual basis, to defer all or any portion of
the annual board fees (including the annual retainer and all attendance fees)
payable to the director/trustee for that calendar year. An application was
submitted to and approved by the SEC to permit deferring directors/trustees to
elect to tie the rate of return on fees deferred pursuant to the Deferred
Compensation Plan to one or more of certain investment portfolios of certain
Funds. Distributions from the deferring directors'/trustees deferral accounts
will be paid in cash, in generally equal quarterly installments over a period of
five years beginning on the date the deferring director's/trustees' retirement
benefits commence under the Retirement Plan. The Board of Directors/Trustees, in
its sole discretion, may accelerate or extend such payments after a
director's/trustee's termination of service. If a deferring director/trustee
dies prior to the commencement of the distribution of amounts in his deferral
account, the balance of the deferral account will be distributed to his
designated beneficiary in a lump sum as soon as practicable after the
director's/trustee's death. If a deferring director/trustee dies after the
commencement of such distribution, but prior to the complete distribution of his
deferral account, the balance of the amounts credited to his deferral account
will be distributed to his designated beneficiary over the remaining period
during which such amounts were distributable to the director/trustee. Amounts
payable under the Deferred Compensation Plan are not funded or secured in any
way and deferring directors/trustees have the status of unsecured creditors of
the Funds from which they are deferring compensation.
47
<PAGE>
Trustee Compensation
--------------------
Board members of the Trust are compensated for their services to the
Nations Funds Family on a flat rate basis, and not on a per registered
investment company or per fund basis as outlined in the following chart.
<TABLE>
<CAPTION>
BOARD MEMBER COMPENSATION ARRANGEMENT
- ------------------------------------------------- -------------------------------------------------------------
<S> <C>
BOARD MEMBER ANNUAL RETAINER: $65,000
BOARD CHAIRMAN: Additional 20% of the base annual
retainer.
Payable in quarterly
installments. Payable pro rata
for partial calendar year of
service. Allocated across
multiple registrants.
MEETING FEES: $5,000 per meeting for in-person meetings
(up to six meetings per calendar year) and $1,000 for
telephone meetings. Allocated across multiple registrants
convened at meetings.
- ------------------------------------------------- -------------------------------------------------------------
AUDIT COMMITTEE MEMBERS CHAIRMAN: Additional 10% of the base annual retainer as
Board Member.
MEETING FEES: $1,000 per meeting if not held within one
calendar day before or after regularly scheduled Board
meetings. Allocated across multiple registrants convened
at meetings.
- ------------------------------------------------- -------------------------------------------------------------
NOMINATING COMMITTEE MEMBERS MEETING FEES: $1,000 per meeting if not held within one
calendar day before or after regularly scheduled Board
meetings. Allocated across multiple registrants convened
at meetings.
- ------------------------------------------------- -------------------------------------------------------------
</TABLE>
SHAREHOLDER AND TRUSTEE LIABILITY
The Trust's Declaration of Trust provides that shareholders shall not
be subject to any personal liability for the acts or obligations of the Trust,
and also provides for indemnification out of the trust property of any
shareholder held personally liable solely by reason of his being or having been
a shareholder and not because of his acts or omissions or some other reason.
The Declaration of Trust states further that no Trustee, officer, or
agent of the Trust shall be personally liable for or on account of any contract,
debt, tort, claim, damage, judgment, or decree arising out of or connected with
the administration or preservation of the trust estate or the conduct of any
business of the Trust; nor shall any Trustee be personally liable to any person
for any action or failure to act except by reason of his own bad faith, willful
misfeasance, gross negligence, or reckless disregard of his duties as Trustee.
The Declaration of Trust also provides that all persons having any claim against
the Trustees shall look solely to the trust property for payment.
With the exceptions stated, the Declaration of Trust provides that a
Trustee is entitled to be indemnified against all liabilities and expenses
reasonably incurred by him in connection with the defense or disposition of any
proceeding in which he may be involved or with which he may be threatened by
reason of his being or having been a Trustee, and that the Trustees have the
power, but not the duty, to indemnify officers and employees of the Trust unless
any such person would not be entitled to indemnification had he or she been a
Trustee.
48
<PAGE>
INVESTMENT ADVISORY, ADMINISTRATION, CUSTODY,
---------------------------------------------
TRANSFER AGENCY, OTHER SERVICE PROVIDERS, SHAREHOLDER SERVICING AND
-------------------------------------------------------------------
DISTRIBUTION AGREEMENTS
-----------------------
INVESTMENT ADVISER AND SUB-ADVISERS
Bank of America and its Investment Adviser and Sub-Adviser Affiliates
---------------------------------------------------------------------
BAAI is the investment adviser to the Funds, except the Feeder Fund.
BACAP is the investment sub-adviser to the MidCap Index Fund and the Kansas
Fund. MacKay Shields is the investment sub-adviser to the High Yield Master
Portfolio.
BAAI also serves as the investment adviser to the funds of Nations
Fund, Inc., Nations Fund Trust, Nations Reserves and the portfolios of Nations
Annuity Trust, Nations LifeGoal Funds, Inc. and Nations Master Investment Trust,
each a registered investment company that is part of the Nations Funds Family.
In addition, BAAI serves as the investment advisor to Hatteras Income
Securities, Inc., Nations Government Income Term Trust 2003, Inc., Nations
Government Income Term Trust 2004, Inc. and Nations Balanced Target Maturity
Fund, Inc., each a closed-end diversified management investment company traded
on the New York Stock Exchange.
The respective principal offices of BAAI and BACAP are located at One
Bank of America Plaza, Charlotte, N.C. 28255. MacKay Shields is located at 9
West 57th Street, New York, New York 10019.
Since 1874, Bank of America and its predecessors have been managing
money for foundations, universities, corporations, institutions and individuals.
Today, Bank of America affiliates collectively manage in excess of $100 billion,
including more than $70 billion in mutual fund assets. It is a company dedicated
to a goal of providing responsible investment management and superior service.
Bank of America is recognized for its sound investment approaches, which place
it among the nation's foremost financial institutions. Bank of America and its
affiliates organization makes available a wide range of financial services to
its over 6 million customers through over 1700 banking and investment centers.
Investment Advisory and Sub-Advisory Agreements
-----------------------------------------------
Pursuant to the terms of the Trust's Investment Advisory Agreement and
Sub-Advisory Agreements (at times, the "Advisory Agreements") with BAAI and/or
BACAP and subject at all times to the control of the Board of Trustees and, in
conformity with the stated policies of the Trust and BACAP each select and
manages the investments of their respective Funds. Each such advisory entity
obtains and evaluates economic, statistical and financial information to
formulate and implement investment policies for the Funds that they advise.
The Advisory Agreements each provide that in the absence of willful
misfeasance, bad faith, negligence or reckless disregard of obligations or
duties thereunder on the part of an Adviser, respectively, or any of its
respective officers, trustees, employees or agents, such Adviser shall not be
subject to liability to the Trust or to any shareholder of the Trust for any act
or omission in the course of, or connected with, rendering services under
thereunder or for any losses that may be sustained in the purchase, holding or
sale of any security.
Each Advisory Agreement became effective with respect to a Fund after
approved by the Board of the Trust, and continues from year to year, provided
that such continuation of the Agreement is specifically approved at least
annually by (a) (i) the Trust's Board or (ii) the vote of "a majority of the
outstanding voting securities" of a Fund (as defined in Section 2(a)(42) of the
1940 Act), and (b) the affirmative vote of a majority of the Trust's Board of
Trustees who are not parties to such Agreement or "interested persons" (as
defined in the 1940 Act) of a party to such Agreement (other than as Trustees of
the Trust), by votes cast in person at a meeting specifically called for such
purpose. The respective Advisory Agreement terminates automatically in the event
of its assignment, and is terminable with respect to a Fund at any time without
penalty by the Trust (by vote of the Board of Trustees or by vote of a majority
of the outstanding voting securities of the Fund) or by BAAI on 60 days' written
notice.
The Funds, in any advertisement or sales literature, may advertise the
names, experience and/or qualifications of the portfolio manager(s) of any Fund,
or if a Fund is managed by team or committee, such Fund may advertise the names,
experience and/or qualifications of any such team or committee member.
The Adviser may waive a portion of its fees; however, any such waiver
may be discontinued at any time. As discussed below," an Adviser will be
required to reduce its fees charged to the Funds, in direct proportion to the
fees payable by such Funds to an Adviser and the Administrator, if the expenses
of the Funds exceed the applicable expense limitation of any state in which the
Funds' shares are registered or qualified for sale.
49
<PAGE>
Because the Funds are new series they have not yet paid any advisory or
sub-advisory fees.
The investment advisory agreement for the High Yield Master Portfolio
between BAAI and NMIT, and the sub-advisory agreement among BAAI, NMIT and
MacKay Shields are generally similar to the Advisory Agreements.
CO-ADMINISTRATORS AND SUB-ADMINISTRATOR
Stephens Inc. and BAAI (the "Co-Administrators") serve as
co-administrators of the Trust pursuant to co-administration agreements
("Co-Administration Agreements"). Under the Co-Administration Agreements, the
co-administrators receive, as compensation for their services rendered,
co-administration fees, computed daily and paid monthly, at the annual rate of:
0.18% of the High Yield Fund; 0.12% the Kansas Fund; and 0.13% of the MidCap
Index Fund, of the average daily net assets of each such Fund. Pursuant to the
co-administration agreements among BAAI, Stephens Inc. and NMIT, the
co-administrators receive with respect to the High Yield Master Portfolio, as
compensation for their services rendered, co-administration fees, computed daily
and paid monthly, at the annual rate of 0.05% of the daily net assets of the
High Yield Master Portfolio.
Pursuant to the Co-Administration Agreement, Stephens has agreed to,
among other things, (i) maintain office facilities for the Funds, (ii) furnish
statistical and research data, data processing, clerical, and internal executive
and administrative services to the Trust, (iii) furnish corporate secretarial
services to the Trust, including coordinating the preparation and distribution
of materials for Board meetings, (iv) coordinate the provision of legal advice
to the Trust with respect to regulatory matters, (v) coordinate the preparation
of reports to the Trust's shareholders and the SEC, including annual and
semi-annual reports, (vi) coordinating the provision of services to the Trust by
the Transfer Agent, Sub-Transfer Agent and the Custodian, and (vii) generally
assist in all aspects of the Trust's operations. Stephens bears all expenses
incurred in connection with the performance of its services.
Also, pursuant to the Co-Administration Agreement, BAAI has agreed to,
among other things, (i) provide accounting and bookkeeping services for the
Funds, (ii) compute each Fund's net asset value and net income, (iii) accumulate
information required for the Trust's reports to shareholders and the SEC, (iv)
prepare and file the Trust's federal and state tax returns, (v) perform monthly
compliance testing for the Trust, and (vi) prepare and furnish the Trust monthly
broker security transaction summaries and transaction listings and performance
information. BAAI bears all expenses incurred in connection with the performance
of its services.
The Co-Administration Agreement may be terminated by a vote of a
majority of the Trustees, by Stephens or by BAAI, respectively, on 60 days'
written notice without penalty. The Co-Administration Agreements are not
assignable without the written consent of the other party. Furthermore, the
Co-Administration Agreements provide that Stephens and BAAI shall not be liable
to the Funds or to their shareholders except in the case of Stephens's or
BAAI's, willful misfeasance, bad faith, gross negligence or reckless disregard
of duty.
BNY serves as sub-administrator for the Funds pursuant to
sub-administration agreements. Pursuant to their terms, BNY assists Stephens and
BAAI in supervising, coordinating and monitoring various aspects of the Funds'
administrative operations. For providing such services, BNY is entitled to
receive a monthly fee from Stephens and BAAI based on an annual rate of 0.01% of
the Funds' average daily net assets.
50
<PAGE>
DISTRIBUTION PLANS AND SHAREHOLDER SERVICING ARRANGEMENTS
PRIMARY A SHARES
----------------
The Trust has not adopted an shareholder servicing or distribution plan
for the Primary A Shares.
