File No. 811-09969
As filed with the Securities and Exchange Commission on December 1, 2000.
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-1A
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY
ACT OF 1940
Amendment No. 1 / X /
(Check appropriate box or boxes)
BBH BROAD MARKET FIXED INCOME PORTFOLIO
(Exact Name of Registrant as Specified in Charter)
63 Wall Street, New York, NY 10005
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, including Area Code: (800) 625-5759
Philip W. Coolidge, 21 Milk Street, Boston, Massachusetts 02109
(Name and Address of Agent for Service)
Copy to:
John E. Baumgardner, Jr., Esq.
Sullivan & Cromwell
125 Broad Street
New York, NY 10004
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PART A
Responses to Items 1 through 3, 5 and 9 have been omitted pursuant to
Item 2(b) of Instruction B of the General Instructions to Form N-1A.
Item 4.Investment Objective, Principal Investment Strategies, and Related Risks
INVESTMENT OBJECTIVE
The investment objective of the Portfolio is to provide maximum total return,
consistent with preservation of capital and prudent investment management.
PRINCIPAL INVESTMENT STRATEGIES
The Investment Adviser invests at the assets of the Portfolio in a broad range
of fixed income securities, primarily U.S. dollar denominated. The Portfolio's
assets may also be invested in non U.S. dollar denominated securities. In
pursuing its investment objective, the Portfolio may use a number of techniques.
These techniques and the securities used include, but are not limited to the
following:
Asset-Backed Securities Payment-In-Kind Bonds
Collateralized Bond Obligations Forward Contracts on Currencies
Collateralized Loan Obligations Futures Contracts on Bonds,
Interest Rates and Indexes
Collateralized Mortgage Obligations
Indexed Securities/
Convertible Bonds Structured Products
Convertible Preferred Stocks Options on Foreign Currencies,
Futures Contracts, Securities
Corporate Securities and Swaps
Domestic and Foreign Government Securities Reset Options
Domestic and Foreign Goverment Yield Curve Options
Agency Securities
Preferred Stocks
Event-Linked Securities Repurchase Agreements
Mortgage-Backed Securities Reverse Repurchase Agreements
Municipal Obligations Restricted Securities
Pass-Through Securities Short Term Instruments
Stripped Mortgage-Backed Securities Swaps and Related Derivative
Instruments
Supranational Securities TBA Mortgage-Backed Securities
Variable Floating-Rate Obligations "When-Issued" Securities
Zero Coupon and Deferred Interest Bonds 144A Securities
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The Investment Adviser seeks to deliver superior risk adjusted returns relative
to the Lehman Brothers Aggregate Bond Index by relying upon securities selection
based upon proprietary credit research and a quantitative decision framework.
The Adviser also seeks to forecast excess returns for each market sector by
identifying sectors with superior risk adjusted prospectus (based on each
sector's historic volatility characteristics). Sector positions are taken in
proportion to the Investment Adviser's conviction, expectations of return and
risk, and the Portfolio's investment policies. The Investment Adviser's Bond
Policy Group establishes risk parameters for the Portfolio and monitors the
distribution of risk across sector, duration and currency categories.
Under normal circumstances, the Investment Adviser invests at least 65% of the
assets of the Portfolio in a broad range of investment grade fixed income
securities. An investment grade security is one rated investment grade at the
time of purchase, by either a nationally recognized statistical rating
organization such as Moody's Investors Service, Inc., Standard & Poor's
Corporation, Fitch IBCA or Duff & Phelps Credit Rating Co. (or, if unrated, a
security that would, in the opinion of the Investment Adviser, be investment
grade if rated by a nationally recognized statistical rating organization). In
the event that a security is downgraded below investment grade, the Investment
Adviser will use his or her expertise and judgement to evaluate when and if to
sell the below investment grade security. The weighted average rating of the
total Portfolio's holdings will be investment grade.
The Investment Adviser may invest a portion of the assets of the Portfolio in
fixed income securities rated below investment grade or if unrated, determined
by the Adviser to be of comparable quality. These non investment grade
securities are commonly referred to as high yield or junk bonds. The Investment
Adviser of the Portfolio may invest in derivative products, such as interest
rate swaps, or other investment companies in order to obtain participation in
non investment grade securities. The Investment Adviser to such investment
companies may be Brown Brothers Harriman.
Rather than investing directly in the securities in which the Portfolio
primarily invests, the Portfolio may use other investment techniques to gain
exposure to market movements related to such securities, such as entering into a
series of contracts to buy or sell such securities and/or as part of a strategy
designed to reduce to exposure to other risks, such as interest rate or currency
risk. The Portfolio may, but is not required to, use derivative instruments for
risk management purposes or as part of its investment strategies. The Investment
Adviser may decide not to employ any of these strategies and there is no
assurance that any derivatives strategy used by the Portfolio will succeed.
PRINCIPAL RISK FACTORS
The principal risks of investing in the Portfolio and the circumstances
reasonably likely to adversely affect an investment are described below. The
price of the Portfolio changes daily based on market conditions and other
factors. An investor may lose money by investing in the Portfolio.
o Market Risk:
This is the risk that the price of a security will fall due to changing
economic, political or market conditions, or due to a company's individual
situation.
o Interest Rate Risk:
Interest rate risk refers to the price fluctuation of a bond in response to
changes in interest rates. In general, bonds with shorter maturities are
less sensitive to interest rate movements than those with longer
maturities.
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o Credit Risk:
Credit risk refers to the likelihood that an issuer will default on interest or
principal payments.
o Issuer Risk:
The value of a security may decline for a number of reasons which directly
relate to the issuer, such as management performance, financial leverage
and reduced demand for the issuer's goods or services.
o Liquidity Risk:
Liquidity risk exists when a particular instrument is difficult to purchase
or sell. If a transaction is particularly large or if the relevant market
is illiquid (as is the case with many restricted securities), it may not be
possible to initiate a transaction or liquidate a position at an
advantageous time or price. Securities in the Portfolio are generally less
liquid than many other investments including but not limited to securities
issued by the U.S. government, commercial paper and those of higher rated
investment grade corporate securities.
o Maturity Risk:
Interest rate risk will generally affect the price of a fixed income
security more if the security has a longer maturity. Fixed income
securities with longer maturities will therefore be more volatile than
other fixed income securities with shorter maturities. Conversely, fixed
income securities with shorter maturities will be less volatile but
generally provide lower returns than fixed income securities with longer
maturities.
o Mortgage Risk:
Rising interest rates tend to extend the duration of mortgage-related
securities, making them more sensitive to changes in interest rates. As a
result, in a period of rising interest rates, the Portfolio that holds
mortgage-related securities may exhibit additional volatility. This is
known as extension risk. In addition, mortgage-related securities are
subject to prepayment risk. When interest rates decline, borrowers may pay
off their mortgages sooner than expected. This can reduce the returns of
the Portfolio because the Portfolio will have to reinvest the money at the
lower prevailing interest rates.
o Derivatives Risk:
Derivatives are financial contracts whose value depends on, or is derived
from, the value of an underlying asset, reference rate or index. The
Portfolio's use of derivative instruments involves risks different from, or
possibly greater than, the risks associated with investing directly in
securities and other traditional investments. Derivatives are subject to a
number of risks described elsewhere in this section, such as liquidity
risk, interest rate risk, market risk and credit risk. They also involve
the risk of mispricing or improper valuation and the risk that changes in
the value of the derivative may not correlate perfectly with the underlying
asset, rate or index. By investing in a derivative instrument, the
Portfolio could lose more than the principal amount invested. Also,
suitable derivative transactions may not be available in all circumstances
and there can be no assurance that the Portfolio will engage in these
transactions to reduce exposure to other risks when that would be
beneficial.
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o Foreign Investment Risk:
Investing in securities of foreign issuers involves risks not typically
associated with investing in securities of domestic issuers including
foreign exchange risk, regulatory and tax risk. Changes in political or
social conditions, diplomatic relations, or limitations on the removal of
funds or assets may adversely affect the value of the investments in the
Portfolio. Changes in government administrations or economic or monetary
policies in the United States or abroad could result in appreciation or
depreciation of portfolio securities and could favorably or unfavorably
affect the Portfolio's operations. The economies of individual foreign
nations differ from the U.S. economy, whether favorably or unfavorably, in
areas such as growth of domestic product, rate of inflation, capital
reinvestment, resource self-sufficiency and balance of payments position.
Interest paid by foreign issuers may be subject to withholding and other
foreign taxes, which may decrease the net return on foreign investments as
compared to interest paid to the Portfolio by domestic issuers.
Because foreign securities generally are denominated and pay interest in
foreign currencies, and the Portfolio holds various foreign currencies from
time to time, the value of the assets of the Portfolio as measured in U.S.
dollars is affected favorably or unfavorably by changes in exchange rates.
The Portfolio also incurs costs in connection with conversion between
various currencies.
o Leveraging Risk:
The use of derivatives may create leveraging risk. The use of leveraging
may cause the Portfolio to liquidate portfolio positions when it may not be
advantageous to do so to satisfy its obligations or to meet segregation
requirements. Leverage, including borrowing, may cause the Portfolio to be
more volatile than if the Portfolio had not been leveraged. This is because
leverage tends to exaggerate the effect of any increase or decrease in the
value of the Portfolio's securities.
o Non Investment Grade Security Risk:
If and to the extent that the Portfolio invests directly or indirectly in
non investment grade securities and unrated securities of similar credit
quality (commonly known as "junk bonds"), it may be subject to greater
levels of market, interest rate, credit, issuer and liquidity risk than a
portfolio that does not invest in such securities. Non investment grade
securities are considered predominantly speculative with respect to the
issuer's continuing ability to make principal and interest payments. An
economic downturn or period of rising interest rates could adversely affect
the market for non investment grade securities and reduce the Portfolio's
ability to sell its non investment grade securities. (See "Liquidity Risk")
Investments in the Portfolio are neither insured nor guaranteed by the U.S.
Government. Beneficial interests in the Portfolio are not deposits or
obligations of, or guaranteed by, Brown Brothers Harriman & Co. or any other
bank, and are not insured by the Federal Deposit Insurance Corporation, the
Federal Reserve Board or any othe federal, state or other governmental agency.
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Item 6. Management, Organization and Capital Structure.
INVESTMENT ADVISER
The Investment Adviser to the Portfolio is Brown Brothers Harriman, Private
Bankers, a New York limited partnership established in 1818. The firm is subject
to examination and regulation by the Superintendent of Banks of the State of New
York and by the Department of Banking of the Commonwealth of Pennsylvania. The
firm is also subject to supervision and examination by the Commissioner of Banks
of the Commonwealth of Massachusetts. The Investment Adviser is located at 59
Wall Street, New York, NY 10005.
The Investment Adviser provides investment advice and portfolio management
services to the Portfolio. Subject to the general supervision of the Trustees of
the Portfolio, the Investment Adviser makes the day-to-day investment decisions
for the Portfolio, places the purchase and sale orders for the portfolio
transactions of the Portfolio, and generally manages the Portfolio's
investments. The Investment Adviser provides a broad range of investment
management services for customers in the United States and abroad. At June 30,
2000, it managed total assets of approximately $35 billion.
A team of individuals manages the Portfolio's securities on a day-to-day
basis. This team includes Mr. Glenn E. Baker, Mr. John P. Nelson and Mr. James
J. Evans. Mr. Baker holds a B.A. and a M.B.A. from the University of Michigan
and is a Chartered Financial Analyst. He joined Brown Brothers Harriman in 1991.
Mr. Nelson holds a B.S. from St. Vincent's College. He joined Brown Brothers
Harriman in 1987. Mr. Evans holds a B.S. from the University of Delaware and a
M.B.A. from New York University and is a Chartered Financial Analyst. He joined
Brown Brothers Harriman in 1996. Prior to joining Brown Brothers Harriman, he
worked at Fleet Investment Advisers.
The Portfolio pays the Investment Adviser an annual fee, computed daily and
payable monthly, equal to 0.30% of the average daily net assets of the
Portfolio. This fee compensates the Investment Adviser for its services and its
expenses (such as salaries of its personnel).
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Item 7. Investor Information.
The Portfolio values its assets on the basis of their market quotations and
valuations provided by independent pricing services. If quotations are not
readily available, the assets are valued at fair value in accordance with
procedures established by the Portfolio's Trustees.
Beneficial interests in the Portfolio are issued solely in private placement
transactions that do not involve any "public offering" within the meaning of
Section 4(2) of the 1933 Act. Investments in the Portfolio may only be made by
other investment companies, insurance company separate accounts, common or
commingled trust funds, or similar organizations or entities which are
"accredited investors" as defined in Rule 501 under the 1933 Act. This
Registration Statement does not constitute an offer to sell, or the solicitation
of an offer to buy, any "security" within the meaning of the 1933 Act.
An investment in the Portfolio may be made without a sales load. All investments
are made at net asset value next determined after an order is received in "good
order" by the Portfolio. The net asset value of the Portfolio is determined once
on each business day.
The minimum initial investment in the Portfolio is $5,000,000. There is no
minimum for subsequent investments. However, because the Portfolio intends to be
as fully invested at all times as is reasonably practicable in order to enhance
the yield on its assets, investments must be made in federal funds (i.e., monies
credited to the account of the Custodian by a Federal Reserve Bank).
The Portfolio reserves the right to cease accepting investments at any time or
to reject any investment order.
An investor in the Portfolio may reduce all or any portion of its investment at
the net asset value next determined after a request in "good order" is furnished
by the investor to the Portfolio. The proceeds of a reduction will be paid by
the Portfolio in federal funds normally on the next Portfolio Business Day after
the reduction is effected, but in any event within seven days. Investments in
the Portfolio may not be transferred.
The right of any investor to receive payment with respect to any reduction may
be suspended or the payment of the proceeds therefrom postponed during any
period in which the New York Stock Exchange is closed (other than weekends or
holidays) or trading on the New York Stock Exchange is restricted or, to the
extent otherwise permitted by the 1940 Act if an emergency exists.
The Portfolio reserves the right under certain circumstances, such as
accommodating requests for substantial withdrawals or liquidations, to pay
distributions in kind to investors (i.e., to distribute portfolio securities as
opposed to cash). If securities are distributed, an investor could incur
brokerage, tax or other charges in converting the securities to cash. In
addition, distribution in kind may result in a less diversified portfolio of
investments or adversely affect the liquidity of the Portfolio.
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Item 8. Distribution Arrangements.
Not applicable.
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PART B
Item 10. Cover Page.
Not applicable.
Table of Contents.
Page
Portfolio History . . . . . . . . . . . . B-1
Description of Portfolio and Its
Investments and Risks . . . . . . . . . . . . . . . . B-1
Management of the Portfolio . . . . . . . . . . . . . B-22
Control Persons and Principal Holders
of Securities . . . . . . . . . . . . . . . . . . . . . B-25
Investment Advisory and Other Services . . . . . . . . B-25
Brokerage Allocation and Other Practices . . . . . . . B-27
Capital Stock and Other Securities . . . . . . . . . . B-28
Purchase, Redemption and Pricing of
Securities . . . . . . . . . . . . . . . . . . . . . . B-29
Tax Status . . . . . . . . . . . . . . . . . . . . . . B-31
Underwriters . . . . . . . . . . . . . . . . . . . . . B-32
Calculations of Performance Data . . . . . . . . . . . B-32
Financial Statements . . . . . . . . . . . . . . . . . B-32
Appendix . . . . . . . . . . . . . . . . . . . . . . . . B-33
Item 11. Portfolio History.
The Portfolio is a trust established on June 15, 1993 under the law of
the State of New York.
Item 12. Description of Portfolio, Investments and Risks.
The following supplements the information contained in Part A concerning the
investment objective, policies and techniques of the Portfolio.
Debt Securities
Corporate Debt Securities
The Portfolio's investment in U.S. dollar or foreign currency-denominated
corporate debt securities of domestic or foreign issuers is limited to corporate
bonds, debentures, notes and other similar corporate debt instruments, including
convertible securities including corporate income-producing securities which
meet the minimum ratings criteria set forth for the Portfolio, or, if unrated,
are in the Adviser's opinion comparable in quality to corporate debt securities
in which the Portfolio may invest.
Corporate income-producing securities may include forms of preferred or
preference stock. The rate of interest on a corporate debt security may be
fixed, floating or variable, and may vary inversely with respect to a reference
rate. The rate of return or return of principal on some debt obligations may be
linked or indexed to the level of exchange rates between the U.S. dollar and a
foreign currency or currencies. Debt securities may be acquired with warrants
attached.
Debt Securities Rating Criteria
Investment grade debt securities are those rated "BBB" or higher by Standard &
Poor's Ratings Group ("Standard & Poor's") or the equivalent rating of other
nationally recognized securities rating organizations. Debt securities rated BBB
are considered medium grade obligations with speculative characteristics, and
adverse economic conditions or changing circumstances may weaken the issuer's
ability to pay interest and repay principal. If the rating of an investment
grade debt security changes to above medium investment grade, the Adviser will
consider if any action is appropriate in light of the Portfolio's investment
objective and policies.
Below investment grade debt securities are those rated "BB" and below by
Standard & Poor's or the equivalent rating of other nationally recognized
securities rating organizations. See the Appendix for a description of rating
categories. An investment grade security is one rated investment grade at the
time of purchase, by either Moody's Investors Service, Inc., Standard & Poor's
Corporation, Fitch IBCA or Duff & Phelps Credit Rating Co. (or, if unrated, a
security that would, in the opinion of the Investment Adviser, be investment
grade if rated by a nationally recognized rating organization). In the event
that a security is downgraded below investment grade, the Investment Adviser
will use his or her expertise and judgement to evaluate when and if to sell the
below investment grade security.
B-1
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Collaterialized Bond Obligations
A Collateralized Bond Obligation (CBO) is a trust typically consisting of
corporate bonds (both US & foreign). CBO'S consist of a portfolio of many
underlying securities where the cashflows from the securitization are derived
from this portfolio. The cashflows from the trust are split into two or more
portions, called tranches, varying in risk and yield. The riskiest portion is
the "Equity" tranche which bears the bulk of defaults from the bonds in the
trust and serves to protect the other, more senior tranches from default in all
but the most severe circumstances. Since it is partially protected from defaults
a senior tranche from a CBO trust typically has a higher rating and lower yield
than its underlying securities, and can be rated investment grade. Despite the
protection from the equity tranche, CBO tranches can experience substantial
losses due to actual defaults, increased sensitivity to defaults due to
collateral default and disappearance of protecting tranches, market anticipation
of defaults, as well as aversion to CBO securities as a class.
