<PAGE>
STATE FARM PROSPECTUS
PROSPECTUS
================================================================================
STATE FARM MUTUAL FUND TRUST
Class A Shares
Class B Shares
================================================================================
DECEMBER 18, 2000
- STATE FARM EQUITY FUND
- STATE FARM SMALL CAP EQUITY FUND
- STATE FARM INTERNATIONAL EQUITY FUND
- STATE FARM S&P 500 INDEX FUND
- STATE FARM SMALL CAP INDEX FUND
- STATE FARM INTERNATIONAL INDEX FUND
- STATE FARM EQUITY AND BOND FUND
- STATE FARM BOND FUND
- STATE FARM TAX ADVANTAGED BOND FUND
- STATE FARM MONEY MARKET FUND
The Securities and Exchange Commission has not approved or disapproved the
shares of the Funds or passed upon the adequacy of this prospectus. Any
representation to the contrary is a criminal offense.
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<TABLE>
<CAPTION>
TABLE OF CONTENTS
PAGE
<S> <C>
FUNDS AT A GLANCE.....................................................................1
State Farm Equity Fund.......................................................1
State Farm Small Cap Equity Fund.............................................3
State Farm International Equity Fund.........................................5
State Farm S&P 500 Index Fund................................................7
State Farm Small Cap Index Fund..............................................9
State Farm International Index Fund.........................................11
State Farm Equity and Bond Fund.............................................13
State Farm Bond Fund........................................................15
State Farm Tax Advantaged Bond Fund.........................................17
State Farm Money Market Fund................................................19
ANNUAL INVESTMENT RETURNS............................................................20
EXPENSE INFORMATION..................................................................21
HOW THE FUNDS INVEST.................................................................24
General Policies Applicable to All Funds....................................24
Fund Summaries..............................................................24
Other Risks of Investing in the Funds.......................................29
MANAGING THE INVESTMENTS OF THE FUNDS................................................31
SHAREHOLDER INFORMATION..............................................................34
What Type of Account Would You Like.........................................34
Minimum Investments.........................................................35
Flexible Sales Charge Options...............................................35
Calculating Net Asset Value.................................................39
How to Buy Shares...........................................................40
How to Exchange Shares......................................................41
How to Redeem Fund Shares...................................................42
DIVIDENDS, DISTRIBUTIONS AND TAXES...................................................45
SHARED DELIVERY......................................................................46
APPENDIX A...........................................................................47
APPENDIX B...........................................................................52
ADDITIONAL INFORMATION ABOUT THE FUNDS...............................................54
</TABLE>
<PAGE>
FUNDS AT A GLANCE
THIS PROSPECTUS PROVIDES INFORMATION ABOUT STATE FARM MUTUAL FUND TRUST
(THE "TRUST"). THE TRUST HAS TEN SEPARATE FUNDS, EACH OF WHICH IS A SEPARATE
INVESTMENT PORTFOLIO WITH ITS OWN INVESTMENT OBJECTIVE, INVESTMENT POLICIES,
RESTRICTIONS, AND RISKS. STATE FARM INVESTMENT MANAGEMENT CORP. (THE "MANAGER")
IS THE INVESTMENT ADVISER TO EACH FUND. EACH FUND OFFERS THREE CLASSES OF
SHARES: CLASS A, CLASS B AND INSTITUTIONAL SHARES. THIS PROSPECTUS OFFERS CLASS
A AND CLASS B SHARES. ADDITIONAL INFORMATION CONCERNING EACH FUND APPEARS
FOLLOWING FUNDS AT A GLANCE.
FUNDS AT A GLANCE
This section discusses each Fund's investment objectives, strategies and risks.
Each Fund summary also describes who should consider investing in the Fund in
the "Investor Profile" section. Please refer to the detailed description of the
Funds' policies in "How the Funds Invest" (beginning on p. 24) for those Funds
you wish to purchase.
STATE FARM EQUITY FUND
INVESTMENT OBJECTIVE --
The State Farm Equity Fund (the "Equity Fund") seeks long-term growth of
capital.
PRINCIPAL INVESTMENT STRATEGIES
HOW DOES THIS FUND PURSUE ITS INVESTMENT OBJECTIVE?
The Equity Fund invests under normal circumstances at least 80% of its assets in
common stocks and other equity securities of U.S. companies with market
capitalizations of at least $1.5 billion. The Manager chooses stocks for the
Fund's portfolio for their long-term potential to generate capital gains.
In making investment decisions on specific securities, the Manager looks for
companies with one or more of the following characteristics:
- Strong cash flow and a recurring revenue stream
- A strong industry position
- A strong financial position
- Strong management with a clearly defined strategy
- Capability to develop new or superior products or services
The Manager may sell securities the Fund holds for a variety of reasons, such as
to secure gains, limit losses, or redeploy assets into more promising
opportunities.
The Fund may invest up to 25% of its assets in equity securities and depositary
receipts of foreign companies.
INVESTOR PROFILE
Who should consider investing in the Equity Fund?
YOU MAY WANT TO INVEST IN THE EQUITY FUND IF YOU:
- can tolerate the price fluctuations and volatility that are inherent in
investing in a broad based large cap stock mutual fund
- want to diversify your investments
- are seeking a growth investment as part of an asset allocation program
OR
- are investing for retirement or other goals that are many years in the future
1
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FUNDS AT A GLANCE CONTINUED
YOU MAY NOT WANT TO INVEST IN THE EQUITY FUND IF YOU:
- are investing with a shorter investment time horizon in mind
- are seeking income rather than capital appreciation
OR
- are uncomfortable with an investment whose value is likely to vary
substantially
RISKS
WHAT ARE THE MAIN RISKS OF INVESTING IN THIS FUND?
[EQUITY FUND RISK CHART]
- MARKET RISK. The Fund invests mostly in common stocks, which represent an
equity interest (ownership) in a business. Stock prices may fluctuate
widely over short or even extended periods in response to company, market,
or economic news. Stock markets also tend to move in cycles, with periods
of rising stock prices and periods of falling stock prices.
- FOREIGN INVESTING RISK. Investing in foreign securities involves higher
trading and custody costs than investing in U.S. companies. Accounting,
legal and reporting practices are different than in the U.S. and regulation
is often less stringent. Potential political or economical instability
presents risks, as does the fluctuation in currency exchange rates, as well
as the possible imposition of exchange control regulation or currency
restrictions that could prevent the conversion of local currencies into
U.S. dollars.
- MANAGEMENT RISK. The Manager's assessment of companies held in the Fund may
prove incorrect, resulting in losses or poor performance, even in a rising
market.
AN INVESTMENT IN THE EQUITY FUND IS NOT A DEPOSIT OF ANY BANK OR OTHER INSURED
DEPOSITORY INSTITUTION AND IS NOT INSURED OR GUARANTEED BY THE FDIC OR ANY OTHER
GOVERNMENT AGENCY. YOU CAN LOSE MONEY BY INVESTING IN THE FUND.
2
<PAGE>
FUNDS AT A GLANCE
STATE FARM SMALL CAP EQUITY FUND
INVESTMENT OBJECTIVE --
The State Farm Small Cap Equity Fund (the "Small Cap Equity Fund") seeks
long-term growth of capital.
INVESTMENT SUB-ADVISER --
Capital Guardian Trust Company ("Capital Guardian").
PRINCIPAL INVESTMENT STRATEGIES
HOW DOES THIS FUND PURSUE ITS INVESTMENT OBJECTIVE?
The Small Cap Equity Fund invests most of its assets in equity securities of
companies with relatively small market capitalizations located in the U.S. The
companies in which Small Cap Equity Fund invests typically have market
capitalizations of $50 million to $1.5 billion at the time the Fund purchases
the securities.
The Fund invests in securities that Capital Guardian thinks are undervalued and
represent good long-term investment opportunities. Capital Guardian may sell
securities when it believes they no longer represent good long-term value.
The Fund may invest up to 25% of its assets in equity securities and depositary
receipts of foreign companies.
INVESTOR PROFILE
Who should consider investing in the Small Cap Equity Fund?
YOU MAY WANT TO INVEST IN THE SMALL CAP EQUITY FUND IF YOU:
- can tolerate the price fluctuations and volatility that are inherent in
investing in a broad based small cap stock mutual fund
- want to diversify your investments
- are seeking a growth investment as part of an asset allocation program
OR
- are investing for retirement or other goals that are many years in the future
YOU MAY NOT WANT TO INVEST IN THE SMALL CAP EQUITY FUND IF YOU:
- are investing with a shorter investment time horizon in mind
- are seeking income rather than capital appreciation
OR
- are uncomfortable with an investment whose value is likely to vary
substantially
3
<PAGE>
FUNDS AT A GLANCE CONTINUED
RISKS
WHAT ARE THE MAIN RISKS OF INVESTING IN THIS FUND?
[SMALL CAP RISK CHART]
- MARKET RISK. The Fund invests mostly in common stocks, which represent an
equity interest (ownership) in a business. Stock prices may fluctuate widely
over short or even extended periods in response to company, market, or
economic news. Stock markets also tend to move in cycles, with periods of
rising stock prices and periods of falling stock prices.
- SMALLER COMPANY SIZE. The Fund invests a large portion of its assets in
smaller capitalization companies. The securities of small capitalization
companies are often more difficult to value or dispose of, more difficult to
obtain information about, and more volatile than stocks of larger, more
established companies. In addition, the markets for the Fund's investments may
not be actively traded, which increases the risk that Capital Guardian may
have difficulty selling securities the Fund holds.
- FOREIGN INVESTING RISK. Investing in foreign securities involves higher
trading and custody costs than investing in U.S. companies. Accounting, legal
and reporting practices are different than in the U.S. and regulation is often
less stringent. Potential political or economic instability presents risks,
as does the fluctuation in currency exchange rates, as well as the possible
imposition of exchange control regulation or currency restrictions that could
prevent the conversion of local currencies into U.S. dollars.
- MANAGEMENT RISK. Capital Guardian's assessment of companies held in the
Fund may prove incorrect, resulting in losses or poor performance, even
in a rising market.
AN INVESTMENT IN THE SMALL CAP EQUITY FUND IS NOT A DEPOSIT OF ANY BANK OR OTHER
INSURED DEPOSITORY INSTITUTION AND IS NOT INSURED OR GUARANTEED BY THE FDIC OR
ANY OTHER GOVERNMENT AGENCY. YOU CAN LOSE MONEY BY INVESTING IN THE FUND.
4
<PAGE>
FUNDS AT A GLANCE
STATE FARM INTERNATIONAL EQUITY FUND
INVESTMENT OBJECTIVE --
The State Farm International Equity Fund (the "International Equity Fund") seeks
long-term growth of capital.
INVESTMENT SUB-ADVISER --
Capital Guardian Trust Company ("Capital Guardian")
PRINCIPAL INVESTMENT STRATEGIES
HOW DOES THIS FUND PURSUE ITS INVESTMENT OBJECTIVE?
The International Equity Fund invests its assets primarily in common stocks of
companies located in 15 European countries (Austria, Belgium, Denmark, Finland,
France, Germany, Ireland, Italy, the Netherlands, Norway, Portugal, Spain,
Sweden, Switzerland and the United Kingdom), Australia, New Zealand, Hong Kong,
Japan and Singapore. The Fund may also invest in companies located in emerging
markets. There is no restriction on the size of the companies in which the Fund
invests.
The Fund invests in securities that Capital Guardian thinks are undervalued and
represent good long-term investment opportunities. Capital Guardian may sell
securities when it believes they no longer represent good long-term value.
INVESTOR PROFILE
Who should consider investing in the International Equity Fund?
YOU MAY WANT TO INVEST IN THE INTERNATIONAL EQUITY FUND IF YOU:
- can tolerate the price fluctuations and volatility that are inherent in
investing in an international stock mutual fund
- want to diversify your investments
- are seeking a growth investment as part of an asset allocation program
OR
- are investing for retirement or other goals that are many years in the future
YOU MAY NOT WANT TO INVEST IN THE INTERNATIONAL EQUITY FUND IF YOU:
- are investing with a shorter investment time horizon in mind
- are seeking income rather than capital appreciation
- are uncomfortable investing in companies that are not located in the United
States
OR
- are uncomfortable with an investment whose value is likely to vary
substantially
5
<PAGE>
FUNDS AT A GLANCE CONTINUED
RISKS
WHAT ARE THE MAIN RISKS OF INVESTING IN THIS FUND?
[INTERNATIONAL EQUITY RISK CHART]
- MARKET RISK. The Fund invests mostly in common stocks, which represent an
equity interest (ownership) in a business. Stock prices may fluctuate widely
over short or even extended periods in response to company, market, or
economic news. Stock markets also tend to move in cycles, with periods of
rising stock prices and periods of falling stock price.
- FOREIGN INVESTING RISK. Investing in foreign securities involves higher
trading and custody costs than investing in U.S. companies. Accounting, legal
and reporting practices are different than in the U.S. and regulation is
often less stringent. Potential political or economical instability presents
risks, as does the fluctuation in currency exchange rates, as well as the
possible imposition of exchange control regulation or currency restrictions
that could prevent the conversion of local currencies into U.S. dollars.
These risks are heightened for emerging or developing countries, which may
experience substantial rates of inflation, may be adversely affected by
barriers and may experience rapid depreciation in their currencies.
- MANAGEMENT RISK. Capital Guardian's assessment of companies held in the Fund
may prove incorrect, resulting in losses or poor performance, even in a
rising market.
AN INVESTMENT IN THE INTERNATIONAL EQUITY FUND IS NOT A DEPOSIT OF ANY BANK OR
OTHER INSURED DEPOSITORY INSTITUTION AND IS NOT INSURED OR GUARANTEED BY THE
FDIC OR ANY OTHER GOVERNMENT AGENCY. YOU CAN LOSE MONEY BY INVESTING IN THE
FUND.
6
<PAGE>
FUNDS AT A GLANCE
STATE FARM S&P 500 INDEX FUND
INVESTMENT OBJECTIVE --
The State Farm S&P 500 Index Fund (the "S&P 500 Index Fund") seeks to provide
investment results that correspond to the total return of publicly traded common
stocks in the aggregate, as represented by the Standard & Poor's 500 Stock Index
(the "S&P 500 -Registered Trademark- Index").*
PRINCIPAL INVESTMENT STRATEGIES
HOW DOES THIS FUND PURSUE ITS INVESTMENT OBJECTIVES?
The S&P 500 Index Fund invests all of its assets in a separate series of an
unaffiliated mutual fund called Master Investment Portfolio (the "Master Fund").
That series, called the S&P 500 Index Master Portfolio, holds each of the stocks
that make up the S&P 500 Index. The S&P 500 Index Master Portfolio and the S&P
500 Index Fund have substantially similar investment objectives. Barclays Global
Fund Advisors ("Barclays") is the investment adviser to the S&P 500 Index Master
Portfolio.
Barclays seeks to achieve investment performance that is similar to the S&P 500
Index (the Fund's target benchmark). The S&P 500 Index is a widely used measure
of large U.S. company stock performance. S&P selects stocks for the S&P 500
Index based upon the following factors:
- market value
- industry group classification (so that the S&P 500 Index represents a broad
range of industry segments within the U.S. economy)
- trading activity, to ensure ample liquidity and efficient share pricing
- fundamental analysis, to ensure that companies in the index are stable
The S&P 500 Index Master Portfolio pursues its investment objective by:
- investing in all of the securities that make up the S&P 500 Index
- investing in these securities in proportions that match the weightings of the
S&P 500 Index
Under normal operating conditions, the S&P 500 Index Master Portfolio seeks to
invest at least 90% of its total assets in stocks that are represented in the
S&P 500 Index.
INVESTOR PROFILE
Who should consider investing in the S&P 500 Index Fund?
YOU MAY WANT TO INVEST IN THE S&P 500 INDEX FUND IF YOU:
- can tolerate the price fluctuations and volatility that are inherent in
investing in a broad based stock mutual fund
- want to invest in stocks, but with an indexing approach
- want to diversify your investments
- are seeking a growth investment as part of an asset allocation program
OR
- are investing for retirement or other goals that are many years in the future
YOU MAY NOT WANT TO INVEST IN THE S&P 500 INDEX FUND IF YOU:
- are investing with a shorter investment time horizon in mind
- are seeking income rather than capital appreciation
OR
- are uncomfortable with an investment whose value is likely to vary
substantially
---------------------------------
* "Standard & Poor's-Registered Trademark-," "S&P-Registered Trademark-,"
"S&P 500-Registered Trademark-," "Standard & Poor's 500 and "500"
are trademarks of The McGraw-Hill Companies, Inc. that the
S&P 500 Index Fund has licensed for use. The S&P 500 Index Fund is not
sponsored, endorsed, sold or promoted by Standard & Poor's, and Standard
& Poor's makes no representations regarding the advisability of investing
in the S&P 500 Index Fund. For more information regarding the S&P 500
Index, see the Trust's Statement of Additional Information.
7
<PAGE>
FUNDS AT A GLANCE CONTINUED
RISKS
THE MAIN RISKS OF INVESTING IN THE S&P 500 INDEX FUND ARE THE SAME AS THE MAIN
RISKS OF INVESTING IN S&P 500 INDEX MASTER PORTFOLIO. WHAT ARE THE MAIN RISKS OF
INVESTING IN THE S&P 500 INDEX MASTER PORTFOLIO?
[S&P 500 Index Risk Chart]
- MARKET RISK. The S&P 500 Index Master Portfolio invests mostly in common
stocks, which represent an equity interest (ownership) in a business. Stock
prices may fluctuate widely over short or even extended periods in response
to company, market, or economic news. Stock markets also tend to move in
cycles, with periods of rising stock prices and periods of falling stock
prices.
- INDEXING RISK. The S&P 500 Index Master Portfolio attempts to match the
performance of the S&P 500 Index, but there is no guarantee that it will be
able to do so. The degree to which the S&P 500 Index Master Portfolio fails
to track the performance of the index is referred to as "tracking error,"
which Barclays expects to be less than 5% over time. The S&P 500 Index Master
Portfolio tries to stay fully invested at all times in assets that will help
it achieve its investment objective. Even when stock prices are falling, the
S&P 500 Index Master Portfolio will stay fully invested and may decline more
than its benchmark index. An index is not a mutual fund and you cannot invest
in an index. The composition and weighting of securities in an index can, and
often do, change.
- MANAGEMENT RISK. Barclays' assessment of the relative weightings of the
companies held in the S&P 500 Index Master Portfolio may prove incorrect,
resulting in losses or poor performance, even in a rising market.
AN INVESTMENT IN THE S&P 500 INDEX FUND IS NOT A DEPOSIT OF ANY BANK OR OTHER
INSURED DEPOSITORY INSTITUTION AND IS NOT INSURED OR GUARANTEED BY THE FDIC
OR ANY OTHER GOVERNMENT AGENCY. YOU CAN LOSE MONEY BY INVESTING IN THE FUND.