INVESTOR A SHARES
-----------------
The Trust has adopted a Shareholder Servicing and Distribution Plan
(the "Investor A Plan") pursuant to Rule 12b-1 under the 1940 Act with respect
to each Fund's Investor A Shares. The Investor A Plan provides that each Fund
may pay, up to 0.25% (on an annualized basis) of the average daily net asset
value of the Funds: (i) the Distributor for reimbursements of
distribution-related expenses actually incurred by the Distributor, including,
but not limited to, expenses of organizing and conducting sales seminars,
printing of prospectuses and statements of additional information (and
supplements thereto) and reports for other than existing shareholders,
preparation and distribution of advertising material and sales literature and
costs of administering the Investor A Plan; or (ii) certain broker/dealers and
other financial institutions ("Agents") who offer shares to their customers and
who have entered into Shareholder Servicing Agreements, and Sales Support
Agreements with respect to the Funds, for providing the services contemplated
thereunder.
The shareholder servicing activities for which compensation may be
received under the Investor A Plan may include, among other things: (i)
aggregating and processing purchase and redemption requests and transmitting
promptly net purchase and redemption orders to the Distributor or transfer
agent; (ii) providing customers with a service that invests the assets of their
accounts in Shares pursuant to specific or pre-authorized instructions; (iii)
processing dividend and distribution payments; (iv) providing information
periodically to customers showing their positions in Shares; (v) arranging for
bank wires; (vi) responding to customers' inquiries concerning their investment
in Shares; (vii) providing subaccounting with respect to Shares beneficially
owned by customers or the information to the Trust necessary for subaccounting;
(viii) if required by law, forwarding shareholder communications (such as
proxies, shareholder reports, annual and semi-annual financial statements and
dividend, distribution and tax notices) to customers; (ix) forwarding to
customers proxy statements and proxies containing any proposals regarding the
Shareholder Servicing Agreement; (x) general shareholder liaison services; and
(xi) providing such other similar services as the Trust may reasonably request
to the extent such firms are permitted to do so under applicable statutes, rules
or regulations.
The Investor A Plan may be terminated at any time by a vote of a
majority of the non-interested Trustees or with respect to a particular Fund, by
vote of a majority of the outstanding securities of the Investor A Shares of
such Fund.
Because the Funds are new series, they have not yet paid any fees
pursuant to the Investor A Plan.
INVESTOR B SHARES
-----------------
The Trust has adopted a Distribution Plan (the "Investor B Distribution
Plan") pursuant to Rule 12b-1 under the 1940 Act with respect to each Fund's
Investor B Shares. The Trust also has adopted a Shareholder Servicing Plan (the
"Investor B Servicing Plan") for each Fund's Investor B Shares.
Under the Investor B Distribution Plan, the Trust may compensate or
reimburse its Distributor for any activities or expenses primarily intended to
result in the sale of Investor B Shares of the Trust's Funds. Payments by the
Trust may not exceed, on an annual basis, 0.75% of the average daily net asset
value of a Fund's Investor B Shares.
The fees payable under the Investor B Distribution Plan are used
primarily to compensate or reimburse the Distributor for distribution services
provided by it, and related expenses incurred, including payments by the
Distributor to compensate or reimburse banks, broker/dealers or other financial
institutions that have entered into Sales Support Agreements with the
Distributor ("Selling Agents"), for sales support services provided, and related
expenses incurred, by such Selling Agents. These services may include:
preparation, printing and distribution of prospectuses, sales literature and
advertising materials by the Distributor or, as applicable, Selling Agents,
attributable to distribution or sales support activities, respectively;
commissions, incentive compensation or other compensation to, and expenses of,
account executives or other employees of the Distributor or Selling Agents,
attributable to distribution or sales support activities, respectively; overhead
and other office expenses of the Distributor or Selling Agents, attributable to
distribution or sales support activities, respectively; opportunity costs
relating to the foregoing (which may be calculated as a carrying charge on the
Distributor's or Selling Agents' unreimbursed expenses incurred in connection
with distribution or sales support activities, respectively); and any other
costs and expenses relating to distribution or sales support activities.
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Notwithstanding anything herein to the contrary, no Fund shall be
obligated to make any payments under this Plan that exceed the maximum amounts
payable under Rule 2830, of the National Association of Securities Dealers, Inc.
Conduct Rules.
Under the Investor B Servicing Plan, the Trust may execute agreements
with broker/dealers, banks and other financial institutions that are dealers of
record or holders of record or which have a servicing relationship ("Servicing
Agents") with the beneficial owners of Investor B Shares of the Trust, pursuant
to which, Servicing Agents shall provide shareholder support services to their
clients who beneficially own Investor B Shares of the Funds in consideration of
a fee, at an annual rate of up to 0.25% of the average daily net asset value of
the Investor B Shares beneficially owned by or attributable to such clients.
Affiliates of the Trust's distributor, administrator, co-administrator and
adviser are eligible to become Servicing Agents and to receive fees under this
Plan. The Investor B Servicing Plan further provides that all expenses incurred
by a Fund in connection with the Agreements and the implementation of such Plan
is be borne either by the holders of the Investor B Shares of the particular
Fund involved. If more than one Fund is involved and these expenses are not
directly attributable to the Investor B Shares of a particular Fund, then the
expenses may be allocated between or among the Shares of the Funds in a fair and
equitable manner.
The Investor B Servicing Plan may be terminated only by a majority of
the Board of Trustees, including a majority of the Trustees who are not
"interested persons," as defined in the Investment Company Act of 1940, of the
Trust.
INVESTOR C SHARES
-----------------
The Trust has adopted a Distribution Plan (the "Investor C Distribution
Plan") pursuant to Rule 12b-1 under the 1940 Act with respect to each Fund's
Investor C Shares. The Trust also has adopted a Shareholder Servicing Plan (the
"Investor C Servicing Plan") for each Fund's Investor C Shares.
Under the Investor C Distribution Plan, the Trust may compensate or
reimburse its Distributor for any activities or expenses primarily intended to
result in the sale of Investor C Shares of the Trust's Funds. Payments by the
Trust may not exceed, on an annual basis, 0.75% of the average daily net asset
value of a Fund's Investor C Shares.
The fees payable under the Investor C Distribution Plan are used
primarily to compensate or reimburse the Distributor for distribution services
provided by it, and related expenses incurred, including payments by the
Distributor to compensate or reimburse banks, broker/dealers or other financial
institutions that have entered into Sales Support Agreements with the
Distributor ("Selling Agents"), for sales support services provided, and related
expenses incurred, by such Selling Agents. These services may include:
preparation, printing and distribution of prospectuses, sales literature and
advertising materials by the Distributor or, as applicable, Selling Agents,
attributable to distribution or sales support activities, respectively;
commissions, incentive compensation or other compensation to, and expenses of,
account executives or other employees of the Distributor or Selling Agents,
attributable to distribution or sales support activities, respectively; overhead
and other office expenses of the Distributor or Selling Agents, attributable to
distribution or sales support activities, respectively; opportunity costs
relating to the foregoing (which may be calculated as a carrying charge on the
Distributor's or Selling Agents' unreimbursed expenses incurred in connection
with distribution or sales support activities, respectively); and any other
costs and expenses relating to distribution or sales support activities.
Notwithstanding anything herein to the contrary, no Fund shall be
obligated to make any payments under this Plan that exceed the maximum amounts
payable under Rule 2830, of the National Association of Securities Dealers, Inc.
Conduct Rules.
Under the Investor C Servicing Plan, the Trust may execute agreements
with broker/dealers, banks and other financial institutions that are dealers of
record or holders of record or which have a servicing relationship ("Servicing
Agents") with the beneficial owners of Investor C Shares of the Trust, pursuant
to which, Servicing Agents shall provide shareholder support services to their
clients who beneficially own Investor C Shares of the Funds in consideration of
a fee, at an annual rate of up to 0.25% of the average daily net asset value of
the Investor C Shares beneficially owned by or attributable to such clients.
Affiliates of the Trust's distributor, administrator, co-administrator and
adviser are eligible to become Servicing Agents and to receive fees under this
Plan. The Investor C Servicing Plan further provides that all expenses incurred
by a Fund in connection with the Agreements and the implementation of such Plan
is be borne either by the holders of the Investor C Shares of the particular
Fund involved. If more than one Fund is involved and these expenses are not
directly attributable to the Investor C Shares of a particular Fund, then the
expenses may be allocated between or among the Shares of the Funds in a fair and
equitable manner.
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The Investor C Servicing Plan may be terminated only by a majority of
the Board of Trustees, including a majority of the Trustees who are not
"interested persons," as defined in the Investment Company Act of 1940, of the
Trust.
INFORMATION APPLICABLE TO INVESTOR A, INVESTOR B, INVESTOR C PLANS
------------------------------------------------------------------
The Investor A Plan, the Investor B Plans and the Investor C Plans
(each a "Plan" and collectively the "Plans") may only be used for the purposes
specified above and as stated in each such Plan. Compensation payable to Selling
Agents or Servicing Agents for shareholder support services under the Plans
subject to, among other things, the National Association of Securities Dealers,
Inc. ("NASD") Conduct Rules, which govern receipt by NASD members of Plan fees
from registered investment companies.
Each Plan requires the officers of the Trust or the Distributor to
provide the Board of Trustees at least quarterly with a written report of the
amounts expended pursuant to the Plan and the purposes for which such
expenditures were made. The Board of Trustees reviews these reports in
connection with its decisions with respect to the Plans.
As required by Rule 12b-1 under the 1940 Act, the Investor A Plan,
Investor B Distribution Plan and Investor C Distribution Plan were approved by
the Board of Trustees, including a majority of the trustees who are not
"interested persons" (as defined in the 1940 Act) of the Trust and who have no
direct or indirect financial interest in the operation of any Plan or in any
agreements related to such Plan.
In approving the Investor A Plan, Investor B Distribution Plan and
Investor C Distribution Plan in accordance with the requirements of Rule 12b-1,
the Trustees considered various factors and determined that there was a
reasonable likelihood that each such Plan will benefit the respective Investor
A, Investor B or Investor C Shares and the holders of such shares. The Investor
A Plan, Investor B Distribution Plan and Investor C Distribution Plan were
approved by the initial shareholders of the Funds' Investor A, B and C Shares,
respectively, on December 9, 1999.
EXPENSES
The Administrator furnishes, without additional cost to the Trust, the
services of the Treasurer and Secretary of the Trust and such other personnel
(other than the personnel of the Adviser) as are required for the proper conduct
of the Trust's affairs. The Distributor bears the incremental expenses of
printing and distributing prospectuses used by the Distributor or furnished by
the Distributor to investors in connection with the public offering of the
Trust's shares and the costs of any other promotional or sales literature,
except that to the extent permitted under the Plans relating to the Investor A,
Investor B or Investor C Shares of each Fund, sales-related expenses incurred by
the Distributor may be reimbursed by the Trust.
The Trust pays or causes to be paid all other expenses of the Trust,
including, without limitation: the fees of the Adviser, the Administrator and
Co-Administrator; the charges and expenses of any registrar, any custodian or
depository appointed by the Trust for the safekeeping of its cash, fund
securities and other property, and any stock transfer, dividend or accounting
agent or agents appointed by the Trust; brokerage commissions chargeable to the
Trust in connection with fund securities transactions to which the Trust is a
party; all taxes, including securities issuance and transfer taxes; corporate
fees payable by the Trust to federal, state or other governmental agencies; all
costs and expenses in connection with the registration and maintenance of
registration of the Trust and its shares with the SEC and various states and
other jurisdictions (including filing fees, legal fees and disbursements of
counsel); the costs and expenses of typesetting prospectuses and statements of
additional information of the Trust (including supplements thereto) and periodic
reports and of printing and distributing such prospectuses and statements of
additional information (including supplements thereto) to the Trust's
shareholders; all expenses of shareholders' and trustees' meetings and of
preparing, printing and mailing proxy statements and reports to shareholders;
fees and travel expenses of trustees or trustee members of any advisory board or
committee; all expenses incident to the payment of any dividend or distribution,
whether in shares or cash; charges and expenses of any outside service used for
pricing of the Trust's shares; fees and expenses of legal counsel and of
independent auditors in connection with any matter relating to the Trust;
membership dues of industry associations; interest payable on Trust borrowings;
postage and long-distance telephone charges; insurance premiums on property or
personnel (including officers and trustees) of the Trust which inure to its
benefit; extraordinary expenses (including, but not limited to, legal claims and
liabilities and litigation costs and any indemnification related thereto); and
all other charges and costs of the Trust's operation unless otherwise explicitly
assumed by the Adviser), the Administrator or Co-Administrator.