Collaterialized Loan Obligations
A Collateralized Loan Obligation (CLO) is a trust typically consisting of loans
made to issuers (both US and foreign). CLO'S consist of a portfolio of many
underlying loans where the cashflows from the securitization are derived from
this portfolio of loans. The cashflows from the trust are split into two or more
portions, called tranches, varying in risk and yield. The riskiest portion is
the "Equity" tranche which bears the bulk of defaults from the loans in the
trust and serves to protect the other, more senior tranches from default in all
but the most severe circumstances. Since it is partially protected from defaults
a senior tranche from a CLO trust typically has a higher rating and lower yield
than its underlying securities, and can be rated investment grade. Despite the
protection from the equity tranche, CLO tranches can experience substantial
losses due to actual defaults, increased sensitivity to defaults due to
collateral default and disappearance of protecting tranches, market anticipation
of defaults, as well as aversion to CLO securities as a class.
Convertible Securities
A convertible debt security is a bond, debenture, note, or other security that
entitles the holder to acquire common stock or other equity securities of the
same or a different issuer. A convertible security generally entitles the holder
to receive interest paid or accrued until the convertible security matures or is
redeemed, converted or exchanged. Before conversion, convertible securities have
characteristics similar to non-convertible debt securities. Convertible
securities rank senior to common stock in a corporation's capital structure and,
therefore, generally entail less risk than the corporation's common stock,
although the extent to which such risk is reduced depends in large measure upon
the degree to which the convertible security sells above its value as a fixed
income security.
Because of the conversion feature, the price of the convertible security will
normally fluctuate in some proportion to changes in the price of the underlying
equity security, and as such is subject to risks relating to the activities of
the issuer and/or general market and economic conditions. The income component
of a convertible security may tend to cushion the security against declines in
the price of the underlying asset. However, the income component of convertible
securities causes fluctuations based upon changes in interest rates and the
credit quality of the issuer. In addition, convertible securities are often
lower-rated securities.
A convertible security may be subject to redemption at the option of the issuer
at a predetermined price. If a convertible security held by the Portfolio is
called for redemption, the Portfolio would be required to permit the issuer to
redeem the security and convert it to underlying common stock, or would sell the
convertible security to a third party, which may have an adverse effect on the
Portfolio's ability to achieve its investment objective. The Portfolio generally
would invest in convertible securities for their favorable price characteristics
and total return potential and would normally not exercise an option to convert.
B-2
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Mortgage-Related and Other Asset-Backed Securities
Mortgage-related securities are interests in pools of residential or commercial
mortgage loans, including first and second mortgage loans made by savings and
loan institutions, mortgage bankers, commercial banks and others. Pools of
mortgage loans are assembled as securities for sale to investors by various
governmental, government-related and private organizations. See "Mortgage
Pass-Through Securities." The Portfolio may also invest in debt securities which
are secured with collateral consisting of mortgage-related securities (see
"Collateralized Mortgage Obligations"), and in other types of mortgage-related
securities.
Mortgage Pass-Through Securities. Interests in pools of mortgage-related
securities differ from other forms of debt securities, which normally provide
for periodic payment of interest in fixed amounts with principal payments at
maturity or specified call dates. Instead, these securities provide a monthly
payment which consists of both interest and principal payments. In effect, these
payments are a "pass-through" of the monthly payments made by the individual
borrowers on their residential or commercial mortgage loans, net of any fees
paid to the issuer or guarantor of such securities. Additional payments are
caused by repayments of principal resulting from the sale of the underlying
property, refinancing or foreclosure, net of fees or costs which may be
incurred. Some mortgage-related securities (such as securities issued by GNMA)
are described as "modified pass-through." These securities entitle the holder to
receive all interest and principal payments owed on the mortgage pool, net of
certain fees, at the scheduled payment dates regardless of whether or not the
mortgagor actually makes the payment.
The rate of prepayments on underlying mortgages will affect the price and
volatility of a mortgage-related security, and may have the effect of shortening
or extending the effective maturity of the security beyond what was anticipated
at the time of purchase. To the extent that unanticipated rates of prepayment on
underlying mortgages increase in the effective maturity of a mortgage-related
security, the volatility of such security can be expected to increase.
The principal governmental guarantor of mortgage-related securities is GNMA.
GNMA is a wholly owned United States Government corporation within the
Department of Housing and Urban Development. GNMA is authorized to guarantee,
with the full faith and credit of the United States Government, the timely
payment of principal and interest on securities issued by institutions approved
by GNMA (such as savings and loan institutions, commercial banks and mortgage
bankers) and backed by pools of mortgages insured by the Federal Housing
Administration (the "FHA"), or guaranteed by the Department of Veterans Affairs
(the "VA").
Government-related guarantors (i.e., not backed by the full faith and credit of
the United States Government) include the Federal National Mortgage Association
("FNMA") and the Federal Home Loan Mortgage Corporation ("FHLMC"). FNMA is a
government-sponsored corporation owned entirely by private stockholders. It is
subject to general regulation by the Secretary of Housing and Urban Development.
FNMA purchases conventional (i.e., not insured or guaranteed by any government
agency) residential mortgages from a list of approved seller/servicers which
include state and federally chartered savings and loan associations, mutual
savings banks, commercial banks and credit unions and mortgage bankers.
Pass-through securities issued by FNMA are guaranteed as to timely payment of
principal and interest by FNMA but are not backed by the full faith and credit
of the United States Government. FHLMC was created by Congress in 1970 for the
purpose of increasing the availability of mortgage credit for residential
housing. It is a government-sponsored corporation formerly owned by the twelve
Federal Home Loan Banks and now owned entirely by private stockholders. FHLMC
issues Participation Certificates ("PCs") which represent interests in
conventional mortgages from FHLMC's national portfolio. FHLMC guarantees the
timely payment of interest and ultimate collection of principal, but PCs are not
backed by the full faith and credit of the United States Government.
Commercial banks, savings and loan institutions, private mortgage insurance
companies, mortgage bankers and other secondary market issuers also create
pass-through pools of conventional residential mortgage loans. Such issuers may,
in addition, be the originators and/or servicers of the underlying mortgage
loans as well as the guarantors of the mortgage-related securities. Pools
created by such non-governmental issuers generally offer a higher rate of
interest than government and government-related pools because there are no
direct or indirect government or agency guarantees of payments in the former
pools. However, timely payment of interest and principal of these pools may be
B-3
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supported by various forms of insurance or guarantees, including individual
loan, title, pool and hazard insurance and letters of credit, which may be
issued by governmental entities, private insurers or the mortgage poolers. The
insurance and guarantees are issued by governmental entities, private insurers
and the mortgage poolers. Such insurance and guarantees and the creditworthiness
of the issuers thereof will be considered in determining whether a
mortgage-related security meets the Portfolio's investment quality standards.
There can be no assurance that the private insurers or guarantors can meet their
obligations under the insurance policies or guarantee arrangements. The
Portfolio may buy mortgage-related securities without insurance or guarantees
if, through an examination of the loan experience and practices of the
originator/servicers and poolers, the Adviser determines that the securities
meet the Portfolio's quality standards. Although the market for such securities
is becoming increasingly liquid, securities issued by certain private
organizations may not be readily marketable.
Mortgage-backed securities that are issued or guaranteed by the U.S. Government,
its agencies or instrumentalities, are not subject to the Portfolio's industry
concentration restrictions, set forth below under "Investment Restrictions," by
virtue of the exclusion from that test available to all U.S. Government
securities. In the case of privately issued mortgage-related securities, the
Portfolio takes the position that mortgage-related securities do not represent
interests in any particular "industry" or group of industries. The assets
underlying such securities may be represented by a portfolio of first lien
residential mortgages (including both whole mortgage loans and mortgage
participation interests) or portfolios of mortgage pass-through securities
issued or guaranteed by GNMA, FNMA or FHLMC. Mortgage loans underlying a
mortgage-related security may in turn be insured or guaranteed by the FHA or the
VA. In the case of private issue mortgage-related securities whose underlying
assets are neither U.S. Government securities nor U.S. Government-insured
mortgages, to the extent that real properties securing such assets may be
located in the same geographical region, the security may be subject to a
greater risk of default than other comparable securities in the event of adverse
economic, political or business developments that may affect such region and,
ultimately, the ability of residential homeowners to make payments of principal
and interest on the underlying mortgages.
Collateralized Mortgage Obligations (CMOs). A CMO is a hybrid between a
mortgage-backed bond and a mortgage pass-through security. CMOs are similar to
both a bond and a pass-through security, as interest and prepaid principal is
paid, in most cases, on a monthly basis. Although CMOs, like bonds, may be
collateralized by whole mortgage loans, CMOS, like pass-through securities, are
more typically collateralized by portfolios of mortgage pass-through securities
guaranteed by GNMA, FHLMC, or FNMA, and their income streams.
CMOs are structured into multiple classes, each bearing a different stated
maturity. Actual maturity and average life will depend upon the prepayment
experience of the collateral. CMOs provide for a modified form of call
protection through a de facto breakdown of the underlying pool of mortgages
according to how quickly the loans are repaid. Monthly payment of principal
received from the pool of underlying mortgages, including prepayments, is first
returned to investors holding the shortest maturity class. Investors holding the
longer maturity classes receive principal only after the first class has been
retired. An investor is partially guarded against a sooner than desired return
of principal because of the sequential payments.
In a typical CMO transaction, a corporation issues multiple series (e.g., A, B,
C, Z) of CMO bonds ("Bonds"). Proceeds of the Bond offering are used to purchase
mortgages or mortgage pass-through certificates ("Collateral"). The Collateral
is pledged to a third party trustee as security for the Bonds. Principal and
interest payments from the Collateral are used to pay principal on the Bonds in
the order A, B, C, Z. The Series A, B, and C Bonds all bear current interest.
Interest on the Series Z Bond is accrued and added to principal and a like
amount is paid as principal on the Series A, B, or C Bond currently being paid
off. When the Series A, B, and C Bonds are paid in full, interest and principal
on the Series Z Bond begins to be paid currently. With some CMOs, the issuer
serves as a conduit to allow loan originators (primarily builders or savings and
loan associations) to borrow against their loan portfolios.
B-4
<PAGE>
Commercial Mortgage-Backed Securities include securities that reflect an
interest in, and are secured by, mortgage loans on commercial real property. The
market for commercial mortgage-backed securities developed more recently and in
terms of total outstanding principal amount of issues is relatively small
compared to the market for residential single-family mortgage-backed securities.
Many of the risks of investing in commercial mortgage-backed securities reflect
the risks of investing in the real estate securing the underlying mortgage
loans. These risks reflect the effects of local and other economic conditions on
real estate markets, the ability of tenants to make loan payments, and the
ability of a property to attract and retain tenants. Commercial mortgage-backed
securities may be less liquid and exhibit greater price volatility than other
types of mortgage- or asset-backed securities.
Other Mortgage-Related Securities. Other mortgage-related securities
include securities other than those described above that directly or indirectly
represent a participation in, or are secured by and payable from, mortgage loans
on real property, including mortgage dollar rolls, CMO residuals or stripped
mortgage-backed securities ("SMBS"). Other mortgage-related securities may be
equity or debt securities issued by agencies or instrumentalities of the U.S.
Government or by private originators of, or investors in, mortgage loans,
including savings and loan associations, homebuilders, mortgage banks,
commercial banks, investment banks, partnerships, trusts and special purpose
entities of the foregoing.
CMO Residuals. CMO residuals are mortgage securities issued by agencies or
instrumentalities of the U.S. Government or by private originators of, or
investors in, mortgage loans, including savings and loan associations,
homebuilders, mortgage banks, commercial banks, investment banks and special
purpose entities of the foregoing.
The cash flow generated by the mortgage assets underlying a series of CMOs is
applied first to make required payments of principal and interest on the CMOs
and second to pay the related administrative expenses of the issuer. The
residual in a CMO structure generally represents the interest in any excess cash
flow remaining after making the foregoing payments. Each payment of such excess
cash flow to a holder of the related CMO residual represents income and/or a
return of capital. The amount of residual cash flow resulting from a CMO will
depend on, among other things, the characteristics of the mortgage assets, the
coupon rate of each class of CMO, prevailing interest rates, the amount of
administrative expenses and the prepayment experience on the mortgage assets. In
particular, the yield to maturity on CMO residuals is extremely sensitive to
prepayments on the related underlying mortgage assets, in the same manner as an
interest-only ("IO") class of stripped mortgage-backed securities. See "Other
Mortgage-Related Securities--Stripped Mortgage-Backed Securities." In addition,
if a series of a CMO includes a class that bears interest at an adjustable rate,
the yield to maturity on the related CMO residual will also be extremely
sensitive to changes in the level of the index upon which interest rate
adjustments are based. As described below with respect to stripped
mortgage-backed securities, in certain circumstances the Portfolio may fail to
recoup fully its initial investment in a CMO residual.
CMO residuals are generally purchased and sold by institutional investors
through several investment banking firms acting as brokers or dealers. The CMO
residual market has only very recently developed and CMO residuals currently may
not have the liquidity of other more established securities trading in other
markets. Transactions in CMO residuals are generally completed only after
careful review of the characteristics of the securities in question. In
addition, CMO residuals may, or pursuant to an exemption therefrom, may not have
been registered under the Securities Act of 1933, as amended (the "1933 Act").
CMO residuals, whether or not registered under the 1933 Act, may be subject to
certain restrictions on transferability, and may be deemed "illiquid" and
subject to the Portfolio's limitations on investment in illiquid securities.
Stripped Mortgage-Backed Securities
SMBS are derivative multi-class mortgage securities. SMBS may be issued by
agencies or instrumentalities of the U.S. Government, or by private originators
of, or investors in, mortgage loans, including savings and loan associations,
mortgage banks, commercial banks, investment banks and special purpose entities
of the foregoing.
B-5
<PAGE>
SMBS are usually structured with two classes that receive different proportions
of the interest and principal distributions on a pool of mortgage assets. A
common type of SMBS will have one class receiving some of the interest and most
of the principal from the mortgage assets, while the other class will receive
most of the interest and the remainder of the principal. In the most extreme
case, one class will receive all of the interest (the "IO" class), while the
other class will receive all of the principal (the principal- only or "PO"
class). The yield to maturity on an IO class is extremely sensitive to the rate
of principal payments (including prepayments) on the related underlying mortgage
assets, and a rapid rate of principal payments may have a material adverse
effect on the Portfolio's yield to maturity from these securities. If the
underlying mortgage assets experience greater than anticipated prepayments of
principal, the Portfolio may fail to recoup some or all of its initial
investment in these securities even if the security is in one of the highest
rating categories.
Although SMBS are purchased and sold by institutional investors through several
investment banking firms acting as brokers or dealers, these securities were
only recently developed. As a result, established trading markets have not yet
developed and, accordingly, these securities may be deemed "illiquid" and
subject to the Portfolio's limitations on investment in illiquid securities.
Other Asset-Backed Securities
Consistent with the Portfolio's investment objectives and policies, the Adviser
also may invest in other types of asset-backed securities. An asset-backed
security is typically a trust consisting of consumer or commercial loans.
Similar to a bond, interest and principal is paid, in most cases, on a monthly
basis. Asset-backed securities may be collaterialized by, but not limited to,
credit card loans, automobile loans, home equity loans and manufactured housing
and airplane leases. Asset-backed securities are typically structured into
multiple classes each bearing a different stated maturity. Actual maturity and
average life will depend upon the prepayment experience of the collateral.
U.S. Government Securities
The Portfolio's assets may be invested in securities issued or guaranteed by the
U.S. Government, its agencies or instrumentalities. These securities, including
those which are guaranteed by federal agencies or instrumentalities, may or may
not be backed by the "full faith and credit" of the United States. In the case
of securities not backed by the full faith and credit of the United States, it
may not be possible to assert a claim against the United States itself in the
event the agency or instrumentality issuing or guaranteeing the security for
ultimate repayment does not meet its commitments. Securities which are not
backed by the full faith and credit of the United States include, but are not
limited to, securities of the Tennessee Valley Authority, the Federal National
Mortgage Association (FNMA) and the U.S. Postal Service, each of which has a
limited right to borrow from the U.S. Treasury to meet its obligations, and
securities of the Federal Farm Credit System, the Federal Home Loan Banks, the
Federal Home Loan Mortgage Corporation ("FHLMC") and the Student Loan Marketing
Association, the obligations of each of which may be satisfied only by the
individual credit of the issuing agency. Securities which are backed by the full
faith and credit of the United States include Treasury bills, Treasury notes,
Treasury bonds and pass through obligations of the Government National Mortgage
Association ("GNMA"), the Farmers Home Administration and the Export-Import
Bank. There is no percentage limitation with respect to investments in U.S.
Government securities.
Variable and Floating Rate Instruments
The Portfolio may invest in variable rate and floating rate instruments. These
are securities whose interest rates are reset daily, weekly or at another
periodic date so that the security remains close to par, minimizing changes in
its market value. These securities often have a demand feature which entitles
the investor to repayment of principal plus accrued interest on short notice. In
calculating the maturity of a variable rate or floating rate instrument for the
Portfolio, the date of the next interest rate reset is used.
Zero Coupon Bonds
The Portfolio may invest in zero coupon bonds. These are securities issued at a
discount from their face value that pay all interest and principal upon
maturity. The difference between the purchase price and par is a specific
compounded interest rate for the investor. In calculating the daily income of
the Portfolio, a portion of the difference between a zero coupon bond's purchase
price and its face value is taken into account as income.
B-6
<PAGE>
Deferred Interest Bonds
A deferred interest bond is a bond such as a zero-coupon bond that does not pay
interest until a later date. Prices for deferred interest bonds are less stable
than for a current coupon bond.
PIK (Payment-In-Kind) Securities
Bonds or preferred stock whose dividends are in the form of additional bonds or
preferred stock.
Municipal Obligations
The Portfolio may purchase municipal obligations when the Adviser believes that
they offer favorable rates of income or capital gain potential when compared to
a taxable investment. The term "municipal obligations" generally is understood
to include debt obligations issued by municipalities to obtain funds for various
public purposes, the interest on which is, in the opinion of bond counsel to the
issuer, excluded from gross income for federal income tax purposes. In addition,
if the proceeds from private activity bonds are used for the construction,
repair or improvement of privately operated industrial or commercial facilities,
the interest paid on such bonds may be excluded from gross income for federal
income tax purposes, although current federal tax laws place substantial
limitations on the size of these issues. The Portfolio's distributions of any
interest it earns on municipal obligations will be taxable to shareholders as
ordinary income.
The two principal classifications of municipal obligations are "general
obligation" and "revenue" bonds. General obligation bonds are secured by the
issuer's pledge of its faith, credit, and taxing power for the payment of
principal and interest. Revenue bonds are payable from the revenues derived from
a particular facility or class of facilities or, in some cases, from the
proceeds of a special excise or other specific revenue source, but not from the
general taxing power. Sizable investments in these obligations could involve an
increased risk to the Portfolio should any of the related facilities experience
financial difficulties. Private activity bonds are in most cases revenue bonds
and do not generally carry the pledge of the credit of the issuing municipality.