8
<PAGE>
FUNDS AT A GLANCE
STATE FARM SMALL CAP INDEX FUND
INVESTMENT OBJECTIVE --
The State Farm Small Cap Index Fund (the "Small Cap Index Fund") seeks to match
as closely as practicable, before fees and expenses, the performance of the
Russell 2000 Small Stock Index-Registered Trademark-* (the "Russell 2000
Index").
PRINCIPAL INVESTMENT STRATEGIES
HOW DOES THIS FUND PURSUE ITS INVESTMENT OBJECTIVES?
The Small Cap Index Fund invests all of its assets in a separate series of the
Master Fund, called the Russell 2000 Index Master Portfolio. The Russell 2000
Index Master Portfolio and the Small Cap Index Fund have substantially similar
investment objectives. Barclays is the investment adviser to the Russell 2000
Index Master Portfolio. Barclays seeks to achieve investment performance for the
Russell 2000 Index Master Portfolio that is similar to the Russell 2000 Index.
The Russell 2000 Index is an unweighted index of 2,000 small companies that is
created by taking the largest 3,000 companies in the U.S. and eliminating the
largest 1,000 of those companies.
The Russell 2000 Index Master Portfolio pursues its investment objective by
investing in a representative sample of the securities contained in the Russell
2000 Index based upon sampling and modeling techniques.
Under normal operating conditions, the Russell 2000 Index Master Portfolio seeks
to invest at least 90% of its total assets in stocks that are represented in the
Russell 2000 Index.
INVESTOR PROFILE
Who should consider investing in the Small Cap Index Fund?
YOU MAY WANT TO INVEST IN THE SMALL CAP INDEX FUND IF YOU:
- can tolerate the price fluctuations and volatility that are inherent in
investing in a broad based small cap stock mutual fund
- want to invest in stocks, but with an indexing approach
- want to diversify your investments
- are seeking a growth investment as part of an asset allocation program
OR
- are investing for retirement or other goals that are many years in the future
YOU MAY NOT WANT TO INVEST IN THE SMALL CAP INDEX FUND IF YOU:
- are investing with a shorter investment time horizon in mind
- are seeking income rather than capital appreciation
OR
- are uncomfortable with an investment whose value is likely to vary
substantially
* The Russell 2000-Registered Trademark- Index is a trademark/service mark,
and Russell-TM- is a trademark, of the Frank Russell Company. The Small
Cap Index Fund is not sponsored, endorsed, sold or promoted by the Frank
Russell Company, and the Frank Russell Company makes no representation
regarding the advisability of investing in the Small Cap Index Fund. For
more information regarding the Russell 2000 Index, see the Trust's
Statement of Additional Information.
9
<PAGE>
FUNDS AT A GLANCE CONTINUED
RISKS
THE MAIN RISKS OF INVESTING IN THE SMALL CAP INDEX FUND ARE THE SAME AS THE MAIN
RISKS OF INVESTING IN THE RUSSELL 2000 INDEX MASTER PORTFOLIO. WHAT ARE THE MAIN
RISKS OF INVESTING IN THE RUSSELL 2000 INDEX MASTER PORTFOLIO?
[Small Cap Index Risk Chart]
- MARKET RISK. The Russell 2000 Index Master Portfolio invests mostly in common
stocks, which represent an equity interest (ownership) in a business. Stock
prices may fluctuate widely over short or even extended periods in response
to company, market, or economic news. Stock markets also tend to move in
cycles, with periods of rising stock prices and periods of falling stock
prices.
- SMALLER COMPANY SIZE. The Russell 2000 Index Master Portfolio invests a large
portion of its assets in smaller capitalization companies. The securities of
small capitalization companies are often more difficult to value or dispose
of, more difficult to obtain information about, and more volatile than stocks
of larger, more established companies. In addition, the markets for the
Russell 2000 Index Master Portfolio's investments may not be actively traded,
which increases the risk that Barclays may have difficulty selling securities
the Russell 2000 Index Master Portfolio holds.
- INDEXING RISK. The Russell 2000 Index Master Portfolio attempts to match the
performance of the Russell 2000 Index, but there is no guarantee that it will
be able to do so. The degree to which the Russell 2000 Index Master Portfolio
fails to track the performance of the index is referred to as "tracking
error," which Barclays expects to be less than 5% over time. The Russell 2000
Index Master Portfolio tries to stay fully invested at all times in assets
that will help it achieve its investment objective. Even when stock prices
are falling, the Russell 2000 Index Master Portfolio will stay fully invested
and may decline more than its benchmark index. An index is not a mutual fund
and you cannot invest in an index. The composition and weighting of
securities in an index can, and often do, change.
AN INVESTMENT IN THE SMALL CAP INDEX FUND IS NOT A DEPOSIT OF ANY BANK OR OTHER
INSURED DEPOSITORY INSTITUTION AND IS NOT INSURED OR GUARANTEED BY THE FDIC OR
ANY OTHER GOVERNMENT AGENCY. YOU CAN LOSE MONEY BY INVESTING IN THE FUND.
10
<PAGE>
FUNDS AT A GLANCE
STATE FARM INTERNATIONAL INDEX FUND
INVESTMENT OBJECTIVE --
The State Farm International Index Fund (the "International Index Fund") seeks
to match as closely as practicable, before fees and expenses, the performance of
an international portfolio of common stocks represented by the Morgan Stanley
Capital International Europe, Australia, and Far East Free Index
("EAFE-Registered Trademark- Free Index").*
PRINCIPAL INVESTMENT STRATEGIES
HOW DOES THIS FUND PURSUE ITS INVESTMENT OBJECTIVES?
The International Index Fund invests all of its assets in a separate series of
the Master Fund, called the International Index Master Portfolio. The
International Index Master Portfolio and the International Index Fund have
substantially similar investment objectives. Barclays is the investment adviser
to the International Index Master Portfolio.
The International Index Fund and International Index Master Portfolio seek to
match the performance of foreign stocks by investing in common stocks included
in the EAFE Free Index (the target benchmark). The EAFE Free Index is a
capitalization-weighted index that currently includes stocks of companies
located in 15 European countries (Austria, Belgium, Denmark, Finland, France,
Germany, Ireland, Italy, the Netherlands, Norway, Portugal, Spain, Sweden,
Switzerland and the United Kingdom), Australia, New Zealand, Hong Kong, Japan
and Singapore. The International Index Master Portfolio selects a representative
sample of the securities contained in the EAFE Free Index based upon sampling
and modeling techniques.
The International Index Master Portfolio attempts to remain as fully invested as
practicable in a pool of stocks and other equity securities that are found in
the EAFE Free Index in a manner that is expected to approximate the performance
of the EAFE Free Index. Under normal operating conditions, the International
Index Master Portfolio seeks to invest at least 90% of its total assets in
stocks that are represented in the EAFE Free Index.
INVESTOR PROFILE
Who should consider investing in the International Index Fund?
YOU MAY WANT TO INVEST IN THE INTERNATIONAL INDEX FUND IF YOU:
- can tolerate the price fluctuations and volatility that are inherent in
investing in a broad based international stock mutual fund
- want to invest in stocks, but with an indexing approach
- want to diversify your investments
- are seeking a growth investment as part of an asset allocation program
OR
- are investing for retirement or other goals that are many years in the future
YOU MAY NOT WANT TO INVEST IN THE INTERNATIONAL INDEX FUND IF YOU:
- are investing with a shorter investment time horizon in mind
- are seeking income rather than capital appreciation
- are uncomfortable investing in companies that are not located in the United
States
OR
- are uncomfortable with an investment whose value is likely to vary
substantially
* The EAFE-Registered Trademark- Free Index is the exclusive property of
Morgan Stanley & Co. Incorporated ("Morgan Stanley"). Morgan Stanley Capital
International is a service mark of Morgan Stanley and has been licensed for
use by the International Index Fund. The International Index Fund is not
sponsored, endorsed, sold or promoted by Morgan Stanley. Morgan Stanley makes
no representation or warranty regarding the advisability of investing in the
International Index Fund. For more information regarding the EAFE-Registered
Trademark- Free Index, see the Trust's Statement of Additional Information.
11
<PAGE>
FUNDS AT A GLANCE CONTINUED
RISKS
THE MAIN RISKS OF INVESTING IN THE INTERNATIONAL INDEX FUND ARE THE SAME AS THE
MAIN RISKS OF INVESTING IN THE INTERNATIONAL INDEX MASTER PORTFOLIO. WHAT ARE
THE MAIN RISKS OF INVESTING IN THE INTERNATIONAL INDEX MASTER PORTFOLIO?
[Int'l Index Risk Chart]
- MARKET RISK. The International Index Master Portfolio invests mostly in
common stocks, which represent an equity interest (ownership) in a business.
Stock prices may fluctuate widely over short or even extended periods in
response to company, market, or economic news. Stock markets also tend to
move in cycles, with periods of rising stock prices and periods of falling
stock prices.
- FOREIGN INVESTING RISK. Investing in foreign securities involves higher
trading and custody costs than investing in U.S. companies. Accounting, legal
and reporting practices are different than in the U.S. and regulation is
often less stringent. Potential political or economic instability presents
risks as does the fluctuation in currency exchange rates, as well as the
possible imposition of exchange control regulation or currency restrictions
that could prevent the conversion of local currencies into U.S. dollars.
These risks are heightened for emerging or developing countries, which may
experience substantial rates of inflation, may be adversely affected by
barriers and may experience rapid depreciation in their currencies.
- INDEXING RISK. The International Index Master Portfolio attempts to match the
performance of the EAFE Free Index, but there is no guarantee that it will be
able to do so. The degree to which the International Index Master Portfolio
fails to track the performance of the index is referred to as "tracking
error," which Barclays expects to be less than 5% over time. The
International Index Master Portfolio tries to stay fully invested at all
times in assets that will help it achieve its investment objective. Even when
stock prices are falling, the International Index Master Portfolio will stay
fully invested and may decline more than the Fund's benchmark index. An index
is not a mutual fund and you cannot invest in an index. The composition and
weighting of securities in an index can, and often do, change.
AN INVESTMENT IN THE INTERNATIONAL INDEX FUND IS NOT A DEPOSIT OF ANY BANK OR
OTHER INSURED DEPOSITORY INSTITUTION AND IS NOT INSURED OR GUARANTEED BY THE
FDIC OR ANY OTHER GOVERNMENT AGENCY. YOU CAN LOSE MONEY BY INVESTING IN THE
FUND.
12
<PAGE>
FUNDS AT A GLANCE CONTINUED
STATE FARM EQUITY AND BOND FUND
INVESTMENT OBJECTIVE --
The State Farm Equity and Bond Fund (the "Equity and Bond Fund") seeks long-term
growth of principal while providing some current income.
PRINCIPAL INVESTMENT STRATEGIES
HOW DOES THIS FUND PURSUE ITS INVESTMENT OBJECTIVE?
The Equity and Bond Fund invests all of its assets in shares of the State Farm
Equity Fund and the State Farm Bond Fund. Generally, the Equity and Bond Fund
attempts to maintain approximately 60% of its net assets in shares of the State
Farm Equity Fund and approximately 40% of its net assets in shares of the State
Farm Bond Fund. The Equity and Bond Fund never invests more than 75% of its net
assets in either underlying Fund. Though the Equity and Bond Fund is not an
asset allocation or market timing mutual fund, it does, from time to time,
adjust the amount of its assets invested in each underlying Fund as economic,
market and financial conditions warrant. Please refer to the descriptions of the
investments of the State Farm Equity Fund and the State Farm Bond Fund for a
discussion of the portfolio securities of these Funds and the risks associated
with each.
INVESTOR PROFILE
Who should consider investing in the Equity and Bond Fund?
YOU MAY WANT TO INVEST IN THE EQUITY AND BOND FUND IF YOU ARE SEEKING:
- long-term growth potential
- some current income
OR
- the convenience of a balanced portfolio of stocks and bonds in a single
investment.
YOU MAY NOT WANT TO INVEST IN THE EQUITY AND BOND FUND IF YOU:
- have a short-term investment horizon
- want the greater growth potential of an investment entirely in equity
securities
OR
- are unwilling to accept share price fluctuations
RISKS
[Equity & Bond Fund Risk Chart]
WHAT ARE THE MAIN RISKS OF INVESTING IN THIS
FUND?
- IN GENERAL. Because the Equity and Bond Fund invests all of its assets in the
State Farm Equity Fund and the State Farm Bond Fund, the risks of investing
in the Equity and Bond Fund are the same as investing in those underlying
Funds.
- MARKET RISK. The Fund invests all of its assets in the State Farm Equity Fund
and the State Farm Bond Fund. The prices of shares of these underlying funds
may fluctuate widely over short or even extended periods in response to
company, market, or economic news. The markets in which the underlying funds
invest also tend to move in cycles, with periods of rising prices and periods
of falling prices.
- FOREIGN INVESTING RISK. The underlying Funds permit investments in foreign
securities. Investing in foreign securities involves higher trading and
custody costs than investing in U.S. companies. Accounting, legal and
reporting practices are different than in the U.S. and regulation is often
less stringent. Potential political or economic instability presents risks,
as does the fluctuation in currency exchange rates, as well as the possible
imposition of exchange control regulation or currency restrictions that could
prevent the conversion of local currencies into U.S. dollars.
- RISK ASSOCIATED WITH INVESTING IN BONDS. The Equity and Bond Fund may invest
up to 75% of its assets in the State Farm Bond Fund. An investment in the
State Farm Bond
13
<PAGE>
FUNDS AT A GLANCE CONTINUED
Fund is subject to risks associated with investing in fixed income
securities, such as bonds, which include:
- INTEREST RATE RISK. The risk that the bonds that the State Farm Bond Fund
holds may decline in market value due to an increase in interest rates.
Another risk associated with interest rate changes is call risk. Call risk
is the risk that during periods of falling interest rates, a bond issuer
will "call" or repay a higher yielding bond before the maturity date of
the bond. Under these circumstances, the State Farm Bond Fund may have to
reinvest the proceeds in an investment that provides a lower yield than
the called bond.
- INCOME RISK. The risk that the income from the bonds the State Farm Bond
Fund holds will decline due to falling interest rates.
- CREDIT RISK. The risk that a bond issuer fails to make principal or
interest payments when due to the State Farm Bond Fund, or that the credit
quality of the issuer falls.
- MANAGEMENT RISK. The Manager's assessment of investments and companies held
in the underlying Funds may prove incorrect, resulting in losses or poor
performance, even in a rising market.
AN INVESTMENT IN THE EQUITY AND BOND FUND IS NOT A DEPOSIT OF ANY BANK OR OTHER
INSURED DEPOSITORY INSTITUTION AND IS NOT INSURED OR GUARANTEED BY THE FDIC OR
ANY OTHER GOVERNMENT AGENCY. YOU CAN LOSE MONEY BY INVESTING IN THE FUND.
14
<PAGE>
FUNDS AT A GLANCE
STATE FARM BOND FUND
INVESTMENT OBJECTIVE --
The State Farm Bond Fund (the "Bond Fund") seeks to realize over a period of
years the highest yield consistent with investing in investment grade bonds.
PRINCIPAL INVESTMENT STRATEGIES
HOW DOES THIS FUND PURSUE ITS INVESTMENT OBJECTIVE?
The Bond Fund invests primarily in investment grade bonds issued by U.S.
companies. Under normal circumstances, the Bond Fund invests at least 80% of its
assets in investment grade bonds or in bonds that are not rated, but that the
Manager has determined to be of comparable quality. A bond is investment grade
if Moody's Investors Service, Inc. ("Moody's") or S&P have rated the bond in one
of their respective four highest rating categories. Non-investment grade bonds
are commonly referred to as "junk bonds." The Bond Fund may invest in the
following instruments:
- CORPORATE DEBT SECURITIES: investment grade securities issued by domestic and
foreign corporations and to a limited extent (up to 20% of its assets), in
lower rated securities;
- U.S. GOVERNMENT DEBT SECURITIES: securities issued or guaranteed by the U.S.
Government or its agencies or instrumentalities;
- FOREIGN GOVERNMENT DEBT SECURITIES: investment grade securities issued or
guaranteed by a foreign government or its agencies or instrumentalities,
payable in U.S. dollars;
- ASSET BACKED AND MORTGAGE BACKED SECURITIES: investment grade securities
backed by mortgages, consumer loans and other assets; or
- OTHER ISSUER DEBT SECURITIES: the Fund may invest up to 20% of its assets in
debt securities and preferred stocks that are convertible into common stocks
as well as nonconvertible preferred stocks or securities.
INVESTOR PROFILE
Who should consider investing in the Bond Fund?
YOU MAY WANT TO INVEST IN THE BOND FUND IF YOU:
- are seeking higher potential returns than money market funds and are willing
to accept the price volatility of bonds with longer maturities
- want to diversify your investments
- are seeking an income mutual fund for an asset allocation program
OR
- are retired or nearing retirement
YOU MAY NOT WANT TO INVEST IN THE BOND FUND IF YOU:
- are investing for maximum return over a long time horizon
- want the greater growth potential of an investment in equity securities
OR
- require stability of your principal
RISKS
WHAT ARE THE MAIN RISKS OF INVESTING IN THIS FUND?
- RISKS ASSOCIATED WITH INVESTING IN BONDS. The Fund invests primarily in
investment grade bonds. An investment in the
[Bond Fund Risk Chart]
15
<PAGE>
FUNDS AT A GLANCE CONTINUED
Fund is subject to risks associated with investing in bonds, which include:
- INTEREST RATE RISK. The risks that the bonds the Fund holds may decline in
value due to an increase in interest rates. Another risk associated with
interest rate changes is call risk. Call risk is the risk that during
periods of falling interest rates, a bond issuer will "call" or repay a
higher yielding bond before the maturity date of the bond. Under these
circumstances, the Fund may have to reinvest the proceeds in an investment
that provides a lower yield than the called bond.
- PREPAYMENT RISK. The risk that homeowners or consumers may repay mortgage
or consumer loans, which may effect the yield of mortgage- or asset-backed
securities that are backed by such loans.
- CREDIT RISK. The risk that a bond issuer fails to make principal or
interest payments when due to the Fund, or that the credit quality of the
issuer falls.
- MANAGEMENT RISK. The Manager's assessment of the bonds held in the Fund may
prove incorrect, resulting in losses or poor performance, even in a
rising market.
- LIQUIDITY RISK. The Manager may have difficulty selling securities the Fund
holds at the time it would like to sell, and at the value the Fund has placed
on those securities.