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Expenses of the Trust which are not directly attributable to the
operations of any class of shares or Fund are pro-rated among all classes of
shares or Fund of the Trust based upon the relative net assets of each class or
Fund. Expenses of the Trust which are not directly attributable to a specific
class of shares but are directly attributable to a specific Fund are prorated
among all the classes of shares of such Fund based upon the relative net assets
of each such class of shares. Expenses of the Trust which are directly
attributable to a class of shares are charged against the income available for
distribution as dividends to such class of shares.
The Advisory Agreement, the Sub-Advisory Agreements, and the
Administration Agreement require BAAI, BACAP, and the Administrator to reduce
their fees to the extent required to satisfy any expense limitations which may
be imposed by the securities laws or regulations thereunder of any state in
which a Fund's shares are registered or qualified for sale, as such limitations
may be raised or lowered from time to time, and the aggregate of all such
investment advisory, sub-advisory, and administration fees shall be reduced by
the amount of such excess. The amount of any such reduction to be borne by BAAI,
BACAP or the Administrator shall be deducted from the monthly investment
advisory and administration fees otherwise payable to BAAI, BACAP and the
Administrator during such fiscal year. If required pursuant to such state
securities regulations, BAAI, BACAP and the Administrator will reimburse the
Trust no later than the last day of the first month of the next succeeding
fiscal year, for any such annual operating expenses (after reduction of all
investment advisory and administration fees in excess of such limitation).
Substantially similar provisions apply to the advisory agreement, sub-advisory
agreement and the administration agreement among NMIT, BAAI and MacKay Shields,
with respect to the High Yield Master Portfolio.
TRANSFER AGENTS AND CUSTODIANS
PFPC, Inc. is located at One Exchange Place, 53 State Street, Boston,
Massachusetts 02109, and acts as transfer agent for each Fund's Shares. Under
the transfer agency agreements, the transfer agent maintains shareholder account
records for the Trust, handles certain communications between shareholders and
the Trust, and distributes dividends and distributions payable by the Trust to
shareholders, and produces statements with respect to account activity for the
Trust and its shareholders for these services. The transfer agent receives a
monthly fee computed on the basis of the number of shareholder accounts that it
maintains for the Trust during the month and is reimbursed for out-of-pocket
expenses.
Bank of America serves as sub-transfer agent for each Fund's Primary A
Shares.
The Bank of New York ("BONY") 100 Church Street, New York, N.Y. 10286
serves as custodian for the Funds' assets. As custodian, BONY maintains the
Funds' securities cash and other property, delivers securities against payment
upon sale and pays for securities against delivery upon purchase, makes payments
on behalf of such Funds for payments of dividends, distributions and
redemptions, endorses and collects on behalf of such Funds all checks, and
receives all dividends and other distributions made on securities owned by such
Funds.
The SEC has amended Rule 17f-5 under the 1940 Act to permit boards to
delegate certain foreign custody matters to foreign custody managers and to
modify the criteria applied in the selection process. Accordingly, BONY serves
as Foreign Custody Manager, pursuant to a Foreign Custody Manager Agreement,
under which the Board of Directors/Trustees retain the responsibility for
selecting foreign compulsory depositories, although BONY agrees to make certain
findings with respect to such depositories and to monitor such depositories.
DISTRIBUTOR
Stephens Inc. (the "Distributor") serves as the principal underwriter
and distributor of the shares of the Funds.
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Pursuant to a distribution agreement (the "Distribution Agreement"),
the Distributor, as agent, sells shares of the Funds on a continuous basis and
transmits purchase and redemption orders that its receives to the Trust or the
Transfer Agent. Additionally, the Distributor has agreed to use appropriate
efforts to solicit orders for the sale of shares and to undertake such
advertising and promotion as it believes appropriate in connection with such
solicitation. Pursuant to the Distribution Agreement, the Distributor, at its
own expense, finances those activities which are primarily intended to result in
the sale of shares of the Funds, including, but not limited to, advertising,
compensation of underwriters, dealers and sales personnel, the printing of
prospectuses to other than existing shareholders, and the printing and mailing
of sales literature. The Distributor, however, may be reimbursed for all or a
portion of such expenses to the extent permitted by a distribution plan adopted
by the Trust pursuant to Rule 12b-1 under the 1940 Act.
The Distribution Agreement will continue year to year as long as such
continuance is approved at least annually by (i) the Board of Directors/Trustees
or a vote of the majority (as defined in the 1940 Act) of the outstanding voting
securities of the Fund and (ii) a majority of the trustees who are not parties
to the Distribution Agreement or "interested persons" of any such party by a
vote cast in person at a meeting called for such purpose. The Distribution
Agreement is not assignable and is terminable with respect to a Fund, without
penalty, on 60 days' notice by the Board of Directors/Trustees, the vote of a
majority (as defined in the 1940 Act) of the outstanding voting securities of
the Fund, or by the Distributor.
INDEPENDENT ACCOUNTANTS AND REPORTS
The Trust issues unaudited financial information semi-annually and
audited financial statements annually. The Trust furnishes proxy statements and
other shareholder reports to shareholders of record.
The annual financial statements will be audited by the Trust's
independent accountant. The Board of Trustees has selected
PricewaterhouseCoopers LLP, 1177 Avenue of the Americas, New York, New York
10036, as the Trust's independent accountant to audit the Trust's books and
review the Trust's tax returns for the Funds' fiscal year ended March 31, 2000.
Because the Trust is a newly registered investment company, it has not
yet issued any annual or semi-annual shareholder reports.
The statement of assets and liabilities of the Trust dated February 19,
2000, included herein, has been included in reliance upon the report of
PricewaterhouseCoopers LLP, given on the authority of said firm as experts in
auditing and accounting.
COUNSEL
Morrison & Foerster LLP serves as legal counsel to the Trust. Their
address is 2000 Pennsylvania Avenue, N.W., Washington, D.C. 20006.
FUND TRANSACTIONS AND BROKERAGE
-------------------------------
GENERAL BROKERAGE POLICY
Subject to policies established by the Board of Trustees of the Trust,
the Adviser is responsible for decisions to buy and sell securities for each
Fund, for the selection of broker/dealers, for the execution of such Fund's
securities transactions, and for the allocation of brokerage fees in connection
with such transactions. The Adviser's primary consideration in effecting a
security transaction is to obtain the best net price and the most favorable
execution of the order. Purchases and sales of securities on a securities
exchange are effected through brokers who charge a negotiated commission for
their services. Orders may be directed to any broker to the extent and in the
manner permitted by applicable law.
In the over-the-counter market, securities are generally traded on a
"net" basis with dealers acting as principal for their own accounts without
stated commissions, although the price of a security usually includes a profit
to the dealer. In underwritten offerings, securities are purchased at a fixed
price that includes an amount of compensation to the underwriter, generally
referred to as the underwriter's concession or discount. On occasion, certain
money market instruments may be purchased directly from an issuer, in which case
no commissions or discounts are paid.
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<PAGE>
In placing orders for portfolio securities of a Fund, the Adviser is
required to give primary consideration to obtaining the most favorable price and
efficient execution. This means that the Adviser will seek to execute each
transaction at a price and commission, if any, which provide the most favorable
total cost or proceeds reasonably attainable in the circumstances. In seeking
such execution, the Adviser will use its best judgment in evaluating the terms
of a transaction, and will give consideration to various relevant factors,
including, without limitation, the size and type of the transaction, the nature
and character of the market for the security, the confidentiality, speed and
certainty of effective execution required for the transaction, the general
execution and operational capabilities of the broker-dealer, the reputation,
reliability, experience and financial condition of the firm, the value and
quality of the services rendered by the firm in this and other transactions and
the reasonableness of the spread or commission, if any. In addition, the Adviser
will consider research and investment services provided by brokers or dealers
who effect or are parties to portfolio transactions of a Fund, the Adviser or
its other clients. Such research and investment services are those which
brokerage houses customarily provide to institutional investors and include
statistical and economic data and research reports on particular companies and
industries. Such services are used by the Adviser in connection with all of its
investment activities, and some of such services obtained in connection with the
execution of transactions for a Fund may be used in managing other investment
accounts. Conversely, brokers furnishing such services may be selected for the
execution of transactions of such other accounts, whose aggregate assets are far
larger than those of a Fund. Services furnished by such brokers may be used by
the Adviser in providing investment advisory and investment management services
for the Trust.
Commission rates are established pursuant to negotiations with the
broker based on the quality and quantity of execution services provided by the
broker in the light of generally prevailing rates. The allocation of orders
among brokers and the commission rates paid are reviewed periodically by the
Trustees of the Trust. On exchanges on which commissions are negotiated, the
cost of transactions may vary among different brokers. Transactions on foreign
stock exchanges involve payment of brokerage commissions which are generally
fixed. Transactions in both foreign and domestic over-the-counter markets are
generally principal transactions with dealers, and the costs of such
transactions involve dealer spreads rather than brokerage commissions. With
respect to over-the-counter transactions, the Adviser, where possible, will deal
directly with dealers who make a market in the securities involved except in
those circumstances in which better prices and execution are available
elsewhere.
In certain instances there may be securities which are suitable for
more than one Fund as well as for one or more of the other clients of the
Adviser. Investment decisions for each Fund and for the Adviser's other clients
are made with the goal of achieving their respective investment objectives. It
may happen that a particular security is bought or sold for only one client even
though it may be held by, or bought or sold for, other clients. Likewise, a
particular security may be bought for one or more clients when one or more other
clients are selling that same security. Some simultaneous transactions are
inevitable when several clients receive investment advice from the same
investment adviser, particularly when the same security is suitable for the
investment objectives of more than one client. When two or more clients are
simultaneously engaged in the purchase or sale of the same security, the
securities are allocated among clients in a manner believed to be equitable to
each. It is recognized that in some cases this system could have a detrimental
effect on the price or volume of the security in a particular transaction as far
as a Fund is concerned. The Trust believes that over time their ability to
participate in volume transactions will produce superior executions for the
Funds.
The portfolio turnover rate for each Fund is calculated by dividing the
lesser of purchases or sales of portfolio securities for the reporting period by
the monthly average value of the portfolio securities owned during the reporting
period. The calculation excludes all securities, including options, whose
maturities or expiration dates at the time of acquisition are one year or less.
Portfolio turnover may vary greatly from year to year as well as within a
particular year, and may be affected by cash requirements for redemption of
shares and by requirements which enable the Funds to receive favorable tax
treatment.
The Funds may participate, if and when practicable, in bidding for the
purchase of portfolio securities directly from an issuer in order to take
advantage of the lower purchase price available to members of a bidding group. A
Fund will engage in this practice, however, only when the Adviser, in its sole
discretion, believes such practice to be otherwise in the Fund's interests.
The Trust will not execute portfolio transactions through, or purchase
or sell portfolio securities from or to the distributor, the Adviser, the
administrator, the co-administrator or their affiliates, acting as principal
(including repurchase and reverse repurchase agreements), except to the extent
permitted by applicable law. In addition, the Trust will not give preference to
correspondents of Bank of America or its affiliates, with respect to such
transactions or securities. (However, the Adviser is authorized to allocate
purchase and sale orders for portfolio securities to certain financial
institutions, including, in the case of agency transactions, financial
institutions which are affiliated with Bank of America or its affiliates, and to
take into account the sale of Fund shares if the Adviser believes that the
quality of the transaction and the commission are comparable to what they would
be with other qualified brokerage firms.) In addition, a Fund will not purchase
securities during the existence of any underwriting or selling group relating
thereto of which the distributor, the Adviser, the administrator, or the
co-administrator, or any of their affiliates, is a member, except to the extent
permitted by the SEC. Under certain circumstances, the Funds may be at a
disadvantage because of these limitations in comparison with other investment
companies which have similar investment objectives but are not subject to such
limitations.