There are, of course, variations in the security of municipal obligations, both
within a particular classification and between classifications.
The mortgage derivatives that the Portfolio may invest in include interests in
collateralized mortgage obligations and stripped mortgage-backed securities.
Event-linked bonds
Event-linked bonds are fixed income securities, for which the return of
principal and payment of interest is contingent on the non-occurrence of a
specific "trigger" event, such as a hurricane, earthquake, or other physical or
weather-related phenomenon. They may be issued by government agencies, insurance
companies, reinsurers, special purpose corporations or other on-shore or
off-shore entities. If a trigger event causes losses exceeding a specific amount
in the geographic region and time period specified in a bond, the Portfolio
investing in the bond may lose a portion or all of its principal invested in the
bond. If no trigger event occurs, the Portfolio will recover its principal plus
interest. For some event-linked bonds, the trigger event or losses may be based
on company-wide losses, index-portfolio losses, industry indices, or readings of
scientific instruments rather than specified actual losses. Often the
event-linked bonds provide for extensions of maturity that are mandatory, or
optional at the discretion of the issuer, in order to process and audit loss
claims in those cases where a trigger event has, or possibly has, occurred. In
addition to the specified trigger events, event-linked bonds may also expose the
Portfolio to certain unanticipated risks including but not limited to issuer
(credit) default, adverse regulatory or jurisdictional interpretations, and
adverse tax consequences.
Event-linked bonds are a relatively new type of financial instrument. As such,
there is no significant trading history of these securities, and there can be no
assurance that a liquid market in these instruments will develop. See "Illiquid
Securities" below. Lack of a liquid market may impose the risk of higher
transaction costs and the possibility that the Portfolio may be forced to
liquidate positions when it would not be advantageous to do so. Event-linked
bonds are typically rated, and the Portfolio will only invest in catastrophe
bonds that meet the credit quality requirements for the Portfolio.
B-7
<PAGE>
Short-Term Investments
Although it is intended that the assets of the Portfolio stay invested in the
securities described above and in the Prospectus to the extent practical in
light of the Portfolio's investment objective and long-term investment
perspective, the Portfolio's assets may be invested in short-term instruments to
meet anticipated expenses or for day-to-day operating purposes. Short-term
instruments consist of foreign and domestic: (i) short-term obligations of
sovereign governments, their agencies, instrumentalities, authorities or
political subdivisions; (ii) other short-term debt securities rated A or higher
by Moody's or Standard & Poor's, or if unrated are of comparable quality in the
opinion of the Investment Adviser; (iii) commercial paper; (iv) bank
obligations, including negotiable certificates of deposit, fixed time deposits
and bankers' acceptances; and (v) repurchase agreements. Time deposits with a
maturity of more than seven days are treated as not readily marketable. At the
time the Portfolio's assets are invested in commercial paper, bank obligations
or repurchase agreements, the issuer must have outstanding debt rated A or
higher by Moody's or Standard & Poor's; the issuer's parent corporation, if any,
must have outstanding commercial paper rated Prime-1 by Moody's or A-1 by
Standard & Poor's; or, if no such ratings are available, the instrument must be
of comparable quality in the opinion of the Investment Adviser. The assets of
the Portfolio may be invested in non-U.S. dollar denominated and U.S. dollar
denominated short-term instruments, including U.S. dollar denominated repurchase
agreements. Cash is held for the Portfolio in demand deposit accounts with the
Portfolio's custodian bank.
When-Issued and Delayed Delivery Securities
The Portfolio may purchase securities on a when-issued or delayed delivery
basis. For example, delivery and payment may take place a month or more after
the date of the transaction. The purchase price and the interest rate payable on
the securities are fixed on the transaction date. The securities so purchased
are subject to market fluctuation and no interest accrues to the Portfolio until
delivery and payment take place.
At the time the commitment to purchase securities for the Portfolio on a
when-issued or delayed delivery basis is made, the transaction is recorded and
thereafter the value of such securities is reflected each day in determining the
Portfolio's net asset value. At the time of its acquisition, a when-issued
security may be valued at less than the purchase price. Commitments for such
when-issued securities are made only when there is an intention of actually
acquiring the securities. To facilitate such acquisitions, a segregated account
with Brown Brothers Harriman & Co. (the Custodian) is maintained for the
Portfolio with liquid assets in an amount at least equal to such commitments.
Such segregated account consists of liquid assets marked to the market daily,
with additional liquid assets added when necessary to insure that at all times
the value of such account is equal to the commitments. On delivery dates for
such transactions, such obligations are met from maturities or sales of the
securities held in the segregated account and/or from cash flow. If the right to
acquire a when-issued security is disposed of prior to its acquisition, the
Portfolio could, as with the disposition of any other portfolio obligation,
incur a gain or loss due to market fluctuation. When-issued commitments for the
Portfolio may not be entered into if such commitments exceed in the aggregate
15% of the market value of the Portfolio's total assets, less liabilities other
than the obligations created by when-issued commitments.
Derivative Instruments
In pursuing its investment objective, the Portfolio may purchase and sell
(write) both put options and call options on securities, securities indexes, and
foreign currencies, and enter into interest rate, foreign currency and index
futures contracts and purchase and sell options on such futures contracts
("futures options") for hedging purposes or as part of their overall investment
strategies. The Portfolio also may purchase and sell foreign currency options
for purposes of increasing exposure to a foreign currency or to shift exposure
to foreign currency fluctuations from one country to another. The Portfolio also
may enter into swap agreements with respect to interest rates and indexes of
securities, and to the extent it may invest in foreign currency-denominated
securities, may enter into swap agreements with respect to foreign currencies.
The Portfolio may invest in structured securities which may be issued by a
trust. If other types of financial instruments, including other types of
options, futures contracts, or futures options are traded in the future, the
Portfolio may also use those instruments, provided that the Portfolio's Trustees
determine that their use is consistent with the Portfolio's investment
objective.
B-8
<PAGE>
The value of some derivative instruments in which the Portfolio may invest may
be particularly sensitive to changes in prevailing interest rates, and, like the
other investments of the Portfolio, the ability of the Portfolio to successfully
utilize these instruments may depend in part upon the ability of the Adviser to
forecast interest rates and other economic factors correctly. If the Adviser
incorrectly forecasts such factors and has taken positions in derivative
instruments contrary to prevailing market trends, the Portfolio could be exposed
to the risk of loss.
The Portfolio might not employ any of the strategies described below, and no
assurance can be given that any strategy used will succeed. If the Adviser
incorrectly forecasts interest rates, market values or other economic factors in
utilizing a derivatives strategy for the Portfolio, the Portfolio might have
been in a better position if it had not entered into the transaction at all.
Also, suitable derivative transactions may not be available in all
circumstances. The use of these strategies involves certain special risks,
including a possible imperfect correlation, or even no correlation, between
price movements of derivative instruments and price movements of related
investments. While some strategies involving derivative instruments can reduce
the risk of loss, they can also reduce the opportunity for gain or even result
in losses by offsetting favorable price movements in related investments or
otherwise, due to the possible inability of a Fund to purchase or sell a
portfolio security at a time that otherwise would be favorable or the possible
need to sell a portfolio security at a disadvantageous time because the
Portfolio is required to maintain asset coverage or offsetting positions in
connection with transactions in derivative instruments, and the possible
inability of the Portfolio to close out or to liquidate its derivatives
positions. In addition, the Portfolio's use of such instruments may cause the
Portfolio to realize higher amounts of short-term capital gains (generally taxed
at ordinary income tax rates) than if it had not used such instruments.
Options on Securities and Indexes
The Portfolio may, to the extent specified herein, purchase and sell both put
and call options on fixed income or other securities or indexes in standardized
contracts traded on foreign or domestic securities exchanges, boards of trade,
or similar entities, or quoted on NASDAQ or on a regulated foreign
over-the-counter market, and agreements, sometimes called cash puts, which may
accompany the purchase of a new issue of bonds from a dealer.
An option on a security (or index) is a contract that gives the holder of the
option, in return for a premium, the right to buy from (in the case of a call)
or sell to (in the case of a put) the writer of the option the security
underlying the option (or the cash value of the index) at a specified exercise
price at any time during the term of the option. The writer of an option on a
security has the obligation upon exercise of the option to deliver the
underlying security upon payment of the exercise price or to pay the exercise
price upon delivery of the underlying security. Upon exercise, the writer of an
option on an index is obligated to pay the difference between the cash value of
the index and the exercise price multiplied by the specified multiplier for the
index option. (An index is designed to reflect features of a particular
financial or securities market, a specific group of financial instruments or
securities, or certain economic indicators.)
The Portfolio will write call options and put options only if they are
"covered." In the case of a call option on a security, the option is "covered"
if the Portfolio owns the security underlying the call or has an absolute and
immediate right to acquire that security without additional cash consideration
(or, if additional cash consideration is required, cash or other assets
determined to be liquid by the Adviser in accordance with procedures established
by the Portfolio's Board of Trustees, in such amount are segregated by its
Custodian) upon conversion or exchange of other securities held by the
Portfolio. For a call option on an index, the option is covered if the Portfolio
maintains with its Custodian assets determined to be liquid by the Adviser in
accordance with procedures established by the Portfolio's Board of Trustees, in
an amount equal to the contract value of the index. A call option is also
covered if the Portfolio holds a call on the same security or index as the call
written where the exercise price of the call held is (i) equal to or less than
the exercise price of the call written, or (ii) greater than the exercise price
of the call written, provided the difference is maintained by the Portfolio in
segregated assets determined to be liquid by the Adviser in accordance with
procedures established by the Porfolio's Board of Trustees. A put option on a
security or an index is "covered" if the Portfolio segregates assets determined
to be liquid by the Adviser in accordance with procedures established by the
Portfolio's Board of Trustees equal to the exercise price. A put option is also
covered if the Portfolio holds a put on the same security or index as the put
written where the exercise price of the put held is (i) equal to or greater than
the exercise price of the put written, or (ii) less than the exercise price of
the put written, provided the difference is maintained by the Portfolio in
segregated assets determined to be liquid by the Adviser in accordance with
procedures established by the Portfolio's Board of Trustees.
B-9
<PAGE>
If an option written by the Portfolio expires unexercised, the Portfolio
realizes a capital gain equal to the premium received at the time the option was
written. If an option purchased by the Portfolio expires unexercised, the
Portfolio realizes a capital loss equal to the premium paid. Prior to the
earlier of exercise or expiration, an exchange traded option may be closed out
by an offsetting purchase or sale of an option of the same series (type,
exchange, underlying security or index, exercise price, and expiration). There
can be no assurance, however, that a closing purchase or sale transaction can be
effected when the Portfolio desires.
The Portfolio may sell put or call options it has previously purchased, which
could result in a net gain or loss depending on whether the amount realized on
the sale is more or less than the premium and other transaction costs paid on
the put or call option which is sold. Prior to exercise or expiration, an option
may be closed out by an offsetting purchase or sale of an option of the same
series. The Portfolio will realize a capital gain from a closing purchase
transaction if the cost of the closing option is less than the premium received
from writing the option, or, if it is more, the Portfolio will realize a capital
loss. If the premium received from a closing sale transaction is more than the
premium paid to purchase the option, the Portfolio will realizes a capital gain
or, if it is less, the Portfolio will realize a capital loss. The principal
factors affecting the market value of a put or a call option include supply and
demand, interest rates, the current market price of the underlying security or
index in relation to the exercise price of the option, the volatility of the
underlying security or index, and the time remaining until the expiration date.
The premium paid for a put or call option purchased by the Portfolio is an asset
of the Portfolio. The premium received for an option written by the Portfolio is
recorded as a deferred credit. The value of an option purchased or written is
marked to market daily and is valued at the closing price on the exchange on
which it is traded or, if not traded on an exchange or no closing price is
available, at the mean between the last bid and asked prices.
The Portfolio may write covered straddles consisting of a combination of a call
and a put written on the same underlying security. A straddle will be covered
when sufficient assets are deposited to meet the Portfolio's immediate
obligations. The Portfolio may use the same liquid assets to cover both the call
and put options where the exercise price of the call and put are the same, or
the exercise price of the call is higher than that of the put. In such cases,
the Portfolio will also segregate liquid assets equivalent to the amount, if
any, by which the put is "in the money."
Risks Associated with Options on Securities and Indexes
There are several risks associated with transactions in options on securities
and on indexes. For example, there are significant differences between the
securities and options markets that could result in an imperfect correlation
between these markets, causing a given transaction not to achieve its
objectives. A decision as to whether, when and how to use options involves the
exercise of skill and judgment, and even a well-conceived transaction may be
unsuccessful to some degree because of market behavior or unexpected events.
During the option period, the covered call writer has, in return for the premium
on the option, given up the opportunity to profit from a price increase in the
underlying security above the exercise price, but, as long as its obligation as
a writer continues, has retained the risk of loss should the price of the
underlying security decline. The writer of an option has no control over the
time when it may be required to fulfill its obligation as a writer of the
option. Once an option writer has received an exercise notice, it cannot effect
a closing purchase transaction in order to terminate its obligation under the
option and must deliver the underlying security at the exercise price. If a put
or call option purchased by the Portfolio is not sold when it has remaining
value, and if the market price of the underlying security remains equal to or
greater than the exercise price (in the case of a put), or remains less than or
equal to the exercise price (in the case of a call), the Portfolio will lose its
entire investment in the option. Also, where a put or call option on a
particular security is purchased to hedge against price movements in a related
security, the price of the put or call option may move more or less than the
price of the related security.
There can be no assurance that a liquid market will exist when the Portfolio
seeks to close out an option position. If the Portfolio were unable to close out
an option that it had purchased on a security, it would have to exercise the
option in order to realize any profit or the option may expire worthless. If the
Portfolio were unable to close out a covered call option that it had written on
a security, it would not be able to sell the underlying security unless the
option expired without exercise. As the writer of a covered call option, the
Portfolio forgoes, during the option's life, the opportunity to profit from
increases in the market value of the security covering the call option above the
sum of the premium and the exercise price of the call.
B-10
<PAGE>
If trading were suspended in an option purchased by the Portfolio, the Portfolio
would not be able to close out the option. If restrictions on exercise were
imposed, the Portfolio might be unable to exercise an option it has purchased.
Except to the extent that a call option on an index written by the Portfolio is
covered by an option on the same index purchased by the Portfolio, movements in
the index may result in a loss to the Portfolio; however, such losses may be
mitigated by changes in the value of the Portfolio's securities during the
period the option was outstanding.
Options on Foreign Currencies
The Portfolio may buy or sell put and call options on foreign currencies either
on exchanges or in the over-the-counter market. A put option on a foreign
currency gives the purchaser of the option the right to sell a foreign currency
at the exercise price until the option expires. A call option on a foreign
currency gives the purchaser of the option the right to purchase the currency at
the exercise price until the option expires. Currency options traded on U.S. or
other exchanges may be subject to position limits which may limit the ability of
the Portfolio to reduce foreign currency risk using such options.
Over-the-counter options differ from traded options in that they are two-party
contracts with price and other terms negotiated between buyer and seller, and
generally do not have as much market liquidity as exchange-traded options.
Futures Contracts and Options on Futures Contracts
The Portfolio may invest in interest rate futures contracts and options thereon
("futures options"), and to the extent it may invest in foreign
currency-denominated securities, may also invest in foreign currency futures
contracts and options thereon. An interest rate, foreign currency or index
futures contract provides for the future sale by one party and purchase by
another party of a specified quantity of a financial instrument, foreign
currency or the cash value of an index at a specified price and time. A futures
contract on an index is an agreement pursuant to which two parties agree to take
or make delivery of an amount of cash equal to the difference between the value
of the index at the close of the last trading day of the contract and the price
at which the index contract was originally written. Although the value of an
index might be a function of the value of certain specified securities, no
physical delivery of these securities is made. A public market exists in futures
contracts covering a number of indexes as well as financial instruments and
foreign currencies, including: U.S. Treasury bonds; U.S. Treasury notes; GNMA
Certificates; three-month U.S. Treasury bills; 90-day commercial paper; bank
certificates of deposit; Eurodollar certificates of deposit; the Australian
dollar; the Canadian dollar; the British pound; the German mark; the Japanese
yen; the French franc; the Swiss franc; the Mexican peso; and certain
multinational currencies, such as the euro. It is expected that other futures
contracts will be developed and traded in the future.
The Portfolio may purchase and write call and put futures options. Futures
options possess many of the same characteristics as options on securities and
indexes (discussed above). A futures option gives the holder the right, in
return for the premium paid, to assume a long position (call) or short position
(put) in a futures contract at a specified exercise price at any time during the
period of the option. Upon exercise of a call option, the holder acquires a long
position in the futures contract and the writer is assigned the opposite short
position. In the case of a put option, the opposite is true.
To comply with applicable rules of the Commodity Futures Trading Commission
("CFTC") under which the Portfolio avoids being deemed a "commodity pool" or a
"commodity pool operator," the Portfolio intends generally to limit its use of
futures contracts and futures options to "bona fide hedging" transactions, as
such term is defined in applicable regulations, interpretations and practice.
For example, the Portfolio might use futures contracts to hedge against
anticipated changes in interest rates that might adversely affect either the
value of the Portfolio's securities or the price of the securities which the
Portfolio intends to purchase. The Portfolio's hedging activities may include
sales of futures contracts as an offset against the effect of expected increases
in interest rates, and purchases of futures contracts as an offset against the
effect of expected declines in interest rates. Although other techniques could
be used to reduce the Portfolio's exposure to interest rate fluctuations, the
Portfolio may be able to hedge its exposure more effectively and perhaps at a
lower cost by using futures contracts and futures options.
The Portfolio will only enter into futures contracts and futures options which
are standardized and traded on a U.S. or foreign exchange, board of trade, or
similar entity, or quoted on an automated quotation system.
B-11
<PAGE>
When a purchase or sale of a futures contract is made by the Portfolio, the
Portfolio is required to deposit with its Custodian (or broker, if legally
permitted) a specified amount of assets determined to be liquid by the Adviser
in accordance with procedures established by the Portfolio's Board of Trustees
("initial margin"). The margin required for a futures contract is set by the
exchange on which the contract is traded and may be modified during the term of
the contract. Margin requirements on foreign exchanges may be different than
U.S. exchanges. The initial margin is in the nature of a performance bond or
good faith deposit on the futures contract which is returned to the Portfolio
upon termination of the contract, assuming all contractual obligations have been
satisfied. The Portfolio expects to earn interest income on its initial margin
deposits. A futures contract held by the Portfolio is valued daily at the
official settlement price of the exchange on which it is traded. Each day the
Portfolio pays or receives cash, called "variation margin," equal to the daily
change in value of the futures contract. This process is known as "marking to
market." Variation margin does not represent a borrowing or loan by the
Portfolio but is instead a settlement between the Portfolio and the broker of
the amount one would owe the other if the futures contract expired. In computing
daily net asset value, the Portfolio will mark to market its open futures
positions.