AN INVESTMENT IN THE BOND FUND IS NOT A DEPOSIT IN ANY BANK OR OTHER INSURED
DEPOSITORY INSTITUTION AND IS NOT INSURED OR GUARANTEED BY THE FDIC OR ANY
OTHER GOVERNMENT AGENCY. YOU CAN LOSE MONEY BY INVESTING IN THE FUND.
16
<PAGE>
FUNDS AT A GLANCE
STATE FARM TAX ADVANTAGED BOND FUND
INVESTMENT OBJECTIVE --
The State Farm Tax Advantaged Bond Fund (the "Tax Advantaged Bond Fund") seeks
as high a rate of income exempt from federal income taxes as is consistent with
prudent investment management.
PRINCIPAL INVESTMENT STRATEGIES
HOW DOES THIS FUND PURSUE ITS INVESTMENT OBJECTIVE?
The Tax Advantaged Bond Fund normally invests so that either (1) 80% or more of
the Fund's net investment income is exempt from regular federal income tax or
(2) 80% or more of the Fund's net assets is invested in securities that produce
income exempt from regular federal income tax.
The Tax Advantaged Bond Fund invests primarily in a diversified selection of
municipal bonds (for example, general obligation bonds of a state or bonds
financing a specific project). Dividends from the Fund largely will be exempt
from federal income tax, but a portion of those dividends may be subject to
alternative minimum tax. The Fund may hold bonds with maturities of one to
thirty years, although a majority of the Fund's investments are in bonds with
maturities longer than five years.
The Fund normally invests at least 80% of its total assets in municipal bonds
within the highest four rating categories of Moody's or S&P, meaning that the
Fund may invest up to 20% of the Fund's total assets in medium and lower-quality
bonds.
The Fund tends to hold most municipal bonds until they mature or are called. The
Fund may sell a bond when the proportion of bonds with longer maturities is
reduced in anticipation of a bond market decline (a result of rising interest
rates), or increased in anticipation of a bond market rise (resulting from a
decline in interest rates), or to meet cash flow needs. The Manager may also
sell a bond if its credit risk increases significantly or if market conditions
have changed so that more attractive investment opportunities are available.
INVESTOR PROFILE
Who should consider investing in the Tax Advantaged Bond Fund?
YOU MAY WANT TO INVEST IN THE TAX ADVANTAGED BOND FUND IF YOU WANT:
- regular tax-free dividends
OR
- to reduce taxes on your investment income
YOU MAY NOT WANT TO INVEST IN THE TAX ADVANTAGED BOND FUND IF YOU:
- are seeking long term capital growth
- want the greater growth potential of an investment in equity securities
- require stability of your principal
OR
- if you are investing through an IRA, 401(k) plan or some other kind of
tax-deferred account.
17
<PAGE>
FUNDS AT A GLANCE CONTINUED
RISKS
WHAT ARE THE MAIN RISKS OF INVESTING IN THE TAX ADVANTAGED BOND FUND?
[Tax Advantaged Bond Risk Chart]
- RISKS ASSOCIATED WITH INVESTING IN BONDS. The Fund usually invests
exclusively in municipal bonds. The risks associated with municipal bond
investments include:
- INTEREST RATE RISK. The risk that the municipal bonds the Fund holds may
decline in market value due to an increase in interest rates. Another risk
associated with interest rate changes is call risk. Call risk is the risk
that during periods of falling interest rates, a bond issuer will "call"
or repay a higher yielding bond before the maturity date of the bond.
Under these circumstances, the Fund may have to reinvest the proceeds in
an investment that provides a lower yield than the called bond.
- INCOME RISK. The risk that the income from the bonds the Fund holds will
decline in value due to falling interest rates.
- CREDIT RISK. The risk that the issuer of the municipal bond fails to make
principal or interest payments when due to the Fund, or that the credit
quality of the issuer falls.
- MANAGEMENT RISK. The Manager's assessment of the municipal bonds held in the
Fund may prove incorrect, resulting in losses or poor performance, even in a
rising market.
- LIQUIDITY RISK. The Manager may have difficulty selling securities the Fund
holds at the time it would like to sell, and at the value the Fund has placed
on those securities.
- MUNICIPAL BOND RISK. Municipal securities can be significantly affected by
political changes as well as uncertainties related to taxation, legislative
changes or the rights of municipal security holders. Because many municipal
securities are issued to finance similar projects (for example, education,
healthcare or transportation), conditions in those sectors can affect the
overall municipal market.
AN INVESTMENT IN THE TAX ADVANTAGED BOND FUND IS NOT A DEPOSIT OF ANY BANK OR
OTHER INSURED DEPOSITORY INSTITUTION AND IS NOT INSURED OR GUARANTEED BY THE
FDIC OR ANY OTHER GOVERNMENT AGENCY. YOU CAN LOSE MONEY BY INVESTING IN THE
FUND.
18
<PAGE>
FUNDS AT A GLANCE
STATE FARM MONEY MARKET FUND
INVESTMENT OBJECTIVE --
The State Farm Money Market Fund (the "Money Market Fund") seeks to maximize
current income to the extent consistent with the preservation of capital and
maintenance of liquidity.
PRINCIPAL INVESTMENT STRATEGIES
HOW DOES THIS FUND PURSUE ITS INVESTMENT OBJECTIVE?
Unlike the other Funds, the Money Market Fund seeks to maintain a stable net
asset value of $1.00 per share. The Fund invests exclusively in short-term, U.S.
dollar-denominated money market securities, including those issued by U.S. and
foreign financial institutions, corporate issuers, the U.S. Government and its
agencies and instrumentalities, municipalities, foreign governments, and
multi-national organizations, such as the World Bank.
INVESTOR PROFILE
Who should consider investing in the Money Market Fund?
YOU MAY WANT TO INVEST IN THE MONEY MARKET FUND IF YOU:
- require stability of principal
- are seeking an investment for the cash portion of an asset allocation program
- are looking for an investment with a lower degree of risk during uncertain
economic times or periods of stock market volatility
OR
- consider yourself a saver rather than an investor
YOU MAY NOT WANT TO INVEST IN THE MONEY MARKET FUND IF YOU:
- are seeking an investment that is likely to significantly outpace inflation
- are investing for retirement or other longer term goals
OR
- are investing for growth or maximum current income
RISKS
WHAT ARE THE MAIN RISKS OF INVESTING IN THE MONEY MARKET FUND?
[Money Market Risk Chart]
Because of the types of securities that the Money Market Fund invests in and
their short-term nature, the level of risk associated with the Money Market Fund
is lower than most other types of mutual funds. However, an investment in the
Fund involves the following risks:
- INTEREST RATE RISK - As with any investment whose yield reflects current
interest rates, the Fund's yield will change over time. The value of the
securities the Fund holds may decline in value due to an increase in interest
rates.
- INCOME RISK - The risk that the income from the securities the Fund holds
will decline in value due to falling interest rates.
- CREDIT RISK - The risk that an issuer, or a party to a repurchase agreement
that the Fund has entered into, defaults on its obligations.
- INFLATION RISK - The risk that the value of the assets or income from an
investment will be worth less in the future as inflation decreases the value
of money.
- MANAGEMENT RISK. The Manager's assessment of investments held in the Fund may
prove incorrect, resulting in losses or poor performance, even in a rising
market.
AN INVESTMENT IN THE MONEY MARKET FUND IS NOT A DEPOSIT OF ANY BANK OR OTHER
INSURED DEPOSITORY INSTITUTION AND IS NOT INSURED OR GUARANTEED BY THE FDIC OR
ANY OTHER GOVERNMENT AGENCY. ALTHOUGH THE MONEY MARKET FUND SEEKS TO PRESERVE
THE VALUE OF YOUR INVESTMENT BY MAINTAINING A STABLE NET ASSET VALUE OF $1.00
PER SHARE, THE FUND MAY NOT SUCCEED AND YOU MAY STILL LOSE MONEY BY INVESTING IN
THE FUND.
19
<PAGE>
ANNUAL INVESTMENT RETURNS
After the Funds have been in operation for a full calendar year, the Funds will
provide performance information to investors to assist them in understanding
that the Funds' returns may vary and that there are possible risks associated
with investing in the Funds. However, past performance will not necessarily
indicate how the Funds will perform in the future.
The Funds are newly organized, and most were modeled after either another mutual
fund that the Manager or Barclays manages or a composite of accounts that
Capital Guardian manages, as shown below:
<TABLE>
<CAPTION>
FUND CORRESPONDING FUND OR COMPOSITE
------------------------------------------------------------------------------------------------
<S> <C>
Equity Fund State Farm Growth Fund, Inc.
Small Cap Equity Fund Capital Guardian U.S. Small Cap Equity Composite
International Equity Fund Capital Guardian Non-U.S. Equity Composite
S&P 500 Index Fund S&P 500 Index Master Portfolio
Small Cap Index Fund Small Cap Equity Index Fund portfolio
of the State Farm
Variable Product Trust
International Index Fund International Index Master Portfolio
Equity and Bond Fund No comparable fund
Bond Fund No comparable fund
Tax Advantaged Bond Fund No comparable fund
Money Market Fund Money Market Fund portfolio of the State Farm
Variable Product Trust
------------------------------------------------------------------------------------------------
</TABLE>
The investment policy of each Fund is substantially similar to its
corresponding fund or composite. Attached as Appendix A to this Prospectus is
the investment performance for each corresponding fund or composite. The data
provided in Appendix A is provided to illustrate the past performance of the
Manager, Barclays and Capital Guardian in managing similar types of
investment mandates.
20
<PAGE>
FUNDS AT A GLANCE
EXPENSE INFORMATION
The following tables describe the fees and expenses you would pay if you buy and
hold shares of the Funds.
SHAREHOLDER TRANSACTION EXPENSES - FOR ALL FUNDS, OTHER THAN THE MONEY MARKET
FUND
(FEES PAID DIRECTLY FROM YOUR INVESTMENT)
<TABLE>
<CAPTION>
CLASS A CLASS B
-----------------------------------------------------------------------------------------------------------
<S> <C> <C>
Maximum sales charge (load) imposed on purchases 3.0% None
Maximum deferred sales charge (load) None 3.00%
Maximum sales charge (load) imposed on
Reinvested dividends None None
Redemption Fee None None
Exchange Fee None None
Maximum Account Fee(1) None None
-----------------------------------------------------------------------------------------------------------
SHAREHOLDER TRANSACTION EXPENSES - MONEY MARKET FUND
(FEES PAID DIRECTLY FROM YOUR INVESTMENT)
CLASS A CLASS B
-----------------------------------------------------------------------------------------------------------
Maximum sales charge (load) imposed on purchases None None
Maximum deferred sales charge (load) None 3.00%
Maximum sales charge (load) imposed on
Reinvested dividends None None
Redemption Fee None None
Exchange Fee None None
Maximum Account Fee(1) None None
-----------------------------------------------------------------------------------------------------------
</TABLE>
(1) If an account balance falls below $500 on the last day of any quarter, the
account may be charged a low balance account fee of $2.50.
21
<PAGE>
ESTIMATED FUND ANNUAL OPERATING EXPENSES (AS A PERCENTAGE OF AVERAGE NET ASSETS)
<TABLE>
<CAPTION>
SMALL CAP EQUITY INTERNATIONAL
EQUITY FUND FUND EQUITY FUND
----------------------------------------------------------------------------------------------------------------------------
CLASS A CLASS B CLASS A CLASS B CLASS A CLASS B
----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Management fees 0.60% 0.60% 0.80% 0.80% 0.80% 0.80%
Shareholder Servicing Fee 0.25% 0.25% 0.25% 0.25% 0.25% 0.25%
12b-1 Distribution Fee 0.25% 0.65% 0.25% 0.65% 0.25% 0.65%
Other expenses(1) 0.16% 0.16% 0.14% 0.14% 0.29% 0.29%
Total Annual Fund Operating Expenses(2) 1.26% 1.66% 1.44% 1.84% 1.59% 1.99%
S&P 500 INDEX FUND(3) SMALL CAP INTERNATIONAL INDEX
INDEX FUND(3) FUND(3)
----------------------------------------------------------------------------------------------------------------------------
CLASS A CLASS B CLASS A CLASS B CLASS A CLASS B
----------------------------------------------------------------------------------------------------------------------------
Management fees 0.20% 0.20% 0.33% 0.33% 0.40% 0.40%
Shareholder Servicing Fee 0.25% 0.25% 0.25% 0.25% 0.25% 0.25%
12b-1 Distribution Fee 0.25% 0.65% 0.25% 0.65% 0.25% 0.65%
Other expenses(1) 0.23% 0.23% 0.33% 0.33% 0.45% 0.45%
Total Annual Fund Operating Expenses(2) 0.93% 1.33% 1.16% 1.56% 1.35% 1.75%
EQUITY AND BOND FUND(4) BOND FUND TAX ADVANTAGED BOND
FUND
----------------------------------------------------------------------------------------------------------------------------
CLASS A CLASS B CLASS A CLASS B CLASS A CLASS B
----------------------------------------------------------------------------------------------------------------------------
Management fees 0.40% 0.40% 0.10% 0.10% 0.10% 0.10%
Shareholder Servicing Fee 0.25% 0.25% 0.25% 0.25% 0.25% 0.25%
12b-1 Distribution Fee 0.25% 0.65% 0.25% 0.65% 0.25% 0.65%
Other expenses(1) 0.29% 0.29% 0.13% 0.13% 0.21% 0.21%
Total Annual Fund Operating Expenses(2) 1.19% 1.59% 0.73% 1.13% 0.81% 1.21%
MONEY MARKET FUND
----------------------------------------------------------------------------------------------------------------------------
CLASS A CLASS B
----------------------------------------------------------------------------------------------------------------------------
Management fees 0.10% 0.10%
Shareholder Servicing Fee 0.25% 0.25%
12b-1 Distribution Fees 0.15% 0.55%
Other expenses(1) 0.14% 0.14%
Total Annual Fund Operating Expenses(2) 0.64% 1.04%
----------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Based on estimated amounts for the current fiscal year.
(2) The Manager has agreed to reimburse each Fund if, and to the extent, the
Fund's total annual operating expenses exceed the following percentage of
each Fund's average net assets:
<TABLE>
<CAPTION>
EXPENSE
FUND REIMBURSEMENT THRESHOLD
--------------------------------------------------------------------------------------
CLASS A CLASS B
--------------------------------------------------------------------------------------
<S> <C> <C>
Equity Fund ...................... 1.20% 1.60%
Small Cap Equity Fund ............ 1.40% 1.80%
International Equity Fund ........ 1.50% 1.90%
S&P 500 Index Fund ............... 0.80% 1.20%
Small Cap Index Fund ............. 0.95% 1.35%
International Index Fund ......... 1.15% 1.55%
Equity and Bond Fund ............. None None
Bond Fund ........................ 0.70% 1.10%
Tax Advantaged Bond Fund ......... 0.70% 1.10%
Money Market Fund ................ 0.60% 1.00%
</TABLE>
This reimbursement arrangement is voluntary and may be eliminated by the
Manager at any time.
(3) For the S&P 500 Index Fund, Small Cap Index Fund and International Index
Fund (the "Equity Index Funds"), total annual operating expenses
include the Fund's and the Master Portfolio's expenses.
(4) The Manager has agreed not to be paid an investment advisory and
management services fee for performing services for the Equity and Bond
Fund. However, the Manager and State Farm VP Management Corp., the
distributor of the Funds, will receive fees for performing services for
the underlying funds in which the Equity and Bond Fund invests. The
management fee, shareholder servicing fee and 12b-1 fee indicated in the
expense table is based on the fees that the Equity Fund and Bond Fund pay
to the Manager and State Farm VP Management Corp. The Manager has agreed
to reimburse the Equity and Bond Fund for all other expenses incurred.
This expense limitation is voluntary and the Manager may eliminate it at
any time.
22
<PAGE>
FUNDS AT A GLANCE
EXPENSE EXAMPLES
These examples are intended to help you compare the cost of investing in a Fund
with the cost of investing in other mutual funds. The examples assume you invest
$10,000 for the time periods indicated, earn a 5% return each year, redeem your
shares at the end of the period and that operating expenses remain constant at
the level above for "Total Annual Fund Operating Expenses." Your actual returns
and costs may be higher or lower than those shown, but based on these
assumptions, your expenses will be:
<TABLE>
<CAPTION>
FUND CLASS A CLASS B
----------------------------------------------------------------------
1 YEAR 3 YEARS 1 YEAR 3 YEARS
----------------------------------------------------------------------
<S> <C> <C> <C> <C>
Equity Fund ............. $425 $688 $469 $798
Small Cap Equity Fund ... $442 $742 $487 $854
International Equity Fund $457 $787 $502 $899
S&P 500 Index Fund ...... $392 $588 $435 $696
Small Cap Index Fund .... $415 $657 $459 $768
International Index Fund $433 $715 $478 $826
Equity and Bond Fund .... $314 $344 $314 $320
Bond Fund ............... $372 $526 $415 $634
Tax Advantaged Bond Fund $380 $551 $423 $659
Money Market Fund ....... $ 65 $205 $406 $606
</TABLE>
Using the same assumptions as for the first table, but assuming that you did not
redeem your shares at the end of each period, you would bear the following
expenses for Class B shares:
<TABLE>
<CAPTION>
FUND 1 YEAR 3 YEARS
------------------------------------------------
<S> <C> <C>
Equity Fund ............. $169 $523
Small Cap Equity Fund ... $187 $579
International Equity Fund $202 $624
S&P 500 Index Fund ...... $135 $421
Small Cap Index Fund .... $159 $493
International Index Fund $178 $551
Equity and Bond Fund .... $162 $502
Bond Fund ............... $115 $359
Tax Advantaged Bond Fund $123 $384
Money Market Fund ....... $106 $331
------------------------------------------------
</TABLE>
23
<PAGE>
HOW THE FUNDS INVEST
GENERAL POLICIES APPLICABLE TO ALL FUNDS
Under ordinary circumstances, each Fund is substantially fully invested. Except
for the S&P 500 Index Fund, Small Cap Index Fund and the International Index
Fund (collectively, the "Equity Index Funds"), and the Money Market Fund, each
Fund may take a temporary defensive position in attempting to respond to adverse
market, economic, political or other conditions. If the Manager or Capital
Guardian determine that market or economic conditions warrant a temporary
defensive position, the Funds each manage may hold up to 100% of their assets in
cash, cash equivalents or other temporary investments such as short-term
government or corporate obligations. During those periods, a Fund's assets may
not be invested in accordance with its strategy and the Fund may not achieve its
investment objective.
Each Fund may also:
- Lend securities to financial institutions, enter into repurchase
agreements and purchase securities on a when-issued or forward commitment
basis; and
- Invest in U.S. dollar-denominated foreign money market securities,
although no more than 25% of a Fund's assets may be invested in foreign
money market securities unless such securities are backed by a U.S. parent
financial institution.