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Certain affiliates of Bank of America Corporation and its subsidiary
banks may have deposit, loan or commercial banking relationships with the
corporate users of facilities financed by industrial development revenue bonds
or private activity bonds purchased by the High Yield Bond Fund or the Kansas
Fund. Bank of America or certain of its affiliates may serve as trustee, tender
agent, guarantor, placement agent, underwriter, or in some other capacity, with
respect to certain issues of municipal securities.
Under the 1940 Act, persons affiliated with the Trust are prohibited
from dealing with the Trust as a principal in the purchase and sale of
securities unless an exemptive order allowing such transactions is obtained from
the SEC. Each of the Funds may purchase securities from underwriting syndicates
of which Bank of America or any of its affiliates is a member under certain
conditions, in accordance with the provisions of a rule adopted under the 1940
Act and any restrictions imposed by the Board of Governors of the Federal
Reserve System.
Investment decisions for each Fund are made independently from those
for the Trust's other investment portfolios, other investment companies, and
accounts advised or managed by the Adviser. Such other investment portfolios,
investment companies, and accounts may also invest in the same securities as the
Funds. When a purchase or sale of the same security is made at substantially the
same time on behalf of one or more of the Funds and another investment
portfolio, investment company, or account, the transaction will be averaged as
to price and available investments allocated as to amount, in a manner which the
Adviser believes to be equitable to each Fund and such other investment
portfolio, investment company or account. In some instances, this investment
procedure may adversely affect the price paid or received by a Fund or the size
of the position obtained or sold by the Fund. To the extent permitted by law,
the Adviser may aggregate the securities to be sold or purchased for the Funds
with those to be sold or purchased for other investment portfolios, investment
companies, or accounts in executing transactions.
Because the Trust is a new registered investment company, it has not
yet paid any brokerage commissions.
SECTION 28(E) STANDARDS
Under Section 28(e) of the Securities Exchange Act of 1934, the Adviser
shall not be "deemed to have acted unlawfully or to have breached its fiduciary
duty" solely because under certain circumstances it has caused the account to
pay a higher commission than the lowest available. To obtain the benefit of
Section 28(e), the Adviser must make a good faith determination that the
commissions paid are "reasonable in relation to the value of the brokerage and
research services provided ...viewed in terms of either that particular
transaction or its overall responsibilities with respect to the accounts as to
which it exercises investment discretion and that the services provided by a
broker provide an adviser with lawful and appropriate assistance in the
performance of its investment decision making responsibilities." Accordingly,
the price to a Fund in any transaction may be less favorable than that available
from another broker/dealer if the difference is reasonably justified by other
aspects of the portfolio execution services offered.
Broker/dealers utilized by the Adviser may furnish statistical,
research and other information or services which are deemed by the Adviser to be
beneficial to the Funds' investment programs. Research services received from
brokers supplement the Adviser's own research and may include the following
types of information: statistical and background information on industry groups
and individual companies; forecasts and interpretations with respect to U.S. and
foreign economies, securities, markets, specific industry groups and individual
companies; information on political developments; fund management strategies;
performance information on securities and information concerning prices of
securities; and information supplied by specialized services to the Adviser and
to the Trust's Directors/Trustees with respect to the performance, investment
activities and fees and expenses of other mutual funds. Such information may be
communicated electronically, orally or in written form. Research services may
also include the providing of equipment used to communicate research
information, the arranging of meetings with management of companies and the
providing of access to consultants who supply research information.
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<PAGE>
The outside research assistance is useful to the Adviser since the
brokers utilized by the Adviser as a group tend to follow a broader universe of
securities and other matters than the Adviser's staff can follow. In addition,
this research provides the Adviser with a diverse perspective on financial
markets. Research services which are provided to the Adviser by brokers are
available for the benefit of all accounts managed or advised by the Adviser. In
some cases, the research services are available only from the broker providing
such services. In other cases, the research services may be obtainable from
alternative sources in return for cash payments. The Adviser is of the opinion
that because the broker research supplements rather than replaces its research,
the receipt of such research does not tend to decrease its expenses, but tends
to improve the quality of its investment advice. However, to the extent that the
Adviser would have purchased any such research services had such services not
been provided by brokers, the expenses of such services to the Adviser could be
considered to have been reduced accordingly. Certain research services furnished
by broker/dealers may be useful to the Adviser with clients other than the
Funds. Similarly, any research services received by the Adviser through the
placement of fund transactions of other clients may be of value to the Adviser
in fulfilling its obligations to the Funds. The Adviser is of the opinion that
this material is beneficial in supplementing its research and analysis; and,
therefore, it may benefit the Trust by improving the quality of the Adviser's
investment advice. The advisory fees paid by the Trust are not reduced because
the Adviser receives such services.
Some broker/dealers may indicate that the provision of research
services is dependent upon the generation of certain specified levels of
commissions and underwriting concessions by the Adviser's clients, including the
Funds.
DESCRIPTION OF SHARES
---------------------
DESCRIPTION OF SHARES OF THE TRUST
The Trust's Board of Trustees has authorized the issuance of the
classes of shares of the Funds indicated above and may, in the future, authorize
the creation of additional investment portfolios or classes of shares.
The Board may classify or reclassify any unissued shares of the Trust
into shares of any class, classes or Fund in addition to those already
authorized by setting or changing in any one or more respects, from time to
time, prior to the issuance of such shares, the preferences, conversion or other
rights, voting powers, restrictions, limitations as to dividends,
qualifications, or terms or conditions of redemption, of such shares and,
pursuant to such classification or reclassification to increase or decrease the
number of authorized shares of any Fund or class. Any such classification or
reclassification will comply with the provisions of the 1940 Act. Fractional
shares shall have the same rights as full shares to the extent of their
proportionate interest.
All shares of a Fund have equal voting rights and will be voted in the
aggregate, and not by series, except where voting by a series is required by law
or where the matter involved only affects one series. For example, a change in a
Fund's fundamental investment policy would be voted upon only by shareholders of
the Fund involved. Shareholders are entitled to one vote for each full share
held and fractional votes for fractional shares held.
The Trust may dispense with an annual meeting of shareholders in any
year in which it is not required to elect Trustees under the 1940 Act. The Trust
will hold a special meeting of its shareholders for the purpose of voting on the
question of removal of a Board member, only to the extent required by the 1940
Act.
Each share of a Fund represents an equal proportional interest in the
Fund with each other share and is entitled to such dividends and distributions
out of the income earned on the assets belonging to the Fund, as are declared in
the discretion of the Board members. In the event of the liquidation or
dissolution of the Trust, shareholders of the Trust's Funds are entitled to
receive the assets attributable to the Fund that are available for distribution,
and a distribution of any general assets not attributable to a particular Fund
that are available for distribution in such manner and on such basis as the
Board members in their sole discretion may determine.
Shareholders are not entitled to any preemptive rights. All shares,
when issued, will be fully paid and non-assessable by the Trust.
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Net investment income for the Funds for dividend purposes consists of
(i) interest accrued and original issue discount earned on a Fund's assets, (ii)
plus the amortization of market discount and minus the amortization of market
premium on such assets, (iii) less accrued expenses directly attributable to the
Fund and the general expenses of the Trust prorated to a Fund on the basis of
its relative net assets, plus dividend or distribution income on a Fund's
assets.
Prior to purchasing shares in one of the Funds, the impact of dividends
or distributions which are expected to be or have been declared, but not paid,
should be carefully considered. Any dividend or distribution declared shortly
after a purchase of such shares prior to the record date will have the effect of
reducing the per share net asset value by the per share amount of the dividend
or distribution. All or a portion of such dividend or distribution, although in
effect a return of capital, may be subject to tax.
Shareholders receiving a distribution in the form of additional shares
will be treated as receiving an amount equal to the fair market value of the
shares received, determined as of the reinvestment date.
The Funds use the so-called "equalization accounting method" to
allocate a portion of earnings and profits to redemption proceeds. This method
permits a fund to achieve more balanced distributions for both continuing and
departing shareholders. Continuing shareholders should realize tax savings or
deferrals through this method, and departing shareholders will not have their
tax obligations change. Although using this method will not affect a Fund's
total returns, it may reduce the amount that otherwise would be distributable to
continuing shareholders by reducing the effect of redemptions on dividend and
distribution amounts.
NET ASSET VALUE DETERMINATION
With respect to the Funds, a security listed or traded on an exchange
is valued at its last sales price on the exchange where the security is
principally traded or, lacking any sales on a particular day, the security is
valued at the mean between the closing bid and asked prices on that day. Each
security traded in the over-the-counter market (but not including securities
reported on the NASDAQ National Market System) is valued at the mean between the
last bid and asked prices based upon quotes furnished by market makers for such
securities. Each security reported on the NASDAQ National Market System is
valued at the last sales price on the valuation date. With respect to the Bond
Funds, securities may be valued on the basis of prices provided by an
independent pricing service. Prices provided by the pricing service may be
determined without exclusive reliance on quoted prices, and may reflect
appropriate factors such as yield, type of issue, coupon rate maturity and
seasoning differential. Securities for which prices are not provided by the
pricing service are valued at the mean between the last bid and asked prices
based upon quotes furnished by market makers for such securities.
Securities for which market quotations are not readily available are
valued at fair value as determined in good faith by or under the supervision of
the Trust's officers in a manner specifically authorized by the Board of
Trustees of the Trust. Short-Term obligations having 60 days or less to maturity
are valued at amortized cost, which approximates market value.
Generally, trading in foreign securities, as well as U.S. Government
securities, money market instruments and repurchase agreements, is substantially
completed each day at various times prior to the close of the New York Stock
Exchange. The values of such securities used in computing the net asset value of
the shares of the Fund are determined as of such times. Foreign currency
exchange rates are also generally determined prior to the close of the New York
Stock Exchange. Occasionally, events affecting the value of such securities and
such exchange rates may occur between the times at which they are determined and
the close of the New York Stock Exchange, which will not be reflected in the
computation of net asset value. If during such periods events occur which
materially affect the value of such securities, the securities will be valued at
their fair market value as determined in good faith by the Trustees.
The Trust may redeem shares involuntarily to reimburse the Funds for
any loss sustained by reason of the failure of a shareholder to make full
payment for Investor Shares purchased by the shareholder or to collect any
charge relating to a transaction effected for the benefit of a shareholder which
is applicable to Investor Shares as provided in the related Prospectuses from
time to time. The Trust also may make payment for redemptions in readily
marketable securities or other property if it is appropriate to do so in light
of the Trust's responsibilities under the 1940 Act.
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Under the 1940 Act, the Funds may suspend the right of redemption or
postpone the date of payment for Shares during any period when (a) trading on
the Exchange is restricted by applicable rules and regulations of the SEC; (b)
the Exchange is closed for other than customary weekend and holiday closings;
(c) the SEC has by order permitted such suspension; or (d) an emergency exists
as determined by the SEC. (The Funds may also suspend or postpone the
recordation of the transfer of their shares upon the occurrence of any of the
foregoing conditions.)
ADDITIONAL INFORMATION CONCERNING TAXES
---------------------------------------
The following information supplements and should be read in conjunction
with the Prospectuses. The Prospectuses of the Funds describe generally the tax
treatment of distributions by the Funds. This section of the SAI includes
additional information concerning Federal income taxes.
GENERAL
The Trust intends to qualify each Fund as a regulated investment
company under Subchapter M of the Internal Revenue Code of 1986, as amended (the
"Code"), as long as such qualification is in the best interest of the Fund's
shareholders. Each Fund will be treated as a separate entity for tax purposes
and, thus, the provisions of the Code applicable to regulated investment
companies generally will be applied to each Fund, rather than to the Trust as a
whole. In addition, net capital gain, net investment income, and operating
expenses will be determined separately for each Fund. As a regulated investment
company, each Fund will not be taxed on its net investment income and capital
gains distributed to shareholders.
Qualification as a regulated investment company under the Code
requires, among other things, that (a) each Fund derive at least 90% of its
annual gross income from dividends, interest, certain payments with respect to
securities loans, gains from the sale or other disposition of stock or
securities or foreign currencies (to the extent such currency gains are directly
related to the regulated investment company's principal business of investing in
stock or securities) and other income (including but not limited to gains from
options, futures or forward contracts) derived with respect to its business of
investing in such stock, securities or currencies; and (b) the Fund diversify
its holdings so that, at the end of each quarter of the taxable year, (i) at
least 50% of the market value of the Fund's assets is represented by cash,
government securities and other securities limited in respect of any one issuer
to an amount not greater than 5% of the Fund's assets and 10% of the outstanding
voting securities of such issuer, and (ii) not more than 25% of the value of its
assets is invested in the securities of any one issuer (other than U.S.