The Portfolio is also required to deposit and maintain margin with respect to
put and call options on futures contracts written by it. Such margin deposits
will vary depending on the nature of the underlying futures contract (and the
related initial margin requirements), the current market value of the option,
and other futures positions held by the Portfolio.
Although some futures contracts call for making or taking delivery of the
underlying securities, generally these obligations are closed out prior to
delivery by offsetting purchases or sales of matching futures contracts (same
exchange, underlying security or index, and delivery month). If an offsetting
purchase price is less than the original sale price, the Portfolio realizes a
capital gain, or if it is more, the Portfolio realizes a capital loss.
Conversely, if an offsetting sale price is more than the original purchase
price, the Portfolio realizes a capital gain, or if it is less, the Portfolio
realizes a capital loss. The transaction costs must also be included in these
calculations.
The Portfolio may write covered straddles consisting of a call and a put written
on the same underlying futures contract. A straddle will be covered when
sufficient assets are deposited to meet the Portfolio's immediate obligations.
The Portfolio may use the same liquid assets to cover both the call and put
options where the exercise price of the call and put are the same, or the
exercise price of the call is higher than that of the put. In such cases, the
Portfolio will also segregate liquid assets equivalent to the amount, if any, by
which the put is "in the money."
Other Considerations
When purchasing a futures contract, the Portfolio will maintain with its
Custodian (and mark-to-market on a daily basis) assets determined to be liquid
by the Adviser in accordance with procedures established by the Portfolio's
Board of Trustees, that, when added to the amounts deposited with a futures
commission merchant as margin, are equal to the market value of the futures
contract. Alternatively, the Portfolio may "cover" its position by purchasing a
put option on the same futures contract with a strike price as high or higher
than the price of the contract held by the Portfolio.
When selling a futures contract, a Portfolio will maintain with its Custodian
(and mark-to-market on a daily basis) assets determined to be liquid by the
Adviser in accordance with procedures established by the Portfolio's Board of
Trustees, that are equal to the market value of the instruments underlying the
contract. Alternatively, the Portfolio may "cover" its position by owning the
instruments underlying the contract (or, in the case of an index futures
contract, a portfolio with a volatility substantially similar to that of the
index on which the futures contract is based), or by holding a call option
permitting the Portfolio to purchase the same futures contract at a price no
higher than the price of the contract written by the Portfolio (or at a higher
price if the difference is maintained in liquid assets with the Portfolio's
Custodian).
When selling a call option on a futures contract, the Portfolio will maintain
with its Custodian (and mark-to-market on a daily basis) assets determined to be
liquid by the Adviser in accordance with procedures established by the
Portfolio's Board of Trustees, that, when added to the amounts deposited with a
futures commission merchant as margin, equal the total market value of the
futures contract underlying the call option. Alternatively, the Portfolio may
cover its position by entering into a long position in the same futures contract
at a price no higher than the strike price of the call option, by owning the
instruments underlying the futures contract, or by holding a separate call
option permitting the Portfolio to purchase the same futures contract at a price
not higher than the strike price of the call option sold by the Portfolio.
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When selling a put option on a futures contract, the Portfolio will maintain
with its Custodian (and mark-to-market on a daily basis) assets determined to be
liquid by the Adviser in accordance with procedures established by the
Portfolio's Board of Trustees, that equal the purchase price of the futures
contract, less any margin on deposit. Alternatively, the Portfolio may cover the
position either by entering into a short position in the same futures contract,
or by owning a separate put option permitting it to sell the same futures
contract so long as the strike price of the purchased put option is the same or
higher than the strike price of the put option sold by the Portfolio.
To the extent that securities with maturities greater than one year are used to
segregate assets to cover the Portfolio's obligations under futures contracts
and related options, such use will not eliminate the risk of a form of leverage,
which may tend to exaggerate the effect on net asset value of any increase or
decrease in the market value of the Portfolio's portfolio, and may require
liquidation of portfolio positions when it is not advantageous to do so.
However, any potential risk of leverage resulting from the use of securities
with maturities greater than one year may be mitigated by the overall duration
limit on a Portfolio's portfolio of securities. Thus, the use of a longer-term
security may require the Portfolio to hold offsetting short-term securities to
balance the Portfolio's portfolio of securities such that the Portfolio's
duration does not exceed the maximum permitted for the Portfolio in Part A.
The requirements for qualification as a regulated investment company also may
limit the extent to which the Portfolio may enter into futures, futures options
or forward contracts. See "Federal Taxes."
Risks Associated with Futures and Futures Options
There are several risks associated with the use of futures contracts and futures
options as hedging techniques. A purchase or sale of a futures contract may
result in losses in excess of the amount invested in the futures contract. There
can be no guarantee that there will be a correlation between price movements in
the hedging vehicle and in the Portfolio's portfolio of securities being hedged.
In addition, there are significant differences between the securities and
futures markets that could result in an imperfect correlation between the
markets, causing a given hedge not to achieve its objectives. The degree of
imperfection of correlation depends on circumstances such as variations in
speculative market demand for futures and futures options on securities,
including technical influences in futures trading and futures options, and
differences between the financial instruments being hedged and the instruments
underlying the standard contracts available for trading in such respects as
interest rate levels, maturities, and creditworthiness of issuers. A decision as
to whether, when and how to hedge involves the exercise of skill and judgment,
and even a well-conceived hedge may be unsuccessful to some degree because of
market behavior or unexpected interest rate trends.
Futures contracts on U.S. Government securities historically have reacted to an
increase or decrease in interest rates in a manner similar to that in which the
underlying U.S. Government securities reacted. Thus, the anticipated spread
between the price of the futures contract and the hedged security may be
distorted due to differences in the nature of the markets. The spread also may
be distorted by differences in initial and variation margin requirements, the
liquidity of such markets and the participation of speculators in such markets.
Futures exchanges may limit the amount of fluctuation permitted in certain
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 the current trading
session. Once the daily limit has been reached in a futures contract subject to
the limit, no more trades may be made on that day at a price beyond that limit.
The daily limit governs only price movements during a particular trading day and
therefore does not limit potential losses because the limit may work to prevent
the liquidation of unfavorable positions. For example, futures prices have
occasionally moved to the daily limit for several consecutive trading days with
little or no trading, thereby preventing prompt liquidation of positions and
subjecting some holders of futures contracts to substantial losses.
There can be no assurance that a liquid market will exist at a time when the
Portfolio seeks to close out a futures or a futures option position, and the
Portfolio would remain obligated to meet margin requirements until the position
is closed. In addition, many of the contracts discussed above are relatively new
instruments without a significant trading history. As a result, there can be no
assurance that an active secondary market will develop or continue to exist.
Reset Options
Typically, a call option or warrant whose strike price may be reset to a lower
strike or a put whose strike price may be reset to a higher strike at some point
during the life of the instrument if the option is out of the money on the reset
date. There may be a limit to the magnitude of the strike price adjustment and
the reset may be triggered by a specific price on the underlying rather than set
on a specific reset date.
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"Yield Curve" Options
Options on the shape of the yield curve. Yield curve options allow buyers to
protect themselves from adverse movements in the yield curve. Yield curve
options are often based on the difference in the yields of bonds of different
maturities.
Additional Risks of Trading Options
Options on securities, futures contracts, options on futures contracts, and
options on currencies may be traded on foreign exchanges. Such transactions may
not be regulated as effectively as similar transactions in the United States;
may not involve a clearing mechanism and related guarantees, and are subject to
the risk of governmental actions affecting trading in, or the prices of, foreign
securities. The value of such positions also could be adversely affected by (i)
other complex foreign political, legal 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.
Swap Agreements
The Portfolio may enter into interest rate, index and, to the extent it may
invest in foreign currency-denominated securities, currency exchange rate swap
agreements. These transactions are entered into in a attempt to obtain a
particular return when it is considered desirable to do so, possibly at a lower
cost to the Portfolio than if the Portfolio had invested directly in an
instrument that yielded that desired return. Swap agreements are two party
contracts entered into primarily by institutional investors for periods ranging
from a few weeks to more than one year. In a standard "swap" transaction, two
parties agree to exchange the returns (or differentials in rates of return)
earned or realized on particular predetermined investments or instruments, which
may be adjusted for an interest factor. The gross returns to be exchanged or
"swapped" between the parties are generally calculated with respect to a
"notional amount," i.e., the return on or increase in value of a particular
dollar amount invested at a particular interest rate, in a particular foreign
currency, or in a "basket" of securities representing a particular index. Forms
of swap agreements include interest rate caps, under which, in return for a
premium, one party agrees to make payments to the other to the extent that
interest rates exceed a specified rate, or "cap"; interest rate floors, under
which, in return for a premium, one party agrees to make payments to the other
to the extent that interest rates fall below a specified rate, or "floor"; and
interest rate collars, under which a party sells a cap and purchases a floor or
vice versa in an attempt to protect itself against interest rate movements
exceeding given minimum or maximum levels.
Most swap agreements entered into by the Portfolio would calculate the
obligations of the parties to the agreement on a "net basis." Consequently, the
Portfolio's current obligations (or rights) under a swap agreement will
generally be equal only to the net amount to be paid or received under the
agreement based on the relative values of the positions held by each party to
the agreement (the "net amount"). The Portfolio's current obligations under a
swap agreement will be accrued daily (offset against any amounts owed to the
Portfolio) and any accrued but unpaid net amounts owed to a swap counterparty
will be covered by the segregation of assets determined to be liquid by the
Adviser in accordance with procedures established by the Portfolio's Board of
Trustees, to avoid any potential leveraging of the Portfolio's portfolio of
securities. Obligations under swap agreements so covered will not be construed
to be "senior securities" for purposes of the Portfolio's investment restriction
concerning senior securities. The Portfolio will not enter into a swap agreement
with any single party if the net amount owed or to be received under existing
contracts with that party would exceed 5% of the Portfolio's assets.
Whether the Portfolio's use of swap agreements will be successful in furthering
its investment objective of total return will depend on the Adviser's ability to
predict correctly whether certain types of investments are likely to produce
greater returns than other investments. Because they are two party contracts and
because they may have terms of greater than seven days, swap agreements may be
considered to be illiquid. Moreover, the Portfolio bears the risk of loss of the
amount expected to be received under a swap agreement in the event of the
default or bankruptcy of a swap agreement counterparty. The Portfolio will enter
into swap agreements only with counterparties that meet certain standards of
creditworthiness. Certain restrictions imposed on the Portfolio by the Internal
Revenue Code may limit the Portfolio's ability to use swap agreements. The swaps
market is a relatively new market and is largely unregulated. It is possible
that developments in the swaps market, including potential government
regulation, could adversely affect the Portfolio's ability to terminate existing
swap agreements or to realize amounts to be received under such agreements.
B-14
<PAGE>
Certain swap agreements are exempt from most provisions of the Commodity
Exchange Act ("CEA") and, therefore, are not regulated as futures or commodity
option transactions under the CEA, pursuant to regulations approved by the CFTC
effective February 22, 1993. To qualify for this exemption, a swap agreement
must be entered into by "eligible participants," which includes the following,
provided the participants' total assets exceed established levels: a bank or
trust company, savings association or credit union, insurance company,
investment company subject to regulation under the 1940 Act, commodity pool,
corporation, partnership, proprietorship, organization, trust or other entity,
employee benefit plan, governmental entity, broker-dealer, futures commission
merchant, natural person, or regulated foreign person. To be eligible, natural
persons and most other entities must have total assets exceeding $10 million;
commodity pools and employee benefit plans must have assets exceeding $5
million. In addition, an eligible swap transaction must meet three conditions.
First, the swap agreement may not be part of a fungible class of agreements that
are standardized as to their material economic terms. Second, the
creditworthiness of parties with actual or potential obligations under the swap
agreement must be a material consideration in entering into or determining the
terms of the swap agreement, including pricing, cost or credit enhancement
terms. Third, swap agreements may not be entered into and traded on or through a
multilateral transaction execution facility.
This exemption is not exclusive, and participants may continue to rely on
existing exclusions for swaps, such as the Policy Statement issued in July 1989
which recognized a safe harbor for swap transactions from regulation as futures
or commodity option transactions under the CEA or its regulations. The Policy
Statement applies to swap transactions settled in cash that (1) have
individually tailored terms, (2) lack exchange-style offset and the use of a
clearing organization or margin system, (3) are undertaken in conjunction with a
line of business, and (4) are not marketed to the public.
Options on Swaps
The Portfolio may enter into options contracts on interest rate swaps, commonly
referred to as swaptions. The buyer of a swaption has the right to enter into an
interest rate swap agreement by some specified date in the future. The swaption
agreement will specify whether the buyer of the swaption will be a fixed-rate
receiver or a fixed-rate payer. The writer of the swaption becomes the
counterparty if the buyer exercise.
Structured Securities
The Portfolio may invest in structured securities. Structured notes are
derivative debt securities, the interest rate or principal of which is
determined by an unrelated indicator. Indexed securities include structured
notes as well as securities other than debt securities, the interest rate or
principal of which is determined by an unrelated indicator. Indexed securities
may include a multiplier that multiplies the indexed element by a specified
factor and, therefore, the value of such securities may be very volatile. To the
extent the Portfolio invests in these securities, however, the Adviser analyzes
these securities in its overall assessment of the effective duration of the
Portfolio's portfolio of securities in an effort to monitor the Portfolio's
interest rate risk.
Foreign Investments
The Portfolio may invest its assets in corporate debt securities of foreign
issuers (including preferred or preference stock), certain foreign bank
obligations (see "Bank Obligations") and U.S. dollar or foreign
currency-denominated obligations of foreign governments or their subdivisions,
agencies and instrumentalities, international agencies and supranational
entities.
Investment in sovereign debt can involve a high degree of risk. The governmental
entity that controls the repayment of sovereign debt may not be able or willing
to repay the principal and/or interest when due in accordance with the terms of
the debt. A governmental entity's willingness or ability to repay principal and
interest due in a timely manner may be affected by, among other factors, its
cash flow situation, the extent of its foreign reserves, the availability of
sufficient foreign exchange on the date a payment is due, the relative size of
the debt service burden to the economy as a whole, the governmental entity's
policy toward the International Monetary Fund, and the political constraints to
which a governmental entity may be subject. Governmental entities may also
depend on expected disbursements from foreign governments, multilateral agencies
and others to reduce principal and interest arrearages on their debt. The
commitment on the part of these governments, agencies and others to make such
B-15
<PAGE>
disbursements may be conditioned on a governmental entity's implementation of
economic reforms and/or economic performance and the timely service of such
debtor's obligations. Failure to implement such reforms, achieve such levels of
economic performance or repay principal or interest when due may result in the
cancellation of such third parties' commitments to lend funds to the
governmental entity, which may further impair such debtor's ability or
willingness to service its debts in a timely manner. Consequently, governmental
entities may default on their sovereign debt. Holders of sovereign debt
(including the Portfolio) may be requested to participate in the rescheduling of
such debt and to extend further loans to governmental entities. There is no
bankruptcy proceeding by which sovereign debt on which governmental entities
have defaulted may be collected in whole or in part.
The Portfolio's investments in foreign currency denominated debt obligations and
hedging activities will likely produce a difference between its book income and
its taxable income. This difference may cause a portion of the Portfolio's
income distributions to constitute returns of capital for tax purposes or
require the Portfolio to make distributions exceeding book income to qualify as
a regulated investment company for federal tax purposes.
Foreign Currency Transactions
The Portfolio may engage in foreign currency transactions. These transactions
may be conducted at the prevailing spot rate for purchasing or selling currency
in the foreign exchange market. The Portfolio also has authority to enter into
forward foreign currency exchange contracts involving currencies of the
different countries in which the fund invests as a hedge against possible
variations in the foreign exchange rates between these currencies and the U.S.
dollar. This is accomplished through contractual agreements to purchase or sell
a specified currency at a specified future date and price set at the time of the
contract.
Transaction hedging is the purchase or sale of forward foreign currency
contracts with respect to specific receivables or payables of the Portfolio,
accrued in connection with the purchase and sale of its portfolio securities
quoted in foreign currencies. Hedging of the portfolio is the use of forward
foreign currency contracts to offset portfolio security positions denominated or
quoted in such foreign currencies. There is no guarantee that the Portfolio will
be engaged in hedging activities when adverse exchange rate movements occur. The
Portfolio will not attempt to hedge all of its foreign portfolio positions and
will enter into such transactions only to the extent, if any, deemed appropriate
by the Adviser.
Hedging against a decline in the value of a currency does not eliminate
fluctuations in the prices of portfolio securities or prevent losses if the
prices of such securities decline. Such transactions also limit the opportunity
for gain if the value of the hedged currency should rise. Moreover, it may not
be possible for the Portfolio to hedge against a devaluation that is so
generally anticipated that the Portfolio is not able to contract to sell the
currency at a price above the devaluation level it anticipates.
The cost to the Portfolio of engaging in foreign currency transactions varies
with such factors as the currency involved, the size of the contract, the length
of the contract period, differences in interest rates between the two currencies
and the market conditions then prevailing. Since transactions in foreign
currency and forward contracts are usually conducted on a principal basis, no
fees or commissions are involved. The Portfolio may close out a forward position
in a currency by selling the forward contract or by entering into an offsetting
forward contract.
The precise matching of the forward contract amounts and the value of the
securities involved will not generally be possible because the future value of
such securities in foreign currencies will change as a consequence of market
movements in the value of those securities between the date on which the
contract is entered into and the date it matures. Using forward contracts to
protect the value of the Portfolio's securities against a decline in the value
of a currency does not eliminate fluctuations in the underlying prices of the
securities. It simply establishes a rate of exchange which the Portfolio can
achieve at some future point in time. The precise projection of short-term
currency market movements is not possible, and short-term hedging provides a
means of fixing the U.S. dollar value of only a portion of the Portfolio's
foreign assets.
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<PAGE>
While the Portfolio will enter into forward contracts to reduce currency
exchange rate risks, transactions in such contracts involve certain other risks.
While the Portfolio may benefit from such transactions, unanticipated changes in
currency prices may result in a poorer overall performance for the Portfolio
than if it had not engaged in any such transactions. Moreover, there may be
imperfect correlation between the Portfolio's holdings of securities quoted or
denominated in a particular currency and forward contracts entered into by the
Portfolio. Such imperfect correlation may cause the Portfolio to sustain losses
which will prevent the Portfolio from achieving a complete hedge or expose the
Portfolio to risk of foreign exchange loss.
