[Logo]BRAZOS INSURANCE FUNDS
PROSPECTUS
August 25, 2000
INVESTMENT OBJECTIVE
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Small Capitalization
BRAZOS Small Cap Growth Portfolio Growth
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BRAZOS INSURANCE FUNDS' SHARES ARE OFFERED PRIMARILY TO
INSURANCE COMPANIES TO FUND BENEFITS UNDER THEIR VARIABLE ANNUITY AND VARIABLE
LIFE INSURANCE CONTRACTS. UNDER CERTAIN CIRCUMSTANCES, SHARES
MAY BE OFFERED TO PENSION PLAN ACCOUNTS.
THE SECURITIES AND EXCHANGE COMMISSION HAS NOT APPROVED OR
DISAPPROVED THESE SECURITIES OR PASSED UPON THE ACCURACY OF THIS PROSPECTUS.
IT IS A CRIME FOR ANYONE TO TELL YOU OTHERWISE.
Transfer Agent:
Firstar Mutual Fund Services, LLC WEBSITE: WWW.BRAZOSINSURANCEFUNDS.COM
Telephone: 888-221-3460
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TABLE OF CONTENTS
Brazos Small Cap Growth Portfolio.................................. 3
Risk Elements...................................................... 5
Information About the Adviser...................................... 7
Adviser's Historical Performance................................... 8
Performance of Similarly Managed Mutual Fund....................... 10
Information For First Time Mutual Fund Investors................... 11
Valuation of Shares................................................ 11
Dividends, Capital Gains Distributions and Taxes................... 12
Purchase of Shares................................................. 12
Redemption of Shares............................................... 13
For More Information......................................... Back Cover
2
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BRAZOS SMALL CAP GROWTH PORTFOLIO
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SUMMARY OF INVESTMENT OBJECTIVE
The investment objective of the Brazos Small Cap Growth Portfolio ("Small
Cap" or the "Portfolio") is to provide maximum capital appreciation, consistent
with reasonable risk to principal.
INVESTMENT POLICIES AND STRATEGIES
The majority of equity securities (65%) in the Portfolio will have market
capitalizations of $1.8 billion or lower, or a capitalization of companies
represented in the Russell 2000 Index at the time of the Portfolio's investment.
This target will fluctuate with changes in market conditions and the composition
of the Russell 2000 Index. As of June 30, 2000, the company with the largest
market capitalization in the Russell 2000 Index was approximately $1.5 billion.
The Portfolio seeks to achieve its objective by investing primarily in
small capitalization companies. The remaining securities acquired by the
Portfolio may have market capitalizations that exceed the target capitalization.
Small Cap generally seeks investment in securities of companies with above
average growth rates, average annual revenues below $1 billion, above average
return on equity, and low debt levels.
The types of equity securities that can be purchased include common stocks
and securities convertible into common stocks. Market conditions may lead to
higher levels (up to 100%) of temporary investments such as money market
instruments or U.S. Treasury Bills. Temporary investments are expected to be 5%
to 10% of each portfolio under normal circumstances.
The investment process involves consistent communications with senior
management, suppliers, competitors and customers in an attempt to understand the
dynamics within each company's business. Small Cap then selects companies with
strong growth in revenue, earnings and cash flow, predictable operating models,
seasoned management, and unique products or services. John McStay Investment
Counsel ("JMIC" or the "Adviser") believes that smaller companies have greater
potential to deliver above average growth rates that may not yet have been
recognized by investors.
To manage fluctuations in the value of the Portfolio's investments, JMIC
invests across 15-20 industry sectors with no industry sector representing more
than 25% of the value of the Portfolio. JMIC may sell securities when the value
of a security or a group of securities within a certain industry sector violates
diversification objectives. A high rate of portfolio turnover involves greater
transaction expenses to the Portfolio's shareholders, which may reduce
performance.
The value of each security at the time of acquisition is not expected to
exceed 4% of the value of investments in the Portfolio. JMIC seeks to reduce
risk by limiting the Portfolio's holdings of a certain stock to an amount less
than or equal to the number of shares traded on the market by all traders during
the last 7 business days.
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RISK CONSIDERATIONS
INVESTMENT SUITABILITY
Small Cap may be appropriate for investors who:
o are seeking long-term capital growth
o are willing to hold an investment over a long period of time in
anticipation of returns that equity securities can provide and
o are able to tolerate fluctuations in principal value of their
investment.
Investment in the Portfolio involves investment risks, including the risk
that investors may lose money. The value of the Portfolio's investments could be
influenced by changes in the stock market as a whole, by changes in a certain
industry, or by changes in certain stocks. The performance results presented
from time to time may reflect periods of above average performance attributable
to the Portfolio's investment in certain securities during the initial public
offering, the performance of a limited number of the securities in the
Portfolio, or other non-recurring factors. It is possible that the performance
may not be repeated in the future. The performance information presented for the
Portfolio will not reflect the impact of the variable annuity or variable life
insurance contract charges. If these charges were reflected, total returns would
be lower.
The Portfolio may, for temporary defensive purposes, invest a percentage
of its total assets, without limitation, in cash or various U.S.
dollar-denominated money market instruments. The value of money market
instruments tends to fall when current interest rates rise. Money market
instruments are generally less sensitive to interest rate changes than
longer-term securities. When the Portfolio's assets are invested in these
instruments, it may not be achieving its investment objective.
To the extent the Portfolio invests in small companies, it may be exposed
to greater risk than if it invested in larger, more established companies. Small
companies may have limited product lines, financial resources, and management
teams. Additionally, the trading volume of small company securities may make
them more difficult to sell. A more in-depth discussion of the types of risks an
equity fund could be subject to is on pages 5-6.
PERFORMANCE INFORMATION
Because Small Cap has less than one year's performance, no performance is
shown for the Portfolio.
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INVESTOR EXPENSES
The expenses you should expect to pay as an investor in the Portfolio are
shown below.
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ANNUAL FUND OPERATING EXPENSES(1)
(EXPENSES THAT ARE DEDUCTED FROM PORTFOLIO ASSETS)
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Management fees 1.25%
Other Expenses(2) 0.80%
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Total operating expenses(3) 2.05%
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(1) JMIC voluntarily reimburses fund expenses and waives advisory fees to
the extent total operating expenses exceed 1.45% for Small Cap. This
cap on expenses is expected to continue until further notice. The
Portfolio may at a later date reimburse to the Adviser the advisory
fees waived or limited and other expenses, including organizational
expenses, assumed and paid by JMIC.
(2) The Portfolio has no sales, redemption, exchange, or account fees with
the exception of a $12.00 fee for each redemption made by wire.
Additionally, some institutions may charge a fee if you buy through
them. Separate account and contract charges are not reflected in the
fees above.
(3) "Other Expenses" is estimated based on expenses expected to be
incurred in the current fiscal period.
The example below shows what a shareholder could pay in expenses over time
and is intended to help you compare the cost of investing in the Portfolio with
the cost of investing in other mutual funds. It uses the same hypothetical
conditions other mutual funds use in their prospectuses: $10,000 initial
investment for the time periods indicated, 5% annual total return, expenses
(without fee waiver) remain unchanged. The figures shown would be the same
whether you sold your shares at the end of a period or kept them. The
Portfolio's actual return and expenses will be different.
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1 YEAR 3 YEARS
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SMALL CAP $208 $643
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RISK ELEMENTS
The objective of the Small Cap Growth Portfolio is to provide maximum
capital appreciation, consistent with reasonable risk to principal by investing
primarily in small capitalization companies.
This table identifies the main elements that make up the Portfolio's overall
risk and reward characteristics described under the Risk Considerations section
for the Portfolio. It also outlines the Portfolio's policies toward various
securities, including those that are designed to help the Portfolio manage risk.
The following policies are not fundamental and the Trustees may change such
policies without shareholder approval.
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<TABLE>
<CAPTION>
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STRATEGIES TO SEEK REWARD POTENTIAL REWARDS POTENTIAL RISKS
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<S> <C> <C>
MARKET CONDITIONS
o Under normal circumstances o Stocks and bonds o The Portfolio's share price
the Portfolio plans to have generally outperformed and performance will
remain fully invested. more stable investments fluctuate in response to
(such as short-term bonds stock and bond market
o The Portfolio seeks to limit and cash equivalents) over movements.
risk through diversification the long term.
in a large number of stocks.
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MANAGEMENT CHOICES
o JMIC focuses on bottom-up o The Portfolio could o The Portfolio could
research, fundamental outperform its benchmark underperform its
security analysis and due to its asset allocation benchmark due to these
valuation methods to and securities choices. same choices and due to
enhance returns. expenses.
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SHORT-TERM TRADING
o The Portfolio's turnover o The Portfolio could realize o Increasing trading would
rate generally will not gains in a short period raise the Portfolio's
exceed 150%. time. brokerage and related costs.
o The Portfolio generally avoids o The Portfolio could protect
short-term trading, except against losses if a stock
to take advantage of attractive is overvalued and its value
or unexpected opportunities or later falls.
to meet demands generated by
shareholder activity.
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SMALL CAP STOCKS
o JMIC focuses on companies o Securities of companies o The Portfolio could lose
with potential for strong with small capitalizations money because of the
growth in revenue, earnings may have greater potential potentially higher risks of
and cash flow; strong than large cap companies to small companies and price
management; leading products deliver above-average growth volatility than investments
or services; and potential rates that may not have yet in general equity markets.
for improvement. been recognized by investors.
o 35% of the Portfolio may
be invested in securities
of larger capitalization
companies.
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</TABLE>
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The following table indicates the maximum percentage under normal
conditions, that the Portfolio may make:
ADR's, EDR's and GDR's............. 5%
Bank obligations.................... 10%
Foreign securities................. 5%
Futures contracts.................. 5%(a) 20%(b)
Illiquid securities................. 15%
Investment companies............... 10%
Lending of securities.............. 33 1/3%
Options transactions............... 5%(a) 20%(b)
Repurchase agreements.............. 33 1/3%
U.S. Government obligations........ 100%
Warrants........................... 5%
When-issued securities............. 33 1/3%
TEMPORARY INVESTMENTS(C)
Cash............................... 100%
Short-term obligations............. 100%
INVESTMENT RESTRICTIONS
Securities of any one issuer....... 5%
Outstanding voting securities
of any one issuer................. 10%
Securities of issuers in any
one industry..................... 25%
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Percentages are of total assets (except for Illiquid Securities which are shown
as a percentage of net assets).
(a) The Portfolio may not purchase futures contracts or options where premiums
and margin deposits exceed 5% of total assets.
(b) The Portfolio may not enter into futures contracts or options where its
obligations would exceed 20% of total assets.
(c) The Portfolio will invest up to 100% of its assets in temporary investments
only when market conditions so require.
INFORMATION ABOUT THE ADVISER
Brazos Insurance Funds (the "Trust") was created in January 2000. In
addition to offering investment advisory services to the Trust, JMIC, a limited
partnership located at 5949 Sherry Lane, Suite 1600, Dallas, Texas, 75225, also
offers investment advisory services to Brazos Mutual Funds, which consists of
the Brazos Small Cap Growth, Brazos Micro Cap Growth, Brazos Mid Cap Growth,
Brazos Real Estate Securities and Brazos Multi Cap Growth Portfolios. JMIC is a
majority owned indirect subsidiary of American International Group, Inc. ("AIG")
and minority owned by the employees of JMIC. JMIC began managing large accounts
for pension plans, endowments, foundations and municipalities in 1983. The
senior management has worked together for approximately 20 years.
JMIC's mission is to capture excess returns while managing risk. JMIC
seeks to accomplish this objective by:
o investing in smaller companies
o investing in rapidly growing companies
o investing in companies with highly predictable revenue and profit
streams
o investing in companies positioned to accelerate profit growth above
general expectations
o constructing diversified portfolios to moderate risk
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JMIC has employed a bottom-up process in researching companies. JMIC
visits virtually every company prior to investing. Bottom-up research often
includes interviews with senior management, as well as the companies'
competitors and suppliers. The list of potential investments is further filtered
by the use of traditional fundamental security analysis and valuation methods.
JMIC manages the Portfolio using a team approach. By using a team
approach, the Trust avoids the risk of changes in portfolio management style
that may be encountered when a lead manager approach is utilized. The team
approach creates portfolio management stability, which provides confidence that
the process is repeatable, and has been used for the last twenty-five years.
JMIC has had minimal (one) professional turnover during the last fifteen years
of management.
For its services to the Portfolio, JMIC is entitled to a contractual fee,
calculated daily and payable monthly, at an annual rate of 1.25% of the
Portfolio's average daily net assets. JMIC will voluntarily waive or reimburse
additional amounts to maintain an expense ratio of 1.45%, including
organizational expenses, to increase the investment return to the Portfolio's
investors. JMIC may terminate all such waivers and/or reimbursements at any
time. Further, any waivers or reimbursements made by JMIC with respect to the
Portfolio are subject to recoupment from the Portfolio within the following
three years, provided that the Portfolio is able to effect such payment to JMIC
and remain in compliance with the foregoing expense limitations.
ADVISER'S HISTORICAL PERFORMANCE
Set forth below are performance data provided by the Adviser pertaining to
the composite of all separately managed accounts of the Adviser that are managed
with substantially similar (although not necessarily identical) objectives,
policies and strategies as those of the Portfolio. The performance shown below
is net of all actual fees and expenses of the separately managed accounts. The
use of the portfolio's expense structure would have lowered the performance
results. Further, the separately managed accounts are not subject to investment
limitations, diversification requirements and other restrictions imposed by the
Investment Company Act of 1940 and Internal Revenue Code; such conditions, if
applicable, may have lowered the returns for the separately managed accounts.
The Adviser's separately managed account performance results set forth below
under "Institutional Equity Results" are not intended to predict or suggest the
return of the Portfolio, but rather to provide the shareholder with information
about the historical investment performance of the Portfolio's Adviser. The
Russell 2000 Index used in the comparison below is an unmanaged index which
assumes reinvestment of dividends on securities in the index and is generally
considered representative of securities similar to those invested in by the
Adviser for the purpose of the composite performance numbers set forth below.