Except for the Equity Index Funds, each Fund may, from time to time, borrow
money in amounts up to 33 1/3% of its total assets (including the amount
borrowed) for temporary purposes to pay for redemptions. A Fund may not purchase
additional securities when borrowings exceed 5% of its total assets (including
the amount borrowed).
FUND SUMMARIES
Each Fund has its own investment objective. The Trust's Board may change these
investment objectives without a vote of the Trust's shareholders. The types of
securities and investment techniques and practices in which each Fund may engage
to achieve its objective, including the principal investment techniques and
practices described for each Fund as described below, are identified in Appendix
B to this Prospectus, and are discussed, together with their risks, in the
Trust's Statement of Additional Information.
EQUITY FUND
In managing the Equity Fund, the Manager seeks to purchase the common stocks of
large U.S. companies that the Manager considers well run and able to generate
long term capital appreciation. Common stocks, in general, offer a way to invest
for long-term growth of capital. The Manager looks for companies with one or
more of the following characteristics:
- Strong cash flows and a recurring revenue stream.
- A strong industry position.
- A strong financial position.
- Strong management with a clearly defined strategy.
- Capability to develop new or superior products or services.
The Fund may invest up to 25% of its assets in foreign equity securities not
publicly traded in the U.S. and depositary receipts (both sponsored and
unsponsored). Foreign investing provides opportunities different from those
available in the U.S. and risks that in some ways may be greater than in U.S.
investments.
SMALL CAP EQUITY FUND
The Small Cap Equity Fund invests its assets primarily in equity securities of
companies with relatively small market capitalizations located in the U.S. These
companies typically will have market capitalizations of $50 million to $1.5
billion at the time the Fund purchases these securities. The basic investment
philosophy of Capital Guardian is to seek undervalued securities that represent
good long-term investment opportunities. Capital Guardian generally will sell
securities when it believes they no longer represent good long-term value. The
Fund may invest up to 25% of its assets in the equity securities of foreign
companies with relatively small market capitalizations and depositary receipts
(both sponsored and unsponsored).
INTERNATIONAL EQUITY FUND
The International Equity Fund invests its assets primarily in common stocks of
companies located in 15 European countries (Austria, Belgium, Denmark, Finland,
France, Germany, Ireland, Italy, the Netherlands, Norway, Portugal, Spain,
Sweden, Switzerland and the United Kingdom), Australia, New
24
<PAGE>
HOW THE FUNDS INVEST
Zealand, Hong Kong, Japan and Singapore. The Fund may also invest in companies
located in emerging markets. The basic investment philosophy of Capital Guardian
is to seek undervalued securities that represent good long-term investment
opportunities. Capital Guardian generally will sell securities when it believes
they no longer represent good long-term value. Foreign investing provides
opportunities different from those available in the U.S. and risks, which in
some ways may be greater than in U.S. investments.
The Fund may also buy and sell foreign currencies (either for current or future
delivery) to facilitate settlements in local markets and to hedge against
currency fluctuations.
S&P 500 INDEX FUND, SMALL CAP INDEX FUND AND INTERNATIONAL INDEX FUND
Each Equity Index Fund invests all of its assets in a separate series of the
Master Fund. Each Master Portfolio has substantially similar investment
objectives, strategies, and policies as the corresponding individual Equity
Index Fund. Barclays serves as investment adviser to each Master Portfolio. The
Master Portfolios may accept investments from other feeder funds. Certain
actions involving other feeder funds, such as a substantial withdrawal, could
affect the Master Portfolio. Barclays and its affiliates invest for their own
accounts in the types of securities in which a Master Portfolio may also invest.
Each Master Portfolio invests mostly in stocks, although each may also invest in
stock index futures contracts and options on futures contracts. By investing in
stocks within its benchmark index, each Master Portfolio avoids the risks of
individual stock selection and, instead, tries to match the performance of its
respective benchmark index, whether that index goes up or down.
Each Master Portfolio attempts to remain as fully invested as practicable in the
stocks that are represented in its benchmark index. Under normal operating
conditions, a Master Portfolio seeks to invest at least 90% of its total assets
in stocks that are represented in its benchmark index.
Barclays does not manage the Master Portfolios according to traditional methods
of "active" investment management, which involves the buying and selling of
securities based on economic, financial and market analysis and investment
judgment. Instead, Barclays utilizes a "passive" or indexing investment approach
for each Master Portfolio, attempting to approximate the investment performance
of the appropriate benchmark index. Barclays selects stocks for each Master
Portfolio so that the overall investment characteristics of each Master
Portfolio (based on market capitalization and industry weightings), fundamental
characteristics (such as return variability, earnings valuation and yield) and
liquidity measures are similar to those of its respective benchmark index.
Each Master Portfolio may invest any assets not invested in stocks that are
represented in its benchmark index in:
- the same type of short-term high quality debt securities in which the
Money Market Fund invests (described below);
- other equity securities that are similar to the stocks making up its
benchmark index or that are awaiting disposition after a change in
composition of the benchmark index or a rebalancing of the portfolio;
- stock index futures contracts, options on such futures contracts; and/or
- cash.
Each Master Portfolio may invest in those financial instruments to find a
short-term investment for uninvested cash balances or to provide liquid assets
for anticipated redemptions by shareholders.
The International Index Master Portfolio may also buy and sell foreign
currencies (either for current or future delivery) to facilitate settlements
in local markets, in connection with stock index futures positions, and to
protect against currency exposure in connection with its distributions to
shareholders, but may not enter into such contracts for speculative purposes
or to avoid the effects of anticipated adverse changes in exchange rates
between foreign currencies and the U.S. dollar. The International Index
Master Portfolio's currency transactions might not achieve it's hedging
purpose and the Fund could lose money on these transactions.
The S&P 500 Index Master Portfolio invests in all of the securities that make up
the S&P 500 Index. However, neither the Russell 2000 Index Master Portfolio nor
the International Index Master Portfolio generally hold all of the issues that
25
<PAGE>
comprise their respective benchmark index, due in part to the costs involved
and, in certain instances, the potential illiquidity of certain securities.
Instead, both the Russell 2000 Index Master Portfolio and the International
Index Master Portfolio attempt to hold a representative sample of the
securities in the appropriate benchmark index, which Barclays will select
utilizing certain sampling and modeling techniques. These sampling and
modeling techniques may not be successful. As a result of these sampling and
modeling techniques, the Master Portfolios and the Equity Index Funds may not
have the identical capitalization, industry and fundamental characteristics
as their benchmarks. Please refer to the Trust's Statement of Additional
Information for a more detailed discussion of the techniques that Barclays
employs in selecting the portfolio securities for each of these Master
Portfolios.
From time to time, the portfolio composition of the Master Portfolios may be
altered (or "rebalanced") to reflect changes in the characteristics of its
benchmark index or, for the Russell 2000 Index Master Portfolio or International
Index Master Portfolio, with a view to bringing the performance and
characteristics of each Master Portfolio more closely in line with that of its
benchmark index.
Barclays attempts to track the performance of each Master Portfolio's benchmark
index, but there is no assurance that Barclays will be successful. The degree to
which a Master Portfolio fails to track the performance of its benchmark index
is referred to as the "tracking error." Barclays expects that, over time, the
tracking error of each Master Portfolio will be less than 5%. Barclays monitors
the tracking error of each Master Portfolio on an ongoing basis and seeks to
minimize tracking error to the extent possible. There can be no assurance that a
Master Portfolio will achieve any particular level of tracking error. For an
explanation of "expected tracking error" and more information on this subject,
see the Trust's Statement of Additional Information.
Another reason why the performance of the Master Portfolios (and the Equity
Index Funds) may not always equal the performance of their benchmark index is
because the performance of each benchmark index does not take into account
management fees or the other expenses that each Master Portfolio and each Equity
Index Fund incurs.
Each Master Portfolio may purchase stock index futures contracts on its
benchmark index or a comparable stock index to simulate investment in its
benchmark index. This may be done to rapidly gain exposure to the securities
comprising its benchmark index in anticipation of purchasing such securities
over time, to reduce transaction costs, or to gain exposure to such securities
at a lower cost than by making direct investments in the cash market. If a
Master Portfolio cannot sell a futures contract that it holds, it may write call
and buy put options on the contract to effectively close out or offset the
contract. No Master Portfolio will use futures contracts or options on futures
contracts for speculation.
EQUITY AND BOND FUND
The Equity and Bond Fund invests in shares of the Equity Fund and the Bond Fund.
The Equity and Bond Fund may hold a portion of its assets in U.S. Government
securities, short-term paper, or may invest in the Money Market Fund or another
money market mutual fund to provide flexibility in meeting redemptions,
expenses, and the timing of new investments, and to serve as a short-term
defense during periods of unusual volatility.
BOND FUND
The Bond Fund invests primarily in investment grade bonds (e.g., those bonds
that S&P or Moody's have rated within their respective four highest rating
categories), and in the same types of securities as the Money Market Fund. Under
normal circumstances, at least 80% of the Fund's total assets will be invested
in investment grade bonds or unrated debt securities that the Manager determines
to be of equivalent quality. The Bond Fund may also invest in investment grade
mortgage-backed and asset-backed securities, including those representing pools
of mortgage, commercial or consumer loans originated by financial institutions.
The Bond Fund emphasizes investment grade bonds and usually maintains a duration
target of less than 7 years based on expectations about the direction of
interest rates and other economic factors. Duration is a measure of sensitivity
of bond prices to interest rate movements. The longer the duration of a debt
obligation, the more sensitive its value is to changes in interest rates.
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<PAGE>
HOW THE FUNDS INVEST
In selecting bonds for the Fund, the Manager seeks to maximize current income
while minimizing risk and volatility through prudent investment management.
Accordingly, the Fund seeks to limit its exposure to very risky or speculative
investments by investing primarily in investment grade bonds that offer the
potential for attractive returns.
The Fund may also invest up to 20% of its assets in the following securities:
- Debt securities that S&P or Moody's have rated lower than the four highest
rating categories or comparable unrated debt securities. Bonds that are
rated lower than BBB by S&P or Baa by Moody's are often referred to as
"junk bonds." Rating agencies consider junk bonds to have varying degrees
of speculative characteristics. Consequently, although they can be
expected to provide higher yields, such securities may be subject to
greater market value fluctuations and greater risk of loss of income and
principal than lower-yielding, higher-rated fixed-income securities. For
more information, see "Description of Bond Ratings" in the Statement of
Additional Information.
- Convertible debt securities, convertible preferred stocks and
nonconvertible preferred stocks. Convertible securities are fixed income
securities that are convertible into common stock at a specified price or
conversion ratio. Convertible securities will at times be priced in the
market like other fixed income securities; that is, their prices will tend
to rise when interest rates decline and will tend to fall when interest
rates rise. However, because a convertible security provides an option to
the holder to exchange the security for either a specified number of the
issuer's common shares at a stated price per share or the cash value of
such common shares, the security market price will tend to fluctuate in
relationship to the price of the common shares into which it is
convertible. Because convertible securities are usually viewed by the
issuer as future common stock, they are generally subordinated to other
senior securities and therefore are rated one category lower than the
issuer's non-convertible debt obligations or preferred stock.
- Bond futures contracts, options, credit swaps, interest rate swaps, and
other types of derivatives. Losses (or gains) involving futures contracts
can sometimes be substantial - in part because a relatively small price
movement in a futures contact may result in an immediate and substantial
loss (or gain) for the Fund. Similar risks exist for other types of
derivatives. For this reason, the Fund will not use futures, options, or
other derivatives for speculative purposes or as leveraged investments
that magnify the gains or losses of an investment. The Fund will invest in
futures and options to (i) keep cash on hand to meet shareholder
redemptions or other needs, while simulating full investment in bonds
and/or (ii) reduce the Fund's transaction costs, for hedging purposes or
to add value when these instruments are favorably priced.
TAX ADVANTAGED BOND FUND
Tax Advantaged Bond Fund invests primarily in a diversified selection of
municipal bonds. Municipal bonds generally are designed to meet longer-term
capital needs and have maturities of more than one year when issued. States,
territories, local governments and municipalities issue municipal bonds to
raise money for various purposes (for example, to pay for a road construction
project, or to build an airport). The interest on a municipal bond is
generally exempt from federal income tax, but may be subject to the federal
alternative minimum tax and state income taxes.
The two principal classifications of municipal bonds are "general obligation"
and "revenue" bonds. General obligation bonds are secured by the issuer's
pledge of its faith, credit, and taxing powers for the payment of principal
and interest. The taxes that can be levied for the payment of debt service
may be limited or unlimited as to the rate or amount of special assessments.
In many cases, voter approval is required before an issuer may sell this type
of bond. Revenue bonds are usually payable only from the revenues derived
from a particular facility or class of facilities or, in some cases, from the
proceeds of a special excise tax or other special revenue source. Although
the principal security behind these bonds may vary, many (but not all
issuers) provide further security in the form of a mortgage or debt service
reserve fund. Some authorities provide further security in the form of the
state's ability (without obligation) to make up deficiencies in the debt
service reserve fund.
Under current tax law, all municipal debt is divided into two groups:
government purpose bonds (discussed above) and
27
<PAGE>
private activity bonds. Private activity bonds are bonds that are issued by a
state or local government or public authority, but principally benefit private
users and generally are considered taxable unless a specific exemption is
provided. Some, but not all, private activity bonds are subject to alternative
minimum tax.
The Fund normally invests so that either (1) at least 80% of the Fund's net
investment income is exempt from regular federal income tax or (2) at least 80%
of the Fund's net assets are invested in securities that produce income exempt
from regular federal income tax.
The Fund tends to hold its municipal bonds until they mature or are called. The
Fund may sell a bond when the proportion of bonds with longer maturities is
reduced in anticipation of a bond market decline (a result of rising interest
rates) or increased in anticipation of a bond market rise (resulting from a
decline in interest rates). The Fund may sell a bond if its credit risk
increases significantly.
Under ordinary circumstances at least 80% of the Fund's total assets will
consist of investment grade municipal bonds (e.g., municipal bonds rated within
the four highest rating categories of Moody's or S&P), and money market
securities and cash. Up to 20% of the Fund's total assets may be invested in
municipal bonds that are unrated or rated below investment grade by Moody's or
by S&P.
Lower-rated municipal bonds and fixed income securities generally carry a
greater degree of risk than higher-rated municipal bonds. Bonds rated below BBB
by S&P and below Baa by Moody's have speculative characteristics, and are
commonly referred to as "junk bonds" and present a higher degree of credit risk.
In addition, the Fund may purchase municipal bonds that represent lease
obligations. These carry special risks because the issuer of the bonds may not
be obligated to appropriate money annually to make payments under the lease. To
reduce this risk, the Fund will only purchase these bonds if the Manager
believes the issuer has a strong incentive to continue making appropriations
until maturity.
The Fund may invest in bond (interest rate) futures and options contracts and
other types of derivatives. Losses (or gains) involving futures can sometimes be
substantial - in part because relatively small price movement in a futures
contract may result in an immediate and substantial loss (or gain) for the Fund.
The Fund will not use futures for speculative purposes or as leveraged
investments that magnify the gains or losses of an investment. The Fund's
obligation to purchase securities under futures contracts will not exceed 20% of
its total assets. The reasons for which the Fund may use futures and options are
to: (i) keep cash on hand to meet shareholder redemptions or other needs, while
simulating full investment in bonds and/or (ii) reduce the Fund's transaction
costs or add value when these instruments are favorably priced.
The Fund invests primarily in a diversified selection of municipal bonds with
maturities of one to thirty years. A majority of the Fund's investments are in
issues with maturities longer than five years.
The Fund will hold assets not invested in municipal bonds in (i)
interest-bearing demand notes, (ii) bank savings accounts, (iii) high-grade
money market securities (iv) U.S. Treasury securities or (v) securities of
taxable or tax-exempt money market mutual funds. To the extent the Manager
invests the Fund's asset in securities of money market mutual funds, you will
pay fund operating expenses at both the Fund level and at the money market
mutual fund level.
The Fund may also invest in variable rate securities, such as inverse floaters,
whose rates vary inversely with changes in market rates of interest. Investments
in such securities involve special risks as compared to a fixed rate municipal
security. The extent of increases and decreases in the value of such securities
and the corresponding change to the net asset value of the Fund generally will
be larger than comparable changes in value of an equal principal amount of a
fixed rate municipal security having similar credit quality, redemption
provisions and maturity.
MONEY MARKET FUND
In selecting securities for the Money Market Fund, the Manager seeks highly
liquid investments that present minimal credit risk. The Fund primarily invests
in high quality short-term money market instruments. At least 95% of the Fund's
assets must be rated in the highest short-term category by at least two
nationally recognized statistical rating organizations ("NRSROs") (or one NRSRO,
if only one has issued a rating),
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<PAGE>
HOW THE FUNDS INVEST
and 100% of the Fund's assets must be invested in securities rated in the two
highest rating categories.
The Fund may invest in securities that are not rated by an NRSRO if the Manager
determines that such securities are of comparable quality to, and present a
comparable amount of risk as, similar securities that have received a rating
from an NRSRO.
WHAT IS A NATIONALLY RECOGNIZED STATISTICAL RATING ORGANIZATION (NRSRO)?
An NRSRO, such as Moody's or S&P, assigns ratings to securities based on its
assessment of the creditworthiness of the issuers. The Statement of Additional
Information has a detailed description of the various rating categories.
Among the securities that the Money Market Fund may invest in are the following:
- Securities issued or guaranteed by the U.S. Government or its agencies,
including Treasury Bills, notes, and securities issued by U.S. government
agencies such as the Federal National Mortgage Association.
- Commercial paper issued or guaranteed by U.S. corporations and certain
other entities that are rated in the two highest rating categories of a
NRSRO.
- Repurchase agreements with certain parties.
- Certain obligations of large (more than $1 billion in total assets) U.S.
banks and their subsidiaries (including, certain Canadian affiliates),
including, but not limited to, bank notes, commercial paper, and
certificates of deposit.
- Other short-term obligations issued by or guaranteed by U.S. corporations,
state and municipal governments, or other entities.
- Securities backed by mortgages, consumer loans and other assets.
Given the types of securities that the Fund invests in, the level of risk
associated with the Fund is lower than most other types of mutual funds. However
every investment involves some kind of risk. To the extent that the Fund invests
in certain securities (for example, repurchase agreements, when-issued
securities or foreign money market securities), the Fund may be affected by
additional risks.
OTHER RISKS OF INVESTING IN THE FUNDS
FOREIGN SECURITIES
Investments in foreign securities, including those of foreign governments,
involve additional risks not normally present when investing in comparable
domestic securities.