Government obligations and the securities of other regulated investment
companies), or in two or more issuers which the Fund controls and which are
determined to be engaged in the same or similar trades or businesses.
Each Fund also must distribute or be deemed to distribute to its
shareholders at least 90% of its net investment income which, for this purpose,
includes net short-term capital gains and certain other items earned in each
taxable year. In general, these distributions must actually or be deemed to be
made in the taxable year. However, in certain circumstances, such distributions
may be made in the 12 months following the taxable year. Furthermore,
distributions declared in October, November or December of one taxable year and
paid by January 31 of the following taxable year will be treated as paid by
December 31 the first taxable year. The Funds intend to pay out substantially
all of their net investment income and net capital gain (if any) for each year.
EXCISE TAX
A 4% nondeductible excise tax will be imposed on each Fund (other than
to the extent of its tax-exempt interest income) to the extent it does not meet
certain minimum distribution requirements by the end of each calendar year. Each
Fund intends to actually or be deemed to distribute substantially all of its net
investment income and net capital gain by the end of each calendar year and,
thus, expects not to be subject to the excise tax.
INVESTMENT THROUGH MASTER PORTFOLIOS
Management of the Master Portfolio corresponding to the Feeder Fund
intends for the Master Portfolio to be treated as a partnership (or, in the
event that a Feeder Fund is the sole investor in a Master Portfolio, as
disregarded from the Feeder Fund) for Federal income tax purposes rather than as
a regulated investment company or a corporation under the Code. Under the rules
applicable to a partnership (or a disregarded entity), a proportionate share of
any interest, dividends, gains and losses of the Master Portfolio will be deemed
to have been realized (I.E., "passed-through") to its investors, regardless of
whether any amounts are actually distributed by the Master Portfolio. Each
investor in the Master Portfolio will be taxed on its shares (as determined in
accordance with the governing instruments of the particular Master Portfolio) of
the Master Portfolio's income and gains in determining its Federal income tax
liability. The determination of such share will be made in accordance with the
Code and regulations promulgated thereunder. It is intended that the Master
Portfolio's assets, income and distributions will be managed in such a way that
an investor in the Master Portfolio will be able to qualify as a regulated
investment company by investing substantially all of its assets through the
Master Portfolio.
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TAXATION OF FUND/MASTER PORTFOLIO INVESTMENTS
Except as provided herein, gains and losses on the sale of portfolio
securities by a Fund or Master Portfolio ("Fund/Master Portfolio") will
generally be capital gains and losses. Such gains and losses will ordinarily be
long-term capital gains and losses if the securities have been held by the
Fund/Master Portfolio for more than one year at the time of disposition of the
securities.
Gains recognized on the disposition of a debt obligation purchased by a
Fund/Master Portfolio at a market discount (generally at a price less than its
principal amount) will be treated as ordinary income to the extent of the
portion of market discount which accrued, but was not previously recognized
pursuant to an available election, during the term the Fund/Master Portfolio
held the debt obligation.
If an option granted by a Fund/Master Portfolio lapses or is terminated
through a closing transaction, such as a repurchase by the Fund/Master Portfolio
of the option from its holder, the Fund/Master Portfolio will realize a
short-term capital gain or loss, depending on whether the premium income is
greater or less than the amount paid by the Fund/Master Portfolio in the closing
transaction. Some realized capital losses may be deferred if they result from a
position which is part of a "straddle," discussed below. If securities are sold
by a Fund/Master Portfolio pursuant to the exercise of a call option written by
it, the Fund/Master Portfolio will add the premium received to the sale price of
the securities delivered in determining the amount of gain or loss on the sale.
If securities are purchased by a Fund/Master Portfolio pursuant to the exercise
of a put option written by it, such Fund/Master Portfolio will subtract the
premium received from its cost basis in the securities purchased.
The amount of any gain or loss realized by a Fund/Master Portfolio on
closing out a regulated futures contract will generally result in a realized
capital gain or loss for Federal income tax purposes. Regulated futures
contracts held at the end of each fiscal year will be required to be "marked to
market" for Federal income tax purposes pursuant to Section 1256 of the Code. In
this regard, they will be deemed to have been sold at market value. Sixty
percent (60%) of any net gain or loss recognized on these deemed sales and sixty
percent (60%) of any net realized gain or loss from any actual sales, will
generally be treated as long-term capital gain or loss, and the remainder will
be treated as short-term capital gain or loss. Transactions that qualify as
designated hedges are excepted from the "mark-to-market" rule and the "60%/40%"
rule.
Under Section 988 of the Code, a Fund/Master Portfolio will generally
recognize ordinary income or loss to the extent gain or loss realized on the
disposition of portfolio securities is attributable to changes in foreign
currency exchange rates. In addition, gain or loss realized on the disposition
of a foreign currency forward contract, futures contract, option or similar
financial instrument, or of foreign currency itself, will generally be treated
as ordinary income or loss. The Funds will attempt to monitor Section 988
transactions, where applicable, to avoid adverse tax impact.
Offsetting positions held by a Fund/Master Portfolio involving certain
financial forward, futures or options contracts may be considered, for tax
purposes, to constitute "straddles." "Straddles" are defined to include
"offsetting positions" in actively traded personal property. The tax treatment
of "straddles" is governed by Section 1092 of the Code which, in certain
circumstances, overrides or modifies the provisions of Section 1256. If a
Fund/Master Portfolio were treated as entering into "straddles" by engaging in
certain financial forward, futures or option contracts, such straddles could be
characterized as "mixed straddles" if the futures, forwards, or options
comprising a part of such straddles were governed by Section 1256 of the Code.
The Fund/Master Portfolio may make one or more elections with respect to "mixed
straddles." Depending upon which election is made, if any, the results with
respect to the Fund/Master Portfolio may differ. Generally, to the extent the
straddle rules apply to positions established by the Fund/Master Portfolio,
losses realized by the Fund/Master Portfolio may be deferred to the extent of
unrealized gain in any offsetting positions. Moreover, as a result of the
straddle and the conversion transaction rules, short-term capital loss on
straddle positions may be recharacterized as long-term capital loss, and
long-term capital gain may be characterized as short-term capital gain or
ordinary income.
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If a Fund/Master Portfolio enters into a "constructive sale" of any
appreciated position in stock, a partnership interest, or certain debt
instruments, the Fund/Master Portfolio must recognize gain (but not loss) with
respect to that position. For this purpose, a constructive sale occurs when the
Fund/Master Portfolio enters into one of the following transactions with respect
to the same or substantially identical property: (i) a short sale; (ii) an
offsetting notional principal contract; or (iii) a futures or forward contract.
If a Fund/Master Portfolio purchases shares in a "passive foreign
investment company" ("PFIC"), the Fund/Master Portfolio may be subject to
Federal income tax and an interest charge imposed by the IRS upon certain
distributions from the PFIC or the Fund/Master Portfolio's disposition of its
PFIC shares. If the Fund/Master Portfolio invests in a PFIC, the Fund/Master
Portfolio intends to make an available election to mark-to-market its interest
in PFIC shares. Under the election, the Fund/Master Portfolio will be treated as
recognizing at the end of each taxable year the difference, if any, between the
fair market value of its interest in the PFIC shares and its basis in such
shares. In some circumstances, the recognition of loss may be suspended. The
Fund/Master Portfolio will adjust its basis in the PFIC shares by the amount of
income (or loss) recognized. Although such income (or loss) will be taxable to
the Fund/Master Portfolio as ordinary income (or loss) notwithstanding any
distributions by the PFIC, the Fund/Master Portfolio will not be subject to
Federal income tax or the interest charge with respect to its interest in the
PFIC under the election.
FOREIGN TAXES
Income and dividends received by a Fund/Master Portfolio from sources
within foreign countries may be subject to withholding and other taxes imposed
by such countries. Tax conventions between certain countries and the United
States may reduce or eliminate such taxes. If more than 50% of the value of a
Fund's/Master Portfolio's total assets at the close of its taxable year consists
of securities of non-U.S. corporations, the Fund/Master Portfolio will be
eligible to file an election with the IRS pursuant to which the regulated
investment company may pass-through to its shareholders foreign taxes paid by
the regulated investment company, which may be claimed either as a credit or
deduction by the shareholders. Only the International Funds expect to qualify
for the election. However, even if a Fund/Master Portfolio qualifies for the
election, foreign taxes will only pass-through to a Fund/Master Portfolio
shareholder if (i) the shareholder holds the Fund/Master Portfolio shares for at
least 16 days during the 30 day period beginning 15 days prior to the date upon
which the shareholder becomes entitled to receive Fund/Master Portfolio
distributions corresponding with the pass-through of the foreign taxes paid by
the Fund/Master Portfolio, and (ii) with respect to foreign source dividends
received by the Fund/Master Portfolio on shares giving rise to foreign tax, the
Fund/Master Portfolio holds the shares for at least 16 days during the 30 day
period beginning 15 days prior to the date upon which the Fund/Master Portfolio
becomes entitled to the dividend.
An individual with $300 or less of creditable foreign taxes generally
is exempt from foreign source income and certain other limitations imposed by
the Code on claiming a credit for such taxes. The $300 amount is increased to
$600 for joint filers.
CAPITAL GAIN DISTRIBUTIONS
Distributions which are designated by a Fund as capital gain
distributions will be taxed to shareholders as long-term term capital gain (to
the extent such distributions equal or exceed the Fund's/Master Portfolio's
actual net capital gains for the taxable year), regardless of how long a
shareholder has held Fund shares. Such distributions will be designated as
capital gain distributions in a written notice mailed by the Fund to its
shareholders not later than 60 days after the close of the Fund's taxable year.
DISPOSITION OF FUND SHARES
A disposition of Fund shares pursuant to a redemption (including a
redemption in-kind) or an exchange will ordinarily result in a taxable capital
gain or loss, depending on the amount received for the shares (or are deemed to
be received in the case of an exchange) and the cost of the shares.
If a shareholder exchanges or otherwise disposes of Fund shares within
90 days of having acquired such shares and if, as a result of having acquired
those shares, the shareholder subsequently pays a reduced sales charge on a new
purchase of shares of the Fund or a different regulated investment company, the
sales charge previously incurred in acquiring the Fund's shares shall not be
taken into account (to the extent such previous sales charges do not exceed the
reduction in sales charges on the new purchase) for the purpose of determining
the amount of gain or loss on the disposition, but will be treated as having
been incurred in the acquisition of such other shares. Also, any loss realized
on a redemption or exchange of shares of the Fund will be disallowed to the
extent that substantially identical shares are acquired within the 61-day period
beginning 30 days before and ending 30 days after the shares are disposed of.
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If a shareholder receives a capital gain distribution with respect to
any Fund share and such Fund share is held for six months or less, then (unless
otherwise disallowed) any loss on the sale or exchange of that Fund share will
be treated as a long-term capital loss to the extent of the capital gain
distribution. In addition, if a shareholder holds Fund shares for six months or
less, any loss on the sale or exchange of those shares will be disallowed to the
extent of the amount of exempt-interest dividends received with respect to the
shares. The Treasury Department is authorized to issue regulations reducing the
six months holding requirement to a period of not less than the greater of 31
days or the period between regular distributions where a Fund regularly
distributes at least 90% of its net tax-exempt interest, if any. No such
regulations have been issued as of the date of this SAI. The loss disallowance
rules described in this paragraph do not apply to losses realized under a
periodic redemption plan.
FEDERAL INCOME TAX RATES
As of the printing of this SAI, the maximum individual tax rate
applicable to ordinary income is 39.6% (marginal tax rates may be higher for
some individuals to reduce or eliminate the benefit of exemptions and
deductions); the maximum individual marginal tax rate applicable to net capital
gain is 20%; and the maximum corporate tax rate applicable to ordinary income
and net capital gain is 35% (marginal tax rates may be higher for some
corporations to reduce or eliminate the benefit of lower marginal income tax
rates). Naturally, the amount of tax payable by an individual or corporation
will be affected by a combination of tax laws covering, for example, deductions,
credits, deferrals, exemptions, sources of income and other matters.