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ADVISER'S
INSTITUTIONAL
SMALL CAP RUSSELL
EQUITY ACCOUNTS 2000 INDEX
(AFTER (BEFORE
EXPENSES) EXPENSES)
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CALENDAR YEARS:
1987 25.6% -8.8%
1988 24.5% 24.9%
1989 31.9% 16.2%
1990 -4.0% -19.5%
1991 68.9% 46.1%
1992 8.7% 18.4%
1993 15.3% 18.9%
1994 -0.1% -1.8%
1995 30.1% 28.4%
1996 32.9% 16.5%
1997 23.4% 22.4%
1998 10.4% -2.5%
1999 12.6% 21.3%
AVERAGE ANNUAL
TOTAL RETURNS
AS OF 12/31/99:
Cumulative 1010.6% 365.8%
Annualized 20.3% 12.6%
1 Year 12.6% 21.3%
3 Year 15.3% 13.1%
5 Year 21.5% 16.7%
10 Year 18.3% 13.4%
Five-Year Mean 21.9% 17.2%
Thirteen-Year Mean 21.6% 13.9%
Value of $1 invested
During 13 years
(1/1/87 - 12/31/99) $11.11 $4.66
1 The Adviser's Institutional Small Cap Equity Accounts represents the
composite of all separately managed accounts of the Adviser that are managed
with substantially similar (although not identical) objectives, policies and
strategies as those of the Small Cap Growth Portfolio. The separately managed
accounts are subject to different expenses and governmental regulations than
the Portfolio.
2 The annualized return of the Adviser's Institutional Small Cap Equity
Accounts is calculated from monthly data, allowing for compounding. The
formula used is in accordance with the methods set forth by the Association
for Investment Management Research ("AIMR"), The Bank Administration
Institute, and the Investment Counsel Association of America. Market value of
the account was the sum of the account's total assets, including cash, cash
equivalents, short term investments, and securities valued at current market
prices.
3 The cumulative return means that $1 invested in the Institutional Small Cap
Equity composite accounts on January 1, 1987 had grown to $11.11 by December
31, 1999.
4 The thirteen-year arithmetic mean is the arithmetic average of the
Institutional Small Cap Equity composite accounts' annual returns listed.
5 The Russell 2000 Index is an unmanaged index which assumes reinvestment of
dividends on securities in the index and is generally considered
representative of securities similar to those invested in by the Adviser for
the purpose of the composite performance numbers set forth above. The Russell
2000 is composed of the 2000 smallest stocks in the Russell 3000, a market
value weighted index of the 3,000 largest U.S. publicly traded companies. The
comparative index is not adjusted to reflect expenses or other fees reflected
in the performance of a mutual fund as required by the SEC.
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6 The Adviser's average annual management fee over the thirteen-year period
(1987-1999) for the Institutional Small Cap Equity composite accounts was 1%
or 100 basis points. On January 1, 1987, the Adviser began managing the
separate accounts using objectives, policies and strategies substantially
similar to those of the Small Cap Growth Portfolio. During the period, fees
on the Adviser's individual accounts ranged from 1% to 1.5% (100 basis points
to 150 basis points). Net returns to investors vary depending on the
management fee. Separate account and contract charges are not reflected in
the returns shown. The individual accounts were not subject to a sales load.
7 Institutional Small Cap Equity composite accounts ("Composite") performance
data is AIMR compliant from 1/1/93 forward. Prior to that time, the only
difference in the calculation is that all portfolios were equally weighted
without regard to dollar value in determining Composite performance. The
Composite includes every account managed in JMIC's small capitalization
style, consistent with AIMR guidelines. This equal weighting method follows
the standards promulgated by the Investment Management Consultants'
Association which predates standards established by AIMR. In 1990, the
Composite results reflected portfolios ranging in number from 3 to 8 and in
size from $3 million to $30 million, with a median size of $13 million. In
1991, the Composite reflected portfolios ranging in number from 8 to 18 and
in size from $1 million to $46 million, with a median size of $15 million. In
1992, the Composite reflected portfolios ranging in number from 20 to 27 and
in size from $4 million to $50 million, with a median size of $17 million.
And, from 1987 through 1989, the Composite consisted of only one portfolio
which for many years served as the model for all accounts managed in this
style.
PERFORMANCE OF SIMILARLY
MANAGED MUTUAL FUND
The Portfolio is recently organized and has only a short-term performance
record. The Portfolio, however, has substantially the same investment objective,
policies and strategies as the Brazos Small Cap Growth Portfolio of Brazos
Mutual Funds (the "Comparable Fund") that is sold directly to the public and is
advised by JMIC. While the Portfolio is managed in a manner similar to that of
the Comparable Fund, investors should be aware that the Portfolio is not the
same fund and will not have the same performance. Investments made by the
Portfolio at any given time may not be the same as those made by the Comparable
Fund. Different performance will result due to factors such as differences in
the cash flows into and out of the Portfolio, different fees and expenses, and
differences in portfolio size and positions.
The historical performance of the Comparable Fund is presented below. You
should not consider the performance of the Comparable Fund as an indication of
the future performance of the Portfolio. The performance figures shown below
reflect the deduction of the historical fees and expenses paid by the Comparable
Fund, and not those to be paid by the Portfolio. The use of the Portfolio's
expense structure would have lowered the performance results. The share class of
the Comparable Fund presented is not subject to a sales load. The figures do not
reflect the deduction of any insurance fees or charges that are imposed by the
insurance company in connection with its sale of variable annuity or variable
life insurance contracts. You should refer to the separate account prospectuses
describing the variable annuity or variable life insurance contracts for
information pertaining to these insurance fees and charges. The insurance
separate account fees will have a detrimental effect on the performance of the
Portfolio. The results shown below reflect the reinvestment of dividends and
distributions, and were calculated in the same manner that will be used by the
Portfolio to calculate its own performance.
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The following table shows the average annual total return of the
Comparable Fund for the stated periods ending December 31, 1999.
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SINCE INCEPTION
ONE YEAR (12/31/96)
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Brazos Small Cap Growth Portfolio 37.01% 33.97%
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INFORMATION FOR FIRST TIME
MUTUAL FUND INVESTORS
The Federal Deposit Insurance Corporation, the Federal Reserve Board or
any other agency does not federally insure Mutual Fund shares.
Investments in Mutual Fund shares involve risks, including possible loss
of principal.
VALUATION OF SHARES
The net asset value of the Portfolio is calculated by adding the value of
all securities and other assets, subtracting the liabilities and dividing the
result by the number of shares outstanding to be determined. The net asset value
is calculated once daily, as of the close of the New York Stock Exchange
("NYSE") on each day that the NYSE is open for business.
The Portfolio uses the last quoted trading price as the market value for
equity securities. For listed securities, the Portfolio uses the price quoted by
the exchange on which the security is primarily traded. Unlisted securities and
listed securities which have not been traded on the valuation date or for which
market quotations are not readily available are valued at the average between
the last price asked and the last price bid. For valuation purposes, quotations
of foreign securities in a foreign currency are converted to U.S. Dollar
equivalents based upon the latest available bid price of such currencies against
U.S. Dollars quoted by any major bank or by any broker.
Bonds and other fixed income securities are valued according to the
broadest and most representative market which will ordinarily be the
over-the-counter market. Net asset value includes interest on fixed income
securities, which is accrued daily. Bonds and other fixed income securities may
be valued on the basis of prices provided by a pricing service when such prices
are believed to reflect the fair value market value of such securities.
Securities purchased with remaining maturities of 60 days or less are valued at
amortized cost when the Board of Trustees (the "Trustees") determines that
amortized cost reflects fair value.
The value of other assets and securities for which no quotations are
readily available (including restricted securities) is determined in good faith
at fair value using methods determined by the Trustees.
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DIVIDENDS, CAPITAL GAINS DISTRIBUTIONS
AND TAXES
DIVIDENDS AND CAPITAL GAINS DISTRIBUTIONS
The Portfolio will distribute annually to shareholders substantially all
of its net investment income and any net realized long-term capital gains. The
Portfolio's dividends and capital gains distributions will be reinvested
automatically in additional shares unless the Trust is notified in writing that
the shareholder elects to receive distributions in cash.
FEDERAL TAXES
The Portfolio intends to qualify as a regulated investment company for
federal income tax purposes by satisfying the requirements of Subchapter M of
the Internal Revenue Code of 1986, as amended, (the "Code"): The Portfolio
intends to comply with the diversification requirements of Section 817(h) of the
Code for variable annuity and variable life insurance contracts so that the
owners of these contracts should not be subject to federal tax on distributions
of dividends and income from the Portfolio to the insurance company separate
accounts. Contract owners should review the prospectus for their variable
annuity or variable life insurance contract for information regarding the tax
consequences to them of purchasing a contract.
STATE AND LOCAL TAXES
Shareholders may also be subject to state and local taxes on distributions
and redemptions. Shareholders should consult with their tax advisers regarding
the tax status of distributions in their state and locality.
PURCHASE OF SHARES
Purchases of shares may be made only by insurance companies for their
separate accounts at the direction of variable annuity and variable life
contract owners. Please refer to the prospectus for your contract or policy for
information on how to direct investments in the Portfolio and any fees that
apply. As a result of an exemptive order from the SEC, the Trust may be offered
to pension plans. References to "shareholder" throughout refer to the vehicle
that invests in the shares of the Trust.
Shares of the Portfolio may be purchased without sales commission, at the
net asset value per share next determined after an order is received by the
insurance company before the earlier of 4:00 p.m. E.S.T. or the close of regular
trading on the New York Stock Exchange (see "Valuation of Shares"). The Trust
reserves the right to reject your purchase order and to suspend the offering of
shares of the Trust. All purchases must be in U.S. dollars.
A potential for certain conflicts may exist between the interests of
variable annuity contract owners and variable life insurance contract owners.
JMIC currently does not foresee any disadvantage to owners of variable annuity
contracts or variable life insurance contracts arising from the fact that shares
of the Portfolio might be held by such entities. The Trustees, however, will
monitor the Trust and the Portfolio in order to identify any material
irreconcilable conflicts
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of interest which may arise, and to determine what action, if any, should be
taken in response to any such conflicts.
OTHER PURCHASE INFORMATION
Investments received by 4 p.m. ET (the close of the NYSE) will be invested
at the price calculated after the NYSE closes that day. Orders received after 4
p.m. ET will receive the price calculated on the next business day.
DISTRIBUTOR
Pembrook Securities, Inc., 5949 Sherry Lane, Suite 1600, Dallas, TX 75225
("Pembrook"), serves as Distributor for shares of the Portfolio. Pembrook will
receive no compensation for distribution of shares of the Portfolio, except for
reimbursement by the Adviser of out-of-pocket expenses. Pembrook is a majority
owned indirect subsidiary of AIG, and minority owned by certain employees of
JMIC, the Trust's adviser, which is also a majority owned indirect subsidiary of
AIG.
REDEMPTION OF SHARES
Redemption of shares may be made only by insurance companies for their
separate accounts at the direction of variable annuity and variable life
insurance contract owners. Please refer to the prospectus for your contract or
policy for information on how to direct redemptions from the Portfolio and fees
that may apply.
Any redemption may be more or less than the purchase price of your shares
depending on the market value of the investment securities held by your
Portfolio.
OTHER REDEMPTION INFORMATION
Normally, the Portfolio will make a payment for all shares redeemed under
proper procedures within one business day of and no more than seven business
days after receipt of the request. The Trust may suspend the right of redemption
or postpone the date, as permitted by the SEC, including under emergency
circumstances and at times when the NYSE is closed.
If the Trustees determine that it would be detrimental to the best
interests of remaining shareholders of the Portfolio to make payment wholly or
partly in cash, the Portfolio may pay redemption proceeds in whole or in part by
a distribution in-kind of liquid securities held by the Portfolio in lieu of
cash in conformity with applicable rules of the SEC. Investors may incur
brokerage charges on the sale of portfolio securities so received in payment of
redemptions.
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FOR MORE INFORMATION
You may obtain the following and other information free of charge:
STATEMENT OF ADDITIONAL INFORMATION (SAI) DATED AUGUST 25, 2000
PROVIDES ADDITIONAL DETAILS ABOUT THE PORTFOLIO'S POLICIES AND MANAGEMENT.
Telephone:
888-221-3460
Mail:
Brazos Insurance Funds
c/o Firstar Mutual Fund Services, LLC
615 East Michigan Street
P.O. Box 701
Milwaukee, WI 53201-0701
By Express Mail:
Brazos Insurance Funds
c/o Firstar Mutual Fund Services, LLC
615 East Michigan Street, 3rd Floor
Milwaukee, Wisconsin 53202
SEC:
Text only versions of Fund documents can be viewed online or
downloaded from: HTTP://WWW.SEC.GOV
You may review and obtain copies of Fund information at the SEC Public Reference
Room in Washington, D.C. (1-202-942-8090). Copies of the information may
be obtained for a fee by writing the Public Reference Section, Washington, D.C.
20549-0102, or by electronic request to [email protected].
Investment Company Act of 1940 File No. 811-9811
WWW.BRAZOSINSURANCEFUNDS.COM
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BRAZOS INSURANCE FUNDS
BRAZOS SMALL CAP GROWTH PORTFOLIO
STATEMENT OF ADDITIONAL INFORMATION
AUGUST 25, 2000
This Statement is not a Prospectus but should be read in conjunction with the
Prospectus of the Brazos Insurance Funds (the "Trust") Small Cap Growth
Portfolio dated August 25, 2000. To obtain the Prospectus, please call the Trust
at 888-221-3460.
TABLE OF CONTENTS
Page
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ABOUT THE BRAZOS INSURANCE FUNDS............................................ 2
INVESTMENT OBJECTIVES AND POLICIES.......................................... 2
INVESTMENT LIMITATIONS...................................................... 11
MANAGEMENT OF THE TRUST..................................................... 12
INVESTMENT ADVISER AND OTHER SERVICES....................................... 14
PORTFOLIO TRANSACTIONS...................................................... 16
DESCRIPTION OF SHARES AND VOTING RIGHTS..................................... 17
DIVIDENDS, CAPITAL GAINS DISTRIBUTIONS AND TAXES............................ 18
PERFORMANCE CALCULATIONS.................................................... 21
APPENDIX A.................................................................. A-1
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ABOUT THE BRAZOS INSURANCE FUNDS
The Trust was organized as a Delaware business trust on January 21, 2000. The
Trust's principal office is located at 5949 Sherry Lane, Suite 1600, Dallas,
Texas 75225; however, all investor correspondence should be directed to Brazos
Insurance Funds, c/o Firstar Mutual Fund Services, LLC, 615 East Michigan
Street, P.O. Box 701, Milwaukee, Wisconsin 53201-0701. The Trust is comprised of
the BRAZOS Small Cap Growth Portfolio (the "Portfolio"). Brazos Insurance Funds
is a diversified, open-end, management investment company.