Some securities of foreign companies and governments may be traded in the
U.S., such as American Depository Receipts ("ADRs"), but most are traded
primarily in foreign markets. The risks of investing in foreign securities
include:
CURRENCY RISK. For securities that are based in value on foreign currencies
(including ADRs), a Fund must buy the local currency to buy a foreign security
and sell the same local currency after it sells the security. Therefore, the
value of that security to a Fund is affected by the value of the local currency
relative to the U.S. currency. As a result, if the value of the local currency
falls relative to U.S. currency, the value of that security falls, even if the
security has not decreased in value in its home country.
POLITICAL AND ECONOMIC RISK. Foreign investments can be subject to greater
political and economic risks. In some countries, there is the risk that the
government may take over assets or operations of the company or impose taxes or
place limits on the removal of assets that would adversely affect the value of
the security. The possibility of default in foreign government securities,
political or social instability or diplomatic developments generally are more of
a concern in developing countries, where the possibility of political
instability (including revolution) and dependence on foreign economic assistance
may be greater than in developed countries.
REGULATORY RISK. In many countries there is less publicly available information
about issuers than is available for companies in the U.S. Foreign companies may
not be subject to uniform accounting, auditing and financial reporting
standards, and auditing practices and requirements may not be comparable to
those applicable to the U.S. companies. In many foreign countries there is less
government supervision and regulation of business and industry practices, and it
may be more difficult to obtain or enforce judgments against foreign entities.
29
<PAGE>
MARKET RISKS. Foreign securities often trade with less frequency and volume than
domestic securities and are therefore less liquid and more volatile than
securities of comparable domestic issuers. Further, the settlement period of
securities transactions in foreign markets may be longer than in domestic
markets.
TRANSACTION COSTS. Commission rates in foreign countries, which are generally
fixed rather than subject to negotiation as in the U.S., are likely to be
higher. In addition, other costs, such as tax and custody costs, are generally
higher than for domestic transactions.
PARTICULAR RISKS FOR DEVELOPING COUNTRIES. In general, the risks noted above are
heightened for developing countries. In addition, certain developing countries
have experienced substantial, and in some cases, rapidly fluctuating rates of
inflation for a number of years. Inflation has, and may continue to have, a
debilitating effect on the underlying economies of these countries. Many
developing countries are heavily dependent on international trade and can be
adversely affected by trade barriers and protectionist measures, as well as the
depreciation or devaluation of their currencies.
HIGH YIELD/HIGH RISK SECURITIES (JUNK BONDS)
These securities tend to offer higher yields than higher-rated securities of
comparable maturities because the historical financial condition of the issuers
of these securities is usually not as strong as that of other issuers.
High yield fixed-income securities usually present greater risk of loss of
income and principal than higher-rated securities. For example, because
investors generally perceive that there are greater risks associated with
investing in medium- or lower-rated securities, the yields and price of such
securities may tend to fluctuate more than those of higher-rated securities.
Moreover, in the lower-quality segments of the fixed income securities market,
changes in perception of the creditworthiness of individual issuers tend to
occur more frequently and in a more pronounced manner than do changes in
higher-quality segments of the fixed-income securities market. The yield and
price of medium-to lower-rated securities therefore may experience greater
volatility than is the case with higher-rated securities.
Under adverse market or economic conditions, the secondary market for high
yield/high risk securities could contract further, independent of any specific
adverse changes in the condition of a particular issuer. As a result, the Funds
could find it more difficult to sell such securities or may be able to sell the
securities only at prices lower than if such securities were widely traded.
Prices realized upon the sale of such lower-rated securities therefore may be
less than the prices used in calculating the Fund's net asset value.
30
<PAGE>
MANAGING THE INVESTMENTS OF THE FUNDS
INVESTMENT ADVISER
State Farm Investment Management Corp. (the "Manager") serves as the investment
adviser to each Fund. Subject to the supervision of the Board of the Trust, the
Manager is responsible for overseeing the day to day operations and business
affairs of the Trust, including monitoring the performance of each Master
Portfolio. The Manager's principal office is located at Three State Farm Plaza,
Bloomington, Illinois 61791-0001. The Manager is wholly-owned by State Farm
Mutual Automobile Insurance Company. The Manager acts as investment adviser to a
variety of other registered investment companies, and as of September 30, 2000,
was responsible for the management of in excess of $5.3 billion in assets.
The Manager also provides all executive, administrative, clerical and other
personnel necessary to operate the Trust and pays the salaries and other costs
of employing all these persons. The Manager furnishes the Trust with office
space, facilities, and equipment and pays the day-to-day expenses related to the
operating and maintenance of such office space, facilities and equipment. Except
for those expenses the Manager expressly assumes, including those noted above,
each Fund otherwise pays for all of its own expenses.
The Equity Fund, Equity and Bond Fund, Bond Fund, Tax Advantaged Bond Fund and
the Money Market Fund are each managed by a team of the Manager's employees
(each an "Advisory Team"). Each Advisory Team makes the investment decisions for
these Funds, subject to the oversight of the Board of the Trust.
INVESTMENT MANAGEMENT OF THE EQUITY INDEX FUNDS
Each Equity Index Fund invests all of its assets in a Master Portfolio, each of
which has substantially similar investment objectives, strategies and risks to
the corresponding Equity Index Fund. Barclays is the investment adviser to the
Master Portfolios. Barclays and its predecessors have been managing index mutual
funds since 1973. Barclays is an indirect subsidiary of Barclays Bank PLC and is
located at 45 Fremont Street, San Francisco, California 94105. As of March 31,
2000, Barclays and its affiliates provided investment advisory services for over
$825 billion of assets. For more information regarding Barclays, please read the
section entitled "Investment Advisory Agreements - Between Barclays and the
Master Portfolios" in the Trust's Statement of Additional Information.
INVESTMENT SUB-ADVISER FOR THE SMALL CAP EQUITY FUND AND INTERNATIONAL EQUITY
FUND
The Manager has engaged Capital Guardian as the investment sub-adviser to
provide day-to-day portfolio management for the Small Cap Equity Fund and the
International Equity Fund. As of September 30, 2000, Capital Guardian provided
investment advisory services for over $124 billion of assets. Capital Guardian,
an experienced investment management organization founded in 1968, serves as
investment adviser to these funds and other funds. Capital Guardian, a wholly
owned subsidiary of The Capital Group Companies, Inc., is headquartered at 333
South Hope Street, Los Angeles, California 90071. For more information regarding
Capital Guardian, please read the section entitled "Investment Advisory
Agreements - Between the Manager and Capital Guardian" in the Trust's Statement
of Additional Information.
Capital Guardian manages the Small Cap Equity Fund and International Equity Fund
using a system of multiple portfolio managers for each Fund. Under this
approach, the portfolio of each Fund is divided into segments, each of which is
managed by an individual manager. Managers decide how their respective segments
will be invested, within the limits provided by a Fund's objective(s) and
policies and by Capital Guardian's investment committee. In addition, Capital
Guardian's research professionals may make investment decisions for a portion of
a Fund's portfolio. The investment decisions for the Small Cap Equity Fund and
the International Equity Fund are made by Capital Guardian, subject to the
oversight of the Board of the Trust.
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<PAGE>
COMPENSATING THE MANAGER FOR ITS SERVICES
Each Fund pays the Manager an investment advisory and management services fee
based upon that Fund's average daily net assets. The fee is accrued daily and
paid to the Manager quarterly at the following annual rates:
<TABLE>
<CAPTION>
RATE OF
FUND ADVISORY FEE
--------------------------------------------------------------------------------
<S> <C>
Equity Fund 0.60% of average daily net assets
Small Cap Equity Fund 0.80% of average daily net assets
International Equity Fund 0.80% of average daily net assets
S&P 500 Index Fund 0.20% of average daily net assets
Small Cap Index Fund 0.35% of average daily net assets
International Index Fund 0.50% of average daily net assets
Equity and Bond Fund None
Bond Fund 0.10% of average daily net assets
Tax Advantaged Bond Fund 0.10% of average daily net assets
Money Market Fund 0.10% of average daily net assets
</TABLE>
The Investment Advisory and Management Services Fee for the Equity Index Funds
include the operating expenses of their corresponding Master Portfolio.
COMPENSATING CAPITAL GUARDIAN FOR ITS SERVICES
The Manager pays Capital Guardian for its services to the Funds it manages at
the rates shown in the table below:
<TABLE>
<CAPTION>
SMALL CAP EQUITY FUND:
<S> <C>
On the first $25 million.......................... 0.75% of average daily net assets
$25 million to $50 million........................ 0.60% of average daily net assets
$50 million to $100 million....................... 0.425% of average daily net assets
Over $100 million................................. 0.375% of average daily net assets
INTERNATIONAL EQUITY FUND:
On the first $25 million.......................... 0.75% of average daily net assets
$25 million to $50 million........................ 0.60% of average daily net assets
$50 million to $250 million....................... 0.425% of average daily net assets
Over $250 million................................. 0.375% of average daily net assets
</TABLE>
For purposes of calculating the fees under the above schedules, other assets
managed by Capital Guardian for companies associated with the Manager are taken
into consideration according to Capital Guardian's fee aggregation and discount
policies.
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<PAGE>
MANAGING THE INVESTMENTS OF THE FUNDS
EQUITY INDEX FUNDS - COMPENSATION IN THE MASTER/FEEDER MUTUAL FUND STRUCTURE
The Equity Index Funds are feeder funds that invest all of their assets in
Master Portfolios with substantially similar investment objectives, strategies
and risks. Barclays provides investment guidance and policy direction for each
Master Portfolio. For its services to the Master Portfolios, Barclays receives
annual fees based on the following annual rates:
<TABLE>
<CAPTION>
FUND ANNUAL MANAGEMENT FEE
--------------------------------------------------------------------------------
<S> <C>
S&P 500 Index Master Portfolio 0.05% of average daily net assets
Russell 2000 Index Master Portfolio 0.10% of the average daily net assets, which
includes a 0.02% administrative fee
International Index Master Portfolio 0.25% of the average daily net assets up to
$1 billion, which includes a 0.10% administrative
fee, and 0.17% of the average daily net assets thereafter,
which includes a 0.07% administrative fee.
</TABLE>
Unlike many traditional actively managed investment funds, there is no single
portfolio manager who makes investment decisions for the Master Portfolios.
Instead, the Master Portfolios track their respective indexes.
FEEDER FUND EXPENSES. Each Equity Index Fund bears its corresponding Master
Portfolio's expenses in proportion to the amount of assets it invests in the
corresponding Master Portfolio. Each Equity Index Fund can set its own
transaction minimums, fund-specific expenses and conditions.
FEEDER FUND RIGHTS. Under the master/feeder structure, the Board of the Trust
retains the right to withdraw the assets of an Equity Index Fund from a
Master Portfolio if it believes doing so is in the best interests of the
Equity Index Fund and its shareholders. If the Board withdraws assets of any
Equity Index Fund, it would then consider whether that Fund should invest in
another master portfolio or take other action.
33
<PAGE>
SHAREHOLDER INFORMATION
You may buy shares of any of the Funds by contacting your State Farm VP
Management Corp. Registered Representative, by submitting a written order
directly to State Farm VP Management Corp. at the address listed below, by
contacting a State Farm VP Management Corp. Investor Services Representative at
1-800-447-4930 from 7:00 a.m. through 7:00 p.m. (Central Time) Monday through
Friday (except holidays), or via the internet.
We will employ reasonable procedures to confirm that telephone and internet
instructions are genuine. These procedures include recording telephone calls,
requiring the use of a personal identification number for internet transactions,
and sending you transaction confirmation statements. If the Manager and the
Funds fail to comply with such procedures, they may be liable for any losses due
to unauthorized or fraudulent instructions. However, the Funds, the Manager and
their respective officers, directors, employees and agents will not be liable
for acting upon instructions given, when reasonably believed to be genuine.
During periods of volatile economic and market conditions, you may have
difficulty initiating a transaction by telephone or by the internet, in which
case you should consider sending in your request by letter or through your State
Farm VP Management Corp. Registered Representative.
Telephone Transaction Privileges are automatically established for you unless
you decline these privileges on the Application. If you currently do not have
the Telephone Transaction Privileges but would like to sign up for these
privileges, you may complete an Investor Account Services Form. Your signature
on the Investor Account Services Form must be guaranteed (see "Signature
Guarantee"). You cannot use Telephone Transaction Privileges to initiate
investments or redemptions in shares in transactions for tax-qualified accounts.
Although the Application or the Investor Account Services Form authorize the
Funds and the Manager to record all telephone instructions, the Funds may not
honor telephone instructions unless permission to record is confirmed by the
caller. Each Fund reserves the right at any time to suspend, limit, modify or
terminate Telephone Transaction Privileges, but will not do so without giving
you at least 30 days' prior written notice.
WHAT TYPE OF ACCOUNT WOULD YOU LIKE?
INDIVIDUAL OR JOINT OWNERSHIP. These are intended for your general investment
needs. A single person owns an individual account. Joint tenant accounts can
have two or more owners, and provide for rights of survivorship. Both types of
accounts are registered under one tax identification number.
GIFT OR TRANSFER TO A MINOR (UGMA, UTMA). These custodial accounts let you
give money to a minor for any purpose. This gift is irrevocable, and the
minor can gain control of the account once he/she reaches the age of
majority, or, in the case of UTMA, age 21. Your application should include
the minor's social security number.
BUSINESS, TRUST OR ORGANIZATION. This account is for a corporation, trust,
association, partnership or similar institution. Along with your application,
please enclose a certified corporate resolution or other appropriate
documentation that indicates which officers, trustees or persons are
authorized to act for the legal entity.
TAX-QUALIFIED ACCOUNTS. A tax-qualified account enables you to defer taxes on
investment income and capital appreciation. Your contributions may be
tax-deductible. Tax-qualified accounts require a special application. Please
contact your State Farm VP Management Corp. Registered Representative or call us
at 1-800-447-4930.
- TRADITIONAL INDIVIDUAL RETIREMENT ACCOUNT (IRA). You may invest up to
$2,000 per tax year in an IRA if you are not age 70 1/2 by the end of the
year and you have "earned" (non-investment) income. If your spouse has
less than $2,000 in earned income, he or she may still contribute up to
$2,000 in an IRA, so long as your combined earned income is at least
$4,000 and you file a joint return.
- ROTH IRA. Compared to the traditional IRA, the Roth IRA has different
eligibility requirements and tax treatment. If you're a single taxpayer
with adjusted gross income up to $95,000, you may contribute up to $2,000
per year - or up to $4,000 per year if you're married with adjusted gross
income up to $150,000 per year and you file a joint return. You also must
have earned income at least equal to your contributions, as with a
traditional IRA, but
34
<PAGE>
you can contribute to a Roth IRA even if you are 70 1/2 or older by the
end of the year. Your contributions to a Roth IRA are not tax-deductible,
but withdrawals are not taxable if your Roth IRA has been in force for at
least five years and you: (1) are at least 59 1/2 years old, (2) have
become disabled, (3) die or (4) use the proceeds (up to $10,000) to
purchase a first home (subject to certain conditions). The amount you can
contribute to a Roth IRA in any year is reduced by the amount you
contribute to a traditional IRA, and vice-versa.
- SIMPLIFIED EMPLOYEE PENSION PLAN (SEP-IRA). If you have a small business
or self employment income, this plan lets you make annual tax-deductible
contributions of up to 15% of the first $170,000 of compensation for you
and any eligible employees.
- EDUCATION IRAs. Allows individuals, subject to certain income limitations,
to contribute up to $500 annually for a child under the age of 18.
Although contributions to an Education IRA are not deductible for federal
income tax purposes, the proceeds are generally not taxable provided
withdrawals are used to pay for qualified higher education expenses. If
contributions are made to a qualified state tuition program for a child,
contributions may not be made to an Education IRA during that tax year.
- OTHER RETIREMENT PLANS. You may also use a Fund for corporate or
self-employed retirement plans. The plan trustee must establish the
appropriate account; the Funds do not offer prototypes of these plans. The
trust or plan must be established before you can open an account. Please
include the date of the trust or plan on the application.
The above is just a summary of the types of retirement accounts available. When
we send your retirement-account application, we will include the applicable IRA
Disclosure Statement. It contains more detailed information about the
requirements for specific IRA accounts.
For more information about the tax advantages and consequences of these various
IRAs and retirement plan accounts, please contact your tax advisor.
MINIMUM INVESTMENTS
Your initial and subsequent investment in each of the Funds has to meet these
minimum requirements.
<TABLE>
<CAPTION>
INVESTMENT MINIMUMS
-----------------------------------------------------------------------------------------------------------
TYPE OF ACCOUNT INITIAL INVESTMENT SUBSEQUENT INVESTMENT
------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Regular Accounts $250 $50
Individual Retirement Accounts $250 $50
Other Tax Qualified Retirement Plans $250 $50
Automatic Investment Plans $50 $50
</TABLE>
The Funds may change the minimum investment amounts.
FLEXIBLE SALES CHARGE OPTIONS
Each Fund offers its shares in two classes to allow you to choose the method of
purchasing shares that is most beneficial to you in light of such factors as the
amount of your investment, your holdings of Fund shares, how long you expect to
hold your investment and other such circumstances.
Class A shares are available for investors choosing an initial sales charge and
Class B shares are for investors who prefer a deferred sales charge. Shares of
each class represent interests in the same Fund, have the same rights and,
except for the differences in sales charges and distribution charges, are
identical in all respects. The two classes have different exchange privileges,
as described below.
The net income attributable to Class A or Class B shares and the dividends
payable on shares of each class will be reduced
35
<PAGE>
by the amount of the shareholder servicing and distribution fees attributable to
those shares and incremental expenses associated with the class. Shareholders of
each class of a Fund have exclusive voting rights on the distribution (12b-1)
plan as it applies to that class. Sales personnel will receive equal
compensation for selling Class A and Class B shares.
CLASS A SHARES
INITIAL SALES CHARGE
INITIAL SALES CHARGE FOR ALL FUNDS EXCEPT THE MONEY MARKET FUND. You can buy
shares of each of the Funds, except the Money Market Fund, at the offering
price, which is the net asset value per share plus a sales load (commission).