Over-the-counter markets for trading foreign forward currency contracts offer
less protection against defaults than is available when trading in currency
instruments on an exchange. Since a forward foreign currency exchange contract
is not guaranteed by an exchange or clearinghouse, a default on the contract
would deprive the Portfolio of unrealized profits or force the Portfolio to
cover its commitments for purchase or resale, if any, at the current market
price.
If the Portfolio enters into a forward contract to purchase foreign currency,
the Custodian or the Adviser will segregate liquid assets.
Forward Exchange Contracts
Foreign exchange contracts are made with currency dealers, usually large
commercial banks and financial institutions. Although foreign exchange rates are
volatile, foreign exchange markets are generally liquid with the equivalent of
approximately $500 billion traded worldwide on a typical day. While the
Portfolio may enter into foreign currency exchange transactions to reduce the
risk of loss due to a decline in the value of the hedged currency, these
transactions also tend to limit the potential for gain. Forward foreign exchange
contracts do not eliminate fluctuations in the prices of the Portfolio's
securities or in foreign exchange rates, or prevent loss if the prices of these
securities should decline. The precise matching of the forward contract amounts
and the value of the securities involved is not generally possible because the
future value of such securities in foreign currencies changes as a consequence
of market movements in the value of such securities between the date the forward
contract is entered into and the date it matures. The projection of currency
market movements is extremely difficult, and the successful execution of a
hedging strategy is highly unlikely.
The Investment Adviser, on behalf of the Portfolio, enters into forward foreign
exchange contracts in order to protect the dollar value of all investments
denominated in foreign currencies. The precise matching of the forward contract
amounts and the value of the securities involved is not always possible because
the future value of such securities in foreign currencies changes as a
consequence of market movements in the value of such securities between the date
the forward contract is entered into and the date it matures.
The Portfolio's recognition of gain or loss due to foreign currency exchange
rates may be treated differently for federal income tax purposes. This
difference may require the Portfolio to make a distribution in excess of its
book income to qualify as a registered investment company for federal income tax
purposes.
Equity Investments
Equity investments may or may not pay dividends and may or may not carry voting
rights. Common stock occupies the most junior position in a company's capital
structure. Convertible securities entitle the holder to exchange the securities
for a specified number of shares of common stock, usually of the same company,
at specified prices within a certain period of time and to receive interest or
dividends until the holder elects to convert. The provisions of any convertible
security determine its ranking in a company's capital structure. In the case of
subordinated convertible debentures, the holder's claims on assets and earnings
are subordinated to the claims of other creditors, and are senior to the claims
of preferred and common shareholders. In the case of convertible preferred
stock, the holder's claims on assets and earnings are subordinated to the claims
of all creditors and are senior to the claims of common shareholders.
B-17
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Borrowings
The Portfolio may borrow for temporary administrative purposes. This borrowing
may be unsecured. Provisions of the 1940 Act require the Portfolio to maintain
continuous asset coverage (that is, total assets including borrowings, less
liabilities exclusive of borrowings) of 300% of the amount borrowed, with an
exception for borrowings not in excess of 5% of the Portfolio's total assets
made for temporary administrative purposes. Any borrowings for temporary
administrative purposes in excess of 5% of the Portfolio's total assets must
maintain continuous asset coverage. If the 300% asset coverage should decline as
a result of market fluctuations or other reasons, the Portfolio may be required
to sell some of its portfolio holdings within three days to reduce the debt and
restore the 300% asset coverage, even though it may be disadvantageous from an
investment standpoint to sell securities at that time. As noted below, the
Portfolio also may enter into certain transactions, including reverse repurchase
agreements, mortgage dollar rolls, and sale-buybacks, that can be viewed as
constituting a form of borrowing or financing transaction by the Portfolio. To
the extent the Portfolio covers its commitment under a reverse repurchase
agreement (or economically similar transaction) by the segregation of assets
determined in accordance with procedures adopted by the Trustees, equal in value
to the amount of the Portfolio's commitment to repurchase, such an agreement
will not be considered a "senior security" by the Portfolio and therefore will
not be subject to the 300% asset coverage requirement otherwise applicable to
borrowings by the Portfolio. Borrowing will tend to exaggerate the effect on net
asset value of any increase or decrease in the market value of the Portfolio's
portfolio of securities. Money borrowed will be subject to interest costs which
may or may not be recovered by appreciation of the securities purchased. The
Portfolio also may be required to maintain minimum average balances in
connection with such borrowing or to pay a commitment or other fee to maintain a
line of credit; either of these requirements would increase the cost of
borrowing over the stated interest rate.
In addition to borrowing for temporary purposes, the Portfolio may enter into
reverse repurchase agreements, mortgage dollar rolls, and economically similar
transactions. A reverse repurchase agreement involves the sale of a
portfolio-eligible security by the Portfolio, coupled with its agreement to
repurchase the instrument at a specified time and price. Under a reverse
repurchase agreement, the Portfolio continues to receive any principal and
interest payments on the underlying security during the term of the agreement.
The Portfolio typically will segregate assets determined to be liquid by the
Adviser in accordance with procedures established by the Portfolio's Trustees,
equal (on a daily mark-to-market basis) to its obligations under reverse
repurchase agreements. However, reverse repurchase agreements involve the risk
that the market value of securities retained by the Portfolio may decline below
the repurchase price of the securities sold by the Portfolio which it is
obligated to repurchase. To the extent that positions in reverse repurchase
agreements are not covered through the segregation of liquid assets at least
equal to the amount of any forward purchase commitment, such transactions would
be subject to the Portfolio's limitations on borrowings, which would restrict
the aggregate of such transactions (plus any other borrowings) to 33 1/3% of the
Portfolio's total assets.
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<PAGE>
A "mortgage dollar roll" is similar to a reverse repurchase agreement in
certain respects. In a "dollar roll" transaction the Portfolio sells a
mortgage-related security, such as a security issued by the Government National
Mortgage Association ("GNMA"), to a dealer and simultaneously agrees to
repurchase a similar security (but not the same security) in the future at a
pre-determined price. A "dollar roll" can be viewed, like a reverse repurchase
agreement, as a collateralized borrowing in which a Fund pledges a
mortgage-related security to a dealer to obtain cash. Unlike in the case of
reverse repurchase agreements, the dealer with which the Portfolio enters into a
dollar roll transaction is not obligated to return the same securities as those
originally sold by the Portfolio, but only securities which are "substantially
identical." To be considered "substantially identical," the securities returned
to the Portfolio generally must: (1) be collateralized by the same types of
underlying mortgages; (2) be issued by the same agency and be part of the same
program; (3) have a similar original stated maturity; (4) have identical net
coupon rates; (5) have similar market yields (and therefore price); and (6)
satisfy "good delivery" requirements, meaning that the aggregate principal
amounts of the securities delivered and received back must be within 2.5% of the
initial amount delivered.
The Portfolio's obligations under a dollar roll agreement must be covered by
segregated liquid assets equal in value to the securities subject to repurchase
by the Portfolio. As with reverse repurchase agreements, to the extent that
positions in dollar roll agreements are not covered by segregated liquid assets
at least equal to the amount of any forward purchase commitment, such
transactions would be subject to the Portfolio's limitations on borrowings.
Furthermore, because dollar roll transactions may be for terms ranging between
one and six months, dollar roll transactions may be deemed "illiquid" and
subject to a Portfolio's overall limitations on investments in illiquid
securities. The Portfolio also may effect simultaneous purchase and sale
transactions that are known as "sale-buybacks". A sale-buyback is similar to a
reverse repurchase agreement, except that in a sale-buyback, the counterparty
who purchases the security is entitled to receive any principal or interest
payments made on the underlying security pending settlement of the Portfolio's
repurchase of the underlying security. The Portfolio's obligations under a
sale-buyback typically would be offset by liquid assets equal in value to the
amount of the Portfolio's forward commitment to repurchase the subject security.
Repurchase Agreements
Repurchase agreements may be entered into only with a primary dealer (as
designated by the Federal Reserve Bank of New York) in U.S. Government
obligations. This is an agreement in which the seller (the Lender) of a security
agrees to repurchase from the Portfolio the security sold at a mutually agreed
upon time and price. As such, it is viewed as the lending of money to the
Lender. The resale price normally is in excess of the purchase price, reflecting
an agreed upon interest rate. The rate is effective for the period of time
assets of the Portfolio are invested in the agreement and is not related to the
coupon rate on the underlying security. The period of these repurchase
agreements is usually short, from overnight to one week, and at no time are
assets of the Portfolio invested in a repurchase agreement with a maturity of
more than one year. The securities which are subject to repurchase agreements,
however, may have maturity dates in excess of one year from the effective date
of the repurchase agreement. The Portfolio always receives as collateral
securities which are issued or guaranteed by the U.S. Government, its agencies
or instrumentalities. Collateral is marked to the market daily and has a market
value including accrued interest at least equal to 100% of the dollar amount
invested on behalf of the Portfolio in each agreement along with accrued
interest. Payment for such securities is made for the Portfolio only upon
physical delivery or evidence of book entry transfer to the account the
Portfolio's Custodian. If the Lender defaults, the Portfolio might incur a loss
if the value of the collateral securing the repurchase agreement declines and
might incur disposition costs in connection with liquidating the collateral. In
addition, if bankruptcy proceedings are commenced with respect to the Lender,
realization upon the collateral on behalf of the Portfolio may be delayed or
limited in certain circumstances. A repurchase agreement with more than seven
days to maturity may not be entered into for the Portfolio if, as a result, more
than 10% of the market value of the Portfolio's total assets would be invested
in such repurchase agreements together with any other investment being held for
the Portfolio for which market quotations are not readily available.
B-19
<PAGE>
Reverse Repurchase Agreements
Reverse repurchase agreements may be entered into only with a primary dealer (as
designated by the Federal Reserve Bank of New York) in U.S. Government
obligations. This is an agreement in which the Portfolio agrees to repurchase
securities sold by it at a mutually agreed upon time and price. As such, it is
viewed as the borrowing of money for the Portfolio. Proceeds of borrowings under
reverse repurchase agreements are invested for the Portfolio. This technique
involves the speculative factor known as leverage. If interest rates rise during
the term of a reverse repurchase agreement utilized for leverage, the value of
the securities to be repurchased for the Portfolio as well as the value of
securities purchased with the proceeds will decline. Proceeds of a reverse
repurchase transaction are not invested for a period which exceeds the duration
of the reverse repurchase agreement. A reverse repurchase agreement may not be
entered into for the Portfolio if, as a result, more than one-third of the
market value of the Portfolio's total assets, less liabilities other than the
obligations created by reverse repurchase agreements, would be engaged in
reverse repurchase agreements. In the event that such agreements exceed, in the
aggregate, one-third of such market value, the amount of the Portfolio's
obligations created by reverse repurchase agreements will be reduced within
three days thereafter (not including weekends and holidays) or such longer
period as the Securities and Exchange Commission may prescribe, to an extent
that such obligations will not exceed, in the aggregate, one-third of the market
value of the Portfolio's assets, as defined above. A segregated account with the
Custodian is established and maintained for the Portfolio with liquid assets in
an amount at least equal to the Portfolio's purchase obligations under its
reverse repurchase agreements. Such segregated account consists of liquid assets
marked to the market daily, with additional liquid assets added when necessary
to insure that at all times the value of such account is equal to the purchase
obligations.
Rule 144A Securities
The Investment Adviser may, on behalf of the Portfolio, purchase securities that
are not registered under the 1933 Act, but that can be sold to "qualified
institutional buyers" in accordance with the requirements stated in Rule 144A
under the 1933 Act (Rule 144A Securities). A Rule 144A Security may be
considered illiquid and therefore subject to the 15% limitation on the purchase
of illiquid securities, unless it is determined on an ongoing basis that an
adequate trading market exists for the security. Guidelines have been adopted
and the daily function of determining and monitoring liquidity of Rule 144A
Securities has been delegated to the Investment Adviser. All relevant factors
will be considered in determining the liquidity of Rule 144A Securities and all
investments in Rule 144A Securities will be carefully monitored.
Illiquid Securities
The Portfolio may invest up to 15% of its net assets in illiquid securities. The
term "illiquid securities" for this purpose means securities that cannot be
disposed of within seven days in the ordinary course of business at
approximately the amount at which the Portfolio has valued the securities.
Illiquid securities are considered to include, among other things, written
over-the-counter options, securities or other liquid assets being used as cover
for such options, repurchase agreements with maturities in excess of seven days,
certain loan participation interests, fixed time deposits which are not subject
to prepayment or provide for withdrawal penalties upon prepayment (other than
overnight deposits), and other securities whose disposition is restricted under
the federal securities laws (other than securities issued pursuant to Rule 144A
under the 1933 Act and certain commercial paper that the Adviser has determined
to be liquid under procedures approved by the Portfolio's Trustees).
Illiquid securities may include privately placed securities, which are sold
directly to a small number of investors, usually institutions. Unlike public
offerings, such securities are not registered under the federal securities laws.
Although certain of these securities may be readily sold, others may be
illiquid, and their sale may involve substantial delays and additional costs.
B-20
<PAGE>
INVESTMENT RESTRICTIONS
-----------------------------------------------------------------
The Portfolio is operated under the following investment restrictions which are
deemed fundamental policies and may be changed only with the approval of the
holders of a "majority of the outstanding voting securities" (as defined in the
1940 Act) of the Portfolio. (See "Additional Information".)
The Portfolio may not:
(1) invest in a security if, as a result of such investment, more than 25% of
its total assets (taken at market value at the time of such investment) would be
invested in the securities of issuers in any particular industry, or in
industrial development revenue bonds based, directly or indirectly, on the
credit of private entities in any one industry; except that this restriction
does not apply to securities issued or guaranteed by the U.S. Government or its
agencies or instrumentalities (or repurchase agreements with respect thereto).
Investments in utilities, gas, electric, water and telephone companies will be
considered as being in separate industries;
(2) with respect to 75% of its assets, invest in a security if, as a result of
such investment, more than 5% of its total assets (taken at market value at the
time of such investment) would be invested in the securities of any one issuer,
except that this restriction does not apply to securities issued or guaranteed
by the U.S. Government or its agencies or instrumentalities. For the purpose of
this restriction, each state and each separate political subdivision, agency,
authority or instrumentality of such state, each multi-state agency or
authority, and each guarantor, if any, are treated as separate issuers of
Municipal Bonds;
(3) with respect to 75% of its assets, invest in a security if, as a result of
such investment, it would hold more than 10% (taken at the time of such
investment) of the outstanding voting securities of any one issuer;
(4) purchase or sell real estate, although it may purchase securities secured by
real estate or interests therein, or securities issued by companies which invest
in real estate, or interests therein;
(5) purchase or sell commodities or commodities contracts or oil, gas or mineral
programs. This restriction shall not prohibit the Portfolio, subject to
restrictions described in Part A and elsewhere in this Part B, from purchasing,
selling or entering into futures contracts, options on futures contracts,
foreign currency forward contracts, foreign currency options, or any interest
rate, securities-related or foreign currency-related hedging instrument,
including swap agreements and other derivative instruments, subject to
compliance with any applicable provisions of the federal securities or
commodities laws;
(6) purchase securities on margin, except for use of short-term credit necessary
for clearance of purchases and sales of portfolio securities, but it may make
margin deposits in connection with transactions in options, futures, and options
on futures;
(7) borrow money, issue senior securities, or pledge, mortgage or hypothecate
its assets, except that the Portfolio may (i) borrow from banks or enter into
reverse repurchase agreements, or employ similar investment techniques, and
pledge its assets in connection therewith, but only if immediately after each
borrowing there is asset coverage of 300% and (ii) enter into transactions in
options, futures, options on futures, and other derivative instruments as
described in Part A and in this Part B (the deposit of assets in escrow in
connection with the writing of covered put and call options and the purchase of
securities on a when-issued or delayed delivery basis, collateral arrangements
with respect to initial or variation margin deposits for futures contracts and
commitments entered into under swap agreements or other derivative instruments,
will not be deemed to be pledges of the Portfolio's assets);
(8) lend any funds or other assets, except that the Portfolio may, consistent
with its investment objective and policies: (a) invest in debt obligations,
including bonds, debentures, or other debt securities, bankers' acceptances and
commercial paper, even though the purchase of such obligations may be deemed to
be the making of loans, (b) enter into repurchase agreements, and (c) lend its
portfolio securities in an amount not to exceed one-third of the value of its
total assets, provided such loans are made in accordance with applicable
guidelines established by the SEC and the Trustees of the Portfolio;
(9) act as an underwriter of securities of other issuers, except to the extent
that in connection with the disposition of portfolio securities, it may be
deemed to be an underwriter under the federal securities laws;
(10) maintain a short position, or purchase, write or sell puts, calls,
straddles, spreads or combinations thereof, except as set forth in Part A and in
this Part B for transactions in options, futures, options on futures, and
transactions arising under swap agreements or other derivative instruments.
B-21
<PAGE>
Non-Fundamental Restrictions. The following polices are not fundamental
and may be changed without investor approval. The Portfolio may not as a matter
of operating policy:
(i) invest more than 15% of the net assets of the Portfolio (taken at
market value at the time of the investment) in "illiquid securities,"
illiquid securities being defined to include securities which may not
be sold or dispposed of in the ordinary course of business within seven
days at approximately the value at which a portfolio has valued the
investment;
(ii) invest more than 5% of the assets of the Portfolio (taken at market
value at the time of investment) in any combination of interest only,
principal only, or inverse floating rate securities;
(iii) invest less than 65% of the value of the total assets of the Portfolio
in a broad range of investment grade fixed income securities.
The Portfolio is classified as diversified for purposes of the 1940 Act, which
means that at least 75% of the total assets is represented by cash; securities
issued by the U.S. Government, its agencies or instrumentalities; and other
securities limited in respect to any one issuer to an amount not greater in
value than 5% of the Portfolio's total assets. The Portfolio does not purchase
more than 10% of all outstanding debt obligations of any one issuer (other than
obligations issued by the U.S. Government, its agencies or instrumentalities).
Under the 1940 Act, a "senior security" does not include any promissory note or
evidence of indebtedness where such loan is for temporary purposes only and in
an amount not exceeding 5% of the value of the total assets of the issuer at the
time the loan is made. A loan is presumed to be for temporary purposes if it is
repaid within sixty days and is not extended or renewed. Notwithstanding the
provisions of fundamental investment restriction (7) above, the Portfolio may
borrow money for temporary administrative purposes. To the extent that
borrowings for temporary administrative purposes exceed 5% of the total assets
of the Portfolio such excess shall be subject to the 300% asset coverage
requirement of that restriction.
To the extent the Portfolio covers its commitment under a reverse repurchase
agreement (or economically similar transaction) by the segregation of assets
determined to be liquid in accordance with procedures adopted by the Portfolio's
Trustees, equal in value to the amount of the Portfolio's commitment to
repurchase, such an agreement will not be considered a "senior security" by the
Portfolio and therefore will not be subject to the 300% asset coverage
requirement otherwise applicable to borrowings by the Portfolio.