CORPORATE SHAREHOLDERS
Corporate shareholders of the Funds may be eligible for the
dividends-received deduction on distributions attributable to dividends received
from domestic corporations, which, if received directly by the corporate
shareholder, would qualify for such deduction. A distribution by a Fund
attributable to dividends of a domestic corporation will only qualify for the
dividends-received deduction if (i) the corporate shareholder generally holds
the Fund shares upon which the distribution is made for at least 46 days during
the 90 day period beginning 45 days prior to the date upon which the shareholder
becomes entitled to the distribution; and (ii) the Fund generally holds the
shares of the domestic corporation producing the dividend income for at least 46
days during the 90 day period beginning 45 days prior to the date upon which the
Fund becomes entitled to such dividend income.
FOREIGN SHAREHOLDERS
Under the Code, distributions of net investment income by a Fund to a
nonresident alien individual, foreign trust (I.E., trust which a U.S. court is
able to exercise primary supervision over administration of that trust and one
or more U.S. persons have authority to control substantial decisions of that
trust), foreign estate (I.E., the income of which is not subject to U.S. tax
regardless of source), foreign corporation, or foreign partnership (each a
"foreign shareholder") will be subject to U.S. withholding tax (at a rate of 30%
or a lower treaty rate if applicable). Withholding will not apply if a
distribution paid by a Fund to a foreign shareholder is "effectively connected"
with a U.S. trade or business (or, if an income tax treaty applies, is
attributable to a U.S. permanent establishment of the foreign shareholder), in
which case the reporting and withholding requirements applicable to U.S. persons
will apply. Distributions of net long-term capital gains are generally not
subject to tax withholding.
BACKUP WITHHOLDING
The Trust may be required to withhold, subject to certain exemptions,
at a rate of 31% ("backup withholding") on dividends, capital gain
distributions, and redemption proceeds (including proceeds from exchanges and
redemptions in-kind) paid or credited to an individual Fund shareholder, if the
shareholder fails to certify that the Taxpayer Identification Number ("TIN")
provided is correct and that the shareholder is not subject to backup
withholding, or the IRS notifies the Trust that the shareholder's TIN is
incorrect or that the shareholder is subject to backup withholding. Such tax
withheld does not constitute any additional tax imposed on the shareholder, and
may be claimed as a tax payment on the shareholder's Federal income tax return.
An investor must provide a valid TIN upon opening or reopening an account.
Failure to furnish a valid TIN to the Trust could subject the investor to
penalties imposed by the IRS.
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SPECIAL TAX CONSIDERATIONS PERTAINING TO THE KANSAS FUND
The Kansas Intermediate Municipal Bond Fund's regular monthly dividends
will not be subject to the Kansas income tax to the extent that they are paid
out of income earned on Kansas municipal securities that are exempt from Kansas
income taxes. The portion of dividends, if any, that is derived from interest on
municipal securities or other obligations that are not exempt from Kansas income
taxes will be subject to Kansas income tax. A shareholder will be subject to
Kansas income tax to the extent the Fund distributes any taxable income or
realized capital gains, or if a shareholder sells or exchanges Fund shares and
realizes a capital gain on the transaction. Distributions treated as long-term
capital gains for federal tax purposes are generally treated the same for Kansas
state tax purposes.
OTHER MATTERS
Investors should be aware that the investments to be made by the Funds
may involve sophisticated tax rules that may result in income or gain
recognition by a Fund without corresponding current cash receipts. Although the
Funds will seek to avoid significant noncash income, such noncash income could
be recognized by a Fund, in which case the Fund may distribute cash derived from
other sources in order to meet the minimum distribution requirements described
above.
The foregoing discussion and the discussions in the Prospectus
applicable to each shareholder address only some of the Federal tax
considerations generally affecting investments in the Fund. Each investor is
urged to consult his or her tax advisor regarding specific questions as to
Federal, state, local or foreign taxes.
ADDITIONAL INFORMATION ON PERFORMANCE
-------------------------------------
Yield information and other performance information for the Trust's
Funds may be obtained by calling (800) 321-7854. From time to time, the yield
and total return of a Fund's Shares may be quoted in advertisements, shareholder
reports, and other communications to shareholders. Quotations of yield and total
return reflect only the performance of a hypothetical investment in a Fund or
class of shares during the particular time period shown. Yield and total return
vary based on changes in the market conditions and the level of a Fund's
expenses, and no reported performance figure should be considered an indication
of performance which may be expected in the future.
Standardized performance for the Funds, I.E., that required in both
form and content by Form N-1A, is shown below and may be advertised by the
Funds. The main purpose of standardized performance is to allow an investor to
review the performance of a Fund's class of shares and compare such performance
with that of investment alternatives, including other mutual funds.
Non-standardized performance also may be advertised by the Funds. One
purpose of providing non-standardized performance to an investor is to provide
that investor with a different snapshot of a Fund's performance that may not be
captured by standardized performance. The non-standardized performance of a
Fund's class of shares, however, may not be directly comparable to the
performance of investment alternatives because of differences in certain
variables (such as the length of time over which performance is shown and the
exclusion of certain charges or expenses) and methods used to value portfolio
securities, compute expenses and calculate performance. Non-standardized
performance may include, but is not limited to, performance for non-standardized
periods, including year-to-date and other periods less than a year, performance
not reflecting the deduction of certain charges, fees and/or expenses, and
performance reflecting the deduction of applicable state or federal taxes.
After-tax returns are generally calculated using the same methodology as that
used in calculating total return, except that such after-tax returns reflect the
deduction of taxes according to applicable federal income and capital gain tax
rates attributable to dividends, distributions and an investor's redemptions. Of
course, after-tax returns for individual investors will vary as the tax rates
applicable to such investors vary. In addition, the Funds may also advertise
their tax efficiency ratios and compare those ratios with other mutual funds. A
tax efficiency ratio is intended to let an investor know how tax efficient a
fund has been over a period of time, and is typically related to its portfolio
turnover rate. That is, an investor could expect that the higher a Fund's
portfolio turnover rate, the greater the percentage of its gains that would have
been realized and consequently, the less tax efficient it was over a given
period of time.
In general, comparisons to other mutual funds or investment
alternatives may be useful to investors who wish to compare past performance of
the Funds or a class with that of competitors. Of course, past performance
cannot be a guarantee of future results.
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Each Fund may quote information obtained from the Investment Company
Institute, national financial publications, trade journals and other industry
sources in its advertising and sales literature. In addition, the Funds also may
compare the performance and yield of a class or series of shares to those of
other mutual funds with similar investment objectives and to other relevant
indices or to rankings prepared by independent services or other financial or
industry publications that monitor the performance of mutual funds. For example,
the performance and yield of a class of shares in a Fund may be compared to data
prepared by Lipper Analytical Services, Inc. Performance and yield data as
reported in national financial publications such as MONEY MAGAZINE, FORBES,
BARRON'S, THE WALL STREET JOURNAL, and THE NEW YORK TIMES, OR in publications of
a local or regional nature, also may be used in comparing the performance of a
class of shares in a Fund. The "yield" and "effective yield" of each class of
shares of a Money Market Fund may be compared to the respective averages
compiled by DONOGHUE'S MONEY FUND REPORT, a widely recognized independent
publication that monitors the performance of money market funds, or to the
average yields reported by the BANK RATE MONITOR for money market deposit
accounts offered by leading banks and thrift institutions in the top five
metropolitan statistical areas.
The Funds also may use the following information in advertisements and
other types of literature, only to the extent the information is appropriate for
the Fund: (i) the Consumer Price Index may be used to assess the real rate of
return from an investment in a Fund; (ii) other government statistics,
including, but not limited to, The Survey of Current Business, may be used to
illustrate investment attributes of a Fund or the general economic, business,
investment, or financial environment in which a Fund operates; (iii) the effect
of tax-deferred compounding on the investment returns of a Fund, or on returns
in general, may be illustrated by graphs, charts, etc., where such graphs or
charts would compare, at various points in time, the return from an investment
in a Fund (or returns in general) on a tax-deferred basis (assuming reinvestment
of capital gains and dividends and assuming one or more tax rates) with the
return on a taxable basis; and (iv) the sectors or industries in which a Fund
invests may be compared to relevant indices of stocks or surveys (E.G., S&P
Industry Surveys) to evaluate a Fund's historical performance or current or
potential value with respect to the particular industry or sector. In addition,
the performance of a Fund's class of shares may be compared to the Standard &
Poor's 500 Stock Index, an unmanaged index of a group of common stocks, the
Consumer Price Index, the Dow Jones Industrial Average, a recognized unmanaged
index of common stocks of 30 industrial companies listed on the New York Stock
Exchange, the Europe, Far East and Australia Index, a recognized unmanaged index
of international stocks, or any similar recognized index. The performance of a
Fund's class of shares also may be compared to a composite index prepared by the
Adviser, an affiliate of the Adviser, or an unaffiliated party to the Adviser.
In addition, the Funds also may use, in advertisements and other types
of literature, information and statements: (1) showing that bank savings
accounts offer a guaranteed return of principal and a fixed rate of interest,
but no opportunity for capital growth; and (2) describing Bank of America, and
its affiliates and predecessors, as one of the first investment managers to
advise investment accounts using asset allocation and index strategies. The
Funds also may include in advertising and other types of literature information
and other data from reports and studies prepared by the Tax Foundation,
including information regarding federal and state tax levels and the related
"Tax Freedom Day."
The Funds also may discuss in advertising and other types of literature
that a Fund has been assigned a rating by an NRSRO, such as Standard & Poor's
Corporation. Such rating would assess the creditworthiness of the investments
held by the Fund. The assigned rating would not be a recommendation to purchase,
sell or hold the Fund's shares since the rating would not comment on the market
price of the Fund's shares or the suitability of the Fund for a particular
investor. In addition, the assigned rating would be subject to change,
suspension or withdrawal as a result of changes in, or unavailability of,
information relating to the Fund or its investments. The Funds may compare a
Fund's performance with other investments which are assigned ratings by NRSROs.
Any such comparisons may be useful to investors who wish to compare the Fund's
past performance with other rated investments.
The Funds also may disclose in sales literature the distribution rate
on the shares of a Fund. Distribution rate, which may be annualized, is the
amount determined by dividing the dollar amount per share of the most recent
dividend by the most recent NAV or maximum offering price per share as of a date
specified in the sales literature. Distribution rate will be accompanied by the
standard 30-day yield as required by the SEC.
In addition, certain potential benefits of investing in world
securities markets may be discussed in promotional materials. Such benefits
include, but are not limited to: a) the expanded opportunities for investment in
securities markets outside the U.S.; b) the growth of securities markets outside
the U.S. vis-a-vis U.S. markets; c) the relative return associated with foreign
securities markets vis-a-vis U.S. markets; and d) a reduced risk of portfolio
volatility resulting from a diversified securities portfolio consisting of both
U.S. and foreign securities.
65
<PAGE>
IBBOTSON DATA. Ibbotson Associates of Chicago, Illinois, ("Ibbotson")
provides historical returns of the capital markets in the United States. The
Funds may compare the performance of their share classes or series to the
long-term performance of the U.S. capital markets in order to demonstrate
general long-term risk versus reward investment scenarios. Performance
comparisons could also include the value of a hypothetical investment in common
stocks, long-term bonds or treasuries.
The capital markets tracked by Ibbotson are common stocks, small
capitalization stocks, long-term corporate bonds, intermediate-term government
bonds, long-term government bonds, Treasury Bills, and the U.S. rate of
inflation. These capital markets are based on the returns of several different
indices. For common stocks, the S&P is used. For small capitalization stocks,
return is based on the return achieved by Dimensional Fund Advisors (DFA) Small
Company Fund. This fund is a market-value-weighted index of the ninth and tenth
deciles of the Exchange, plus stocks listed on the American Stock Exchange
(AMEX) and over-the-counter (OTC) with the same or less capitalization as the
upperbound of the Exchange ninth docile. At year-end 199, the DFA Small Company
Fund contained approximately 2,663 stocks, with a weighted average market
capitalization of $16.7 million. The unweighted average market capitalization
was $82.97 million, while the median was $6.0 million.