INVESTMENT OBJECTIVES AND POLICIES
The following policies supplement the investment policies of the Portfolio as
set forth in the Prospectus:
SHORT-TERM INVESTMENTS
Occasionally, the Portfolio may invest a portion of its assets in the following
money market instruments, consistent with its investment policies.
(1) Time deposits, certificates of deposit (including marketable
variable rate certificates of deposit) and bankers' acceptances
issued by a commercial bank or savings and loan association.
Time deposits are non-negotiable deposits maintained in a banking institution
for a specified period of time (not longer than seven days) at a stated interest
rate. Time deposits maturing from two business days through seven calendar days
will not exceed 10% of the total assets of the Portfolio under most
circumstances.
Certificates of deposit are negotiable short-term obligations issued by
commercial banks or savings and loan associations collateralized by funds
deposited in the issuing institution. Variable rate certificates of deposit are
certificates of deposit on which the interest rate is periodically adjusted
prior to their stated maturity based upon a specified market rate. A bankers'
acceptance is a time draft drawn on a commercial bank by a borrower, usually in
connection with an international commercial transaction.
The Portfolio will not invest in any security issued by a commercial bank unless
(i) the bank has total assets of at least $1 billion, or the equivalent in other
currencies, (ii) in the case of U.S. banks, it is a member of the Federal
Deposit Insurance Corporation, and (iii) in the case of foreign branches of U.S.
banks, the security is, in the opinion of the Adviser, of an investment quality
comparable to other debt securities which may be purchased by the Portfolio;
(2) Commercial paper rated A-1 or A-2 by S&P or Prime-1 or Prime-2 by
Moody's or, if not rated, issued by a corporation having an
outstanding unsecured debt issue rated A or better by Moody's or by
S&P;
(3) Short-term corporate obligations rated A or better by Moody's or by
S&P;
(4) U.S. Government obligations including bills, notes, bonds and other
debt securities issued by the U.S. Treasury. These are direct
obligations of the U.S.
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Treasury, supported by the full faith and credit pledge of the U.S.
Government and differ mainly in interest rates, maturities and dates
of issue;
(5) U.S. Government agency securities issued or guaranteed by U.S.
Government sponsored instrumentalities and Federal agencies; and
(6) Repurchase agreements collateralized by securities listed above.
REPURCHASE AGREEMENTS
The Portfolio may invest in repurchase agreements collateralized by U.S.
Government securities. In addition, the Portfolio may invest in repurchase
agreements collateralized by certificates of deposit, and certain bankers'
acceptances and other securities outlined above under "Short-Term Investments."
In a repurchase agreement, a Portfolio buys a security and simultaneously
commits to sell that security back at an agreed upon price plus an agreed upon
market rate of interest. Under a repurchase agreement, the seller will be
required to maintain the value of the securities subject to the agreement at not
less than the repurchase price if such securities mature in one year or less, or
102% of the repurchase price if such securities mature in more than one year.
The use of repurchase agreements involves certain risks. While the Trust's
management acknowledges these risks, it is expected that they can be controlled
through stringent security selection criteria and careful monitoring procedures.
WHEN-ISSUED, FORWARD DELIVERY AND DELAYED SETTLEMENT SECURITIES
The Portfolio may purchase and sell securities on a "when-issued," "delayed
settlement" or "forward delivery" basis. "When-issued" or "forward delivery"
refers to securities whose terms and indenture are available, and for which a
market exists, but which are not available for immediate delivery. When-issued
and forward delivery transactions may be expected to occur a month or more
before delivery is due. Delayed settlement is a term used to describe settlement
of a securities transaction in the secondary market which will occur sometime in
the future. No payment or delivery is made by the Portfolio until it receives
payment or delivery from the other party to any of the above transactions. The
Portfolio will maintain a separate account of cash, U.S. Government securities,
other high grade debt obligations or other liquid securities at least equal to
the value of purchase commitments until payment is made. Such segregated
securities will either mature or, if necessary, be sold on or before the
settlement date. Typically, no income accrues on securities purchased on a
delayed delivery basis prior to the time delivery is made, although the
Portfolio may earn income on securities it has deposited in a segregated
account.
The Portfolio may engage in when-issued transactions to obtain what is
considered to be an advantageous price and yield at the time of the transaction.
When the Portfolio engages in when-issued or forward delivery transactions, it
does so to acquire securities consistent with its investment objective and
policies and not for the purpose of investment leverage.
PORTFOLIO TURNOVER
It is expected that the annual portfolio turnover rate for the Portfolio will
not exceed 150%. In addition to Portfolio trading costs, higher rates (100% or
more) of portfolio turnover may result
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in an increase of transaction expenses. See "DIVIDENDS, CAPITAL GAINS
DISTRIBUTIONS AND TAXES" for information on taxation. The Portfolio will not
normally engage in short-term trading, but it reserves the right to do so.
INVESTMENT COMPANIES
The Portfolio reserves the right to invest up to 10% of its total assets,
calculated at the time of investment, in securities of other open-end or
closed-end investment companies. No more than 5% of the Portfolio's total assets
may be invested in securities of any one investment company nor may it acquire
more than 3% of the voting securities of any investment company. The Portfolio
will indirectly bear its proportionate share of any management fees paid by an
investment company in which it invests in addition to its advisory fee.
RESTRICTED SECURITIES
The Portfolio may purchase restricted securities that are not registered for
sale to the general public but which are eligible for resale to qualified
institutional investors under Rule 144A of the Securities Act of 1933. Under the
supervision of the Trust's Board of Trustees, the Adviser determines the
liquidity of such investments by considering all relevant factors. Provided that
a dealer or institutional trading market in such securities exists, these
restricted securities are not treated as illiquid securities for purposes of the
Portfolio's investment limitations. The Portfolio will invest no more than 15%
of its net assets in illiquid securities. The prices realized from the sales of
these securities could be less than those originally paid by the Portfolio or
less than what would be considered the fair value of such securities.
FOREIGN INVESTMENTS
The Portfolio may invest in common stocks of companies listed on foreign stock
exchanges, and may also invest in stocks traded in the over-the-counter market.
Common stocks for this purpose also include securities having common stock
characteristics such as rights and warrants to purchase common stocks.
Additionally, the Portfolio may also invest in foreign equity securities in the
form of American Depository Receipts (ADRs) and other similar global
instruments. ADRs (sponsored or unsponsored) are receipts typically issued by a
U.S. bank or trust company evidencing ownership of the underlying foreign
securities. Most ADRs are traded on a U.S. stock exchange. Issuers of
unsponsored ADRs are not contractually obligated to disclose material
information in the U.S. and, therefore, there may not be a correlation between
such information and the market value of the unsponsored ADR.
Investing in foreign companies may involve additional risks and considerations
which are not typically associated with investing in U.S. companies. Since
stocks of foreign companies are normally denominated in foreign currencies, the
Portfolio may be affected favorably or unfavorably by changes in currency rates
and in exchange control regulations, and may incur costs in connection with
conversions between various currencies. Some countries may withhold portions of
dividends and interest at the source. Under the Internal Revenue Code, foreign
exchange gains and losses are treated as ordinary gain or loss.
As non-U.S. companies are not generally subject to uniform accounting, auditing
and financial reporting standards and practices comparable to those applicable
to U.S. companies, comparable information may not be readily available about
certain foreign companies. Securities of some
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non-U.S. companies may be less liquid and more volatile than securities of
comparable U.S. companies. In addition, in certain foreign countries, there is
the possibility of expropriation or confiscatory taxation, political or social
instability, or diplomatic developments which could affect U.S. investments in
those countries.
SECURITIES LENDING
The Portfolio may lend its investment securities to qualified institutional
investors who need to borrow securities in order to complete certain
transactions, such as covering short sales, avoiding failures to deliver
securities or completing arbitrage transactions. By lending investment
securities, the Portfolio attempts to increase its income through the receipt of
interest on the loan. Any gain or loss in the market price of the securities
loaned that might occur during the term of the loan would be for the Portfolio's
accounts. The Portfolio may lend its investment securities to qualified brokers,
dealers, domestic and foreign banks or other financial institutions, so long as
the terms, the structure and the aggregate amount of such loans are not
inconsistent with the Investment Company Act of 1940, as amended, (the "1940
Act") or the rules and regulations or interpretations of the Securities and
Exchange Commission (the "Commission") thereunder, which currently require that
(a) the borrower pledge and maintain with the Portfolio collateral consisting of
cash, an irrevocable letter of credit issued by a domestic U.S. bank or
securities issued or guaranteed by the United States Government having a value
at all times not less than 100% of the value of the securities loaned, (b) the
borrower add to such collateral whenever the price of the securities loaned
rises (i.e., the borrower "marks to the market" on a daily basis), (c) the loan
be made subject to termination by the Portfolio at any time, and (d) the
Portfolio receives reasonable interest on the loan (which may include the
Portfolio investing any cash collateral in interest bearing short-term
investments). All relevant facts and circumstances, including the
creditworthiness of the broker, dealer or institution, will be considered in
making decisions with respect to the lending of securities, subject to review by
the Board of Trustees.
At the present time, the Staff of the Commission does not object if an
investment company pays reasonable negotiated fees in connection with loaned
securities so long as such fees are set forth in a written contract and approved
by the investment company's Board of Trustees. The Portfolio will continue to
retain any voting rights with respect to the loaned securities. If a material
event occurs affecting an investment on a loan, the loan must be called and the
securities voted.
HEDGING STRATEGIES
The Portfolio may engage in various portfolio strategies to hedge against
adverse movements in the equity markets. The Portfolio may write (i.e., sell)
covered call options on its portfolio securities, purchase put and call options
on securities and engage in transactions in related options on futures. Each of
these portfolio strategies is described below:
a) FUTURES CONTRACTS
The Portfolio may enter into futures contracts. Futures contracts provide for
the future sale by one party and purchase by another party of a specified amount
of a specific security at a specified future time and at a specified price.
Futures contracts which are standardized as to
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maturity date and underlying financial instrument are traded on national futures
exchanges. Futures exchanges and trading are regulated under the Commodity
Exchange Act by the Commodity Futures Trading Commission ("CFTC"), a U.S.
Government agency.
Although futures contracts by their terms call for actual delivery or acceptance
of the underlying securities, in most cases the contracts are closed out before
the settlement date without the making or taking of delivery. Closing out an
open futures position is done by trading an opposite position ("buying" a
contract which has previously been "sold" or "selling" a contract previously
"purchased") in an identical contract to terminate the position. Brokerage
commissions are incurred when a futures contract is bought or sold.
Futures traders are required to make a good faith margin deposit in cash or
acceptable securities with a broker or custodian to initiate and maintain open
positions in futures contracts. A margin deposit is intended to assure
completion of the contract (delivery or acceptance of the underlying security)
if it is not terminated prior to the specified delivery date. Minimal initial
margin requirements are established by the futures exchange and may be changed.
Brokers may establish deposit requirements which are higher than the exchange
minimums. Futures contracts are customarily purchased and sold on margin that
may range upward from less than 5% of the value of the contract being traded.
After a futures contract position is opened, the value of the contract is
marked-to-market daily. If the futures contract price changes to the extent that
the margin on deposit does not satisfy margin requirements, payment of
additional "variation" margin will be required. Conversely, change in the
contract value may reduce the required margin, resulting in a repayment of
excess margin to the contract holder. Variation margin payments are made to and
from the futures broker for as long as the contract remains open. The Portfolio
expects to earn interest income on its margin deposits.
Traders in futures contracts may be broadly classified as either "hedgers" or
"speculators." Hedgers use the futures markets primarily to offset unfavorable
changes in the value of securities otherwise held for investment purposes or
expected to be acquired by them. Speculators are less inclined to own the
securities underlying the futures contracts which they trade and use futures
contracts with the expectation of realizing profits from a fluctuation in
interest rates.
Regulations of the CFTC applicable to the Portfolio require that all of its
futures transactions constitute bona fide straddles positions or that the
Portfolio's commodity futures and option positions be for other purposes, to the
extent that the aggregate initial margins and premiums required to establish
such non-hedging positions do not exceed five percent of the liquidation value
of the Portfolio. The Portfolio will only sell futures contracts to protect
securities it owns against price declines or purchase contracts to protect
against an increase in the price of securities it intends to purchase. As
evidence of this hedging interest, the Portfolio expects that approximately 75%
of its futures contract purchases will be "completed," that is, equivalent
amounts of related securities will have been purchased or will be purchased by
the Portfolio on the settlement date of the futures contracts.
Although techniques other than the sale and purchase of futures contracts could
be used to control the Portfolio's exposure to market fluctuations, the use of
futures contracts may be a more effective means of hedging this exposure. While
the Portfolio will incur commission expenses in both opening and closing out
futures positions, these costs are lower than transaction costs incurred in the
purchase and sale of the underlying securities.
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RESTRICTIONS ON THE USE OF FUTURES CONTRACTS
The Portfolio will not enter into futures contract transactions to the extent
that, immediately thereafter, the sum of its initial margin deposits on open
contracts exceeds 5% of the market value of its total assets. In addition, the
Portfolio will not enter into futures contracts to the extent that its
outstanding obligations to purchase securities under these contracts would
exceed 20% of its total assets.
RISK FACTORS IN FUTURES TRANSACTIONS
The Portfolio will minimize the risk that it will be unable to close out a
futures position by only entering into futures which are traded on national
futures exchanges and for which there appears to be a liquid secondary market.
However, there can be no assurance that a liquid secondary market will exist for
a particular futures contract at any given time. Thus, it may not be possible to
close a futures position. In the event of adverse price movements, the Portfolio
would continue to be required to make daily cash payments to maintain its
required margin. In such situations, if the Portfolio has insufficient cash, it
may have to sell securities to meet daily margin requirements at a time when it
may be disadvantageous to do so. In addition, the Portfolio may be required to
make delivery of the instruments underlying futures contracts it holds. The
inability to close futures positions also could have an adverse impact on the
Portfolio's ability to effectively hedge.
The risk of loss in trading futures contracts in some strategies can be
substantial due both to the low margin deposits required and the extremely high
degree of leverage involved in futures pricing. As a result, a relatively small
price movement in a futures contract may result in immediate and substantial
loss (as well as gain) to the investor. For example, if at the time of purchase,
10% of the value of the futures contract is deposited as margin, a subsequent
10% decrease in the value of the futures contract would result in a total loss
of the margin deposit, before any deduction for the transaction costs, if the
account were then closed out. A 15% decrease would result in a loss equal to
150% of the original margin deposit if the contract were closed out. Thus, a
purchase or sale of a futures contract may result in excess of the amount
invested in the contract. However, because the futures strategies of the
Portfolio are engaged in only for hedging purposes, the Adviser does not believe
that the Portfolio is subject to the risks of loss frequently associated with
futures transactions. The Portfolio would presumably have sustained comparable
losses if, instead of futures contracts, it had invested in the underlying
financial instrument and sold them after the decline.