The staff of the SEC has taken the position that purchased over-the-counter
("OTC") options and the assets used as cover for written OTC options are
illiquid securities. Therefore, the Portfolio has adopted an investment policy
pursuant to which the Portfolio will not purchase or sell OTC options if, as a
result of such transactions, the sum of the market value of OTC options
currently outstanding which are held by the Portfolio, the market value of the
underlying securities covered by OTC call options currently outstanding which
were sold by the Portfolio and margin deposits on the Portfolio's existing OTC
options on futures contracts exceeds 15% of the net assets of the Portfolio,
taken at market value, together with all other assets of the Portfolio which are
illiquid or are otherwise not readily marketable. However, if an OTC option is
sold by the Portfolio to a primary U.S. Government securities dealer recognized
by the Federal Reserve Bank of New York and if the Portfolio has the
unconditional contractual right to repurchase such OTC option from the dealer at
a predetermined price, then the Portfolio will treat as illiquid such amount of
the underlying securities equal to the repurchase price less the amount by which
the option is "in-the-money" (i.e., current market value of the underlying
securities minus the option's strike price). The repurchase price with the
primary dealers is typically a formula price which is generally based on a
multiple of the premium received for the option, plus the amount by which the
option is "in-the-money." This policy is not a fundamental policy of the
Portfolio and may be amended by the Portfolio's Trustees without the approval of
shareholders. However, the Portfolio will not change or modify this policy prior
to the change or modification by the SEC staff of its position.
B-22
<PAGE>
Percentage and Rating Restrictions. If a percentage or rating restriction on
investment or utilization of assets set forth above or referred to in Part A is
adhered to at the time an investment is made or assets are so utilized, a later
change in percentage resulting from changes in the value of the portfolio
securities or a later change in the rating of a portfolio security is not
considered a violation of policy.
Item 13. Management.
TRUSTEES AND OFFICERS
-----------------------------------------------------------------
The Portfolio's Trustees, in addition to supervising the actions of the
Portfolio's Investment Adviser, decide upon matters of general policy with
respect to the Portfolio.
Because of the services rendered to the Portfolio by the Investment Adviser and
by its Administrator, the Portfolio requires no employees, and its respective
officers (all of whom are employed by 59 Wall Street Administrators), other than
the Chairman, receive no compensation from the Portfolio.
The Trustees of the Portfolio and executive officers of the Portfolio, their
principal occupations during the past five years (although their titles may have
varied during the period) and business addresses are:
TRUSTEES OF THE PORTFOLIO
J.V. SHIELDS, JR.*(aged 62) - Trustee (since May 2000); Trustee of the
BBH Portfolios(1) (since October 1999); Director of The 59 Wall Street Fund,
Inc.; Trustee of The 59 Wall Street Trust; Managing Director, Chairman and Chief
Executive Officer of Shields & Company; Chairman of Capital Management
Associates, Inc.; Director of Flowers Industries, Inc.(2). Vice Chairman and
Trustee of New York Racing Association. His business address is Shields &
Company, 140 Broadway, New York, NY 10005.
EUGENE P. BEARD** (aged 65) - Trustee (since May 2000); Trustee of the
BBH Portfolios (since October 1999); Director of The 59 Wall Street Fund, Inc.;
Trustee of The 59 Wall Street Trust; Executive Vice President Finance and
Operations of The Interpublic Group of Companies. His business address is The
Interpublic Group of Companies, Inc., 1271 Avenue of the Americas, New York, NY
10020.
DAVID P. FELDMAN** (aged 60) - Trustee (since May 2000); Trustee of the
BBH Portfolios (since October 1999); Director of The 59 Wall Street Fund, Inc.;
Trustee of The 59 Wall Street Trust; Retired; Vice President and Investment
Manager of AT&T Investment Management Corporation (prior to October 1997);
Director of Dreyfus Mutual Funds, Jeffrey Co. and Heitman Financial. His
business address is 3 Tall Oaks Drive, Warren, NJ 07059.
ALAN G. LOWY** (aged 61) - Trustee (since May 2000); Trustee of the BBH
Portfolios (since October 1999); Director of The 59 Wall Street Fund, Inc.;
Trustee of The 59 Wall Street Trust;Private Investor. His business address is
4111 Clear Valley Drive, Encino, CA 91436.
ARTHUR D. MILTENBERGER** (aged 61) - Trustee (since May 2000); Trustee
of the BBH Portfolios (since October 1999); Director of The 59 Wall Street Fund,
Inc.; Trustee of The 59 Wall Street Trust; Retired, Executive Vice President and
Chief Financial Officer of Richard K. Mellon and Sons (prior to June 1998);
Treasurer of Richard King Mellon Foundation (prior to June 1998); Vice President
of the Richard King Mellon Foundation; Trustee, R.K. Mellon Family Trusts;
General Partner, Mellon Family Investment Company IV, V and VI; Director of
Aerostructures Corporation (since 1996) (3). His business address is Richard K.
Mellon and Sons, P.O. Box RKM, Ligonier, PA 15658.
RICHARD L. CARPENTER** (aged 67) - Trustee (since May 2000); Trustee of
the BBH Portfolios; Trustee of Dow Jones Islamic Market Index Portfolio (since
March 1999); Director of The 59 Wall Street Fund, Inc. (since October 1999);
Trustee of The 59 Wall Street Trust (since October 1999); Retired; Director of
Investments, Pennsylvania Public School Employees' Retirement System (prior to
December 1997). His business address is 12664 Lazy Acres Court, Nevada City, CA
95959.
CLIFFORD A. CLARK** (aged 70) - Trustee (since May 2000); Trustee of
the BBH Portfolios; Trustee of Dow Jones Islamic Market Index Portfolio (since
March 1999); Director of The 59 Wall Street Fund, Inc. (since October 1999);
Trustee of The 59 Wall Street Trust (since October 1999); Retired. His business
address is 42 Clowes Drive, Falmouth, MA 02540.
B-23
<PAGE>
DAVID M. SEITZMAN** (aged 71) - Trustee (since May 2000); Trustee of
the BBH Portfolios; Director of The 59 Wall Street Fund, Inc. (since October
1999); Trustee of The 59 Wall Street Trust (since October 1999); Physician,
Private Practice. His business address is 7117 Nevis Road, Bethesda, MD 20817.
J. ANGUS IVORY (aged 68) - Trustee (since May 2000); Trustee of the BBH
Portfolios (since October 1999); Trustee of Dow Jones Islamic Market Index
Portfolio (since March 1999); Director of The 59 Wall Street Fund, Inc. (since
October 1999); Trustee of The 59 Wall Street Trust (since October 1999); Trustee
of Islamic Global Equity Fund (since November 2000); Retired; Director of Brown
Brothers Harriman Ltd., subsidiary of Brown Brothers Harriman & Co.; Director of
Old Daily Saddlery; Advisor, RAF Central Fund; Committee Member, St. Thomas
Hospital Pain Clinic (since 1999).
OFFICERS OF THE PORTFOLIO
PHILIP W. COOLIDGE (aged 49) -- President; President of the BBH
Portfolios; Chief Executive Officer and President of Signature Financial Group,
Inc. ("SFG"), 59 Wall Street Distributors, Inc. ("59 Wall Street Distributors")
and 59 Wall Street Administrators, Inc. ("59 Wall Street Administrators").
LINWOOD C. DOWNS (aged 38) - Treasurer; Treasurer of the BBH
Portfolios; Senior Vice President and Treasurer of SFG.
MOLLY S. MUGLER (aged 48) -- Secretary; Secretary of the BBH
Portfolios; Vice President and Secretary of SFG; Secretary of 59 Wall Street
Distributors and 59 Wall Street Administrators.
SUSAN JAKUBOSKI (aged 36) - Assistant Treasurer; Assistant Treasurer
and Assistant Secretary of the BBH Portfolios; Vice President, Assistant
Secretary and Assistant Treasurer of Signature Financial Group (Cayman) Limited.
CHRISTINE D. DORSEY (aged 30) -- Assistant Secretary; Assistant
Secretary of the BBH Portfolios; Vice President of SFG (since January 1996);
Paralegal and Compliance Officer, various financial companies (July 1992 to
January 1996).
-------------------------
*Mr. Shields is an "interested person" of the Portfolio because of his
affiliation with a registered broker-dealer. Except for Mr. Shields, no Trustee
is an "interested person" of the Portfolio as that term is defined in the 1940
Act.
**These Trustees are members of the Audit Committee of the Portfolio.
(1) The Portfolios consist of the following active investment companies:
BBH U.S. Money Market Portfolio, BBH U.S. Equity Portfolio, BBH
European Equity Portfolio, BBH Pacific Basin Equity Portfolio, BBH
International Equity Portfolio, BBH High Yield Fixed Income Portfolio
and BBH Global Equity Portfolio and the following inactive investment
companies: BBH U.S. Balanced Growth Portfolio and BBH Intermediate
Tax-Exempt Bond Portfolio.
(2) Shields & Company, Capital Management Associates, Inc. and Flowers
Industries, Inc., with which Mr. Shields is associated, are a
registered broker-dealer and a member of the New York Stock Exchange, a
registered investment adviser, and a diversified food company,
respectively.
(3) Richard K. Mellon and Sons, Richard King Mellon Foundation, R.K. Mellon
Family Trusts, Mellon Family Investment Company IV, V and VI and
Aerostructures Corporation, with which Mr. Miltenberger is or has been
associated, are a private foundation, a private foundation, a trust, an
investment company and an aircraft manufacturer, respectively.
The address of each officer is 21 Milk Street, Boston, Massachusetts
02109. Messrs. Coolidge and Downs and Mss. Mugler, Jakuboski and Dorsey also
hold similar positions with other investment companies for which affiliates of
59 Wall Street Distributors serve as the principal underwriter.
B-24
<PAGE>
Trustees of the Portfolio
The Trustees of the Portfolio receive a base annual fee of $15,000
(except the Chairman who receives a base annual fee of $20,000) and such base
annual fee is allocated among all series of The 59 Wall Street Fund, Inc., all
series of The 59 Wall Street Trust and the Portfolio and any other active
Portfolios having the same Board of Trustees based upon their respective net
assets. In addition, each series of The 59 Wall Street Fund, Inc. and The 59
Wall Street Trust, the Portfolio and each other active BBH Portfolio which has
commenced operations pays an annual fee to each Trustee of $1,000.
<TABLE>
<S> <C> <C> <C> <C>
Pension or Total
Aggregate Retirement Compensation
Compensation Benefits Accrued Estimated Annual from Fund
Name of Person, from the Fund as Part of Benefits upon Complex* Paid
Position Complex** Expenses Retirement to Trustees*
J.V. Shields, Jr., $250 none none $36,000
Trustee
Eugene P. Beard, $250 none none $31,000
Trustee
Richard L. Carpenter, $250 none none $31,000
Trustee
Clifford A. Clark, $250 none none $31,000
Trustee
David P. Feldman, $250 none none $31,000
Trustee
J. Angus Ivory, $250 none none $31,000
Trustee
Alan G. Lowy, $250 none none $31,000
Trustee
Arthur D. Miltenberger, $250 none none $31,000
Trustee
David M. Seitzman, $250 none none $31,000
Trustee
<FN>
* The Fund Complex consists of The 59 Wall Street Fund, Inc. (which currently
consists of six series), The 59 Wall Street Trust (which currently consists of
four series) and the seven active BBH Portfolios.
**Estimated to be paid as of October 31, 2000.
</FN>
</TABLE>
By virtue of the responsibilities assumed by Brown Brothers Harriman & Co. under
the Investment Advisory Agreement with the Portfolio, and by Brown Brothers
Harriman Trust Company LLC of New York ("Brown Brothers Harriman Trust Company
LLC") under the Administration Agreement with the Portfolio (see "Investment
Adviser" and "Administrator"), the Portfolio does not require employees other
than its officers, and none of its officers devote full time to the affairs of
the Portfolio, or, other than the Chairman, receive any compensation from the
Portfolio.
B-25
<PAGE>
Item 14. Control Persons and Principal Holders of Securities.
As of November 1, 2000, Brown Brothers Harriman Trust Company (Cayman)
Limited owned 99% of the outstanding beneficial interests in the Portfolio. So
long as Brown Brothers Harriman Trust Company (Cayman) Limited controls the
Portfolio, it may take actions without the approval of any other holder of
beneficial interest in the Portfolio.
Brown Brothers Harriman Trust Company (Cayman) Limited has informed the
Portfolio that whenever it is requested to vote on matters pertaining to the
Portfolio (other than a vote by the Portfolio to continue the operation of the
Portfolio upon the withdrawal of another investor in the Portfolio), it will
hold a meeting of its investors and will cast its vote as instructed by those
investors.
Item 15. Investment Advisory and Other Services.
INVESTMENT ADVISER
-----------------------------------------------------------------
Under an Investment Advisory Agreement with the Portfolio, subject to the
general supervision of the Portfolio's Trustees and in conformance with the
stated policies of the Portfolio, Brown Brothers Harriman & Co. provides
investment advice and portfolio management services to the Portfolio. In this
regard, it is the responsibility of Brown Brothers Harriman & Co. to make the
day-to-day investment decisions for the Portfolio, to place the purchase and
sale orders for portfolio transactions, and to manage, generally, the
investments of the Portfolio.
The Investment Advisory Agreement between Brown Brothers Harriman & Co. and the
Portfolio is dated May 9, 2000 and remains in effect for two years from such
date and thereafter, but only as long as the agreement is specifically approved
at least annually (i) by a vote of the holders of a "majority of the outstanding
voting securities" (as defined in the 1940 Act) of the Portfolio or by the
Portfolio's Trustees, and (ii) by a vote of a majority of the Trustees of the
Portfolio who are not parties to the Investment Advisory Agreement or
"interested persons" (as defined in the 1940 Act) of the Portfolio ("Independent
Trustees") cast in person at a meeting called for the purpose of voting on such
approval. The Investment Advisory Agreement was most recently approved by the
Independent Trustees on May 9, 2000. The Investment Advisory Agreement
terminates automatically if assigned and is terminable at any time without
penalty by a vote of a majority of the Trustees of the Portfolio, or by a vote
of the holders of a "majority of the outstanding voting securities" (as defined
in the 1940 Act) of the Portfolio on 60 days' written notice to Brown Brothers
Harriman & Co. and by Brown Brothers Harriman & Co. on 90 days' written notice
to the Portfolio. (See "Additional Information".)
The investment advisory fee paid to the Investment Adviser is calculated daily
and paid monthly at an annual rate equal to 0.30% of the Portfolio's average
daily net assets.
The investment advisory services of Brown Brothers Harriman & Co. to the
Portfolio are not exclusive under the terms of the Investment Advisory
Agreement. Brown Brothers Harriman & Co. is free to and does render investment
advisory services to others, including other registered investment companies.
Pursuant to license agreements between Brown Brothers Harriman & Co. and each of
59 Wall Street Administrators and 59 Wall Street Distributors (each a Licensee),
dated June 22, 1993 and June 8, 1990, respectively, each Licensee may continue
to use in its name 59 Wall Street, the current and historic address of Brown
Brothers Harriman & Co., only if Brown Brothers Harriman & Co. does not
terminate the respective license agreement, which would require the Licensee to
change its name to eliminate all reference to 59 Wall Street. Pursuant to a
license agreement between the Portfolio and Brown Brothers Harriman & Co. dated
May 9, 2000, the Portfolio may continue to use in its name BBH. The agreement
may be terminated by Brown Brothers Harriman & Co. at any time upon written
notice to the Portfolio upon the expiration or earlier termination of any
investment advisory agreement between the Portfolio and Brown Brothers Harriman
& Co. Termination of the agreement would require the Portfolio to change its
name to eliminate all reference to BBH.
B-26
<PAGE>
ADMINISTRATOR
-------------------------------------------------------------------
Brown Brothers Harriman Trust Company LLC acts as Administrator of the
Portfolio. Brown Brothers Harriman Trust Company LLC is a wholly-owned
subsidiary of Brown Brothers Harriman & Co. Brown Brothers Harriman Trust
Company LLC in its capacity as Administrator of the Portfolio, administers all
aspects of the Portfolio's operations subject to the supervision of the
Portfolio's Trustees except as set forth above under "Investment Adviser". In
connection with its responsibilities as Administrator for the Portfolio and at
its own expense, Brown Brothers Harriman Trust Company LLC (i) provides the
Portfolio with the services of persons competent to perform such supervisory,
administrative and clerical functions as are necessary in order to provide
effective administration of the Portfolio, including the maintenance of certain
books and records, receiving and processing requests for increases and decreases
in the beneficial interests in the Portfolio, notification to the Investment
Adviser of available funds for investment, reconciliation of account information
and balances between the Custodian and the Investment Adviser, and processing,
investigating and responding to investor inquiries; (ii) oversees the
performance of administrative and professional services to the Portfolio by
others, including the Custodian; (iii) provides the Portfolio with adequate
office space and communications and other facilities; and (iv) prepares and/or
arranges for the preparation, but does not pay for, the periodic updating of the
Portfolio's registration statement for filing with the SEC, and the preparation
of tax returns for the Portfolio and reports to investors and the SEC.
The Administration Agreement between the Portfolio and Brown Brothers Harriman
Trust Company LLC (dated May 9, 2000) will remain in effect for successive
annual periods but only so long as such agreement is specifically approved at
least annually in the same manner as the Portfolio's Investment Advisory
Agreement (see "Investment Adviser"). The Independent Trustees most recently
approved the Portfolio's Administration Agreement on May 9, 2000. The agreement
will terminate automatically if assigned by either party thereto and is
terminable at any time without penalty by a vote of a majority of the Trustees
of the Portfolio or by a vote of the holders of a "majority of the outstanding
voting securities" (as defined in the 1940 Act) of the Portfolio. (See
"Additional Information"). The Portfolio's Administration Agreement is
terminable by the Trustees of the Portfolio or by the Portfolio's corresponding
Fund and other investors in the Portfolio on 60 days' written notice to Brown
Brothers Harriman Trust Company LLC and by Brown Brothers Harriman Trust Company
LLC on 90 days' written notice to the Portfolio.
Pursuant to a Subadministrative Services Agreement with Brown Brothers Harriman
Trust Company LLC, 59 Wall Street Administrators performs such subadministrative
duties for the Portfolio as are from time to time agreed upon by the parties. 59
Wall Street Administrators' subadministrative duties may include providing
equipment and clerical personnel necessary for maintaining the organization of
the Portfolio, participation in the preparation of documents required for
compliance by the Portfolio with applicable laws and regulations, preparation of
certain documents in connection with meetings of Trustees of and investors in
the Portfolio, and other functions that would otherwise be performed by the
Administrator of the Portfolio as set forth above. For performing such
subadministrative services, 59 Wall Street Administrators receives such
compensation as is from time to time agreed upon, but not in excess of the
amount paid to the Administrator from the Portfolio.