Unlike an investment in a common stock mutual fund, an investment in
bonds that are held to maturity provides a fixed and stated rate of return.
Bonds have a senior priority in liquidation or bankruptcy to common stocks, and
interest on bonds is generally paid from assets of the corporation before any
distributions to common shareholders. Bonds rated in the two highest rating
categories are considered high quality and to present minimal risks of default.
See Schedule A for a more complete explanation of these ratings of corporate
bonds. An advantage of investing in government bonds is that, in many cases,
they are backed by the credit and taxing power of the United States government,
and therefore, such securities may present little or no risk of default.
Although government securities fluctuate in price, they are highly liquid and
may be purchased and sold with relatively small transaction costs (direct
purchase of Treasury securities can be made with no transaction costs).
Long-term corporate bond returns are based on the performance of the
Salomon Brothers Long-Term-High-Grade Corporate Bond Index and include nearly
all "Aaa-" and "Aa-" rated bonds. Returns on intermediate-term government bonds
are based on a one-bond portfolio constructed each year, containing a bond which
is the shortest noncallable bond available with a maturity not less than 5
years. This bond is held for the calendar year and returns are recorded. Returns
on long-term government bonds are based on a one-bond portfolio constructed each
year, containing a bond that meets several criteria, including having a term of
approximately 20 years. The bond is held for the calendar year and returns are
recorded. Returns on U.S. Treasury Bills are based on a one-bill portfolio
constructed each month, containing the shortest-term bill having not less than
one month to maturity. The total return on the bill is the month end price
divided by the previous month-end price, minus one. Data up to 1976 is from the
U.S. Government Bond file at the University of Chicago's Center for Research in
Security Prices; the Wall Street Journal is the source thereafter. Inflation
rates are based on the CPI. Ibbotson calculates total returns in the same method
as the Funds.
YIELD CALCULATIONS
Income calculated for the purposes of calculating a Fund's yield
differs from income as determined for other accounting purposes. Because of the
different accounting methods used, and because of the compounding assumed in
yield calculations, the yield quoted for a Fund may differ from the rate of
distributions a Fund paid over the same period or the rate of income reported in
the Funds' financial statements.
Yield is calculated separately for the Primary A, Investor A, Investor
B and Investor C Shares of a Fund by dividing the net investment income per
share for a particular class or series of shares (as described below) earned
during a 30-day period by the maximum offering price per share on the last day
of the period (for Primary A, maximum offering price per share is the same as
the net asset value per share) and annualizing the result on a semi-annual basis
by adding one to the quotient, raising the sum to the power of six, subtracting
one from the result and then doubling the difference. For a class or series of
shares in a Fund, net investment income per share earned during the period is
based on the average daily number of shares outstanding during the period
entitled to receive dividends and includes dividends and interest earned during
the period minus expenses accrued for the period, net of reimbursements. This
calculation can be expressed as follows:
66
<PAGE>
Yield = 2 [(a-b+ 1)(6) - 1]
---
cd
Where: a = dividends and interest earned during the period.
b = expenses accrued for the period (net of reimbursements).
c = the average daily number of shares outstanding
during the period that were entitled to receive
dividends.
d = maximum offering price per share on the last day
of the period (again, for Primary A Shares, this
is equivalent to net asset value per share).
For the purpose of determining net investment income earned during the
period (variable- "a" in the formula), dividend income on equity securities held
by a Fund is recognized by accruing 1/360 of the stated dividend rate of the
security each day that the security is in the portfolio. Each Fund calculates
interest earned on any debt obligations held in its portfolio by computing the
yield to maturity of each obligation held by it based on the market value of the
obligation (including actual accrued interest) at the close of business on the
last business day of each month, or, with respect to obligations purchased
during the month, the purchase price (plus actual accrued interest) and dividing
the result by 360 and multiplying the quotient by the market value of the
obligation (including actual accrued interest) in order to determine the
interest income on the obligation for each day of the subsequent month that the
obligation is in the portfolio. For purposes of this calculation, it is assumed
that each month contains 30 days. The maturity of an obligation with a call
provision is the next call date on which the obligation reasonably may be
expected to be called or, if none, the maturity date. With respect to debt
obligations purchased at a discount or premium, the formula generally calls for
amortization of the discount or premium. The amortization schedule will be
adjusted monthly to reflect changes in the market values of such debt
obligations. The California Municipal Bond Fund, Municipal Income Fund,
Short-Term Municipal Income Fund, Intermediate Municipal Bond Fund, the State
Intermediate Municipal Bond Funds and the State Municipal Bond Funds calculate
interest gained on tax-exempt obligations issued without original issue discount
and having a current market discount by using the coupon rate of interest
instead of the yield to maturity. In the case of tax-exempt obligations that are
issued with original issue discount, where the discount based on the current
market value exceeds the then-remaining portion of original issue discount, the
yield to maturity is the imputed rate based on the original issue discount
calculation. Conversely, where the discount based on the current market value is
less than the remaining portion of the original issue discount, the yield to
maturity is based on the market value.
Expenses accrued for the period (variable "b" in the formula) include
recurring fees charged by Nations Funds to shareholder accounts in proportion to
the length of the base period. Undeclared earned income will be subtracted from
the maximum offering price per share (which for Primary A and Primary B Shares
is net asset value per share) (variable "d" in the formula). Undeclared earned
income is the net investment income which, at the end of the base period, has
not been declared as a dividend, but is reasonably expected to be and is
declared as a dividend shortly thereafter. A Fund's maximum offering price per
share for purposes of the formula includes the maximum sales charge, if any,
imposed by the Fund, as reflected in the Fund's prospectus.
The Funds may provide additional yield calculations in communications
(other than advertisements) to the holders of Primary A, Investor A, Investor B
or Investor C Shares. These may be calculated based on the Primary A, Investor
A, Investor B or Investor C Shares' net asset values per share (rather than
their maximum offering prices) on the last day of the period covered by the
yield computations. That is, some communications provided to the holders of
Primary A, Investor A, Investor B or Investor C Shares may also include
additional yield calculations prepared for the holders of Primary A Shares. Such
additional quotations, therefore, will not reflect the effect of the sales
charges mentioned above.
Because the Funds are new series they do not yet have any historical
yield performance.
67
<PAGE>
TOTAL RETURN CALCULATIONS
Total return measures both the net investment income generated by, and
the effect of any realized or unrealized appreciation or depreciation of the
underlying investments in a Fund. The Funds' average annual and cumulative total
return figures are computed in accordance with the standardized methods
prescribed by the SEC. Average annual total return figures are computed by
determining the average annual compounded rates of return over the periods
indicated in the advertisement, sales literature or shareholders' report that
would equate the initial amount invested to the ending redeemable value,
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 at the end of the period of a
hypothetical $1,000 payment made at the beginning of such
period.
This calculation (i) assumes all dividends and distributions are
reinvested at net asset value on the appropriate reinvestment dates, and (ii)
deducts (a) the maximum sales charge from the hypothetical initial $1,000
investment, and (b) all recurring fees, such as advisory and administrative
fees, charged as expenses to all shareholder accounts. Any performance
calculations reflect the deduction of sales charges, if any, that would have
been deducted from a sale of shares.
Cumulative total return is based on the overall percentage change in
value of a hypothetical investment in the Fund, assuming all Fund dividends and
capital gain distributions are reinvested, without reflecting the effect of any
sales charge that would be paid by an investor, and is not annualized.
Cumulative total return is computed by finding the cumulative
compounded rate of return over the period indicated in the advertisement that
would equate the initial amount invested to the ending redeemable value,
according to the following formula:
CTR = (ERV-P) 100
-----
P
Where: CTR = Cumulative total return
ERV = ending redeemable value at the end of the period of a
hypothetical $1,000 payment made at the beginning of such
period
P = initial payment of $1,000.
This calculation (i) assumes all dividends and distributions are
reinvested at net asset value on the appropriate reinvestment dates, and (ii)
deducts (a) the maximum sales charge from the hypothetical initial $1,000
investment, and (b) all recurring fees, such as advisory and administrative
fees, charged as expenses to all shareholder accounts.
Because the Funds are new series they do not yet have any historical
return performance.
ADDITIONAL INFORMATION ABOUT MACKAY SHIELDS'S PERFORMANCE APPEARING IN THE
PROSPECTUSES FOR THE HIGH YIELD FUND
The High Yield Composite contained in the Prospectuses includes all
discretionary high yield accounts managed by MacKay Shields with substantially
similar objectives for a full quarter. Composite performance reflects
reinvestment of income and dividends and is a market-weighted average of the
time-weighted return, before advisory fees, of each account for the period since
inception. Performance is expressed in US Dollars. The composite creation and
inception date is 7/1/91. Fees, which are described in MacKay Shields' ADV Part
II, and related expenses will reduce returns. For example, a .50% annual
investment advisory fee would have the effect of reducing the annual compound
return by .50% in the first year and by a cumulative 2.53% in the fifth year.
Non-fee paying portfolios are not included in the composite. Past performance is
not necessarily indicative of future results.
68
<PAGE>
MacKay Shields, an SEC-registered investment adviser, has prepared and
presented the performance information in compliance with the Performance
Presentation Standards of the Association for Investment Management and Research
(AIMR-PPSTM). AIMR has not been involved with the preparation or review of this
report. MacKay Shields (and its High Yield composite) has received a Level 1
verification from an independent accounting firm for the period January 1, 1988
through the most recent quarter. An opinion is available on request, as is a
complete list and description of the firm's composites. Balanced segments may be
utilized within this composite. Each balanced segment includes its own cash
balance. No leverage has been used in this composite. The asset mix of high
yield accounts may not be precisely comparable to the CS First Boston High Yield
Index. One account was removed from the composite after 12/31/95 because it was
no longer representative of the style. The number of accounts, composite assets
(in millions), percentage of total firm assets, and standard deviation of annual
returns were as follows at year-ends 1991-1999, respectively: 1, $299, 3.7% N/A;
1, $510, 6.1%, 0.0; 1, $935, 8.8%, 0.0; 1, $1,126, 8.9%, 0.0; 4, $1,756, 9.6%,
0.0; 5, $261, 1.1%, 3.2; 6, $254, 0.9%, 2.2; 10, $670, 2.2%, 1.8; 17,$1,901,
5.6%, 2.4.
At December 31, 1999 MacKay Shields was managing a total of $6,750
million of High Yield assets. Of the total assets managed in the High Yield
style, $1,901 million, or 28.2% is represented in the High Yield Composite.
69
<PAGE>
MISCELLANEOUS
-------------
CERTAIN RECORD HOLDERS
The name, address and percentage of ownership of each person who is
known by the Registrant to have owned of record or beneficially five percent or
more of any of the Funds as of February 10, 2000 is:
<TABLE>
<CAPTION>
Class; Amount
of Shares
Owned; Type of Percentage Percentage
Fund Name and Address Ownership of Class of Fund
---- ---------------- --------- -------- -------
<S> <C> <C> <C>
High Yield Fund Stephens Inc. Primary A; 1; 100% 25%
111 Center Street Record and
Little Rock, AR 72201 Beneficial
Stephens Inc. Investor A; 1; 100% 25%
111 Center Street Record and
Little Rock, AR 72201 Beneficial
Stephens Inc. Investor B; 1; 100% 25%
111 Center Street Record and
Little Rock, AR 72201 Beneficial
Stephens Inc. Investor C; 1; 100% 25%
111 Center Street Record and
Little Rock, AR 72201 Beneficial
Kansas Fund Stephens Inc. Primary A; 1; 100% 25%
111 Center Street Record and
Little Rock, AR 72201 Beneficial
Stephens Inc. Investor A; 1; 100% 25%
111 Center Street Record and
Little Rock, AR 72201 Beneficial
Stephens Inc. Investor B; 1; 100% 25%
111 Center Street Record and
Little Rock, AR 72201 Beneficial
Stephens Inc. Investor C; 1; 100% 25%
111 Center Street Record and
Little Rock, AR 72201 Beneficial
MidCap Index Fund Stephens Inc. Primary A; 1; 100% 50%
111 Center Street Record and
Little Rock, AR 72201 Beneficial
Stephens Inc. Investor A; 1; 100% 50%
111 Center Street Record and
Little Rock, AR 72201 Beneficial
</TABLE>
70
<PAGE>
SCHEDULE A
----------
DESCRIPTION OF RATINGS
The following summarizes the highest six ratings used by Standard &
Poor's Corporation ("S&P") for corporate and municipal bonds. The first four
ratings denote investment-grade securities.