Utilization of futures transactions by the Portfolio does involve the risk of
imperfect or no correlation where the securities underlying the futures
contracts have different maturities than the portfolio securities being hedged.
It is also possible that the Portfolio could lose money on futures contracts and
also experience a decline in value of portfolio securities. There is also the
risk of loss by the Portfolio of margin deposits in the event of bankruptcy of a
broker with whom the Portfolio has an open position in a futures contract or
related option.
Most futures exchanges limit the amount of fluctuation permitted in futures
contract prices during a single trading day. The daily limit establishes the
maximum amount that the price of a futures contract may vary either up or down
from the previous day's settlement price at the end of a trading session. Once
the daily limit has been reached in a particular type of contract, no trades may
be made on that day at a price beyond that limit. The daily limit governs only
price
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movement during a particular trading day and, therefore, does not limit
potential losses because the limit may prevent the liquidation of unfavorable
positions. Futures contract prices have occasionally moved to the daily limit
for several consecutive trading days with little or no trading thereby
preventing prompt liquidation of futures positions and subjecting some futures
traders to substantial losses.
Futures contracts may be traded on foreign exchanges. Such transactions are
subject to the risks of governmental actions affecting trading in or the prices
of the securities. The value of such positions also could be adversely affected
by (i) other complex foreign political and economic factors, (ii) lesser
availability than in the United States of data on which to make trading
decisions, (iii) delays in the Portfolio's ability to act upon economic events
occurring in foreign markets during non-business hours in the United States,
(iv) the imposition of different exercise and settlement terms and procedures
and margin requirements than in the United States, and (v) lesser trading
volume.
The investment by the Portfolio in futures contracts and options on futures
contracts is subject to many complex and special tax rules. The treatment by the
Portfolio of certain futures and forward contracts is generally governed by
Section 1256 of the Internal Revenue Code of 1986, as amended (the "Code").
These "Section 1256" positions generally include listed options on futures
contracts, regulated futures contracts and certain foreign currency contracts
and options thereon.
Absent a tax election to the contrary, each such Section 1256 position held by
the Portfolio will be marked-to-market (i.e., treated as if it were sold for
fair market value) on the last business day of the Portfolio's fiscal year, and
all gain or loss associated with fiscal year transactions and marked-to-market
positions at fiscal year end (except certain currency gain or loss covered by
Section 988 of the Code) will generally be treated as 60% long-term capital gain
or loss and 40% short-term capital gain or loss. The effect of Section 1256
mark-to-market rules may be to accelerate income or to convert what otherwise
would have been long-term capital gains into short-term capital gains or
short-term capital losses into long-term capital losses within the Portfolio.
The acceleration of income on Section 1256 positions may require the Portfolio
to accrue taxable income without the corresponding receipt of cash. In order to
generate cash to satisfy the distribution requirements of the Code, the
Portfolio may be required to dispose of portfolio securities that it otherwise
would have continued to hold or to use cash flows from other sources such as the
sale of the Portfolio's shares. In these ways, any or all of these rules may
affect both the amount, character and timing of income distributed to
shareholders by the Portfolio.
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b) OPTIONS
The Portfolio may purchase and sell put and call options on securities and
futures contracts for hedging purposes. Investments in options involve some of
the same considerations that are involved in connection with investments in
futures contracts (e.g., 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 security or 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 on which it is based or 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 or securities.
WRITING COVERED CALL OPTIONS
The principal reason for writing call options is to attempt to realize, through
the receipt of premiums, a greater return than would be realized on securities
alone. By writing covered call options, the Portfolio gives up the opportunity,
while the option is in effect, to profit from any price increase in the
underlying security above the option exercise price. In addition, the
Portfolio's ability to sell the underlying security will be limited while the
option is in effect unless it effects a closing purchase transaction. A closing
purchase transaction cancels out the Portfolio's position as the writer of an
option by means of an offsetting purchase of an identical option prior to the
expiration of the option that it has written. Covered call options serve as a
partial hedge against the price of the underlying security declining. The
Portfolio writes only covered options, which means that so long as the Portfolio
is obligated as the writer of the option it will, in a segregated account with
its custodian, maintain cash, U.S. government securities, other high grade
liquid debt securities or other liquid securities denominated in U.S. dollars
with a value equal to or greater than the exercise price of the underlying
securities.
PURCHASING OPTIONS
The amount of any appreciation in the value of the underlying security subject
to a put will be partially offset by the amount of the premium paid for the put
option and any related transaction costs. Prior to its expiration, a put option
may be sold in a closing sale transaction and profit or loss from a sale will
depend on whether the amount received is more or less than the premium paid for
the put option plus the related transaction costs. A closing sale transaction
cancels out the Portfolio's position as purchaser of an option by means of an
offsetting sale of an identical option prior to the expiration of the option
that it has purchased. In certain circumstances, the Portfolio may purchase call
options on securities held in its investment portfolios on which it has written
call options or on securities which it intends to purchase.
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c) SHORT SALES
The Portfolio may seek to hedge investments or realize additional gains through
short sales. The Portfolio may make short sales, which are transactions in which
the Portfolio sells a security it does not own, in anticipation of a decline in
the market value of the security. To complete such a transaction, the Portfolio
must borrow the security to make delivery to the buyer. The Portfolio then is
obligated to replace the security borrowed by purchasing it at the market price
at or prior to the time of replacement. The price at such time may be more or
less than the price at which the security was sold. Until the security is
replaced, the Portfolio is required to repay the lender any dividends or
interest that accrue during the period of the loan. To borrow the security, the
Portfolio also may be required to pay a premium, which would increase the cost
of the security sold. The net proceeds of the short sale will be retained by the
broker, to the extent necessary to meet margin requirements, until the short
position is closed out. The Portfolio also will incur transaction costs in
effecting short sales.
The Portfolio will incur a loss as a result of the short sale if the price of
the security increases between the date of the short sale and the date on which
the Portfolio replaces the borrowed security. The Portfolio will realize a gain
if the security declines in price between those dates. The amount of any gain
will be decreased, and the amount of any loss increased by the amount of the
premium, dividends, interest, or expenses the Portfolio may be required to pay
in connection with a short sale.
No securities will be sold short if, after effect is given to any such short
sale, the total market value of all securities sold short would exceed 25% of
the value of the Portfolio's net equity. The Portfolio similarly will limit its
short sales of the securities of any single issuer if the market value of the
securities that have been sold short would exceed two percent (2%) of the value
of the Portfolio's net equity or if such securities would constitute more than
two percent (2%) of any class of the issuer's securities.
Whenever the Portfolio engages in short sales, its custodian segregates an
amount of cash or U.S. Government securities or other high-grade liquid debt
securities equal to the difference between (a) the market value of the
securities sold short at the time they were sold short and (b) any cash or U.S.
Government securities required to be deposited with the broker in connection
with the short sale (not including the proceeds from the short sale). The
segregated assets are marked-to-market daily, provided that at no time will the
amount deposited in it plus the amount deposited with the broker be less than
the market value of the securities at the time they were sold short.
In addition, the Portfolio may make short sales "against the box," i.e. when a
security identical to one owned by the Portfolio is borrowed and sold short. If
the Portfolio enters into a short sale against the box, it is required to
segregate securities equivalent in kind and amount to the securities sold short
(or securities convertible or exchangeable into such securities) and is required
to hold such securities while the short sale is outstanding. The Portfolio will
incur transaction costs, in connection with opening, maintaining, and closing
short sales against the box. A short sale may result in the recognition of gain
with respect to a security for Federal income tax purposes under certain rules
which treat certain short sales of the same or substantially identical positions
with respect to such a security as a constructive sale at the time a short
position is entered into by the Portfolio. See, "DIVIDENDS, CAPITAL GAINS
DISTRIBUTIONS AND TAXES."
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Except as specified above and as described under "INVESTMENT LIMITATIONS" below,
the foregoing investment policies are not fundamental and the Trustees may
change such policies without an affirmative vote of a majority of the
outstanding voting securities of the Portfolio, as defined in the 1940 Act.
INVESTMENT LIMITATIONS
The following limitations supplement those set forth in the Prospectus. Whenever
an investment limitation sets forth a percentage limitation on investment or
utilization of assets, such limitation shall be determined immediately after and
as a result of the Portfolio's acquisition of such security or other asset.
Accordingly, any later increase or decrease resulting from a change in values,
net assets or other circumstances will not be considered when determining
whether the investment complies with the Portfolio's investment limitations.
Investment limitations (1) through (9) described below are fundamental policies
and cannot be changed without approval by a "majority of the outstanding shares"
(as defined in the 1940 Act) of the Portfolio. The Portfolio will not:
(1) with respect to 75% of its assets, invest more than 5% of its total
assets at the time of purchase in the securities of any single
issuer (other than obligations issued or guaranteed as to principal
and interest by the government of the U.S. or any agency or
instrumentality thereof);
(2) with respect to 75% of its assets, purchase more than 10% of any
class of the outstanding voting securities of any issuer;
(3) borrow money, except as a temporary measure for extraordinary or
emergency purposes and then, in no event, in excess of 33 1/3% of
the Portfolio's gross assets valued at the lower of market or cost,
and the Portfolio may not purchase additional securities when
borrowings exceed 5% of total gross assets;
(4) pledge, mortgage or hypothecate any of its assets to an extent
greater than 33% of its total assets at fair market value;
(5) invest in physical commodities or contracts on physical commodities;
(6) purchase or sell real estate or real estate limited partnerships,
although it may purchase and sell securities of companies which deal
in real estate and may purchase and sell securities which are
secured by interests in real estate;
(7) make loans except (i) by purchasing debt securities in accordance
with its investment objectives; (ii) by lending its portfolio
securities to banks, brokers, dealers and other financial
institutions so long as such loans are not inconsistent with the
1940 Act or the rules and regulations or interpretations of the
Commission thereunder; and (iii) as otherwise permitted by exemptive
order of the Commission;
(8) underwrite the securities of other issuers;
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(9) issue senior securities, as defined in the 1940 Act, except that
this restriction shall not be deemed to prohibit the Portfolio from
(i) making any permitted borrowings, mortgages or pledges, or (ii)
entering into options, futures or repurchase transactions;
(10) invest in futures and/or options on futures unless (i) not more than
5% of the Portfolio's assets are required as deposit to secure
obligations under such futures and/or options on futures contracts,
provided, however, that in the case of an option that is
in-the-money at the time of purchase, the in-the-money amount may be
excluded in computing such 5%; and (ii) not more than 20% of the
Portfolio's assets are invested in futures and options;
(11) purchase on margin except as specified in (10) above;
(12) invest more than an aggregate of 15% of the net assets of the
Portfolio, determined at the time of investment, in securities
subject to legal or contractual restrictions on resale or securities
for which there are no readily available markets.
In addition, the Portfolio has adopted a fundamental policy that it will not
acquire any securities of companies within one industry if, as a result of such
acquisition, more than 25% of the value of the Portfolio's total assets would be
invested in securities of companies within such industry; provided, however,
that there shall be no limitation on the purchase of obligations issued or
guaranteed by the U.S. Government, its agencies or instrumentalities, or
instruments issued by U.S. banks when the Portfolio adopts a temporary defensive
position.
MANAGEMENT OF THE TRUST
TRUSTEES AND OFFICERS
The Officers of the Trust manage its day-to-day operations and are responsible
to the Trust's Board of Trustees. The Trustees set broad policies for the Trust
and elect its Officers. The following is a list of the Trustees and Officers of
the Trust and a brief statement of their present positions and principal
occupations during the past five years:
*DAN L. HOCKENBROUGH President, Chief Financial Officer and Chairman of
5949 Sherry Lane the Board of Brazos Insurance Funds and Trustee,
Suite 1600 President, Treasurer and Chief Financial Officer of
Dallas, Texas 75225 Brazos Mutual Funds; Since August 1996, Business
Age 41 Manager of John McStay Investment Counsel. Formerly,
Chief Financial Officer of Waugh Enterprises, Inc.
from November 1995 until August 1996; and Assistant
Controller of Hicks, Muse, Tate & Furst Incorporated
from December 1992 to November 1995.
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GEORGE W. GAU Trustee of the Trust, Professor of Finance, George S.
8009 Long Canyon Dr. Watson Centennial Professor in Real Estate, College
Austin, TX 78730 and Graduate School of Business, University of Texas
Age 53 at Austin since 1988; J. Ludwig Mosle Centennial
Memorial Professor in Investments and Money
Management, since 1996; and Chairman of the Board and
Chief Executive Officer, The MBA Investment Fund,
L.L.C., a $10 million fund that is the first private
investment company to be managed by students, since
1994.
JOHN H. MASSEY Trustee of the Trust; Private Investor and a Director
4004 Windsor Avenue of The Paragon Group, Inc., Chancellor Broadcasting,
Dallas, Texas 75205 Inc., Bank of the Southwest, Columbine JDS Systems,
Age 61 Inc. and FSW Holdings, Inc. and Director of the
Sunrise Television Group, Inc.; Chairman of the Board
and Chief Executive Officer of Life Partners Group,
Inc. from October 1994 until August 1996.
DAVID M. REICHERT Trustee of the Trust; Private Investor; formerly
7415 Stonecrest Drive Senior Vice President and Portfolio Manager of Moffet
Dallas, Texas 75240 Capital Management, an investment counseling firm,
Age 61 from January 1995 until June 1996 and Senior Vice
President and Portfolio Manager of American Capital
Asset Management, a mutual fund management company,
from April 1989 to December 1994.
*LOREN J. SOETENGA Vice President and Treasurer of Brazos Insurance
5949 Sherry Lane Funds and Vice President of Brazos Mutual Funds,
Suite 1600 Principal of John McStay Investment Counsel.
Dallas, Texas 75225 Formerly, Partner of Chronos Management, Inc. until
Age 32 1996.
*TRICIA A. HUNDLEY Vice President, Secretary and Compliance Officer of
5949 Sherry Lane Brazos Insurance Funds and Vice President, Secretary
Suite 1600 and Compliance Officer of Brazos Mutual Funds;
Dallas, Texas 75225 Partner of John McStay Investment Counsel since 1987.
Age 50
* This person is deemed to be an "interested person" of the Trust as that term
is defined in the 1940 Act.