PLACEMENT AGENT
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The Portfolio has not retained the services of a principal underwriter or
distributor, since interests in the Portfolio are offered solely in private
placement transactions. 59 Wall Street Distributors, Inc. acting as agent for
the Portfolio, serves as the placement agent of interests in the Portfolio. 59
Wall Street Distributors receives no compensation for serving as placement
agent.
EXPENSE PAYMENT AGREEMENT
-----------------------------------------------------------------
Under an expense payment agreement dated May 9, 2000, Brown Brothers Harriman
Trust Company LLC pays the expenses of the Portfolio, other than fees paid to
Brown Brothers Harriman Trust Company LLC under the Portfolio's Administration
Agreement and other than expenses relating to the organization of the Portfolio.
In return, Brown Brothers Harriman Trust Company LLC receives a fee from the
Portfolio such that after such payment the aggregate expenses of the Portfolio
do not exceed an agreed upon annual rate, currently 0.40% of the average daily
net assets of the Portfolio. Such fees are computed daily and paid monthly.
B-27
<PAGE>
CUSTODIAN
-------------------------------------------------------------------
Brown Brothers Harriman & Co., 40 Water Street, Boston, Massachusetts 02109, is
Custodian for the Portfolio. As Custodian, it is responsible for maintaining
books and records of portfolio transactions and holding the Portfolio's
securities and cash pursuant to a custodian agreement with the Portfolio. Cash
is held for the Portfolio in demand deposit accounts at the Custodian. Subject
to the supervision of the Administrator of the Portfolio, the Custodian
maintains the accounting and portfolio transaction records for the Portfolio and
each day computes the net asset value and net income of the Portfolio.
INDEPENDENT AUDITORS
-------------------------------------------------------------------
Deloitte & Touche LLP are the independent auditors for the Portfolio.
CODE OF ETHICS
-------------------------------------------------------------------
The Portfolio, the Adviser and the Placement Agent each have adopted a code of
ethics pursuant to Rule 17j-1 under the 1940 Act. Each code of ethics permits
personnel subject to such code of ethics to invest in securities, including
securities that may be purchased or held by the Portfolio. However, the codes of
ethics contain provisions and requirements designed to identify and address
certain conflicts of interest between personal investment activities and the
interests of the Portfolio. Of course, there can be no assurance that the codes
of ethics will be effective in identifying and addressing all conflicts of
interest relating to personal securities transactions. The code of ethics of the
Portfolio, the Adviser and the Placement Agent are on file with and are
available from the SEC by calling 1-202-942-8090. Additionally, this information
is available on the EDGAR database at the SEC's internet site at
http://www.sec.gov. A copy may be obtained, after paying a duplicating fee, by
electronic request at the following e-mail address: [email protected].
Item 16. Brokerage Allocation, Transactions and Other Practices.
The securities in which the Portfolio invests are traded primarily in the
over-the-counter markets on a net basis and do not normally involve either
brokerage commissions or transfer taxes. Where possible transactions on behalf
of the Portfolio are entered directly with the issuer or from an underwriter or
market maker for the securities involved. Purchases from underwriters of
securities may include a commission or concession paid by the issuer to the
underwriter, and purchases from dealers serving as market makers may include a
spread between the bid and asked price. The policy of the Portfolio regarding
purchases and sales of securities is that primary consideration is given to
obtaining the most favorable prices and efficient executions of transactions. In
seeking to implement the Portfolio's policies, the Investment Adviser effects
transactions with those brokers and dealers who the Investment Adviser believes
provide the most favorable prices and are capable of providing efficient
executions. While reasonably competitive spreads or commissions are sought for
the Portfolio, it will not necessarily be paying the lowest spread or commission
available. If the Investment Adviser believes such prices and executions are
obtainable from more than one broker or dealer, it may give consideration to
placing portfolio transactions with those brokers and dealers who also furnish
B-28
<PAGE>
research and other services to the Portfolio or Investment Adviser. Such
services may include, but are not limited to, any one or more of the following:
information as to the availability of securities for purchase or sale;
statistical or factual information or opinions pertaining to investment; wire
services; and appraisals or evaluations of portfolio securities. A 100% turnover
would occur, for example, if all portfolio securities (excluding short-term
obligations) were replaced once in a period of one year. The amount of brokerage
commissions and taxes on realized capital tend to increase as the level of
portfolio activity increases.
On those occasions when Brown Brothers Harriman & Co. deems the purchase or sale
of a security to be in the best interests of the Portfolio as well as other
customers, Brown Brothers Harriman & Co. to the extent permitted by applicable
laws and regulations, may, but is not obligated to, aggregate the securities to
be sold or purchased for the Portfolio with those to be sold or purchased for
other customers in order to obtain best execution, including lower brokerage
commissions, if appropriate. In such event, allocation of the securities so
purchased or sold as well as any expenses incurred in the transaction are made
by Brown Brothers Harriman & Co. in the manner it considers to be most equitable
and consistent with its fiduciary obligations to its customers, including the
Portfolio. In some instances, this procedure might adversely affect the
Portfolio.
Over-the-counter purchases and sales are transacted directly with principal
market makers, except in those circumstances in which, in the judgment of the
Investment Adviser, better prices and execution of orders can otherwise be
obtained. If the Portfolio effects a closing transaction with respect to a
futures or option contract, such transaction normally would be executed by the
same broker-dealer who executed the opening transaction. The writing of options
by the Portfolio may be subject to limitations established by each of the
exchanges governing the maximum number of options in each class which may be
written by a single investor or group of investors acting in concert, regardless
of whether the options are written on the same or different exchanges or are
held or written in one or more accounts or through one or more brokers. The
number of options which the Portfolio may write may be affected by options
written by the Investment Adviser for other investment advisory clients. An
exchange may order the liquidation of positions found to be in excess of these
limits, and it may impose certain other sanctions.
Item 17. Capital Stock and Other Securities.
The Portfolio is organized as a trust under the laws of the State of New York.
Under the Declaration of Trust, the Trustees are authorized to issue beneficial
interests in the Portfolio. Investors are entitled to participate pro rata in
distributions of taxable income, loss, gain and credit of the Portfolio. Upon
liquidation or dissolution of the Portfolio, investors are entitled to share pro
rata in the Portfolio's net assets available for distribution to its investors.
Investments in the Portfolio have no preference, preemptive, conversion or
similar rights and are fully paid and nonassessable, except as set forth below.
Investments in the Portfolio may not be transferred. Certificates representing
an investor's beneficial interest in the Portfolio are issued only upon the
written request of an investor.
Each investor is entitled to a vote in proportion to the amount of its
investment in the Portfolio. Investors in the Portfolio do not have cumulative
voting rights, and investors holding more than 50% of the aggregate beneficial
interest in the Portfolio may elect all of the Trustees if they choose to do so
and in such event the other investors in the Portfolio would not be able to
elect any Trustee. The Portfolio is not required and has no current intention to
hold annual meetings of investors but the Portfolio will hold special meetings
of investors when in the judgment of the Portfolio's Trustees it is necessary or
desirable to submit matters for an investor vote. Changes in fundamental
policies will be submitted to investors for approval. Investors have under
certain circumstances (e.g., upon application and submission of certain
specified documents to the Trustees by a specified percentage of the outstanding
interests in the Portfolio) the right to communicate with other investors in
connection with requesting a meeting of investors for the purpose of removing
one or more Trustees. Investors also have the right to remove one or more
Trustees without a meeting by a declaration in writing by a specified percentage
of the outstanding interests in the Portfolio. Upon liquidation of the
Portfolio, investors would be entitled to share pro rata in the net assets of
the Portfolio available for distribution to investors. No material amendment may
be made to the Portfolio's Declaration of Trust without the affirmative majority
vote of investors (with the vote of each being in proportion to the amount of
its investment).
The term "majority of the outstanding voting securities" (as defined in the 1940
Act) currently means the vote of (i) 67% or more of the outstanding voting
securities present at a meeting, if the holders of more than 50% of the
outstanding voting securities are present in person or represented by proxy; or
(ii) more than 50% of the outstanding voting securities, whichever is less.
B-29
<PAGE>
The end of the Portfolio's fiscal year is October 31.
Under the anticipated method of operation of the Portfolio, the Portfolio will
not be subject to any income tax. However, each investor in the Portfolio will
be taxable on its share (as determined in accordance with the governing
instruments of the Portfolio) of the Portfolio's ordinary income and capital
gain in determining its income tax liability. The determination of such share
will be made in accordance with the Internal Revenue Code of 1986, as amended
(the "Code"), and regulations promulgated thereunder.
It is intended that the Portfolio's assets, income and distributions will be
managed in such a way that an investor in the Portfolio will be able to satisfy
the requirements of Subchapter M of the Code, assuming that the investor
invested all of its assets in the Portfolio.
Investor inquiries may be directed to 59 Wall Street Distributors, 21 Milk
Street, Boston, Massachusetts 02109, (617) 423-0800.
The Portfolio may enter into a merger or consolidation, or sell all or
substantially all of its assets, if approved by the vote of two thirds of its
investors (with the vote of each being in proportion to its percentage of the
beneficial interests in the Portfolio), except that if the Trustees recommend
such sale of assets, the approval by vote of a majority of the investors (with
the vote of each being in proportion to its percentage of the beneficial
interests of the Portfolio) will be sufficient. The Portfolio may also be
terminated (i) upon liquidation and distribution of its assets if approved by
the vote of two thirds of its investors (with the vote of each being in
proportion to the amount of its investment) or (ii) by the Trustees by written
notice to its investors.
Investors in the Portfolio will be held personally liable for its obligations
and liabilities, subject, however, to indemnification by the Portfolio in the
event that there is imposed upon an investor a greater portion of the
liabilities and obligations of the Portfolio than its proportionate beneficial
interest in the Portfolio. The Declaration of Trust also provides that the
Portfolio shall maintain appropriate insurance (for example, fidelity bonding
and errors and omissions insurance) for the protection of the Portfolio, its
investors, Trustees, officers, employees and agents covering possible tort and
other liabilities. Thus, the risk of an investor incurring financial loss on
account of investor liability is limited to circumstances in which both
inadequate insurance existed and the Portfolio itself was unable to meet its
obligations.
The Portfolio's Declaration of Trust further provides that obligations of the
Portfolio are not binding upon the Trustees individually but only upon the
property of the Portfolio and that the Trustees will not be liable for any
action or failure to act, but nothing in the Declaration of Trust protects a
Trustee against any liability to which he would otherwise be subject by reason
of wilful misfeasance, bad faith, gross negligence, or reckless disregard of the
duties involved in the conduct of his office.
Item 18. Purchase, Redemption and Pricing of Securities.
Beneficial interests in the Portfolio are issued solely in private placement
transactions that do not involve any "public offering" within the meaning of
Section 4(2) of the 1933 Act. Investments in the Portfolio may only be made by
other investment companies, insurance company separate accounts, common or
commingled trust funds, or similar organizations or entities which are
"accredited investors" as defined in Rule 501 under the 1933 Act. This
Registration Statement does not constitute an offer to sell, or the solicitation
of an offer to buy, any "security" within the meaning of the 1933 Act.
An investment in the Portfolio may be made without a sales load. All investments
are made at net asset value next determined after an order is received by the
Portfolio. The net asset value of the Portfolio is determined once on each
business day.
There is no minimum initial or subsequent investment in the Portfolio. However,
because the Portfolio intends to be as fully invested at all times as is
reasonably practicable in order to enhance the yield on its assets, investments
must be made in federal funds (i.e., monies credited to the account of the
Custodian by a Federal Reserve Bank).
The Portfolio reserves the right to cease accepting investments at any time or
to reject any investment order.
B-30
<PAGE>
Each investor in the Portfolio may add to or reduce its investment in the
Portfolio on each day the New York Stock Exchange is open for regular trading.
At 4:00 P.M., New York time on each such business day, the value of each
investor's beneficial interest in the Portfolio is determined by multiplying the
net asset value of the Portfolio by the percentage, effective for that day,
which represents that investor's share of the aggregate beneficial interests in
the Portfolio. Any additions or withdrawals, which are to be effected on that
day, are then effected. The investor's percentage of the aggregate beneficial
interests in the Portfolio is then recomputed as the percentage equal to the
fraction (i) the numerator of which is the value of such investor's investment
in the Portfolio as of 4:00 P.M New York time on such day plus or minus, as the
case may be, the amount of any additions to or withdrawals from the investor's
investment in the Portfolio effected on such day, and (ii) the denominator of
which is the aggregate net asset value of the Portfolio as of 4:00 P.M. New York
time, on such day plus or minus, as the case may be, the amount of the net
additions to or withdrawals from the aggregate investments in the Portfolio by
all investors in the Portfolio. The percentage so determined is then applied to
determine the value of the investor's interest in the Portfolio as of 4:00 P.M.,
New York time on the following business day of the Portfolio.
The net income and capital gains and losses, if any, of the Portfolio are
determined at 4:00 p.m., New York time on each business day. Net income for days
other than business days is determined as of 4:00 p.m., New York time on the
immediately preceding business day. All the net income, as defined below, and
capital gains and losses, if any, so determined are allocated pro rata among the
investors in the Portfolio at the time of such determination.
For this purpose the "net income" of the Portfolio (from the time of the
immediately preceding determination thereof) consists of (i) accrued interest,
accretion of discount and amortization of premium less (ii) all actual and
accrued expenses of the Portfolio (including the fees payable to the Investment
Adviser and Administrator of the Portfolio).
The value of investments listed on a domestic securities exchange is based on
the last sale prices as of the regular close of the New York Stock Exchange
(which is currently 4:00 P.M New York time) or, in the absence of recorded
sales, at the average of readily available closing bid and asked prices on such
Exchange. Unlisted securities are valued at the average of the quoted bid and
asked prices in the over-the-counter market. The value of each security for
which readily available market quotations exist is based on a decision as to the
broadest and most representative market for such security.
Bonds and other fixed income securities (other than short-term obligations but
including listed issues) are valued on the basis of valuations furnished by a
pricing service, use of which has been approved by the Board of Trustees. In
making such valuations, the pricing service utilizes both dealer-supplied
valuations and electronic data processing techniques which take into account
appropriate factors such as institutional-size trading in similar groups of
securities, yield, quality, coupon rate, maturity, type of issue, trading
characteristics and other market data, without exclusive reliance upon quoted
prices or exchange or over-the-counter prices.
Securities or other assets for which market quotations are not readily available
are valued at fair value in accordance with procedures established by and under
the general supervision and responsibility of the Portfolio's Trustees. Such
procedures include the use of independent pricing services, which use prices
based upon yields or prices of securities of comparable quality, coupon,
maturity and type; indications as to values from dealers; and general market
conditions. Short-term investments which mature in 60 days or less are valued at
amortized cost if their original maturity was 60 days or less, or by amortizing
their value on the 61st day prior to maturity, if their original maturity when
acquired was more than 60 days, unless this is determined not to represent fair
value by the Trustees of the Portfolio.
Trading in securities on most foreign exchanges and over-the-counter markets is
normally completed before the close of the New York Stock Exchange and may also
take place on days the New York Stock Exchange is closed. If events materially
affecting the value of foreign securities occur between the time when the
exchange on which they are traded closes and the time when the Portfolio's net
asset value is calculated, such securities would be valued at fair value in
accordance with procedures established by and under the general supervision of
the Portfolio's Trustees.
B-31
<PAGE>
If the Portfolio determines that it would be detrimental to the best interest of
the remaining investors in the Portfolio to make payment wholly or partly in
cash, payment of the redemption price may be made in whole or in part by a
distribution in kind of securities from the Portfolio, in lieu of cash, in
conformity with the applicable rules of the Securities and Exchange Commission
(the "SEC"). If interests are redeemed in kind, the redeeming investor might
incur transaction costs in converting the assets into cash. The method of
valuing portfolio securities is described above and such valuation will be made
as of the same time the redemption price is determined.
An investor in the Portfolio may reduce all or any portion of its investment at
the net asset value next determined after a request in "good order" is furnished
by the investor to the Portfolio. The proceeds of a reduction will be paid by
the Portfolio in federal funds normally on the next Portfolio Business Day after
the reduction is effected, but in any event within seven days. Investments in
the Portfolio may not be transferred.
The right of any investor to receive payment with respect to any reduction may
be suspended or the payment of the proceeds therefrom postponed during any
period in which the New York Stock Exchange is closed (other than weekends or
holidays) or trading on the New York Stock Exchange is restricted or, to the
extent otherwise permitted by the 1940 Act if an emergency exists.
The Portfolio reserves the right under certain circumstances, such as
accommodating requests for substantial withdrawals or liquidations, to pay
distributions in kind to investors (i.e., to distribute portfolio securities as
opposed to cash). If securities are distributed, an investor could incur
brokerage, tax or other charges in converting the securities to cash. In
addition, distribution in kind may result in a less diversified portfolio of
investments or adversely affect the liquidity of the Portfolio.
Item 19. Tax Status.
The Portfolio is organized as a New York trust. The Portfolio is not subject to
any income or franchise tax in the State of New York or the Commonwealth of
Massachusetts. However each investor in the Portfolio will be taxable on its
share (as determined in accordance with the governing instruments of the
Portfolio) of the Portfolio's ordinary income and capital gain in determining
its income tax liability. The determination of such share will be made in
accordance with the Internal Revenue Code of 1986, as amended (the "Code"), and
regulations promulgated thereunder.
Although, as described above, the Portfolio will not be subject to federal
income tax, it will file appropriate income tax returns.
It is intended that the Portfolio's assets will be managed in such a way that an
investor in the Portfolio will be able to satisfy the requirements of Subchapter
M of the Code.
Gains or losses on sales of securities by the Portfolio will be treated as
long-term capital gains or losses if the securities have been held by it for
more than one year except in certain cases where, if applicable, the Portfolio
acquires a put or writes a call thereon. Other gains or losses on the sale of
securities will be short-term capital gains or losses.
FOREIGN TAXES. The Portfolio may be subject to foreign withholding taxes with
respect to income received from sources within foreign countries.
OTHER TAXATION. The investment by an investor in the Portfolio does not cause
the investor to be liable for any income or franchise tax in the State of New
York. Investors are advised to consult their own tax advisers with respect to
the particular tax consequences to them of an investment in the Portfolio.
B-32
<PAGE>
Item 20. Underwriters.
The placement agent for the Portfolio is 59 Wall Street Distributors, Inc.,
which receives no compensation for serving in this capacity. Other investment
companies, insurance company separate accounts, common and commingled trust
funds and similar organizations and entities may continuously invest in the
Portfolio acted as placement agent for the Portfolio under the same terms and
conditions as set forth herein.