AAA - This is the highest rating assigned by S&P to a debt
obligation and indicates an extremely strong capacity to pay interest
and repay principal.
AA - Debt rated AA is considered to have a very strong capacity to
pay interest and repay principal and differs from AAA issues only in a
small degree.
A - Debt rated A has a strong capacity to pay interest and repay
principal although it is somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than debt
in higher-rated categories.
BBB - Debt rated BBB is regarded as having an adequate capacity to
pay interest and repay principal. Whereas it normally exhibits adequate
protection parameters, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity to pay
interest and repay principal for debt in this category than for those
in higher-rated categories.
BB, B - Bonds rated BB and B are regarded, on balance as
predominantly speculative with respect to capacity to pay interest and
repay principal in accordance with the terms of the obligation. Debt
rated BB has less near-term vulnerability to default than other
speculative issues. However, it faces major ongoing uncertainties or
exposure to adverse business, financial, or economic conditions which
could lead to inadequate capacity to meet timely interest and principal
payments. Debt rated B has a greater vulnerability to default but
currently has the capacity to meet interest payments and principal
repayments. Adverse business, financial, or economic conditions will
likely impair capacity or willingness to pay interest and repay
principal.
To provide more detailed indications of credit quality, the AA, A and
BBB, BB and B ratings may be modified by the addition of a plus or minus sign to
show relative standing within these major rating categories.
The following summarizes the highest six ratings used by Moody's
Investors Service, Inc. ("Moody's") for corporate and municipal bonds. The first
four denote investment grade securities.
Aaa - Bonds that 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 that are rated Aa are judged to be of high quality by
all standards. Together with the Aaa group they comprise what are
generally known as high grade bonds. They are rated lower than the best
bonds because margins of protection may not be as large as in Aaa
securities or fluctuation of protective elements may be of greater
amplitude or there may be other elements present which make the long-term
risks appear somewhat larger than in Aaa securities.
A - Bonds that are rated A possess many favorable investment
attributes and are to be considered upper medium grade obligations.
Factors giving security to principal and interest are considered adequate,
but elements may be present which suggest a susceptibility to impairment
sometime in the future.
Baa - Bonds that 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 that 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 as well safeguarded during both good times and bad times over
the future. Uncertainty of position characterizes bonds in this class.
A-1
<PAGE>
B - Bond that 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.
Moody's applies numerical modifiers (1, 2 and 3) with respect to
corporate bonds rated Aa through B. The modifier 1 indicates that the bond being
rated ranks in the higher end of its generic rating category; the modifier 2
indicates a mid-range ranking; and the modifier 3 indicates that the bond ranks
in the lower end of its generic rating category. With regard to municipal bonds,
those bonds in the Aa, A and Baa groups which Moody's believes possess the
strongest investment attributes are designated by the symbols Aa1, A1 or Baa1,
respectively.
The following summarizes the highest four ratings used by Duff & Phelps
Credit Rating Co. ("D&P") for bonds, each of which denotes that the securities
are investment grade.
AAA - Bonds that are rated AAA are of the highest credit quality.
The risk factors are considered to be negligible, being only slightly more
than for risk-free U.S. Treasury debt.
AA - Bonds that are rated AA are of high credit quality. Protection
factors are strong. Risk is modest but may vary slightly from time to time
because of economic conditions.
A - Bonds that are rated A have protection factors which are
average but adequate. However risk factors are more variable and greater
in periods of economic stress.
BBB - Bonds that are rated BBB have below average protection
factors but still are considered sufficient for prudent investment.
Considerable variability in risk exists during economic cycles.
To provide more detailed indications of credit quality, the AA, A and
BBB ratings may modified by the addition of a plus or minus sign to show
relative standing within these major categories.
The following summarizes the highest four ratings used by Fitch
Investors Service, Inc. ("Fitch") for bonds, each of which denotes that the
securities are investment grade:
AAA - Bonds considered to be investment grade and of the highest
credit quality. The obligor has an exceptionally strong ability to pay
interest and repay principal, which is unlikely to be affected by
reasonably foreseeable events.
AA - Bonds considered to be investment grade and of very high
credit quality. The obligor's ability to pay interest and repay principal
is very strong, although not quite as strong as bonds rated AAA. Because
bonds rated in the AAA and AA categories are not significantly vulnerable
to foreseeable future developments, short-term debt of these issuers is
generally rated F-1+.
A - Bonds considered to be investment grade and of high credit
quality. The obligor's ability to pay interest and repay principal is
considered to be strong, but may be more vulnerable to adverse changes in
economic conditions and circumstances than bonds with higher ratings.
BBB - Bonds considered to be investment grade and of satisfactory
credit quality. The obligor's ability to pay interest and repay principal
is considered to be adequate. Adverse changes in economic conditions and
circumstances, however, are more likely to have adverse impact on these
bonds, and therefore impair timely payment. The likelihood that the
ratings of these bonds will fall below investment grade is higher than for
bonds with higher ratings.
To provide more detailed indications of credit quality, the AA, A and
BBB ratings may be modified by the addition of a plus or minus sign to show
relative standing within these major rating categories.
The following summarizes the two highest ratings used by Moody's for
short-term municipal notes and variable-rate demand obligations:
MIG-1/VMIG-1 -- Obligations bearing these designations are of the best
quality, enjoying strong protection from established cash flows, superior
liquidity support or demonstrated broad-based access to the market for
refinancing.
MIG-2/VMIG-2 -- Obligations bearing these designations are of high
quality, with ample margins of protection although not so large as in the
preceding group.
A-2
<PAGE>
The following summarizes the two highest ratings used by S&P for
short-term municipal notes:
SP-1 - Indicates very strong or strong capacity to pay principal and
interest. Those issues determined to possess overwhelming safety characteristics
are given a "plus" (+) designation.
SP-2 - Indicates satisfactory capacity to pay principal and interest.
The three highest rating categories of D&P for short-term debt, each of
which denotes that the securities are investment grade, are D-1, D-2, and D-3.
D&P employs three designations, D-1+, D-1 and D-1-, within the highest rating
category. D-1+ indicates highest certainty of timely payment. Short-term
liquidity, including internal operating factors and/or access to alternative
sources of funds, is judged to be "outstanding, and safety is just below
risk-free U.S. Treasury short-term obligations." D-1 indicates very high
certainty of timely payment. Liquidity factors are excellent and supported by
good fundamental protection factors. Risk factors are considered to be minor.
D-1 indicates high certainty of timely payment. Liquidity factors are strong and
supported by good fundamental protection factors. Risk factors are very small.
D-2 indicates good certainty of timely payment. Liquidity factors and company
fundamentals are sound. Although ongoing funding needs may enlarge total
financing requirements, access to capital markets is good. Risk factors are
small. D-3 indicates satisfactory liquidity and other protection factors which
qualify the issue as investment grade. Risk factors are larger and subject to
more variation. Nevertheless, timely payment is expected.
The following summarizes the two highest rating categories used by
Fitch for short-term obligations each of which denotes that the securities are
investment grade:
F-1+ securities possess exceptionally strong credit quality. Issues
assigned this rating are regarded as having the strongest degree of assurance
for timely payment.
F-1 securities possess very strong credit quality. Issues assigned this
rating reflect an assurance of timely payment only slightly less in degree than
issues rated F-1+.
F-2 securities possess good credit quality. Issues carrying this rating
have a satisfactory degree of assurance for timely payment, but the margin of
safety is not as great as for issues assigned the F-1+ and F-1 ratings.
Commercial paper rated A-1 by S&P indicates that the degree of safety
regarding timely payment is strong. Those issues determined to possess extremely
strong safety characteristics are denoted A-1+. Capacity for timely payment on
commercial paper rated A-2 is satisfactory, but the relative degree of safety is
not as high as for issues designated A-1.
The rating Prime-1 is the highest commercial paper rating assigned by
Moody's. Issuers rated Prime-1 (or related supporting institutions) are
considered to have a superior capacity for repayment of senior short-term
promissory obligations. Issuers rated Prime-2 (or related supporting
institutions) are considered to have a strong capacity for repayment of senior
short-term promissory obligations. This will normally be evidenced by many of
the characteristics of issuers rated Prime-1, but to a lesser degree. Earnings
trends and coverage ratios, while sound, will be more subject to variation.
Capitalization characteristics, while still appropriate, may be more affected by
external conditions. Ample alternate liquidity is maintained.
For commercial paper, D&P uses the short-term debt ratings described
above.
For commercial paper, Fitch uses the short-term debt ratings described
above.
Thomson BankWatch, Inc. ("BankWatch") ratings are based upon a
qualitative and quantitative analysis of all segments of the organization
including, where applicable, holding company and operating subsidiaries.
BankWatch ratings do not constitute a recommendation to buy or sell securities
of any of these companies. Further, BankWatch does not suggest specific
investment criteria for individual clients.
BankWatch long-term ratings apply to specific issues of long-term debt
and preferred stock. The long-term ratings specifically assess the likelihood of
untimely payment of principal or interest over the term to maturity of the rated
instrument. The following are the four investment grade ratings used by
BankWatch for long-term debt:
AAA - The highest category; indicates ability to repay principal
and interest on a timely basis is extremely high.
A-3
<PAGE>
AA - The second highest category; indicates a very strong ability
to repay principal and interest on a timely basis with limited incremental
risk versus issues rated in the highest category.
A - The third highest category; indicates the ability to repay
principal and interest is strong. Issues rated "A" could be more
vulnerable to adverse developments (both internal and external) than
obligations with higher ratings.
BBB - The lowest investment grade category; indicates an acceptable
capacity to repay principal and interest. Issues rated "BBB" are, however,
more vulnerable to adverse developments (both internal and external) than
obligations with higher ratings.
Long-term debt ratings may include a plus (+) or minus (-) sign to
indicate where within a category the issue is placed.
The BankWatch short-term ratings apply to commercial paper, other
senior short-term obligations and deposit obligations of the entities to which
the rating has been assigned. The BankWatch short-term ratings specifically
assess the likelihood of an untimely payment of principal or interest.
TBW-1 The highest category; indicates a very high
likelihood that principal and interest will be paid
on a timely basis.
TBW-2 The second highest category; while the degree of
safety regarding timely repayment of principal and
interest is strong, the relative degree of safety is
not as high as for issues rated "TBW-1".
TBW-3 The lowest investment grade category; indicates that
while more susceptible to adverse developments (both
internal and external) than obligations with higher
ratings, capacity to service principal and interest
in a timely fashion is considered adequate.
TBW-4 The lowest rating category; this rating is regarded
as non-investment grade and therefore speculative.
The following summarizes the four highest long-term debt ratings used
by IBCA Limited and its affiliate, IBCA Inc. (collectively "IBCA"):
AAA - Obligations for which there is the lowest expectation of
investment risk. Capacity for timely repayment of principal and
interest is substantial such that adverse changes in business, economic
or financial conditions are unlikely to increase investment risk
significantly.
AA - Obligations for which there is a very low expectation of
investment risk. Capacity for timely repayment of principal and
interest is substantial. Adverse changes in business, economic or
financial conditions may increase investment risk albeit not very
significantly.
A - Obligations for which there is a low expectation of investment
risk. Capacity for timely repayment of principal and interest is
strong, although adverse changes in business, economic or financial
conditions may lead to increased investment risk.
BBB - Obligations for which there is currently a low expectation of
investment risk. Capacity for timely repayment of principal and
interest is adequate, although adverse changes in business, economic or
financial conditions are more likely to lead to increased investment
risk than for obligations in other categories.
A plus or minus sign may be appended to a rating below AAA to denote
relative status within major rating categories.
The following summarizes the two highest short-term debt ratings used by
IBCA:
A1+ When issues possess a particularly strong credit feature, a
rating of A1+ is assigned.
A1 - Obligations supported by the highest capacity for timely
repayment.
A2 - Obligations supported by a good capacity for timely repayment.
A-4