You may qualify for a reduced sales charge, or the sales charge may be waived,
as described below under "When Will the Initial Sales Charge be Reduced or
Waived?" The sales charge on shares of these Funds is:
<TABLE>
<CAPTION>
SALES CHARGE AS A PERCENTAGE OF
--------------------------------------------------------------------------------------------------------
AMOUNT OF PURCHASE OFFERING PRICE NET AMOUNT INVESTED
--------------------------------------------------------------------------------------------------------
<S> <C> <C>
Less than $50,000 3.00% 3.09%
$50,000 to $99,999 2.5% 2.56%
$100,000 to $199,999 2.0% 2.04%
$200,000 to $299,999 1.5% 1.52%
$300,000 to $399,999 1.00% 1.01%
$400,000 to $499,999 0.5% 0.503%
$500,000 or more 0%* 0%
</TABLE>
* No sales charge is imposed at the time of purchase on amounts of $500,000 or
more. However, for investment of $500,000 or more in Class A shares of any Fund
other than the Money Market Fund, a contingent deferred sales charge will be
charged if shares are redeemed within 12 months following their purchase at the
rate of 0.5% on the lesser of the value of the shares redeemed (exclusive of
reinvested dividends and capital gains distributions) or the cost of such
shares. The contingent deferred sales charge may be waived in certain
circumstances. See "When will the Contingent Deferred Sales Charge be Waived?"
on p. 39.
INITIAL SALES CHARGE FOR THE MONEY MARKET FUND. The initial sales charge does
not apply to new investments in the Money Market Fund. New investments in the
Money Market Fund will only be accepted in Class A shares. New investment means
all investments except those made through exchanges from another Fund described
in this Prospectus.
WHEN WILL THE INITIAL SALES CHARGE BE REDUCED OR WAIVED?
There are several ways to reduce the initial sales charge:
- Combined Purchases
- Rights of Accumulation
- Special Waivers for Certain Categories of Investors
- Reinvestment Privilege
- Letter of Intent
Your State Farm VP Management Corp. Registered Representative or an Investor
Services Representative can explain these programs to you and help you determine
if you qualify for a sales charge waiver. The sales charge waiver programs may
be changed or discontinued at any time.
COMBINED PURCHASES. Purchases made at the same time for any of the Funds in
related accounts may be aggregated for the purpose of receiving a discounted
sales charge. Investments in related accounts in both Class A and Class B shares
(in certain circumstances) which may be aggregated to qualify for a reduced
sales charge include purchases made for you, your spouse and children under the
age of 21, as well as those made in a tax-qualified plan such as a personal IRA
for those individuals or by a company solely controlled by those individuals or
in a trust established exclusively for the benefit of those individuals.
Purchases by a trustee or other fiduciary account including pension,
profit-sharing or other employee benefit trusts created pursuant to a qualified
plan may be combined to qualify for a reduction of the sales charge. Reduced
36
<PAGE>
SHAREHOLDER INFORMATION
sales charges may also be applied to purchases by qualified employee benefit
plans of a single corporation or of corporations affiliated with each other.
Purchases made for a customer in nominee or street name accounts (accounts which
hold the customer's shares in the name of a broker or another nominee such as a
bank trust department) may not be aggregated with those made for other accounts
and may not be aggregated with other nominee or street name accounts unless
otherwise qualified as noted above. YOU MUST TELL US OR YOUR STATE FARM VP
MANAGEMENT CORP. REGISTERED REPRESENTATIVE AT THE TIME YOUR ORDERS ARE PLACED
THAT THERE ARE MULTIPLE ORDERS WHICH QUALIFY FOR A REDUCED SALES CHARGE.
RIGHTS OF ACCUMULATION. Purchases may also qualify for a reduced sales charge
based on the current total net asset value of your account and any related
accounts in any of the Funds. You must tell us or your State Farm VP Management
Corp. Registered Representative at the time your order is placed that it
qualifies for a reduced sales charge based on related holdings in existing Fund
accounts.
LETTER OF INTENT. You may qualify for a reduced sales charge if you enter
into a non-binding Letter of Intent, telling us that you intend to buy,
within 13 months, shares that, if purchased all at once, would qualify. Fund
shares purchased in the 90 day period prior to entering into the Letter of
Intent may be combined with new purchases in related accounts as shown above
to reach the investment commitment of the Letter of Intent. YOU MUST TELL US
OR YOUR STATE FARM VP MANAGEMENT CORP. REGISTERED REPRESENTATIVE IF YOU WANT
PURCHASES MADE DURING THE PREVIOUS 90 DAYS OR PURCHASES MADE IN RELATED
ACCOUNTS TO COUNT TOWARD YOUR INVESTMENT COMMITMENT. Up to 5% of the stated
amount of the Letter of Intent will be held in escrow to cover additional
sales charges which may be due if investments over the 13-month period are
not sufficient to qualify for the sales charge reduction.
SPECIAL WAIVERS. You may purchase Class A shares without an initial sales
charge if:
- You are purchasing shares of the Money Market Fund.
- You are a current or retired agent or employee of the State Farm Insurance
Companies or a family member of such a person. A "family member" includes
a legally married spouse, lineal ascendants (e.g., parents, grandparents,
etc.), spousal lineal ascendants and lineal descendants (e.g., children,
grandchildren,including stepchildren, court appointed foster children, and
legally adopted children).
- You are purchasing shares by reinvesting the proceeds of the redemption of
shares of one or more of the Funds. You must provide appropriate
documentation that the redemption occurred not more than 90 days prior to
the reinvestment of the proceeds, and that the shares were at one time
subject to an initial sales charge or contingent deferred sales charge.
- You are reinvesting dividends or other distributions from a Fund.
- You are a participant in a retirement plan reinvesting loan repayments.
- You are acquiring Fund shares issued in connection with the acquisition by
a Fund of another investment company.
Class A shares may also be purchased without an initial sales charge in the
following situations. However, redemption of such shares within 12 months of
purchase are subject to a contingent deferred sales charge of 0.5% of the lesser
of the value of the shares redeemed or the total cost of the shares:
- You purchase $500,000 or more of the Funds' shares.
- You are a qualified retirement plan, with a single account or a
nonqualified deferred compensation plan which meets at least one of the
following four criteria: (1) the plan has at least 50 eligible
participants; (2) the plan makes an initial investment of $250,000 or
more; (3) the plan sponsor demonstrates to the satisfaction of the
Trust that the aggregate purchases by the plan will be equal to at
least $250,000 within a reasonable period of time, as determined by the
Trust in its sole discretion; or (4) the sum of the current market
value of the plan assets invested in any of the Funds or the current
purchase amount is at least $250,000; and
- You are a bank trust department investing funds over which you exercise
exclusive discretionary investment authority and that are held in a
fiduciary, agency, advisory, custodial or similar capacity.
37
<PAGE>
If you qualify to purchase shares without an initial sales charge due to a
special waiver, you must complete the "Purchase at NAV" form which can be
obtained by calling 1-800-447-4930 or by contacting your State Farm VP
Management Corp. Registered Representative. The Purchase at NAV form must be
sent to the Manager with the Application or with your purchase order.
DISTRIBUTION AND SERVICE FEES
Each Fund has adopted a plan pursuant to Rule 12b-1 under the Investment
Company Act of 1940 (the "1940 Act"), which provides that the Funds will pay
a distribution fee. Because these fees are paid out of the Funds' assets on
an ongoing basis, over time these fees will increase the cost of your
investment and may cost you more than paying other types of sales charges.
For all Funds other than the Money Market Fund, Class A shares are subject to
a distribution fee of up to 0.25% per year of the average daily net assets of
Class A shares. For the Money Market Fund, Class A shares are subject to a
distribution fee of up to 0.15% per year of the average daily net assets of
Class A shares. The Equity and Bond Fund does not directly pay a 12b-1 fee,
but its stockholders will effectively pay these 12b-1 fees because of the
Fund's underlying investments in the Equity Fund and the Bond Fund. The
distribution fee is payable to State Farm VP Management Corp. to reimburse it
for services and expenses incurred in connection with the distribution of
Fund shares, including unreimbursed expenses incurred in years prior to the
year of payment. These expenses include payments to State Farm VP Management
Corp. Registered Representatives, expenses of printing and distributing
prospectuses to persons other than Fund shareholders, and expenses of
preparing, printing and distributing advertising and sales literature. In
addition, Class A shares of each Fund pay (other than the Equity and Bond
Fund) a shareholder servicing fee of up to 0.25% per year of the average
daily net assets of that Class to the Manager, which may be paid to provide
ongoing account services to shareholders. Although Equity and Bond Fund does
not directly pay this fee, the Funds in which the Equity and Bond Fund invest
impose this fee. Shareholder services may include establishing and
maintaining shareholder accounts, answering shareholder inquiries and
providing other personal services to shareholders. The Manager and State Farm
VP Management Corp. may profit from the shareholder servicing and 12b-1 fees.
CLASS B SHARES
CONTINGENT DEFERRED SALES CHARGE
Unlike an initial sales charge, which is paid when you purchase shares, a
contingent deferred sales charge is only paid if you sell your shares during
a certain period of time. Class B shares are offered at net asset value
without an initial sales charge, but subject to a contingent deferred sales
charge as set forth in the table below. The schedule shows the contingent
deferred sales charges applicable for the first through sixth years of
redemption after purchase. The schedule applicable to a specific purchase is
determined at the time the purchase is made. The contingent deferred sales
charge is imposed on the lesser of the value of the shares redeemed
(exclusive of reinvested dividends and capital gains distributions) or the
cost of such shares.
<TABLE>
<CAPTION>
CONTINGENT DEFERRED SALES CHARGE APPLICABLE IN THE YEAR OF REDEMPTION AFTER PURCHASE*
-----------------------------------------------------------------------------------------
FIRST SECOND THIRD FOURTH FIFTH SIXTH
-----------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
3.00% 2.75 % 2.75% 2.50% 2.00% 1.00%
</TABLE>
* No contingent deferred sales charge is paid on an exchange of shares, nor is
one paid on the sale of shares received as a reinvestment of dividends or
capital gains distribution. Class B shares will convert to Class A shares two
years after the expiration of the contingent deferred sales charge for that
purchase. Shares received as a reinvestment of dividends or capital gains
distributions will be converted to Class A shares in the same proportion as
purchased shares are converted.
Purchases of $100,000 or more generally will not be accepted in Class B
shares. Class A shares will be issued in these cases.
In determining whether a contingent deferred sales charge is applicable to a
redemption of Class B shares, the calculation will be made in a manner that
results in the lowest possible charge. It will be assumed that the redemption is
made first from shares acquired through the reinvestment of dividends and
distributions; then from amounts representing the increase in net asset value of
your holdings of Class B shares above the
38
<PAGE>
SHAREHOLDER INFORMATION
total amount of payments for the purchase of Class B shares during the preceding
six years; then from shares held beyond the applicable contingent deferred sales
charge period; and finally, from shares subject to the lowest contingent
deferred sales charge.
AUTOMATIC CONVERSION OF CLASS B SHARES
Class B shares are automatically converted to Class A shares two years after the
expiration of any contingent deferred sales charge. This conversion feature
relieves Class B shareholders of the higher asset-based sales charge that
otherwise applies to Class B shares under the Class B distribution plan
described below. The conversion is based on the relative net asset value of the
two Classes, and no charge is imposed in connection with the conversion.
WHEN WILL THE CONTINGENT DEFERRED SALES CHARGE SCHEDULE BE WAIVED?
A contingent deferred sales charge will not be assessed on Class A shares (for
purchases of $500,000 or more) or Class B shares for:
- exchanges of Class A or Class B shares of one Fund for the same Class of
shares of another Fund;
- redemptions from tax-deferred retirement plans and Individual Retirement
Accounts for required minimum distributions due to attainment of age
70-1/2;
- redemptions from tax-deferred retirement plans for returns of excess
contributions to the plan, termination of employment, participant loans
and hardship withdrawals;
- redemptions as a result of death of the registered shareholder or in the
case of joint accounts, of all registered shareholders;
- redemptions as a result of the disability of the registered shareholder
(as determined in writing by the Social Security Administration) which
occurs after the account was established; and
- redemptions for failure to meet minimum account balances.
DISTRIBUTION AND SHAREHOLDER SERVICING FEES
For all Funds except the Money Market Fund, Class B shares are charged fees at
an annual rate of 0.90% of the average daily net assets to compensate State Farm
VP Management Corp. and the Manager for certain distribution and shareholder
servicing expenses. These fees consist of a fee at an annual rate of 0.65% for
distribution expenses pursuant to a plan adopted under Rule 12b-1 under the 1940
Act, and a fee for the Manager at an annual rate of 0.25% of average daily net
assets for shareholder servicing expenses. For the Money Market Fund, Class B
shares are charged fees at an annual rate of 0.80% of the average daily net
assets to compensate State Farm VP Management Corp. and the Manager for certain
distribution and shareholder servicing expenses. These fees consist of a fee at
an annual rate of 0.55% for distribution expenses pursuant to a plan adopted
under Rule 12b-1 under the 1940 Act and a fee at an annual rate of 0.25% for
shareholder servicing expenses. There are no distribution or shareholder
servicing fees on the Equity and Bond Fund; although the underlying Funds in
which the Equity and Bond Fund invests impose those fees.
CALCULATING NET ASSET VALUE
The offering price of the shares of each Fund is its Net Asset Value (NAV), plus
an initial sales charge on the Class A shares. NAV is calculated by adding all
of the assets of a Fund, subtracting the Fund's liabilities, then dividing by
the number of outstanding shares. A separate NAV is calculated for each class of
each Fund. We calculate the NAV of the Equity Index Funds based on the NAVs of
each corresponding Master Portfolio. Each are calculated on the same day.
The NAV for each Fund is determined as of the time of the close of regular
session trading on the New York Stock Exchange ("NYSE") (currently at 4:00 p.m.,
Eastern Time), on each day when the NYSE is open for business. Shares of the
Funds will not be priced on days when the NYSE is closed. Each Fund values its
assets at their current market value when market quotations are readily
available. If a market value cannot be established, the Board of the Trust
values assets in accordance with procedures approved by the Board of Trustees.
Money market securities, other than U.S. Treasury securities, that mature within
60 days or less are valued using the amortized cost method, unless the Board of
Trustees determines that this does not represent fair value.
All investments by the International Equity Fund and International Index Fund
are valued in U.S. dollars based on the then prevailing exchange rate. Because
each of these international
39
<PAGE>
funds invest in securities that are listed on foreign exchanges that trade on
days when the Fund does not price its shares, the value of the foreign
securities owned by these Funds may change on days when you will not be able to
purchase or redeem the shares. Specific information about how the Funds value
certain assets is set forth in the Statement of Additional Information.
Investments in a Master Portfolio are valued based on an interestholder's
proportionate ownership interest in the Master Portfolio's aggregate net assets
as next determined after an order is received in proper form. The aggregate NAV
of each Master Portfolio (i.e., the value of it's assets less liabilities) is
determined as of 4:00 p.m. (Eastern time) on each day the New York Stock
Exchange is open for business. The Master Portfolio's investments are valued
each business day, typically by using available market quotations or at fair
value determined in good faith by the Master Fund's Board of Trustees.
HOW TO BUY SHARES
GENERAL
You must indicate at the time of investment whether you are purchasing Class
A shares or Class B shares. If you do not indicate Class A or Class B shares,
we will assume you want to purchase Class A shares. You also are required by
federal regulations to certify your Taxpayer Identification or Social
Security Number when opening your account. Failure to provide an
identification number could subject you to back-up withholding on any
distributions, redemptions or disbursements from your account.
Purchase orders are effected at the net asset value per share next determined
after receipt of the order in proper form by State Farm VP Management Corp.
or its Registered Representatives, plus the applicable sales charge for Class
A shares. Receipt of an order in proper form means that State Farm VP
Management Corp. or its Registered Representative have received the order and
payment for shares.
All checks should be made payable to State Farm Mutual Funds. Third-party
checks will not be accepted. All payments should be in U.S. dollars and
should be drawn only on U.S. banks. The Funds reserve the right to reject any
purchase order.
OPENING AND ADDING TO AN ACCOUNT
THROUGH YOUR STATE FARM VP MANAGEMENT CORP. REGISTERED REPRESENTATIVE. Contact
your Registered Representative directly for instructions.
BY WRITING TO THE MANAGER. To open a new account in writing, complete and sign
the Application and mail it to State Farm Mutual Funds, P.O. Box 219548, Kansas
City, Missouri 64121-9548, together with a check made payable to "State Farm
Mutual Funds" or a properly completed ACH authorization. You may obtain an
Application by calling the State Farm VP Management Corp. call center at
1-800-447-4930. You may make subsequent investments at any time by mailing a
check to the Manager, payable to State Farm Mutual Funds, along with the
detachable investment slip found at the top of your confirmation statement. You
may also send a letter of instruction indicating your account registration,
account number and the Fund name.
BY TELEPHONE. With the Telephone Investment Privilege, you can purchase
additional Fund shares by having the Fund make an electronic withdrawal from
your pre-designated bank account. To make a telephone investment, call
1-800-447-4930.
BY THE INTERNET. Visit our web site at www.statefarm.com, and click on the
"Mutual Funds" link. If you would like to open an account, print and complete
the Application and mail it along with your personal check or an ACH
authorization to State Farm Mutual Funds, P.O. Box 219548, Kansas City, Missouri
64121-9548. If you would like to add to your account that has already been
established, follow the instructions presented on the screen.
BY AUTOMATIC INVESTING. The automatic investment plan allows you to make regular
investments in a Fund through automatic transfers from your bank account. To
sign up, complete the appropriate section of the Application or get an Investor
Account Services Form by calling 1-800-447-4930. You can make periodic
investments of $50 or more by authorizing a Fund to withdraw funds from your
bank or credit union account. There is no charge to participate in the automatic
investment plan. You can stop the withdrawals at any time by notifying your
State Farm VP Management Corp. Registered Representative, by writing the
Manager, or by contacting an Investor Services Representative at 1-800-447-4930.
40
<PAGE>
SHAREHOLDER INFORMATION
GENERAL POLICIES ON BUYING SHARES
- Your purchase order must be received by 4:00 p.m., Eastern Time to get
that day's NAV. It is the responsibility of your State Farm VP Management
Corp. Registered Representative to promptly submit purchase orders to the
Funds.
- All purchases are subject to the sales charge, unless they qualify for a
sales charge reduction or waiver programs.
- All checks must be payable in U.S. dollars, drawn on a U.S. bank and made
payable to "State Farm Mutual Funds." Money orders and third-party checks
will not be accepted.
- Unless you instruct otherwise, all of your income dividends and capital
gain distributions will be reinvested in your account. You may, however,
at any time request in writing, by calling 1-800-447-4930, or by visiting
our website at www.statefarm.com to have your income dividends and
capital gain distributions paid to you in cash.
- Stock certificates will not be issued.
- The Manager will send to you by mail a confirmation of each transaction,
other than purchases by the automatic investment plan method. You will
receive confirmation of your purchases by the automatic investment plan
method promptly after the end of each calendar quarter.
- Each Fund reserves the right, in its sole discretion, to reject purchases
when, in the judgment of the Manager, the purchase would not be in the
best interest of the Fund. No order to purchase shares is binding on a
Fund until it has been confirmed in writing and the Fund has received
payment.