REMUNERATION OF TRUSTEES AND OFFICERS
Each Trustee of the Trust who is not an "interested person" of the Trust, as
defined by the Investment Company Act of 1940, as amended, or an officer of the
Trust, receives compensation for his services as Trustee consisting of a $1,250
quarterly retainer fee per Portfolio of the Trust and a $1,250 fee for each
meeting of the Board. Each Trustee is reimbursed for reasonable out-of-pocket
expenses incurred in connection with attendance at the Board meeting.
Trustees who are also officers or affiliated persons receive no remuneration for
their service as Trustees. The Trust's officers and employees are paid by either
the Adviser or the Administrator and receive no compensation from the Trust.
PRINCIPAL HOLDERS OF SECURITIES
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Shares of the Portfolio will be owned by insurance companies as depositors of
separate accounts which are used to fund variable annuity contracts and variable
life insurance contracts. Great-West Life & Annuity Insurance Company may be
deemed a control person of the Fund in that upon the commencement of the
offering of the Portfolio, certain of its separate accounts held 100% of the
shares of the Portfolio.
As of the date of this Statement of Additional Information, the Trustees and
officers of the Trust owned in the aggregate less than 1% of the total
outstanding shares of the Portfolio.
INVESTMENT ADVISER AND OTHER SERVICES
John McStay Investment Counsel, L.P. ("JMIC" or the "Adviser") which was formed
as a limited partnership in 1983, is located at 5949 Sherry Lane, Suite 1600,
Dallas, Texas 75225 and acts as the Adviser for the Trust and Brazos Mutual
Funds (the "Company"), consisting of the Brazos Small Cap Growth, Brazos Micro
Cap Growth, Brazos Mid Cap Growth, Brazos Real Estate Securities, and the Brazos
Multi Cap Growth Portfolios. On June 30, 1999, JMIC reorganized and completed
the sale of an 80% managing membership interest in JMIC to American
International Group, Inc. ("AIG") resulting in JMIC becoming a majority owned
indirect subsidiary of AIG and minority owned by the employees of JMIC.
The Adviser provides investment management services to institutions and
individuals and currently has approximately $5.8 billion in assets under
management.
DISTRIBUTOR
Pembrook Securities, Inc. (the "Distributor") acts as Distributor for the Trust
pursuant to the Distribution Agreement between the Distributor and the Trust.
The Distributor will receive no compensation for distribution of shares of the
Portfolio, except for reimbursement by the Adviser of out-of-pocket expenses.
ADMINISTRATION FEES
Firstar Mutual Fund Services, LLC (the "Administrator" or "FMFS") 615 E.
Michigan Street, Milwaukee, WI 53202 serves as Administrator, Transfer Agent and
Dividend Paying Agent of the Trust and also provides accounting services to the
Trust pursuant to the Portfolio Administration Servicing Agreement between FMFS
and the Trust. FMFS is an indirect wholly-owned subsidiary of Firstar
Corporation, a multi-bank holding company.
As Administrator, FMFS supplies corporate secretarial services, office
facilities, non-investment-related statistical and research data, executive and
administrative services, internal auditing and regulatory compliance services.
FMFS also assists in the preparation of reports to shareholders, prepares proxy
statements, updates prospectuses and makes filings with the Securities and
Exchange Commission and state securities authorities. FMFS performs certain
budgeting and financial reporting and compliance monitoring activities. For the
services provided as Administrator, FMFS receives an annual fee from the Trust
equal to the greater of: (1) a
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minimum annual fee of $40,000 or (2) an asset-based fee, equal to a percentage
of the average daily net assets of the Trust, according to the following
schedule:
7 basis points on the first $200 million
6 basis points on the next $500 million
4 basis points on the balance
The Administrator's fee shall be payable monthly, as soon as practicable after
the last day of each month, based on the Trust's average daily net assets as
determined at the close of business on each business day throughout the month.
FMFS also serves as Transfer Agent and Dividend Paying Agent of the Trust.
CUSTODIAN
Firstar Bank, N.A. ("Firstar"), serves as the Custodian for the Trust pursuant
to the Custody Agreement, including Fund accounting services, between Firstar
and the Trust. As custodian the Bank has agreed to (a) maintain a separate
account or accounts in the name of the Trust, (b) hold and transfer portfolio
securities on account of the Trust, (c) accept receipts and make disbursements
of money on behalf of the Trust, (d) collect and receive all income and other
payments and distributions on account of the Trust's portfolio securities, and
(e) make periodic reports to the Trust's Trustees concerning the Trust's
operations. Firstar is authorized to select one or more banks or trust companies
to serve as sub-custodian on behalf of the Trust, provided that Firstar remains
responsible for the performance of all its duties under the Custodian Agreement
and holds the Trust harmless from the negligent acts and omissions of any
sub-custodian. For its services to the Trust under the Custodian Agreement,
Firstar receives a fee in addition to transaction charges and out-of-pocket
expenses.
INDEPENDENT ACCOUNTANTS
PricewaterhouseCoopers LLP, 1177 Avenue of the Americas, New York, NY 10036 is
the independent accountants for the Trust.
ADVISORY FEES
As compensation for services rendered by the Adviser under the Investment
Advisory Agreement, the Trust pays the Adviser an annual fee in monthly
installments, calculated by applying the following annual percentage rates to
the Portfolio's average daily net assets for the month:
BRAZOS Small Cap Growth Portfolio ....................................... 1.25%
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PORTFOLIO TRANSACTIONS
The Investment Advisory Agreement authorizes the Adviser to select the brokers
or dealers that will execute the purchases and sales of investment securities
for the Portfolio and directs the Adviser to use its best efforts to obtain the
best execution with respect to all transactions for the Portfolio. The Adviser
may, however, consistent with the interests of the Portfolio, select brokers on
the basis of the research, statistical and pricing services they provide to the
Portfolio. Information and research received from such brokers will be in
addition to, and not in lieu of, the services required to be performed by the
Adviser under the Investment Advisory Agreement. A commission paid to such
brokers may be higher than that which another qualified broker would have
charged for effecting the same transaction, provided that such commissions are
paid in compliance with the Securities Exchange Act of 1934, as amended, and
that the Adviser determines in good faith that such commission is reasonable in
terms either of the transaction or the overall responsibility of the Adviser to
the Portfolio and the Adviser's other clients.
It is not the Trust's practice to allocate brokerage or principal business on
the basis of sales of shares which may be made through broker-dealer firms.
However, the Adviser may place portfolio orders with qualified broker-dealers
who recommend the Portfolio or who act as agents in the purchase of shares of
the Portfolio for their clients.
Some securities considered for investment by the Portfolio may also be
appropriate for other clients served by the Adviser. If purchases or sales of
securities consistent with the investment policies of the Portfolio and one or
more of these other clients served by the Adviser is considered at or about the
same time, transactions in such securities will be allocated among the Portfolio
and clients in a manner deemed fair and reasonable by the Adviser. Although
there is no specified formula for allocating such transactions, the various
allocation methods used by the Adviser, and the results of such allocations, are
subject to periodic review by the Trust's Board of Trustees.
The Investment Advisory Agreement authorizes the Adviser to select the brokers
or dealers that will execute the purchases and sales of investment securities
for the Portfolio. The Agreement directs the Adviser to use its best efforts to
obtain the best available price and most favorable execution for all
transactions of the Portfolio. The Adviser may buy and sell securities for the
account through the Adviser's affiliated broker-dealer. In such instances, the
affiliated broker-dealer will complete transactions pursuant to procedures
designed to ensure that charges for the transactions do not exceed usual and
customary levels obtainable from other, unaffiliated broker-dealers. Such
transactions and the procedures are supervised by the Trust's Board of Trustees.
It is understood that the affiliated broker-dealer will not be utilized in
situations where, in the Adviser's judgment, the brokerage services of another
security firm would be in the best interest of the Portfolio. If consistent with
the interests of the Portfolio, the Adviser may select brokers on the basis of
research, statistical and pricing services these brokers provide to the
Portfolio. Information and research received from such brokers will be in
addition to, and not in lieu of, the services required to be performed by the
Adviser under the Investment Advisory Agreement. Such brokers may be paid a
higher commission than that which another qualified broker would have charged
for effecting the same transaction, provided that such commissions are paid in
compliance with the Securities Exchange Act of 1934, as amended, and that the
Adviser determines in good faith that the commission is reasonable in terms
either of the transaction or the overall responsibility of the Adviser to the
Portfolio and the Adviser's other clients.
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DESCRIPTION OF SHARES AND VOTING RIGHTS
The Trust's Agreement and Declaration of Trust permits the Trust to issue an
unlimited number of shares of beneficial interest, with a par value of $.001 per
Share. The Trustees have the power to designate one or more series
("Portfolios") or classes of shares of beneficial interest without further
action by shareholders.
On each matter submitted to a vote of the shareholders, each holder of a share
shall be entitled to one vote for each whole share and each fractional share
shall be entitled to a proportionate fractional vote. The shareholders of the
Portfolio are the insurance companies for their separate accounts using the
Portfolio to fund variable annuity contracts and variable life contracts. The
insurance company depositors of the separate accounts pass voting rights to
shares held for variable annuity contracts and variable life contracts through
to contract owners as described in the prospectus for the applicable variable
annuity or variable life insurance contract.
In the event of liquidation of the Trust, the holders of the shares of the
Portfolio shall be entitled to receive, when and as declared by the Trustees,
the excess of the assets belonging to the Portfolio, over the liabilities
belonging to the Portfolio. The assets so distributable to the holders of shares
of the Portfolio or class thereof shall be distributed to the holders in
proportion to the number of shares of the Portfolio held by them and recorded on
the books of the Trust. The liquidation of the Portfolio may be authorized at
any time by vote of a majority of the Trustees then in office.
Shareholders have no pre-emptive or other rights to subscribe to any additional
shares or other securities issued by the Trust, except as the Trustees in their
sole discretion shall have determined by resolution.
The shares of the Portfolio are fully paid and nonassessable, have no preference
as to conversion, exchange, dividends, retirement or other features and have no
pre-emptive rights. They have noncumulative voting rights, which means that the
holders of more than 50% of the shares voting for the election of Trustees can
elect 100% of the Trustees. A shareholder is entitled to one vote for each full
share held (and a fractional vote for each fractional share held), then standing
in his name on the books of the Trust.
Annual meetings will not be held except as required by the 1940 Act and other
applicable laws. The Trust has undertaken that its Trustees will call a meeting
of shareholders if such a meeting is requested in writing by the holders of not
less than 10% of the outstanding shares of the Trust. The Trust will assist
shareholder communications in such matters.
DIVIDENDS, CAPITAL GAINS DISTRIBUTIONS AND TAXES
The dividends on the shares of beneficial interest, par value $.001, of the
Trust, consisting of all of the Portfolio's net investment income, will be
declared and distributed annually to the extent not previously declared as a
dividend. Distributions are declared and paid at least annually in the aggregate
amount so that the Portfolio avoids any federal income tax liability and
satisfies the annual distribution requirements set forth in Section 4982 of the
Internal Revenue Code of 1986,
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as amended (the "Code") treating the required distribution percentage as 100%
instead of 98%, and taking into account other amounts that have been or will be
declared for distribution. Distribution payment will be made to each shareholder
of record, at the time of declaration of the dividend, in additional shares of
the Portfolio which will be credited to the shareholder's account or, at the
shareholder's option, in cash, except that dividends payable to holders who
redeem all of their shares shall be distributed in cash within five business
days after redemption.
To determine the net investment income, the general assets and liabilities of
the Trust not belonging to the Portfolio are allocated to or charged against the
assets belonging to the Portfolio in proportion to the relative assets of the
Portfolio at the time the Portfolio's net asset value was last determined.
Further provisions concerning the payment of dividends are set forth in the
Statement of Additional Information, as from time to time amended.
Designated officers of the Trust are authorized to treat any amounts declared
for distribution, to the extent permitted by Code Section 855, as a "Throwback
dividend" distributed during the Trust's immediately preceding fiscal year, and
to make designations with respect to any amounts declared as they deem
appropriate, including designations of dividends as capital gain dividends to
the extent permitted under Code Section 852(b)(3), designations of
exempt-interest dividends pursuant to Code Section 852(b)(5), designations of
foreign taxes paid and gross income derived from foreign sources pursuant to
Code Section 853(c) and designations under Code Section 854(b) of dividends
eligible for the corporate dividends-received deduction under Code Section 243.
The Portfolio will be treated as a separate entity (and hence as a separate
"regulated investment company") for Federal tax purposes. Any net capital gains
recognized by the Portfolio will be distributed to its investors without need to
offset (for Federal income tax purposes) such gains against any net capital
losses of another Portfolio.
The Portfolio may engage in certain transactions, such as short sales, and may
invest in certain instruments, such as futures contracts, which may result in
constructive sales of appreciated positions in securities for Federal income tax
purposes. A constructive sale generally occurs when the Portfolio has entered
into a short sale of the same or substantially identical securities or if it
enters into a futures or forward contract to deliver the same or substantially
identical securities and in certain other circumstances. If a constructive sale
occurs, the Portfolio will recognize either ordinary income or capital gain
depending on the length of time which it held the security which was
constructively sold.
Dividends paid by the Portfolio from net investment income and short-term
capital gains, either in cash or reinvested in shares, will be taxable to
shareholders as ordinary income. Dividends paid from the Portfolio will
generally qualify in part for the 70% dividends-received deductions for
corporations, but the portion of the dividends so qualified depends on the
aggregate qualifying dividend income received by the Portfolio from domestic
(U.S.) sources.
Distributions paid by the Portfolio from long-term capital gains are subject to
income tax as long-term capital gains regardless of the length of time the
shareholder has owned shares in the Portfolio. Also, for those shareholders
subject to tax, if purchases of shares in the Portfolio are made shortly before
the record date for a capital gains distribution or a dividend, a portion of the
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investment will be returned as a taxable distribution. Shareholders are notified
annually by the Trust as to the Federal income tax status of dividends and
distributions paid by the Portfolio. Dividends and distributions may also be
subject to state and local taxes. Dividends declared in October, November, or
December to shareholders of record in such month and paid in January of the
following year will be deemed to have been paid by the Portfolio and received by
the shareholders on December 31.
The Portfolio is required to withhold 31% of taxable dividends, capital gains
distributions, and redemptions paid to shareholders who have not complied with
IRS taxpayer identification regulations. You may avoid this withholding
requirement by certifying on the account registration form your proper Taxpayer
Identification Number and by certifying that you are not subject to backup
withholding.