Item 21. Calculations of Performance Data.
Not applicable.
Item 22. Financial Statements.
The Portfolio's statement of asset and liabilities dated June 1, 2000 included
herein has been included in reliance upon the report of Deloitte & Touche LLP,
independent auditors for the Portfolio, as experts in accounting and auditing.
B-33
<PAGE>
BBH BROAD MARKET FIXED INCOME PORTFOLIO
STATEMENT OF ASSETS AND LIABILITIES
June 1, 2000
ASSETS:
Cash $100,100
LIABILITIES:
Accrued expenses -
-------------
NET ASSETS $100,100
=============
See Notes to Statement of Assets and Liabilities.
B-34
<PAGE>
BBH BROAD MARKET FIXED INCOME PORTFOLIO
NOTES TO STATEMENT OF ASSETS AND LIABILITIES
1. Organization. BBH Broad Market Fixed Income Portfolio (the
"Portfolio") is registered under the Investment Company Act of 1940, as amended,
as an open-ended management investment company which was organized as a trust
under the laws of the State of New York on June 15, 1993. The Declaration of the
Trust permits the Trustees to create an unlimited number of beneficial interests
in the Portfolio.
B-35
<PAGE>
INDEPENDENT AUDITORS' REPORT
Trustees and Investors
BBH Broad Market Fixed Income Portfolio:
We have audited the accompanying statement of assets and liabilities of BBH
Broad Market Fixed Income Portfolio (the "Portfolio") as of June 1, 2000
(expressed in United States dollars). This financial statement is the
responsibility of the Portfolio's management. Our responsibility is to express
an opinion on this financial statement based on our audit.
We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the statement of
assets and liabilities is free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statement. An audit includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating the
overall financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, this statement assets and liabilities presents fairly, in all
material respects, the financial position of the Portfolio as of June 1, 2000 in
conformity with accounting principles generally accepted in the United States of
America.
Boston, Massachusetts
June 2, 2000
B-36
<PAGE>
Appendix A - Description of Ratings
The Portfolio's investments may range in quality from securities rated in the
lowest category in which the Portfolio is permitted to invest to securities
rated in the highest category (as rated by Moody's, Standard & Poor's, Fitch's,
Duff & Phelps or, if unrated, determined by the Investment Adviser to be of
comparable quality). The percentage of the Portfolio's assets invested in
securities in a particular rating category will vary. The following terms are
generally used to describe the credit quality of fixed income securities:
Investment Grade Debt Securities are those rated in one of the four highest
rating categories or, if unrated, deemed comparable by the Investment Adviser.
Below Investment Grade, High Yield Securities ("Junk Bonds") are those rated
lower than Baa by Moody's or BBB by Standard & Poor's and comparable securities.
They are deemed to be predominately speculative with respect to the issuer's
ability to repay principal and interest.
Moody's Investors Service, Inc. - Corporate Bond Ratings
Aaa: Bonds which are rated Aaa are judged to be of the best quality. They carry
the smallest degree of investment risk and are generally referred to as "gilt
edge." Interest payments are protected by a large or by an exceptionally stable
margin and principal is secure. While the various protective elements are likely
to change, such changes as can be visualized are most unlikely to impair the
fundamentally strong position of such issues.
Aa: Bonds which are rated Aa are judged to be of high quality by all standards.
Together with the Aaa group they comprise what are generally known as high-grade
bonds. They are rated lower than the best bonds because margins of protection
may not be as large as in Aaa securities or fluctuation of protective elements
may be of greater amplitude or there may be other elements present that make the
long-term risks appear somewhat larger than with Aaa securities.
A: Bonds which are rated A possess many favorable investment attributes and are
to be considered as upper-medium-grade obligations. Factors giving security to
principal and interest are considered adequate but elements may be present that
suggest a susceptibility to impairment sometime in the future.
Baa: Bonds which are rated Baa are considered as medium-grade obligations (i.e.,
they are neither highly protected nor poorly secured). Interest payments and
principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
B-37
<PAGE>
Ba: Bonds which are rated Ba are judged to have speculative elements; their
future cannot be considered as well-assured. Often the protection of interest
and principal payments may be very moderate and thereby not well safeguarded
during both good and bad times over the future. Uncertainty of position
characterizes bonds in this class.
B: Bonds which are rated B generally lack characteristics of a desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
Caa: Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to principal or
interest.
Ca: Bonds which are rated Ca represent obligations which are speculative in a
high degree. Such issues are often in default or have other marked shortcomings.
C: Bonds which are rated C are the lowest rated class of bonds and issues so
rated can be regarded as having extremely poor prospects of ever attaining any
real investment standing.
Moody's applies numerical modifiers, 1, 2, and 3 in each generic rating
classified from Aa through B in its corporate bond rating system. The modifier 1
indicates that the security ranks in the higher end of its generic rating
category; the modifier a mid-range ranking; and the modifier 3 indicates that
the issue ranks in the lower end of its generic rating category.
Corporate Short-Term Debt Ratings
Moody's short-term debt ratings are opinions of the ability of issuers to repay
punctually senior debt obligations which have an original maturity not exceeding
one year. Obligations relying upon support mechanisms such as letters of credit
and bonds of indemnity are excluded unless explicitly rated.
Moody's employs the following three designations, all judged to be investment
grade, to indicate the relative repayment ability of rated issuers:
B-38
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PRIME-1: Issuers rated Prime-1 (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 rated Prime-2 (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 rated Prime-3 (or supporting institutions) have an acceptable
ability for repayment of senior short-term 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 rated Not Prime do not fall within any of the Prime rating
categories.
Short-Term Municipal Bond Ratings
There are four rating categories for short-term municipal bonds that define an
investment grade situation, which are listed below. In the case of variable rate
demand obligations (VRDOs), a two- component rating is assigned. The first
element represents an evaluation of the degree of risk associated with scheduled
principal and interest payments, and the other represents an evaluation of the
degree of risk associated with the demand feature. The short-term rating
assigned to the demand feature of VRDOs is designated as VMIG. When either the
long- or short-term aspect of a VRDO is not rated, that piece is designated NR,
e.g., Aaa/NR or NR/VMIG 1. MIG ratings terminate at the retirement of the
obligation while VMIG rating expiration will be a function of each issue's
specific structural or credit features.
B-39
<PAGE>
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. All security elements
are accounted for but there is 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.
Corporate Bond Ratings
Standard & Poor's Ratings Services - Investment Grade
AAA: Debt rated AAA has the highest rating assigned by Standard & Poor's.
Capacity to pay interest and repay principal is extremely strong.
AA: Debt rated AA has a very strong capacity to pay interest and repay principal
and differs from the highest rated issues only in small degree.
A: Debt rated A has a strong capacity to pay interest and repay principal
although it is somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions than debt in higher rated categories.
BBB: Debt rated BBB is regarded as having an adequate capacity to pay interest
and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions, or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than in higher-rated categories.
B-40
<PAGE>
Speculative Grade
Debt rated BB, B, CCC, CC, and C is regarded as having predominantly speculative
characteristics with respect to capacity to pay interest and repay principal. BB
indicates the least degree of speculation and C the highest. While such debt
will likely have some quality and protective characteristics, these are
outweighed by large uncertainties or major exposures to adverse conditions.
BB: Debt rated BB has less near-term vulnerability to default than other
speculative issues. However, it faces major ongoing uncertainties or exposure to
adverse business, financial, or economic conditions which could lead to
inadequate capacity to meet timely interest and principal payments. The BB
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied BBB- rating.
B: Debt rated B has a greater vulnerability to default but currently has the
capacity to meet interest payments and principal repayments. Adverse business,
financial, or economic conditions will likely impair capacity or willingness to
pay interest and repay principal. The B rating category is also used for debt
subordinated to senior debt that is assigned an actual or implied BB or
BB-rating.
CCC: Debt rated CCC has a currently identifiable vulnerability to default and is
dependent upon favorable business, financial, and economic conditions to meet
timely payment of interest and repayment of principal. In the event of adverse
business, financial or economic conditions, it is not likely to have the
capacity to pay interest and repay principal. The CCC rating category is also
used for debt subordinated to senior debt that is assigned an actual or implied
B or B- rating.
CC: The rating CC is typically applied to debt subordinated to senior debt that
is assigned an actual or implied CCC rating.
C: The rating C is typically applied to debt subordinated to senior debt that is
assigned an actual or implied CCC- debt rating. The C rating may be used to
cover a situation where a bankruptcy petition has been filed, but debt service
payments are continued.
CI: The rating CI is reserved for income bonds on which no interest is being
paid.
D: Debt rated D is in payment default. The D rating category is used when
interest payments or principal payments 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 also be
used upon the filing of a bankruptcy petition if debt service payments are
jeopardized.
Plus (+) or Minus (-): The ratings from AA to CCC may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
B-41
<PAGE>
Provisional ratings: The letter "p" indicates that the rating is provisional. A
provisional rating assumes the successful completion of the project being
financed by the debt being rated and indicates that payment of debt service
requirements is largely or entirely dependent upon the successful and 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.
r: The "r" is attached to highlight derivative, hybrid, and certain other
obligations that Standard & Poor's believes may experience high volatility or
high variability in expected returns due to non- credit risks. Examples of such
obligations are: securities whose principal or interest return is 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.
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.
Fitch Investors Service ("Fitch") - Investment Grade
AAA, AA and A - Bonds rated AAA are considered to be investment grade and of the
highest quality. The obligor has an extraordinary ability to pay interest and
repay principal, which is unlikely to be affected by reasonably foreseeable
events. Bonds rated AA are considered to be investment grade and of high
quality. The obligor's ability to pay interest and repay principal, while very
strong, is somewhat less than for AAA rated securities or more subject to
possible change over the term of the issue. Bonds rated A are considered to be
investment grade and of good quality. The obligor's ability to pay interest and
repay principal is considered to be strong, but may be more vulnerable to
adverse changes in economic conditions and circumstances than bonds with higher
ratings.
B-42
<PAGE>
Commercial Paper Rating Definitions
A Standard & Poor's commercial paper rating is a current assessment of the
likelihood of timely payment of debt having an original maturity of no more than
365 days. Ratings are graded into several categories, ranging from A for the
highest quality obligations to D for the lowest. These categories are as
follows:
A-1: This highest category indicates that the degree of safety regarding timely
payment is strong. Those issues determined to possess extremely strong safety
characteristics are denoted with a plus sign (+) designation.
A-2: Capacity for timely payment on issues with this designation is
satisfactory. However, the relative degree of safety is not as high as for
issues designated A-1.
A-3: Issues carrying this designation have adequate capacity for timely payment.
They are, however, more vulnerable to the adverse effects of changes in
circumstances than obligations carrying the higher designations.
B: Issues rated B are regarded as having only speculative capacity for timely
payment.
C: This rating is assigned to short-term debt obligations with a doubtful
capacity for payment.
D: Debt rated D is in payment default. The D rating category is used when
interest payments or principal payments 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.
Fitch - Commercial Paper ratings reflect current appraisal of the degree of
assurance of timely payment. F-1+ issues are regarded as having the strongest
degree of assurance for timely payment. An F-1 rating reflects an assurance of
timely payment only slightly less in degree than an F-1+ rating. The symbol LOC
may follow either category and indicates that a letter of credit issued by a
commercial bank is attached to the commercial paper.
A commercial paper rating is not a recommendation to purchase, sell or hold a
security inasmuch as it does not comment as to market price or suitability for a
particular investor. The ratings are based on current information furnished to
Standard & Poor's or Fitch by the issuer or obtained from other sources it
considers reliable. Standard & Poor's or Fitch does not perform an audit in
connection with any rating and may, on occasion, rely on unaudited financial
information. The ratings may be changed, suspended, or withdrawn as a result of
changes in or unavailability of such information.
B-43
<PAGE>
Duff & Phelps Credit Rating Co.
Long-Term Debt and Preferred Stock Ratings
Rating Scale
These ratings represent a summary opinion of the issuer's long-term
fundamental quality. Rating determination is based on qualitative and
quantitative factors which may vary according to the basic economic and
financial characteristics of each industry and each issuer. Important
considerations are vulnerability to economic cycles as well as risks related to
such factors as competition, government action, regulation, technological
obsolescence, demand shifts, cost structure, and management depth and expertise.
The projected viability of the obligor at the trough of the cycle is a critical
determination.
Each rating also takes into account the legal form of the security (e.g., first
mortgage bonds, subordinated debt, preferred stock, etc.). The extent of rating
dispersion among the various classes of
securities is determined by several factors including relative weightings of the
different security classes in the capital structure, the overall credit strength
of the issuer, and the nature of covenant protection. From time to time, Duff &
Phelps Credit Rating Co. places issuers or security classes on Rating Watch. The
Rating Watch status results from a need to notify investors and the issuer that
there are conditions present leading us to re-evaluate the current rating(s).
A listing on Rating Watch, however, does not mean a rating change is
inevitable. The Rating Watch status can either be resolved quickly or over a
longer period of time, depending on the reasons surrounding the placement on
Rating Watch. The "up" designation means a rating may be upgraded; the "down"
designation means a rating may be downgraded, and the "uncertain" designation
means a rating may be raised or lowered.
Ratings of `BBB-' and higher fall within the definition of investment grade
securities, as defined by bank and insurance supervisory authorities. Structured
finance issues, including real estate, asset-backed and mortgage-backed
financings, use this same rating scale. Duff & Phelps Credit Rating claims
paying ability ratings of insurance companies use the same scale with minor
modification in the definitions (see page vii). Thus, an investor can compare
the credit quality of investment alternatives across industries and structural
types. A "Cash Flow Rating" (as noted for specific ratings) addresses the
likelihood that aggregate principal and interest will equal or exceed the rated
amount under appropriate stress conditions.
B-44
<PAGE>
Rating Definition
AAA
Highest credit quality. The risk factors are negligible, being only slightly
more than for risk-free U.S. Treasury debt.
AA+
AA
AA-
High credit quality. Protection factors are strong. Risk is modest but may vary
slightly from time to time because of economic conditions.
A+
A
A-
Protection factors are average but adequate. However, risk factors are more
variable in periods of greater economic stress.
BBB+
BBB
BBB-
Below-average protection factors but still considered sufficient for prudent
investment. Considerable variability in risk during economic cycles.
BB+
BB
BB-
Below investment grade but deemed likely to meet obligations when due. Present
or prospective financial protection factors fluctuate according to industry
conditions. Overall quality may move up or down frequently within this category.
B+
B
B-
Below investment grade and possessing risk that obligations will not be met when
due. Financial protection factors will fluctuate widely according to economic
cycles, industry conditions and/or company fortunes. Potential exists for
frequent changes in the rating within this category or into a higher or lower
rating grade.
B-45
<PAGE>
CCC
Well below investment-grade securities. Considerable uncertainty exists as to
timely payment of principal, interest or preferred dividends. Protection factors
are narrow and risk can be substantial with unfavorable economic/industry
conditions, and/or with unfavorable company developments.
DD
Defaulted debt obligations. Issuer failed to meet scheduled principal and/or
interest payments.
DP
Preferred stock with dividend arrearages.
Credit ratings are based on information obtained from sources believed to be
accurate and reliable and are not a recommendation to buy, sell or hold a
financial obligation. We do not perform an audit in connection with any
information received and may rely on unaudited information. Credit ratings may
be subject to revision, suspension or withdrawal at any time as necessary due to
changes in or unavailability of information or other circumstances.
. B-46
<PAGE>
PART C
Item 23. Exhibits.
(a) Amended and Restated Declaration of Trust.(1)
(b) By-laws.(1)
(c) Not Applicable.
(d) Investment Advisory Agreement.(1)
(e) Placement Agent Agreement.(1)
(f) Not Applicable.
(g) Custodian Agreement. (1)
(h) Administration Agreement. (1)
(h)(i) Expense Payment Agreement. (1)
(i) Not Applicable.
(j) Not Applicable.
(k) Not Applicable.
(l) Forms of Investment representation letters
of initial investors.(1)
(m) Not Applicable.
(n) Not Applicable.
(o) Not Applicable.
(p)(i)Code of Ethics of the Portfolio.(1)
(p)(ii)Code of Ethics of the Brown Brothers Harriman & Co.(1)
(p)(iii) Code of Ethics of 59 Wall Street Distributors, Inc. (1)
_____________________________
(1) Filed with the initial Registration Statement on Form N-1A on June 5, 2000.
<PAGE>
Item 24. Persons Controlled by or Under Common Control with Registrant.
Not applicable.
Item 25. Indemnification.
Reference is hereby made to Article V of the Registrant's Declaration
of Trust, filed in the initial Registration Statement as an Exhibit.
The Trustees and officers of the Registrant are insured under an errors
and omissions liability insurance policy. The Registrant and its officers are
also insured under the fidelity bond required by Rule 17g-1 under the Investment
Company Act of 1940, as amended.
Item 26. Business and Other Connections of Investment Adviser.
The Registrant's investment adviser, Brown Brothers Harriman & Co., is
a New York limited partnership. Brown Brothers Harriman & Co. conducts a general
banking business and is a member of the New York Stock Exchange.
To the knowledge of the Registrant, none of the general partners or
officers of Brown Brothers Harriman & Co. is engaged in any other business,
profession, vocation or employment of a substantial nature.
C-2
<PAGE>
Item 27. Principal Underwriters.
Not applicable.
Item 28. Location of Accounts and Records.
All accounts, books and other documents required to be maintained by
Section 31(a) of the Investment Company Act of 1940 and the Rules thereunder are
maintained at the offices of:
BBH Broad Market Fixed Income Portfolio
63 Wall Street
New York, NY 10005
Brown Brothers Harriman & Co.
59 Wall Street
New York, NY 10005
(investment adviser)
Brown Brothers Harriman Trust Company LLC
63 Wall Street
New York, NY 10005
(administrator)
59 Wall Street Administrators, Inc.
21 Milk Street
Boston, MA 02109
(subadministrator)
59 Wall Street Distributors, Inc.
21 Milk Street
Boston, MA 02109
(placement agent)
Brown Brothers Harriman & Co.
40 Water Street
Boston, MA 02109
(custodian)
Item 29. Management Services.
Not applicable.
Item 30. Undertakings.
Not applicable.
C-3
<PAGE>
SIGNATURES
Pursuant to the requirements of the Investment Company Act of 1940, BBH
Broad Market Fixed Income Portfolio has duly caused this amendment to its
registration statement on Form N-1A to be signed on its behalf by the
undersigned, thereto duly authorized, in the City of Boston, Commonwealth of
Massachusetts on the 1st day of December, 2000.
BBH BROAD MARKET FIXED INCOME PORTFOLIO
By: /s/ PHILIP W. COOLIDGE
Philip W. Coolidge
President