- You are required by federal regulations to certify your taxpayer
identification or Social Security number when opening your account.
Failure to provide an identification number could subject you to backup
withholding on any distributions, redemptions, or disbursements from your
account. Further, you must reside in a jurisdiction where Fund shares may
lawfully be offered for sale.
HOW TO EXCHANGE SHARES
Except for exchanges from new investments in shares of the Money Market Fund
(see below), you may exchange your shares for shares of the same Class of
another Fund without a sales charge. A new investment in the Money Market Fund
is an investment you initially make in that Fund by means other than through an
exchange from another Fund. If you are exchanging a new investment in shares of
the Money Market Fund for Class A shares of another Fund, an initial sales
charge will apply at the time of the exchange. If you are exchanging a new
investment in shares of the Money Market Fund for Class B shares of another
Fund, you are treated as purchasing the Class B shares of the other Fund on the
day of the exchange.
Fund shares may be exchanged as follows:
THROUGH YOUR STATE FARM VP MANAGEMENT REGISTERED REPRESENTATIVE. Contact your
State Farm VP Management Corp. Registered Representative directly for
instructions.
IN WRITING. A written exchange request must be signed by all of the owners of
the account, must be sent to the Manager, and must clearly indicate your account
number, account registration and the Fund names and the number of shares or the
dollar amount you wish to exchange. Send your request to State Farm Mutual
Funds, P.O. Box 219548, Kansas City, Missouri 64121-9548.
BY TELEPHONE. With the Telephone Exchange Privilege, you may call the Manager
and request an exchange. You must identify the existing account by giving the
Fund's name, registration of the account and account number, and must specify
the dollar amount or number of shares to be exchanged and the Fund to which the
exchange should be made.
BY THE INTERNET. For accounts other than qualified plans, you can exchange
shares of one Fund for another through our web site at www.statefarm.com. Just
click on the "Mutual Funds" link at that site and follow the instructions
presented on the screen.
41
<PAGE>
GENERAL POLICIES ON EXCHANGING SHARES
- An exchange will be effective on the day your request is received, if it
is received by State Farm VP Management Corp. or its Registered
Representatives before the Funds calculate their NAVs on that day; a
request received after the time the NAV is calculated will be effective at
the next calculated NAV. All Funds calculate their NAVs as of the close of
regular session trading on the NYSE (currently at 4:00 p.m., Eastern
Time) or each day the NYSE is open for business.
- You have to meet the minimum investment requirements of the Fund into
which you are exchanging.
- For all Funds, other than the Money Market Fund, you may make 4 exchanges
out of the Fund during a calendar year. There is no charge for exchanges,
provided that you exchange your shares for shares of the same class of
another Fund. After the fourth exchange out of a Fund during a calendar
year, the Manager will not allow you to directly exchange shares from that
Fund to another Fund.
- You may make an unlimited number of exchanges out of the Money Market Fund
during a calendar year. See "Flexible Sales Charge Options" in this
Prospectus for information about sales charges when exchanging shares of
the Money Market Fund.
- Because excessive trading can hurt Fund performance and shareholders, the
Funds may refuse any exchange purchase if: (1) the Manager believes the
Fund would be harmed or unable to invest effectively; or (2) the Fund
receives or anticipates simultaneous orders that may significantly affect
the Fund.
- You can only exchange shares if the Fund has received good payment for
those shares.
- An exchange is a sale of shares from one Fund and the purchase of shares
of another Fund for federal income tax purposes, which may produce a
taxable gain or loss in a taxable account.
- Before making an exchange please read the description of the Fund to be
purchased in this prospectus.
- The Trust may terminate or modify the exchange program at any time, but
the Trust will seek to give shareholders at least 60 days notice prior to
such change.
HOW TO REDEEM FUND SHARES
You may redeem shares of any of the Funds by contacting your State Farm VP
Management Corp. Registered Representative, by sending a written request, by
telephone, by using our systematic withdrawal program, or by exchanging into
another Fund.
THROUGH YOUR STATE FARM VP MANAGEMENT CORP. REPRESENTATIVE. Contact your State
Farm VP Management Corp. Registered Representative directly for instructions.
IN WRITING. You may redeem all or any portion of your shares by sending a
written request to the Manager:
State Farm Mutual Funds
P.O. Box 219548
Kansas City, Missouri 64121-9548
Your redemption request must clearly identify the exact name(s) in which your
account is registered, your account number, the Fund name and the number of
shares or dollar amount you wish to redeem.
All shareowners of record must sign the redemption request, including each joint
holder of a joint account. The Fund reserves the right to require further
documentation in order to verify the authority of the person seeking to redeem.
If you request a redemption of more than $100,000, your signature, and the
signatures of any joint owners of your account, must be guaranteed as described
under "Signature Guarantee."
Redemption proceeds you request in writing normally will be sent by check to
your address of record. If you give specific instructions in your written
redemption request, and your signature is guaranteed as described under
"Signature Guarantee," you may have the proceeds sent to another payee or to an
address other than the address of record. If you request expedited delivery of
the redemption proceeds, a fee of $15.00 will be deducted from your redemption
proceeds.
BY TELEPHONE. With the Telephone Redemption Privilege, you can redeem shares by
calling 1-800-447-4930. You may redeem shares by telephone up to and including
$100,000 if the proceeds are to be sent to the address of record, or you may
redeem up to the entire value of your account if the proceeds are to be
electronically transferred to a pre-designated bank account.
42
<PAGE>
SHAREHOLDER INFORMATION
BY THE INTERNET. Visit our website at www.statefarm.com -TM-, click on the
"Mutual Funds" link, and follow the instructions presented on the screen.
SYSTEMATIC WITHDRAWAL PROGRAM. If you own $5,000 or more of a Fund's shares at
the current net asset value, you may have a specified dollar amount withdrawn
from your account, payable to you or to another designated payee on a monthly,
quarterly or annual basis of $100 or more. Because withdrawals are sales, they
may produce a gain or loss. You should not purchase additional shares at the
same time that you are participating in the systematic withdrawal plan, because
your purchase will likely be subject to a sales charge and the withdrawal will
be a taxable redemption and may produce a taxable gain or loss.
The Funds reserve the right to amend the systematic withdrawal program on 30
days' notice. The program may be terminated at any time by a shareowner or by a
Fund. For more information contact your State Farm VP Management Corp.
Registered Representative or the Manager at the address shown above.
GENERAL REDEMPTION POLICIES
- Each Fund will redeem shares at the Fund's net asset value next determined
after receipt by the Fund of a proper request for redemption. Any
applicable contingent deferred sales charge on Class B shares redeemed
will be deducted from the redemption proceeds. It is the responsibility of
your State Farm VP Management Corp. Registered Representative to submit to
the Fund a redemption request promptly after you deliver your request to
the State Farm VP Management Corp. Registered Representative.
- A Fund generally will redeem shares in cash or electronic transfer.
Redemptions of more than $500,000 of a Fund's assets during any 90-day
period by one shareowner will normally be paid in cash, but may be paid
wholly or partly by a distribution in-kind of securities. If a redemption
is paid in-kind, the redeeming shareowner may incur brokerage fees in
selling the securities received.
- Payment for shares redeemed will be mailed within seven days after the
Fund receives a redemption request, either in writing, or by telephone, in
proper form.
- If you try to redeem shares paid for by check or electronic transfer
within 15 days after they have been purchased, the Fund may delay sending
the redemption proceeds until it can verify that payment of the purchase
price for the shares has been, or will be, collected.
- Each Fund may suspend the right of redemption or postpone a redemption
payment more than seven days during any period when (a) the NYSE is closed
for other than customary weekend and holiday closings, (b) trading on the
NYSE is restricted, (c) there are emergency circumstances as determined by
the Securities and Exchange Commission, or (d) the Securities and Exchange
Commission has by order permitted such suspension for the protection of
shareowners of the Fund; provided that applicable rules and regulations of
the Securities and Exchange Commission shall govern as to whether any
condition prescribed in (b) through (d) exists.
- Once the Manager has received and accepted your redemption request, you
may not cancel or revoke it. We cannot accept a redemption request that
specifies a particular date or price or any other conditions.
- You may change your address of record by calling 1-800-447-4930, or by
sending a written request to the Manager. If you request an address change
by telephone, redemption proceeds will be sent to the former address
during the fifteen day period after the Manager receives your request.
- For IRA non-systematic withdrawals a shareholder should complete the
Distribution Request Form which can be obtained by calling 1-800-447-4930
or by visiting our website at www.statefarm.com.-TM-
- If you request, redemption proceeds will be sent electronically to your
pre-designated bank account. The electronic transfer will be completed
either through the ACH method or through the wire transfer method,
whichever you choose. With the ACH method the redemption proceeds will
usually be deposited in your pre-designated bank account within one or two
business days after the processing of the redemption request. With the
wire transfer method, the redemption proceeds will usually be deposited in
your pre-designated bank account on the next business day after the
receipt of the redemption request. If you
43
<PAGE>
choose electronic deposit of your proceeds using the wire transfer method,
the Manager will charge you a $15.00 fee, and this fee will be subtracted
from your redemption proceeds. There currently is no charge for electronic
transfer of redemption proceeds using the ACH method. Your bank may charge
additional fees for electronic transfers you initiate. The wire transfer
method is not available to shareowners participating in the systematic
withdrawal program. To change the bank or account designated to receive
your redemption proceeds, send a written request (not by fax) signed by
each shareowner with each signature guaranteed as described in this
prospectus under "Signature guarantee" to:
State Farm Mutual Funds
P.O. Box 219548
Kansas City, Missouri 64121-9548
If the registered owner(s) of the new bank account is/are the same as the
registered owner(s) of the former bank account, no signature guarantee is
necessary.
- If your account value falls below the minimum investment amount (see
p. 35) and you are not participating in the automatic investment program,
the Fund may redeem your shares and send the proceeds to you at your
registered address. You will receive notice that we intend to do this at
least 30 days in advance so that you may increase the balance in your
account if you choose. If your account falls below $10, we may redeem your
shares and send you the proceeds, without notice to you.
- Because servicing smaller accounts is very expensive, if your account
balance falls below $500 on the last day of the calendar quarter through
redemptions or any other reason, your account will be charged a low
balance fee of $2.50 per quarter. The low balance fee does not apply (1)
if your accounts in all the State Farm Funds have a combined value of $500
or more, (2) to IRAs or other prototype retirement plans, (3) accounts
participating in the automatic investment plan or (4) omnibus or nominee
accounts. The Funds may waive the fee, in their discretion, in the event
of a significant market correction.
SIGNATURE GUARANTEE
A signature guarantee is a written representation, signed by an officer or
authorized employee of the guarantor, that the signature of the shareowner is
genuine. The guarantor must be an institution authorized to guarantee signatures
by applicable state law. Such institutions include banks, broker-dealers,
savings and loan associations and credit unions. A notary public cannot provide
a signature guarantee.
The signature guarantee must appear, together with the signature of each
registered owner, either
- on the written request for redemption that exceeds $100,000, which clearly
identifies the exact name(s) in which the account is registered, the
account number, the Fund name and the number of shares or the dollar
amount to be redeemed;
- on a separate "stock power," an instrument of assignment which should
specify the total number of shares to be exchanged or redeemed (this stock
power may be obtained from most banks and stock brokers);
- if you request that a redemption check be made payable to anyone other
than the shareholder(s) of record, that request must be signed and
accompanied by a signature guarantee of each registered owner;
- if you request that a redemption check be mailed to an address other
than the address of record, that request must be signed and accompanied
by a signature guarantee of each registered owner; or
- on the Investor Account Services Form used to establish the Telephone
Investment, Redemption and/or Exchange Privilege(s), and on the Investor
Account Services Form used to change the pre-designated bank account into
which redemption proceeds may be deposited. If pre-designated bank account
information is changed but the registered owner(s) of the bank account
remains the same, no signature guarantee will be required.
The Funds will waive the requirement for a signature guarantee if your State
Farm VP Management Corp. Registered Representative certifies in writing that
your signature is genuine.
44
<PAGE>
DIVIDENDS
DISTRIBUTIONS
AND TAXES
Each Fund intends to distribute substantially all of its net investment income
and any net capital gain realized from sales of its portfolio securities.
The Equity Fund, Equity Index Funds, Small Cap Equity Fund, Equity and Bond Fund
and International Equity Fund declare and pay dividends and capital gain
distributions, if any, at least annually.
The Bond Fund, the Money Market Fund, and the Tax Advantaged Bond Fund declare
dividends daily and pay dividends monthly on the last business day of the month.
Capital gain distributions on these Funds, if any, are generally paid annually.
All dividends and capital gain distributions from a Fund are automatically
reinvested in shares of that Fund on the reinvestment date, unless you
previously have elected to receive dividends and distributions in cash. If the
total dividend is less than $10 for an account owner of a Fund, the dividend
will automatically be reinvested in additional shares of the Fund.
TAXES ON DISTRIBUTIONS. Distributions from each Fund, other than the Tax
Advantaged Bond Fund, are generally subject to federal income tax, and may be
subject to state or local taxes. If you are a U.S. citizen residing outside the
United States, your distributions may also be taxed by the country in which you
reside. Your distributions are taxable when they are paid, whether you take them
in cash or reinvest them in additional shares.
The dividends from the Tax Advantaged Bond Fund will largely be exempt from
regular federal income tax, because the Tax Advantaged Bond Fund invests
primarily in municipal bonds. A portion of the Tax Advantaged Bond Fund's
dividends may be subject to the federal alternative minimum tax (AMT). Tax
Advantaged Bond Fund dividends may be subject to state and local taxes. Tax
Advantaged Bond Fund will provide you annually with the state-by-state sources
of its income.
For federal tax purposes, a Fund's income and short-term capital gain
distributions are taxed as dividends; long-term capital gain distributions are
taxed as long-term capital gains, no matter how long you have held your Fund
shares.
Every January, the Funds will send you and the IRS a statement called Form 1099
showing the sources and amounts of taxable distributions you received in the
previous calendar year.
FOREIGN TAXES. A Fund may receive income from sources in foreign countries, and
that income may be subject to foreign taxes at its source. If your Fund pays
non-refundable taxes to foreign governments during the year, those taxes will
reduce that Fund's dividend, but will still be included in your taxable income.
You may be able to claim an offsetting credit or deduction on your tax return
for your share of foreign taxes paid by a Fund for a particular year if more
than 50% of its total assets consists of stock or securities in foreign
corporations and the Fund makes a special tax election for such year whereby
each of its shareholders includes in his gross income and treats as paid by him
his proportionate share of such foreign taxes. It is expected that only
International Equity Fund and International Index Fund may qualify for this
election. We will send you detailed information about the foreign tax credit or
deduction each year.
TAXES ON TRANSACTIONS. A redemption is a sale for federal income tax purposes.
Your redemption proceeds may be more or less than your cost depending upon the
net asset value at the time of the redemption and, as a result, you may realize
a capital gain or loss. Gain or loss is computed on the difference between the
amount you receive in exchange for the shares redeemed and their basis.
An exchange of any Fund's shares for shares of another Fund will be treated as a
sale of the Fund's shares at their fair market value and any gain on the
transaction may be subject to federal income tax.
Whenever you sell shares of a Fund, you will receive a confirmation statement
showing how many shares you sold and at what price. You also will receive a
year-end statement every January. This will allow you or your tax preparer to
determine the tax consequences of each redemption. However, be sure to keep your
regular account statements; their information will be essential in calculating
the amount of your capital gains or losses.
To invest in any of the Funds, you must be a U.S. resident with a social
security or taxpayer identification number. When you sign your account
application, you must certify that your social security or taxpayer
identification number is correct and that you are not subject to backup
withholding If you fail to comply with this procedure, the Fund must
withhold 31% of your taxable distributions and redemptions.
45
<PAGE>
SHARED DELIVERY
SHARED DELIVERY OF PROSPECTUS AND FUND REPORTS. The rules governing mutual funds
require each of the Funds semiannually to furnish to its shareowners a report
containing that Fund's financial statements and the Funds generally send each
new prospectus to all shareowners. Each Fund intends to send one copy of each
prospectus and report to an address shared by more than one shareowner (commonly
referred to as "householding" delivery). By signing the Account Application, you
consent to the "householded" delivery of the prospectus and reports unless and
until you revoke your consent by notifying the Fund as set forth below.
REVOCATION OF SHARED DELIVERY. If you want to receive an individual copy (rather
than a shared or "householded" copy) of a Fund's prospectus or report you may
contact the Manager to request individual delivery in writing at State Farm
Investment Management Corp., P.O. Box 2194548, Kansas City, Missouri 64121-9548
or by telephone at 1-800-447-4930. You may revoke your consent at any time. The
Fund will commence sending individual copies within 30 days after it receives
notice that you have revoked your consent.
46
<PAGE>
APPENDIX A
PAST PERFORMANCE OF THE MANAGER, CAPITAL GUARDIAN AND BARCLAYS
The investment performance for each of the funds or composites below
indicates the performance of the Manager, Capital Guardian and Barclays in
managing substantially similar mutual funds or other accounts with investment
objectives, policies, strategies, and risks that are substantially similar to
those of the Fund to which each is compared. The "composites" shown below are
an aggregation of all accounts managed by Capital Guardian that have
investment objectives, policies, strategies, and risks that are substantially
similar to those of the Funds to which each is compared. The performance
below is shown for the one-, three-, five- and ten-year periods (or since
inception, if shorter) ending September 30, 2000 and does not represent the
performance of the Funds. The composite performance data has been provided by
Capital Guardian. The performance data for the corresponding funds is the
historical performance of other investment companies managed by the Manager
or Barclays.
Each Capital Guardian composite includes all discretionary, taxable,
fee-paying accounts and mutual funds that Capital Guardian managed or
sub-advised, all of which have similar investment profiles. The accounts that
are included in the composites are not subject to the same types of expenses
to which the Funds are subject, nor to the diversification requirements,
specific tax restrictions and investment limitations imposed on the Funds by
the 1940 Act or Subchapter M of the Internal Revenue Code. In fact, the
expenses of the accounts included in the composites are lower than the Funds'
expenses. Consequently, if the Funds had been included in the composites, or
if the accounts included in the composite had been regulated as investment
companies under the federal securities and tax laws, the composites'
performance results would have been lower than what is shown below.
The corresponding funds shown below have lower expenses than the Fund to
which each is compared. Accordingly, if the Manager or Barclays had managed
the Funds during the same periods presented below, the Funds' returns would
have been lower. The presentation of the investment results of the
corresponding funds and composites is not intended to predict or suggest the
returns that might be experienced by the Funds or an individual investor in
the Funds. Investors should also be aware that the use of a methodology
different from that used above to calculate performance could result in
different performance data and that the methodology used above for the
composites is not the SEC standard to calculate total return for mutual
funds. As a result, the performance results for the composites may differ
from the results calculated according to the SEC's method.