In order for the Portfolio to continue to qualify for Federal income tax
treatment as a regulated investment company under the Code, at least 90% of the
Portfolio's gross income for a taxable year must be derived from certain
qualifying income, i.e., dividends, interest, income derived from loans of
securities and gains from the sale or other disposition of stock, securities or
foreign currencies, or other related income, including gains from options,
futures and forward contracts, derived with respect to its business investing in
stock, securities or currencies. Any net gain realized from the closing out of
futures contracts will, therefore, generally be qualifying income for purposes
of the 90% requirement.
Except for transactions the Portfolio has identified as hedging transactions,
the Portfolio is required for Federal income tax purposes to recognize as income
for the taxable year its net unrealized gains and losses on certain forward
currency and futures contracts as of the end of the taxable year as well as
those actually realized during the year. In most cases, any such gain or loss
recognized with respect to a regulated futures contract is considered to be 60%
long-term capital gain or loss and 40% short-term capital gain or loss without
regard to the holding period of the contract. Recognized gain or loss
attributable to a foreign currency forward contract is treated as 100% ordinary
income. Furthermore, foreign currency futures contracts which are intended to
hedge against a change in the value of securities held by the Portfolio may
affect the holding period of such securities and, consequently, the nature of
the gain or loss on such securities upon disposition.
The Portfolio may be subject to foreign withholding taxes on income or gains
recognized with respect to its investment in certain foreign securities. If the
Portfolio purchases shares in certain foreign investment entities, called
"passive foreign investment companies," the Portfolio may be subject to U.S.
Federal income tax and a related interest charge on a portion of any "excess
distribution" or gain from the disposition of such shares, even if such income
is distributed as a taxable dividend by the Portfolio to its shareholders. If
more than 50% of the total assets of the Portfolio are invested in securities of
foreign corporations, the Portfolio may elect to pass-through to its
shareholders their pro rata share of foreign income taxes paid by the Portfolio.
If this election is made, shareholders will be required to include in their
gross income their pro rata share of the foreign taxes paid by the Portfolio.
However, shareholders will be entitled to deduct (as an itemized deduction in
the case of individuals) their share of such foreign taxes in computing their
taxable income or to claim a credit for such taxes against their U.S. Federal
income tax, subject to certain limitation under the Code. Finally, the Portfolio
may recognize gain or loss on transactions in foreign currencies as a by-product
of its investment in foreign securities.
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The Portfolio will distribute to shareholders annually any net capital gains
which have been recognized for Federal income tax purposes (including unrealized
gains at the end of the Portfolio's taxable year) on futures transactions. Such
distribution will be combined with distributions of capital gains realized on
the Portfolio's other investments, and shareholders will be advised on the
nature of the payment.
Under Code Section 817(h), a variable life insurance or annuity contract will
not be treated as a life insurance policy or annuity contract, respectively,
under the Code, unless the segregated asset account upon which such contract or
policy is based is "adequately diversified." A segregated asset account will be
adequately diversified if it satisfies one of two alternative tests set forth in
the Treasury Regulations. Specifically, the Treasury Regulations provide that,
except as permitted by the "safe harbor" discussed below, as of the end of each
calendar quarter (or within 30 days thereafter) no more than 55% of the
segregated asset account's total assets may be represented by any one
investment, no more than 70% by any two investments, no more than 80% by any
three investments and no more than 90% by any four investments. For this
purpose, all securities of the same issuer are considered a single investment,
and each U.S. Government agency and instrumentality is considered a separate
issuer. As a safe harbor, a segregated asset account will be treated as being
adequately diversified if the diversification requirements under Subchapter M
are satisfied and no more than 55% of the value of the account's total assets
are cash and cash items, U.S. Government securities and securities of other
regulated investment companies. In addition, a segregated asset account with
respect to a variable life insurance contract is treated as adequately
diversified to the extent of its investment in securities issued by the United
States Treasury.
For purposes of these alternative diversification tests, a segregated asset
account investing in shares of a regulated investment company will be entitled
to "look through" the regulated investment company to its pro rata portion of
the regulated investment company's assets, provided that the shares of such
regulated investment company are held only by insurance companies and certain
fund managers (a "Closed Fund").
If the segregated asset account upon which a variable contract is based is not
"adequately diversified" under the foregoing rules for each calendar quarter,
then (a) the variable contract is not treated as a life insurance contract or
annuity contract under the Code for all subsequent periods during which such
account is not "adequately diversified" and (b) the holders of such contract
must include as ordinary income the `income on the contract" for each taxable
year. Further, the income on a life insurance contract for all prior taxable
years is treated as received or accrued during the taxable year of the
policyholder in which the contract ceases to meet the definition of a "life
insurance contract" under the Code. The "income on the contract" is, generally,
the excess of (i) the sum of the increase in the net surrender value of the
contract during the taxable year and the cost of the life insurance protection
provided under the contract during the year, over (ii) the premiums paid under
the contract during the taxable year. In addition, if a Portfolio does not
constitute a Closed Fund, the holders of the contracts and annuities which
invest in the Portfolio through a segregated asset account may be treated as
owners of Portfolio shares and may be subject to tax on distributions made by
the Portfolio.
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PERFORMANCE CALCULATIONS
PERFORMANCE
The Portfolio may from time to time quote various performance figures to
illustrate past performance. Performance quotations by investment companies are
subject to rules adopted by the Commission, which require the use of
standardized performance quotations or, alternatively, that every
non-standardized performance quotation furnished by the Trust be accompanied by
certain standardized performance information computed as required by the
Commission. Current yield and average annual compounded total return quotations
used by the Trust are based on the standardized methods of computing performance
mandated by the Commission. An explanation of those and other methods used to
compute or express performance follows.
YIELD
Current yield reflects the income per share earned by the Portfolio's
investment. The current yield of the Portfolio is determined by dividing the net
investment income per share earned during a 30-day base period by the maximum
offering price per share on the last day of the period and annualizing the
result. Expenses accrued for the period include any fees charged to all
shareholders during the base period.
This figure is obtained using the following formula:
6
Yield = 2 [( a-b/cd + 1) -1]
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 income distributions
d = the maximum offering price per share on the last day of the
period.
TOTAL RETURN
The average annual total return of the Portfolio is determined by finding the
average annual compounded rates of return over 1, 5 and 10 year periods that
would equate an initial hypothetical $1,000 investment to its ending redeemable
value. The calculation assumes that all dividends and distributions are
reinvested when paid. The quotation assumes the amount was completely redeemed
at the end of each 1, 5 and 10 year period and the deduction of all applicable
Trust expenses on an annual basis.
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These figures will be calculated according to the following formula:
n
P(1+T) = ERV
where:
P = a hypothetical initial payment of $ 1,000
T = average annual total return
n = number of years
ERV = ending redeemable value of a hypothetical $1,000 payment made
at the beginning of the 1, 5 or 10 year periods at the end of
the 1, 5 or 10 year periods (or fractional portion thereof).
COMPARISONS
To help investors better evaluate how an investment in the Portfolio might
satisfy their investment objective, advertisements regarding the Trust may
discuss various measures of Trust performance as reported by various financial
publications. Advertisements may also compare performance (as calculated above)
to performance as reported by other investments, indices and averages. The
following publications, indices and averages may be used:
(1) Dow Jones Composite Average or its component averages - an unmanaged
index composed of 30 blue-chip industrial corporation stocks (Dow
Jones Industrial Average), 15 utilities company stocks and 20
transportation stocks. Comparisons of performance assume
reinvestment of dividends.
(2) Standard & Poor's 500 Stock Index or its component indices - an
unmanaged index composed of 400 industrial stocks, 40 financial
stocks, 40 utilities stocks and 20 transportation stocks.
Comparisons of performance assume reinvestment of dividends.
(3) Standard & Poor's MidCap 400 Index - an unmanaged index measuring
the performance of non-S&P 500 stocks in the mid-range sector of the
U.S. stock market.
(4) The New York Stock Exchange composite or component indices -
unmanaged indices of all industrial, utilities, transportation and
finance stocks listed on the New York Stock Exchange.
(5) Wilshire 5000 Equity Index or its component indices - represents the
return on the market value of all common equity securities for which
daily pricing is available. Comparisons of performance assume
reinvestment of dividends.
(6) Lipper - Mutual Fund Performance Analysis and Lipper - Fixed Income
Fund Performance Analysis - measure total return and average current
yield for the mutual fund industry. Rank individual mutual fund
performance over specified time periods, assuming reinvestment of
all distributions, exclusive of any applicable sales charges.
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(7) Morgan Stanley Capital International EAFE Index and World Index -
respectively, arithmetic, market value-weighted averages of the
performance of over 900 securities listed on the stock exchanges of
countries in Europe, Australia and the Far East, and over 1,400
securities listed on the stock exchanges of these continents,
including North America.
(8) Goldman Sachs 100 Convertible Bond Index - currently includes 67
bonds and 33 preferred stocks. The original list of names was
generated by screening for convertible issues of 100 million or
greater in market capitalization. The index is priced monthly.
(9) Salomon Brothers GNMA Index - includes pools of mortgages originated
by private lenders and guaranteed by the mortgage pools of the
Government National Mortgage Association.
(10) Salomon Brothers High Grade Corporate Bond Index - consists of
publicly issued, non-convertible corporate bonds rated AA or AAA. It
is a value-weighted, total return index, including approximately 800
issues with maturities of 12 years or greater.
(11) Salomon Brothers Broad Investment Grade Bond - is a market-weighted
index that contains approximately 4,700 individually priced
investment grade corporate bonds rated BBB or better, U.S.
Treasury/agency issues and mortgage pass through securities.
(12) Lehman Brothers Long-Term Treasury Bond - is composed of all bonds
covered by the Lehman Brothers Treasury Bond Index with maturities
of 10 years or greater.
(13) NASDAQ Industrial Index - is composed of more than 3,000 industrial
issues. It is a value-weighted index calculated on price change only
and does not include income.
(14) Value Line - composed of over 1,600 stocks in the Value Line
Investment Survey.
(15) Russell 2000 - composed of the 2,000 smallest stocks in the Russell
3000, a market value-weighted index of the 3,000 largest U.S.
publicly-traded companies.
(16) Russell 2000 Growth - measures the performance of those Russell 2000
companies with higher price-to-book ratios and higher forecasted
growth values.
(17) Russell 2000 Value - measures the performance of those Russell 2000
companies with lower price-to-book ratios and lower forecasted
growth values.
(18) Russell 2500 - composed of the 2,500 smallest stocks in the Russell
3000, a market value-weighted index of the 3,000 largest U.S.
publicly-traded companies.
(19) Composite Indices - 60% Standard & Poor's 500 Stock Index, 30%
Lehman Brothers Long-Term Treasury Bond and 10% U.S. Treasury Bills;
70% Standard & Poor's 500 Stock Index and 30% NASDAQ Industrial
Index; 35% Standard & Poor's 500 Stock Index and 65% Salomon
Brothers High Grade Bond Index; all
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stocks on the NASDAQ system exclusive of those traded on an
exchange, and 65% Standard & Poor's 500 Stock Index and 35% Salomon
Brothers High Grade Bond Index.
(20) CDA Mutual Fund Report published by CDA Investment Technologies,
Inc. - analyzes price, current yield, risk, total return and average
rate of return (average compounded growth rate) over specified time
periods for the mutual fund industry.
(21) Mutual Fund Source Book published by Morningstar, Inc. - analyzes
price, yield, risk and total return for equity funds.
(22) Financial publications: Business Week, Changing Times, Financial
World, Forbes, Fortune, Money, Barron's, Consumer's Digest,
Financial Times, Global Investor, Wall Street Journal and
Weisenberger Investment Companies Service - publications that rate
fund performance over specified time periods.
(23) Consumer Price Index (or Cost of Living Index), published by the
U.S. Bureau of Labor Statistics - a statistical measure of change
over time in the price of goods and services in major expenditure
groups.
(24) Stocks, Bonds, Bills and Inflation, published by Ibbotson Associates
- historical measure of yield, price and total return for common and
small company stock, long-term government bonds, U.S. Treasury bills
and inflation.
(25) Savings and Loan Historical Interest Rates - as published by the
U.S. Savings & Loan League Fact Book.
(26) Lehman Brothers Government/Corporate Index - a combination of the
Government and Corporate Bond Indices. The Government Index includes
public obligations of the U.S. Treasury, issues of Government
agencies, and corporate debt backed by the U.S. Government. The
Corporate Bond Index includes fixed-rate nonconvertible corporate
debt. Also included are Yankee Bonds and nonconvertible debt issued
by or guaranteed by foreign or international governments and
agencies. All issues are investment grade (BBB) or higher, with
maturities of at least one year and an outstanding par value of at
least $100 million for U.S. Government issues and $25 million for
others. Any security downgraded during the month is held in the
index until month-end and then removed. All returns are market value
weighted inclusive of accrued income.
(27) Lehman Brothers Intermediate Government/Corporate Index - an
unmanaged index composed of a combination of the Government and
Corporate Bond Indices. All issues are investment grade (BBB) or
higher, with maturities of one to ten years and an outstanding par
value of at least $100 million for U.S. Government issues and $25
million for others. The Government Index includes public obligations
of the U.S. Treasury, issues of Government agencies, and corporate
debt backed by the U.S. Government. The Corporate Bond Index
includes fixed-rate nonconvertible corporate debt. Also included are
Yankee Bonds and nonconvertible debt issued by or guaranteed by
foreign or international governments and agencies. Any security
downgraded during the month is held in
24
<PAGE>
the index until month-end and then removed. All returns are market
value weighted inclusive of accrued income.
(28) Historical data supplied by the research departments of First Boston
Corporation; the J.P. Morgan companies; WP Brothers; Merrill Lynch,
Pierce, Fenner & Smith; Lehman Brothers, Inc.; and Bloomberg L.P.
(29) NAREIT Equity Index - a compilation of market-weighted securities
data collected from all tax-qualified equity real estate investment
trusts listed on the New York and American Stock Exchanges and the
NASDAQ. The index tracks performance, as well as REIT assets, by
property type and geographic region.
(30) Wilshire Real Estate Securities Index, published by Wilshire
Associates - a market capitalization-weighted index of publicly
traded real estate securities, such as real estate investment
trusts, real estate operating companies and partnerships.
In assessing such comparisons of performance, an investor should keep in mind
that the composition of the investments in the reported indices and averages is
not identical to the composition of investments in the Portfolio, that the
averages are generally unmanaged, and that the items included in the
calculations of such averages may not be identical to the formula used by the
Portfolio to calculate its performance. In addition, there can be no assurance
that the Portfolio will continue this performance as compared to such other
averages.
CODE OF ETHICS
The Trust, Adviser and the Distributor have each adopted a Code of Ethics which
restricts, to a certain extent, personal transactions by access persons of the
Trust and imposes certain disclosure and reporting obligations. Personnel
subject to the Trust's Code of Ethics may make personal investments in
securities in which the Portfolio may also invest. The Trust's Codes of Ethics
can be reviewed and copied at the SEC's Public Reference Room in Washington, DC.
Information on the operation of the Public Reference Room may be obtained by
calling the SEC at 1-202-942-8090. The Codes of Ethics are also available on the
EDGAR database on the SEC Internet website at http://www.sec.gov, and copies of
these codes may be obtained, after paying a duplicating fee, by electronic
request to at the following e-mail address: [email protected], or by writing
the SEC's Public Reference Section, Washington, DC 20549-0102.
25
<PAGE>
APPENDIX A
COMMERCIAL PAPER RATINGS
A Standard & Poor's commercial paper rating is a current opinion of
the creditworthiness of an obligor with respect to financial obligations having
an original maturity of no more than 365 days. The following summarizes the
rating categories used by Standard and Poor's for commercial paper:
"A-1" - Obligations are rated in the highest category indicating that
the obligor's capacity to meet its financial commitment on the obligation is
strong. Within this category, certain obligations are designated with a plus
sign (+). This indicates that the obligor's capacity to meet its financial
commitment on these obligations is extremely strong.
"A-2" - Obligations are somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than obligations in
higher rating categories. However, the obligor's capacity to meet its financial
commitment on the obligation is satisfactory.
"A-3" - Obligations exhibit adequate protection parameters. However,
adverse economic conditions or changing circumstances are more likely to lead to
a weakened capacity of the obligor to meet its financial commitment on the
obligation.
"B" - Obligations are regarded as having significant speculative
characteristics. The obligor currently has the capacity to meet its financial
commitment on the obligation; however, it faces major ongoing uncertainties
which could lead to the obligor's inadequate capacity to meet its financial
commitment on the obligation.
"C" - Obligations are currently vulnerable to nonpayment and are
dependent upon favorable business, financial, and economic conditions for the
obligor to meet its financial commitment on the obligation.
"D" - Obligations are in payment default. The "D" rating category is
used when payments on an obligation are not made on the date due even if the
applicable grace period has not expired, unless Standard & Poor's believes that
such payments will be made during such grace period. The "D" rating will be used
upon the filing of a bankruptcy petition or the taking of a similar action if
payments on an obligation are jeopardized.
Moody's commercial paper ratings are opinions of the ability of
issuers to repay punctually senior debt obligations not having an original
maturity in excess of one year, unless explicitly noted. The following
summarizes the rating categories used by Moody's for commercial paper:
<PAGE>
"Prime-1" - Issuers (or supporting institutions) have a superior
ability for repayment of senior short-term debt obligations. Prime-1 repayment
ability will often be evidenced by many of the following characteristics:
leading market positions in well-established industries; high rates of return on
funds employed; conservative capitalization structure with moderate reliance on
debt and ample asset protection; broad margins in earnings coverage of fixed
financial charges and high internal cash generation; and well-established access
to a range of financial markets and assured sources of alternate liquidity.
"Prime-2" - Issuers (or supporting institutions) have a strong ability
for repayment of senior short-term debt obligations. This will normally be
evidenced by many of the characteristics cited above but to a lesser degree.
Earnings trends and coverage ratios, while sound, may be more subject to
variation. Capitalization characteristics, while still appropriate, may be more
affected by external conditions. Ample alternate liquidity is maintained.
"Prime-3" - Issuers (or supporting institutions) have an acceptable
ability for repayment of senior short-term debt obligations. The effect of
industry characteristics and market compositions may be more pronounced.
Variability in earnings and profitability may result in changes in the level of
debt protection measurements and may require relatively high financial leverage.
Adequate alternate liquidity is maintained.
"Not Prime" - Issuers do not fall within any of the Prime rating
categories.
The three rating categories of Duff & Phelps for investment grade
commercial paper and short-term debt are "D-1," "D-2" and "D-3." Duff & Phelps
employs three designations, "D-1+," "D-1" and "D-1-," within the highest rating
category. The following summarizes the rating categories used by Duff & Phelps
for commercial paper:
"D-1+" - Debt possesses the highest certainty of timely payment.
Short-term liquidity, including internal operating factors and/or access to
alternative sources of funds, is outstanding, and safety is just below risk-free
U.S. Treasury short-term obligations.
"D-1" - Debt possesses very high certainty of timely payment.
Liquidity factors are excellent and supported by good fundamental protection
factors. Risk factors are minor.
"D-1-" - Debt possesses high certainty of timely payment. Liquidity
factors are strong and supported by good fundamental protection factors. Risk
factors are very small.
"D-2" - Debt possesses 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" - Debt possesses satisfactory liquidity and other protection
factors qualify issues as to investment grade. Risk factors are larger and
subject to more variation. Nevertheless, timely payment is expected.
<PAGE>
"D-4" - Debt possesses speculative investment characteristics.
Liquidity is not sufficient to insure against disruption in debt service.
Operating factors and market access may be subject to a high degree of
variation.
"D-5" - Issuer failed to meet scheduled principal and/or interest
payments.
Fitch IBCA short-term ratings apply to debt obligations that have time
horizons of less than 12 months for most obligations, or up to three years for
U.S. public finance securities. The following summarizes the rating categories
used by Fitch IBCA for short-term obligations:
"F1" - Securities possess the highest credit quality. This designation
indicates the best capacity for timely payment of financial commitments and may
have an added "+" to denote any exceptionally strong credit feature.
"F2" - Securities possess good credit quality. This designation
indicates a satisfactory capacity for timely payment of financial commitments,
but the margin of safety is not as great as in the case of the higher ratings.
"F3" - Securities possess fair credit quality. This designation
indicates that the capacity for timely payment of financial commitments is
adequate; however, near-term adverse changes could result in a reduction to
non-investment grade.
"B" - Securities possess speculative credit quality. This designation
indicates minimal capacity for timely payment of financial commitments, plus
vulnerability to near-term adverse changes in financial and economic conditions.
"C" - Securities possess high default risk. This designation indicates
that default is a real possibility and that the capacity for meeting financial
commitments is solely reliant upon a sustained, favorable business and economic
environment.
"D" - Securities are in actual or imminent payment default.
Thomson Financial BankWatch short-term ratings assess the likelihood
of an untimely payment of principal and interest of debt instruments with
original maturities of one year or less. The following summarizes the ratings
used by Thomson Financial BankWatch:
"TBW-1" - This designation represents Thomson Financial BankWatch's
highest category and indicates a very high likelihood that principal and
interest will be paid on a timely basis.
"TBW-2" - This designation represents Thomson Financial BankWatch's
second-highest category and indicates that 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."
<PAGE>
"TBW-3" - This designation represents Thomson Financial BankWatch's
lowest investment-grade category and indicates that while the obligation is more
susceptible to adverse developments (both internal and external) than those with
higher ratings, the capacity to service principal and interest in a timely
fashion is considered adequate.
"TBW-4" - This designation represents Thomson Financial BankWatch's
lowest rating category and indicates that the obligation is regarded as
non-investment grade and therefore speculative.
CORPORATE AND MUNICIPAL LONG-TERM DEBT RATINGS
The following summarizes the ratings used by Standard & Poor's for
corporate and municipal debt:
"AAA" - An obligation rated "AAA" has the highest rating assigned by
Standard & Poor's. The obligor's capacity to meet its financial commitment on
the obligation is extremely strong.
"AA" - An obligation rated "AA" differs from the highest rated
obligations only in small degree. The obligor's capacity to meet its financial
commitment on the obligation is very strong.
"A" - An obligation rated "A" is somewhat more susceptible to the
adverse effects of changes in circumstances and economic conditions than
obligations in higher-rated categories. However, the obligor's capacity to meet
its financial commitment on the obligation is still strong.
"BBB" - An obligation rated "BBB" exhibits adequate protection
parameters. However, adverse economic conditions or changing circumstances are
more likely to lead to a weakened capacity of the obligor to meet its financial
commitment on the obligation.
Obligations rated "BB," "B," "CCC," "CC" and "C" are regarded as
having significant speculative characteristics. "BB" indicates the least degree
of speculation and "C" the highest. While such obligations will likely have some
quality and protective characteristics, these may be outweighed by large
uncertainties or major exposures to adverse conditions.
"BB" - An obligation rated "BB" is less vulnerable to nonpayment than
other speculative issues. However, it faces major ongoing uncertainties or
exposure to adverse business, financial or economic conditions which could lead
to the obligor's inadequate capacity to meet its financial commitment on the
obligation.
"B" - An obligation rated "B" is more vulnerable to nonpayment than
obligations rated "BB", but the obligor currently has the capacity to meet its
financial commitment on the
<PAGE>
obligation. Adverse business, financial or economic conditions will likely
impair the obligor's capacity or willingness to meet its financial commitment on
the obligation.
"CCC" - An obligation rated "CCC" is currently vulnerable to
nonpayment, and is dependent upon favorable business, financial and economic
conditions for the obligor to meet its financial commitment on the obligation.
In the event of adverse business, financial, or economic conditions, the obligor
is not likely to have the capacity to meet its financial commitment on the
obligation.
"CC" - An obligation rated "CC" is currently highly vulnerable to
nonpayment.
"C" - The "C" rating may be used to cover a situation where a
bankruptcy petition has been filed or similar action taken, but payments on this
obligation are being continued.
"D" - An obligation rated "D" is in payment default. The "D" rating
category is used when payments on an obligation are not made on the date due
even if the applicable grace period has not expired, unless Standard & Poor's
believes that such payments will be made during such grace period. The "D"
rating also will be used upon the filing of a bankruptcy petition or the taking
of a similar action if payments on an obligation are jeopardized.
PLUS (+) OR MINUS (-) - The ratings from "AA" through "CCC" may be
modified by the addition of a plus or minus sign to show relative standing
within the major rating categories.
"c" - The 'c' subscript is used to provide additional information to
investors that the bank may terminate its obligation to purchase tendered bonds
if the long-term credit rating of the issuer is below an investment-grade level
and/or the issuer's bonds are deemed taxable.
"p" - The letter 'p' indicates that the rating is provisional. A
provisional rating assumes the successful completion of the project financed by
the debt being rated and indicates that payment of debt service requirements is
largely or entirely dependent upon the successful, timely completion of the
project. This rating, however, while addressing credit quality subsequent to
completion of the project, makes no comment on the likelihood of or the risk of
default upon failure of such completion. The investor should exercise his own
judgment with respect to such likelihood and risk.
* Continuance of the ratings is contingent upon Standard & Poor's
receipt of an executed copy of the escrow agreement or closing documentation
confirming investments and cash flows.
"r" - The 'r' highlights derivative, hybrid, and certain other
obligations that Standard & Poor's believes may experience high volatility or
high variability in expected returns as a result of noncredit risks. Examples of
such obligations are securities with principal or interest return indexed to
equities, commodities, or currencies; certain swaps and options; and
interest-only and principal-only mortgage securities. The absence of an 'r'
symbol should not be taken as an indication that an obligation will exhibit no
volatility or variability in total return.
<PAGE>
N.R. Not rated. Debt obligations of issuers outside the United States
and its territories are rated on the same basis as domestic corporate and
municipal issues. The ratings measure the creditworthiness of the obligor but do
not take into account currency exchange and related uncertainties.
The following summarizes the ratings used by Moody's for corporate and
municipal long-term debt:
"Aaa" - Bonds are judged to be of the best quality. They carry the
smallest degree of investment risk and are generally referred to as "gilt
edged." Interest payments are protected by a large or by an exceptionally stable
margin and principal is secure. While the various protective elements are likely
to change, such changes as can be visualized are most unlikely to impair the
fundamentally strong position of such issues.
"Aa" - Bonds are judged to be of high quality by all standards.
Together with the "Aaa" group they comprise what are generally known as
high-grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in "Aaa" securities or fluctuation of
protective elements may be of greater amplitude or there may be other elements
present which make the long-term risk appear somewhat larger than the "Aaa"
securities.
"A" - Bonds possess many favorable investment attributes and are to be
considered as upper-medium-grade obligations. Factors giving security to
principal and interest are considered adequate, but elements may be present
which suggest a susceptibility to impairment sometime in the future.
"Baa" - Bonds are considered as medium-grade obligations, (i.e., they
are neither highly protected nor poorly secured). Interest payments and
principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
"Ba," "B," "Caa," "Ca," and "C" - Bonds that possess one of these
ratings provide questionable protection of interest and principal ("Ba"
indicates speculative elements; "B" indicates a general lack of characteristics
of desirable investment; "Caa" indicates poor standing; "Ca" represents
obligations which are speculative in a high degree; and "C" represents the
lowest rated class of bonds). "Caa," "Ca" and "C" bonds may be in default.
Con. (---) - Bonds for which the security depends upon the completion
of some act or the fulfillment of some condition are rated conditionally. These
are bonds secured by (a) earnings of projects under construction, (b) earnings
of projects unseasoned in operating experience, (c) rentals which begin when
facilities are completed, or (d) payments to which some other limiting condition
attaches. Parenthetical rating denotes probable credit stature upon completion
of construction or elimination of basis of condition.
<PAGE>
Note: Moody's applies numerical modifiers 1, 2, and 3 in each generic
rating classification from "Aa" through "Caa". The modifier 1 indicates that the
obligation ranks in the higher end of its generic rating category; the modifier
2 indicates a mid-range ranking; and the modifier 3 indicates a ranking in the
lower end of its generic rating category.
The following summarizes the long-term debt ratings used by Duff &
Phelps for corporate and municipal long-term debt:
"AAA" - Debt is considered to be of the highest credit quality. The
risk factors are negligible, being only slightly more than for risk-free U.S.
Treasury debt.
"AA" - Debt is considered to be of high credit quality. Protection
factors are strong. Risk is modest but may vary slightly from time to time
because of economic conditions.
"A" - Debt possesses protection factors which are average but
adequate. However, risk factors are more variable in periods of greater economic
stress.
"BBB" - Debt possesses below-average protection factors but such
protection factors are still considered sufficient for prudent investment.
Considerable variability in risk is present during economic cycles. This is the
lowest investment grade category.
"BB," "B," "CCC," "DD," and "DP" - Debt that possesses one of these
ratings is considered to be below investment grade. Although below investment
grade, debt rated "BB" is deemed likely to meet obligations when due. Debt rated
"B" possesses the risk that obligations will not be met when due. Debt rated
"CCC" is well below investment grade and has considerable uncertainty as to
timely payment of principal, interest or preferred dividends. Debt rated "DD" is
a defaulted debt obligation, and the rating "DP" represents preferred stock with
dividend arrearages.
To provide more detailed indications of credit quality, the "AA," "A,"
"BBB," "BB" and "B" ratings may be modified by the addition of a plus (+) or
minus (-) sign to show relative standing within these major categories.
The following summarizes the ratings used by Fitch IBCA for corporate
and municipal bonds:
"AAA" - Bonds considered to be investment grade and of the highest
credit quality. These ratings denote the lowest expectation of credit risk and
are assigned only in case of exceptionally strong capacity for timely payment of
financial commitments. This capacity is highly unlikely to be adversely affected
by foreseeable events.
"AA" - Bonds considered to be investment grade and of very high credit
quality. These ratings denote a very low expectation of credit risk and indicate
very strong capacity for timely payment of financial commitments. This capacity
is not significantly vulnerable to foreseeable events.
<PAGE>
"A" - Bonds considered to be investment grade and of high credit
quality. These ratings denote a low expectation of credit risk and indicate
strong capacity for timely payment of financial commitments. This capacity may,
nevertheless, be more vulnerable to changes in circumstances or in economic
conditions than is the case for higher ratings.
"BBB" - Bonds considered to be investment grade and of good credit
quality. These ratings denote that there is currently a low expectation of
credit risk. The capacity for timely payment of financial commitments is
considered adequate, but adverse changes in circumstances and in economic
conditions are more likely to impair this capacity. This is the lowest
investment grade category.
"BB" - Bonds considered to be speculative. These ratings indicate that
there is a possibility of credit risk developing, particularly as the result of
adverse economic change over time; however, business or financial alternatives
may be available to allow financial commitments to be met. Securities rated in
this category are not investment grade.
"B" - Bonds are considered highly speculative. These ratings indicate
that significant credit risk is present, but a limited margin of safety remains.
Financial commitments are currently being met; however, capacity for continued
payment is contingent upon a sustained, favorable business and economic
environment.
"CCC", "CC", "C" - Bonds have high default risk. Default is a real
possibility, and capacity for meeting financial commitments is solely reliant
upon sustained, favorable business or economic developments. "CC" ratings
indicate that default of some kind appears probable, and "C" ratings signal
imminent default.
"DDD," "DD" and "D" - Bonds are in default. The ratings of obligations
in this category are based on their prospects for achieving partial or full
recovery in a reorganization or liquidation of the obligor. While expected
recovery values are highly speculative and cannot be estimated with any
precision, the following serve as general guidelines. "DDD" obligations have the
highest potential for recovery, around 90%-100% of outstanding amounts and
accrued interest. "DD" indicates potential recoveries in the range of 50%-90%,
and "D" the lowest recovery potential, i.e., below 50%.
Entities rated in this category have defaulted on some or all of their
obligations. Entities rated "DDD" have the highest prospect for resumption of
performance or continued operation with or without a formal reorganization
process. Entities rated "DD" and "D" are generally undergoing a formal
reorganization or liquidation process; those rated "DD" are likely to satisfy a
higher portion of their outstanding obligations, while entities rated "D" have a
poor prospect for repaying all obligations.
To provide more detailed indications of credit quality, the Fitch IBCA
ratings from and including "AA" to "CCC" may be modified by the addition of a
plus (+) or minus (-) sign to denote relative standing within these major rating
categories.
'NR' indicates the Fitch IBCA does not rate the issuer or issue in
question.
<PAGE>
`Withdrawn': A rating is withdrawn when Fitch IBCA deems the amount of
information available to be inadequate for rating purposes, or when an
obligation matures, is called, or refinanced.
RatingAlert: Ratings are placed on RatingAlert to notify investors
that there is a reasonable probability of a rating change and the likely
direction of such change. These are designated as "Positive", indicating a
potential upgrade, "Negative", for a potential downgrade, or "Evolving", if
ratings may be raised, lowered or maintained. RatingAlert is typically resolved
over a relatively short period.
Thomson Financial BankWatch assesses the likelihood of an untimely
repayment of principal or interest over the term to maturity of long term debt
and preferred stock which are issued by United States commercial banks, thrifts
and non-bank banks; non-United States banks; and broker-dealers. The following
summarizes the rating categories used by Thomson BankWatch for long-term debt
ratings:
"AAA" - This designation indicates that the ability to repay principal
and interest on a timely basis is extremely high.
"AA" - This designation indicates a very strong ability to repay
principal and interest on a timely basis, with limited incremental risk compared
to issues rated in the highest category.
"A" - This designation indicates that 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" - This designation represents the lowest investment-grade
category and indicates an acceptable capacity to repay principal and interest.
Issues rated "BBB" are more vulnerable to adverse developments (both internal
and external) than obligations with higher ratings.
"BB," "B," "CCC," and "CC," - These designations are assigned by
Thomson Financial BankWatch to non-investment grade long-term debt. Such issues
are regarded as having speculative characteristics regarding the likelihood of
timely repayment of principal and interest. "BB" indicates the lowest degree of
speculation and "CC" the highest degree of speculation.
"D" - This designation indicates that the long-term debt is in
default.
PLUS (+) OR MINUS (-) - The ratings from "AAA" through "CC" may
include a plus or minus sign designation which indicates where within the
respective category the issue is placed.
<PAGE>
MUNICIPAL NOTE RATINGS
A Standard and Poor's note rating reflects the liquidity factors and
market access risks unique to notes due in three years or less. The following
summarizes the ratings used by Standard & Poor's for municipal notes:
"SP-1" - The issuers of these municipal notes exhibit a strong
capacity to pay principal and interest. Those issues determined to possess a
very strong capacity to pay debt service are given a plus (+) designation.
"SP-2" - The issuers of these municipal notes exhibit satisfactory
capacity to pay principal and interest, with some vulnerability to adverse
financial and economic changes over the term of the notes.
"SP-3" - The issuers of these municipal notes exhibit speculative
capacity to pay principal and interest.
Moody's ratings for state and municipal notes and other short-term
loans are designated Moody's Investment Grade ("MIG") and variable rate demand
obligations are designated Variable Moody's Investment Grade ("VMIG"). Such
ratings recognize the differences between short-term credit risk and long-term
risk. The following summarizes the ratings by Moody's Investors Service, Inc.
for short-term notes:
"MIG-1"/"VMIG-1" - This designation denotes best quality. There is
present strong protection by established cash flows, superior liquidity support
or demonstrated broad-based access to the market for refinancing.
"MIG-2"/"VMIG-2" - This designation denotes high quality. Margins of
protection are ample although not so large as in the preceding group.
"MIG-3"/"VMIG-3" - This designation denotes favorable quality, with
all security elements accounted for but lacking the undeniable strength of the
preceding grades. Liquidity and cash flow protection may be narrow and market
access for refinancing is likely to be less well established.
"MIG-4"/"VMIG-4" - This designation denotes adequate quality.
Protection commonly regarded as required of an investment security is present
and although not distinctly or predominantly speculative, there is specific
risk.
"SG" - This designation denotes speculative quality. Debt instruments
in this category lack margins of protection.
Fitch IBCA and Duff & Phelps use the short-term ratings described
under Commercial Paper Ratings for municipal notes.
<PAGE>
Brazos Insurance Funds
BRAZOS Small Cap Growth Portfolio
Statement of Assets and Liabilities
August 18, 2000
ASSETS:
Cash $100,000
Receivable from Adviser 113,218
--------
Total Assets 213,218
--------
LIABILITIES:
Payable to Adviser 113,218
--------
Total Liabilities 113,218
--------
NET ASSETS $100,000
========
NET ASSETS CONSIST OF:
Paid in capital at par $ 10
Paid in capital in excess 99,990
--------
$100,000
========
Shares of beneficial interest issued and outstanding,
$0.001 par value; unlimited shares authorized 10,000
========
Net Asset value, offering and redemption
price per share (net assets/shares outstanding) $ 10.00
========
See accompanying notes to the financial statements
<PAGE>
Brazos Insurance Funds
BRAZOS Small Cap Growth Portfolio
Statement of Operations
For the One Day Period Ended August 18, 2000
EXPENSES:
Organization expenses $ 113,218
Less: Expenses waived by (113,218)
---------
Adviser
Net income/(loss) $0
==
See accompanying notes to the financial statements
<PAGE>
Brazos Insurance Funds
Notes to the Financial Statements
1. ORGANIZATION
The Brazos Insurance Funds (the "Trust") was organized as a Delaware
business trust on January 21, 2000 and is registered under the Investment
Company Act of 1940, as amended (the "1940 Act"), as an open-end management
investment company issuing its shares in series, each series representing a
distinct portfolio with its own investment objectives and policies. The
series presently authorized is the BRAZOS Small Cap Growth Portfolio (the
"Portfolio"). Pursuant to the 1940 Act, the Portfolio is a "diversified"
series of the Trust. The Portfolio has had no operations other than those
related to organizational matters, including the sale of 10,000 shares of
the Portfolio for cash in the amount of $100,000 to capitalize the
Portfolio, which shares were sold to Great-West Life & Annuity Insurance
Company (the "Company") on August 18, 2000.
2. SIGNIFICANT ACCOUNTING POLICIES
(a) Organization Expenses
Expenses incurred by the Trust in connection with the organization are
expensed as incurred. These expenses were advanced by the Adviser, and
the Adviser has agreed to voluntarily reimburse the Portfolio for
these expenses, subject to potential recovery (see Note 3).
(b) Federal Income Taxes
The Portfolio intends to comply with the requirements of the Internal
Revenue Code necessary to qualify as a regulated investment company
and to make the requisite distributions of income and capital gains to
its shareholders sufficient to relieve it from all or substantially
all Federal income taxes.
3. INVESTMENT ADVISER
The Trust has an Investment Advisory Agreement (the "Agreement") with John
McStay Investment Counsel ("JMIC" or the "Adviser"), with whom certain
Officers and Trustees of the Trust are affiliated, to furnish investment
advisory services to the Portfolio. JMIC is a majority owned indirect
subsidiary of American International Group, Inc. and minority owned by the
employees of JMIC. In addition to offering investment adviser services to
the Trust, JMIC also offers investment adviser services to Brazos Mutual
Funds, which consists of the Brazos Small Cap Growth, Brazos Micro Cap
Growth, Brazos Mid Cap Growth, Brazos Real Estate Securities and Brazos
Multi Cap Growth Portfolios. Under the terms of the Agreement, the Trust,
on behalf of the Portfolio, compensates the Adviser for its management
services at the annual rate of 1.25% of the Portfolio's average daily net
assets.
The Adviser has agreed to voluntarily waive its management fee and/or
reimburse the Portfolio's other expenses, including organization expenses,
to the extent necessary to ensure that the Portfolio's operating expenses,
do not exceed 1.45% of its average daily net assets. This cap on expenses
is expected to continue until further notice. Any such waiver or
reimbursement is subject to later
<PAGE>
adjustment to allow the Adviser to recoup amounts waived or reimbursed to
the extent actual fees and expense for a period are less than the expense
limitation cap of 1.45%, provided, however, that the Adviser shall only be
entitled to recoup such amounts for a period of three years from the date
such amount was waived or reimbursed.
4. AGREEMENTS
Firstar Mutual Fund Services, LLC (the "Administrator" or "FMFS") serves as
Administrator, Transfer Agent and Dividend Paying Agent of the Trust and
also provides accounting services to the Trust pursuant to the Portfolio
Accounting Servicing Agreement between FMFS and the Trust. FMFS is an
indirect wholly-owned subsidiary of Firstar Corporation, a multi-bank
holding company.
As Administrator, FMFS supplies corporate secretarial services, office
facilities, non-investment-related statistical and research data, executive
and administrative services, internal auditing and regulatory compliance
services. FMFS also assists in the preparation of reports to shareholders,
prepares proxy statements, updates prospectuses and makes filings with the
Securities and Exchange Commission and state securities authorities. FMFS
performs certain budgeting and financial reporting and compliance
monitoring activities. For the services provided as Administrator, FMFS
receives an annual fee from the Trust equal to the greater of: (1) a
minimum annual fee of $40,000 or (2) an asset based fee, equal to .07% of
the average daily net assets of the Trust up to $200 million, .06% on the
next $500 million and .04% on the balance.
Certain officers of FMFS are also officers of the Trust.
Firstar Bank, N.A. ("Firstar"), serves as the Custodian for the Trust
pursuant to the Custody Agreement between Firstar and the Trust. As
custodian, Firstar has agreed to (a) maintain a separate account or
accounts in the name of the Trust, (b) hold and transfer portfolio
securities on account of the Trust, (c) accept receipts and make
disbursements of money on behalf of the Trust, (d) collect and receive all
income and other payments and distributions on account of the Trust's
portfolio securities, and (e) make periodic reports to the Trust's Trustees
concerning the Trust's operations. For its services to the Trust under the
Custody Agreement, Firstar receives a fee in addition to transaction
charges and out-of-pocket expenses.
5. DISTRIBUTOR
Pembrook Securities ("Pembrook"), serves as distributor for shares of the
Portfolio. Pembrook is a majority owned indirect subsidiary of American
International Group, Inc. ("AIG"), and minority owned by certain employees
of JMIC, the Trust's adviser, which is also a majority owned indirect
subsidiary of AIG. Pembrook will receive no compensation for distribution
of shares of the Portfolio, except for reimbursement by the Adviser of
out-of-pocket expenses.
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Report of Independent Accountants
To the Board of Trustees
and Shareholder of
Brazos Insurance Funds
In our opinion, the accompanying statement of assets and liabilities and the
related statement of operations present fairly, in all material respects, the
financial position of Brazos Insurance Funds - BRAZOS Small Cap Growth Portfolio
(the "Fund") at August 18, 2000, and the results of its operations for the one
day then ended, in conformity with accounting principles generally accepted in
the United States. These financial statements are the responsibility of the
Fund's management; our responsibility is to express an opinion on these
financial statements based on our audit. We conducted our audit of these
financial statements in accordance with auditing standards generally accepted in
the United States, which require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audit provides a reasonable basis for the opinion expressed above.
1. PricewaterhouseCoopers LLP
1177 Avenue of the Americas
New York, New York
August 18, 2000