<TABLE>
<CAPTION>
CORRESPONDING FUND OR COMPOSITE
INCEPTION DATE
FUND ASSET SIZE AS OF SEPTEMBER 30, 2000
-------------------------------------------------------------------------------------------------------------
Equity Fund State Farm Growth Fund, Inc.
March 14, 1968
$3,059,847,118
Average Annual Total Returns
----------------------------
(For Periods ended September 30, 2000)
One Year Three Years Five Years Ten Years
-------- ----------- ---------- ----------
<S> <C> <C> <C> <C>
16.12% 15.02% 18.41% 17.08%
--------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Small Cap Equity Fund Capital Guardian U.S. Small Cap Equity Composite
September 30, 1977
$6,690,819,855
Average Annual Total Returns
-----------------------------
(For periods ended September 30, 2000)
One Year Three Years Five Years Ten Years
-------- ----------- ---------- ---------
<S> <C> <C> <C> <C>
34.29% 13.72% 20.11% 21.30%
--------------------------------------------------------------------------------------------------------------
</TABLE>
47
<PAGE>
<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------------
International Equity Fund Capital Guardian Non-U.S. Equity Composite
December 30, 1978
$55,456,251,576
Average Annual Total Returns
----------------------------
(For periods ended September 30, 2000)
One Year Three Years Five Years Ten Years
-------- ----------- ---------- ----------
<S> <C> <C> <C> <C>
14.19% 16.87% 17.99% 16.17%
--------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
S&P 500 Index Fund S&P 500 Index Master Portfolio
March 1, 1994
$3,541,487,099
Average Annual Total Returns
----------------------------
(For periods ended September 30, 2000)
One Year Three Years Five Years Ten Years
-------- ----------- ---------- ---------
<S> <C> <C> <C> <C>
13.17% 16.32% 21.52% 19.64%
--------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Small Cap Equity Index Fund Small Cap Index Fund portfolio of the State Farm Variable
Product Trust
January 29, 1998
$134,853,154
Average Annual Total Returns
----------------------------
(For periods ended September 30, 2000)
One Year Since Inception
-------- ---------------
<S> <C> <C>
22.83% 7.87%
--------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
International Index Fund International Index Master Portfolio
October 1, 1999
$80,759,721
Average Annual Total Returns
----------------------------
(For periods ended September 30, 2000)
One Year Since Inception
-------- ---------------
<S> <C> <C>
5.57% 5.57%
--------------------------------------------------------------------------------------------------------------
</TABLE>
Equity and Bond Fund No comparable Fund.
--------------------------------------------------------------------------------
Bond Fund No comparable Fund
--------------------------------------------------------------------------------
Tax Advantaged Bond Fund No comparable Fund
--------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Money Market Fund Money Market Fund portfolio of the State Farm
Variable Product Trust
(January 29, 1998)
$44,100,373
Average Annual Total Returns
----------------------------
(For periods ended September 30, 2000)
One Year Since Inception
-------- ----------------
<S> <C> <C>
5.75% 5.23%
--------------------------------------------------------------------------------------------------------------
</TABLE>
48
<PAGE>
The investment performance indicated in the following four tables shows the
average annual total returns for the one-, three-, five- and ten-year periods
(or since inception, if shorter) for each of the corresponding funds or
composites indicated above, adjusted to reflect the expenses of the Funds,
including sales charges where indicated, for the periods ended September 30,
2000. THE PERFORMANCE DISCLOSED BELOW IS NOT THE PERFORMANCE OF THE FUNDS BUT
RATHER THE PERFORMANCE OF THE CORRESPONDING FUND OR COMPOSITE ADJUSTED TO
REFLECT CHARGES AND EXPENSES OF THE FUNDS. Although each Fund has
substantially similar investment objectives and policies and the same
portfolio managers as the corresponding fund or composite, you should not
assume that the Funds will have the same future performance as the
corresponding fund or composite. For example, any Fund's future performance
may be greater or less than the performance of the corresponding fund or
composite due to, among other things, differences in expenses, asset sizes
and cash flows between a Fund and the corresponding fund or composite. THE
PERFORMANCE FIGURES QUOTED REPRESENT PAST PERFORMANCE AND ARE NOT INTENDED TO
INDICATE FUTURE PERFORMANCE. INVESTMENT RETURNS AND NET ASSET VALUE WILL
FLUCTUATE SO THAT YOUR SHARES, WHEN REDEEMED, MAY BE WORTH MORE OR LESS THAN
THEIR ORIGINAL COST.
The following four tables show the average annualized total returns for the
corresponding funds or composites for the one-, three-, five-and ten-year (or
life of the corresponding fund or composite, if shorter) periods ended
September 30, 2000. These figures are based on the actual gross investment
performance of the corresponding funds or composites. From the gross
investment performance figures, the maximum Total Fund Operating Expenses
shown on p.22 are deducted to arrive at the net return. The first table for
each Class reflects a deduction for the maximum applicable sales charge,
while the second table for each Class reflects no deduction for sales charge.
Performance figures will be lower when sales charges are taken into effect.
ASSUMING CLASS A SHARES TOTAL FUND OPERATING EXPENSES AND
THE MAXIMUM INITIAL SALES CHARGE APPLICABLE TO CLASS A SHARES
<TABLE>
<CAPTION>
CORRESPONDING FUND OR COMPOSITE (INCEPTION DATE) 1 YEAR 3 YEARS 5 YEARS 10 YEARS OR
(CORRESPONDS TO . . . .) SINCE INCEPTION
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
State Farm Growth Fund, Inc. (March 14, 1968)
(Equity Fund) 11.48% 12.70% 16.53% 15.58%
------------------------------------------------------------------------------------------------------------------------
Capital Guardian U.S. Small Cap Equity Composite
(Small Cap Equity Fund) 28.82% 11.05% 17.88% 19.55%
------------------------------------------------------------------------------------------------------------------------
Capital Guardian Non-U.S. Equity Composite
(International Equity Fund) 9.17% 14.06% 15.66% 14.21%
------------------------------------------------------------------------------------------------------------------------
S&P 500 Index Master Portfolio (March 1, 1994)
(S&P 500 Index Fund) 8.89% 14.26% 19.90% 18.21%
------------------------------------------------------------------------------------------------------------------------
Small Cap Equity Index Fund portfolio of the
State Farm Variable Product Trust (January 29,
1998)
(Small Cap Index Fund) 18.48% 5.98%
------------------------------------------------------------------------------------------------------------------------
International Index Master Portfolio (October 1,
1999)
(International Index Fund) 1.20% 1.20%
------------------------------------------------------------------------------------------------------------------------
Money Market Fund portfolio of the State Farm
Variable Product Trust (January 29, 1998)
(Money Market Fund) 5.61% 5.08%
------------------------------------------------------------------------------------------------------------------------
</TABLE>
49
<PAGE>
ASSUMING CLASS A SHARES TOTAL FUND OPERATING EXPENSES AND
WITH NO INITIAL SALES CHARGE
<TABLE>
<CAPTION>
CORRESPONDING FUND OR COMPOSITE (INCEPTION DATE) 1 YEAR 3 YEARS 5 YEARS 10 YEARS OR
(CORRESPONDS TO . . . .) SINCE INCEPTION
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
State Farm Growth Fund, Inc. (March 14, 1968)
(Equity Fund) 14.97% 13.86% 17.25% 15.94%
------------------------------------------------------------------------------------------------------------------------
Capital Guardian U.S. Small Cap Equity Composite
(Small Cap Equity Fund) 32.85% 12.21% 18.61% 19.91%
------------------------------------------------------------------------------------------------------------------------
Capital Guardian Non-U.S. Equity Composite
(International Equity Fund) 12.60% 15.30% 16.45% 14.57%
------------------------------------------------------------------------------------------------------------------------
S&P 500 Index Master Portfolio (March 1, 1999)
(S&P 500 Index Fund) 12.29% 15.44% 20.64% 18.76%
------------------------------------------------------------------------------------------------------------------------
Small Cap Equity Index Fund portfolio of the
State Farm Variable Product Trust (January 29,
1998)
(Small Cap Index Fund) 22.17% 7.21%
------------------------------------------------------------------------------------------------------------------------
International Index Master Portfolio (October 1,
1999)
(International Index Fund) 4.37% 4.37%
------------------------------------------------------------------------------------------------------------------------
Money Market Fund portfolio of the State Farm
Variable Product Trust (January 29, 1998)
(Money Market Fund) 5.61% 5.08%
------------------------------------------------------------------------------------------------------------------------
</TABLE>
ASSUMING CLASS B SHARES TOTAL FUND OPERATING EXPENSES AND
THE REDEMPTION AT THE END OF THE APPLICABLE TIME PERIOD
<TABLE>
<CAPTION>
CORRESPONDING FUND OR COMPOSITE (INCEPTION DATE) 1 YEAR 3 YEARS 5 YEARS 10 YEARS OR
(CORRESPONDS TO . . . .) SINCE INCEPTION
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
State Farm Growth Fund, Inc. (March 14, 1968)
(Equity Fund) 11.57% 12.76% 16.64% 15.54%
------------------------------------------------------------------------------------------------------------------------
Capital Guardian U.S. Small Cap Equity Composite
(Small Cap Equity Fund) 29.45% 11.08% 18.01% 19.50%
------------------------------------------------------------------------------------------------------------------------
Capital Guardian Non-U.S. Equity Composite
(International Equity Fund) 9.20% 14.16% 15.76% 14.16%
------------------------------------------------------------------------------------------------------------------------
S&P 500 Index Master Portfolio (March 1, 1999)
(S&P 500 Index Fund) 8.89% 14.36% 20.06% 18.31%
------------------------------------------------------------------------------------------------------------------------
Small Cap Equity Index Fund portfolio of the
State Farm Variable Product Trust (January 29,
1998)
(Small Cap Index Fund) 18.77% 6.01%
------------------------------------------------------------------------------------------------------------------------
International Index Master Portfolio (October 1,
1999)
(International Index Fund) 0.97% 0.97%
------------------------------------------------------------------------------------------------------------------------
Money Market Fund portfolio of the State Farm
Variable Product Trust (January 29, 1998)
(Money Market Fund) 2.21% 3.84%
------------------------------------------------------------------------------------------------------------------------
</TABLE>
50
<PAGE>
<TABLE>
<CAPTION>
ASSUMING CLASS B SHARES TOTAL FUND OPERATING EXPENSES AND
NO REDEMPTION AT THE END OF THE APPLICABLE TIME PERIOD
CORRESPONDING FUND OR COMPOSITE (INCEPTION DATE) 1 YEAR 3 YEARS 5 YEARS 10 YEARS OR
(CORRESPONDS TO . . . .) SINCE INCEPTION
------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
State Farm Growth Fund, Inc. (March 14, 1998)
(Equity Fund) 14.57% 13.46% 16.85% 15.54%
------------------------------------------------------------------------------------------------------------------------
Capital Guardian Small Cap Equity Composite
(Small Cap Equity Fund) 32.45% 11.79% 18.20% 19.50%
------------------------------------------------------------------------------------------------------------------------
Capital Guardian Non-U.S. Equity Composite
(International Equity Fund) 12.20% 14.83% 15.97% 14.16%
------------------------------------------------------------------------------------------------------------------------
S&P 500 Index Master Portfolio (March 1, 1999)
(S&P 500 Index Fund) 11.89% 15.04% 20.24% 18.36%
------------------------------------------------------------------------------------------------------------------------
Small Cap Equity Index Fund portfolio of the
State Farm Variable Product Trust (January 29,
1998)
(Small Cap Index Fund) 21.77% 6.81%
------------------------------------------------------------------------------------------------------------------------
International Index Master Portfolio (October 1,
1999)
(International Index Fund) 3.97% 3.97%
------------------------------------------------------------------------------------------------------------------------
Money Market Fund portfolio of the State Farm
Variable Product Trust (January 29, 1998)
(Money Market Fund) 5.21% 4.68%
------------------------------------------------------------------------------------------------------------------------
</TABLE>
51
<PAGE>
APPENDIX B
<TABLE>
<CAPTION>
Equity Small Interna- S&P Small Interna- Equity Bond Tax Money
Fund Cap tional 500 Cap tional and Fund Advantaged Market
Equity Equity Index Index Index Bond Bond Fund
Fund Fund Fund Fund Fund Fund Fund
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
------------------------------------------------------------------------------------------------------------------------------------
SYMBOLS y - PERMITTED n - NOT PERMITTED
------------------------------------------------------------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------------------------------------
Debt Securities n n n y n n y y y n
------------------------------------------------------------------------------------------------------------------------------------
Asset-Backed Securities n n n n n n y y n n
------------------------------------------------------------------------------------------------------------------------------------
Collateralized Mortgage Obligations and
Multiclass Pass-Through Securities n n n n n n y y n n
------------------------------------------------------------------------------------------------------------------------------------
Corporate Asset-Backed Securities n n n n n n n n n n
------------------------------------------------------------------------------------------------------------------------------------
Mortgage Pass-Through Securities n n n n n n y y n n
------------------------------------------------------------------------------------------------------------------------------------
Stripped Mortgage-Backed Securities n n n n n n n n n n
------------------------------------------------------------------------------------------------------------------------------------
Corporate Securities y y y y y y y y y y
------------------------------------------------------------------------------------------------------------------------------------
Loans and Other Direct Indebtedness n n n n n n n n n n
------------------------------------------------------------------------------------------------------------------------------------
Lower Rated Bonds n n n n n n y y y n
------------------------------------------------------------------------------------------------------------------------------------
Municipal Bonds n n n n n n n n y n
------------------------------------------------------------------------------------------------------------------------------------
Speculative Bonds n n n n n n y y y n
------------------------------------------------------------------------------------------------------------------------------------
U.S. Government Securities y y y y y y y y y n
------------------------------------------------------------------------------------------------------------------------------------
Variable and Floating Rate Obligations n n n y y y n n y n
------------------------------------------------------------------------------------------------------------------------------------
Zero Coupon Bonds n n n n n n y y y n
------------------------------------------------------------------------------------------------------------------------------------
Equity Securities y y y y y y y y n n
------------------------------------------------------------------------------------------------------------------------------------
Foreign Securities Exposure y y y n n y y n n n
------------------------------------------------------------------------------------------------------------------------------------
Depositary Receipts y y y n n y y n n n
------------------------------------------------------------------------------------------------------------------------------------
Dollar-Denominated Foreign Money Market Securities y y y y y y y y y y
------------------------------------------------------------------------------------------------------------------------------------
Emerging Markets n n y n n y n n n n
------------------------------------------------------------------------------------------------------------------------------------
Foreign Securities y y y n n y y n n n
------------------------------------------------------------------------------------------------------------------------------------
Forward Contracts y y y n n y y n n n
------------------------------------------------------------------------------------------------------------------------------------
Futures Contracts n n n y y y y y y n
------------------------------------------------------------------------------------------------------------------------------------
Indexed Securities/Structured Products n n n n n n n n n n
------------------------------------------------------------------------------------------------------------------------------------
Inverse Floating Rate Obligations n n n n n n n n y n
------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
51
<PAGE>
<TABLE>
<CAPTION>
Equity Small Interna- S&P Small Interna- Equity Bond Tax Money
Fund Cap tional 500 Cap tional and Fund Advan- Market
Equity Equity Index Index Index Bond taged Fund
Fund Fund Fund Fund Fund Fund Bond
Fund
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
-----------------------------------------------------------------------------------------------------------------------------------
SYMBOLS y - PERMITTED n - NOT PERMITTED
------------------------------------------------------------------------------------------------------------------------------------
Investment in Other Investment Companies
------------------------------------------------------------------------------------------------------------------------------------
Open-End y y y y y y y y y y
------------------------------------------------------------------------------------------------------------------------------------
Closed-End y y y y y y y y y y
------------------------------------------------------------------------------------------------------------------------------------
Lending of Portfolio Securities y y y y y y y y y y
------------------------------------------------------------------------------------------------------------------------------------
Leveraging Transactions y y y y y y y y y y
------------------------------------------------------------------------------------------------------------------------------------
Bank Borrowings y y y n n n y y y y
------------------------------------------------------------------------------------------------------------------------------------
Mortgage "Dollar-Roll" Transactions n n n n n n n n n n
------------------------------------------------------------------------------------------------------------------------------------
Reverse Repurchase Agreements y y y y y y y y y y
------------------------------------------------------------------------------------------------------------------------------------
Options n n n y y y y y y n
------------------------------------------------------------------------------------------------------------------------------------
Options on Foreign Currencies n n n n n n n n n n
------------------------------------------------------------------------------------------------------------------------------------
Options on Futures Contracts n n n y y y y y y n
------------------------------------------------------------------------------------------------------------------------------------
Options on Securities n n n n n n n n n n
------------------------------------------------------------------------------------------------------------------------------------
Options on Stock Indices n n n y y y n n n n
------------------------------------------------------------------------------------------------------------------------------------
Reset Options n n n n n n n n n n
------------------------------------------------------------------------------------------------------------------------------------
"Yield Curve" Options n n n n n n n n n n
------------------------------------------------------------------------------------------------------------------------------------
Repurchase Agreements y y y y y y y y y y
------------------------------------------------------------------------------------------------------------------------------------
Restricted Securities y y y y y y y y y y
------------------------------------------------------------------------------------------------------------------------------------
Short Sales n n n n n n n n n n
------------------------------------------------------------------------------------------------------------------------------------
Short Sales Against the Box n n n n n n n n n n
------------------------------------------------------------------------------------------------------------------------------------
Short Term Instruments y y y y y y y y y y
------------------------------------------------------------------------------------------------------------------------------------
Swaps and Related Derivative Instruments n n n n n n y y y n
------------------------------------------------------------------------------------------------------------------------------------
Temporary Borrowings y y y n n n y y y y
------------------------------------------------------------------------------------------------------------------------------------
Temporary Defensive Positions y y y n n n y y y n
------------------------------------------------------------------------------------------------------------------------------------
Warrants n y y y y y y y n n
------------------------------------------------------------------------------------------------------------------------------------
"When-issued" Securities y y y y y y y y y y
------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
53
<PAGE>
ADDITIONAL INFORMATION ABOUT THE FUNDS
For investors who would like more information about the Funds, the following
documents are available free upon request.
STATEMENT OF ADDITIONAL INFORMATION (SAI). The SAI contains additional
information about all aspects of the Funds. A current SAI has been filed with
the Securities and Exchange Commission and is incorporated in this prospectus by
reference.
TO OBTAIN THE SAI WITHOUT CHARGE, YOU MAY WRITE TO STATE FARM INVESTMENT
MANAGEMENT CORP. AT ONE STATE FARM PLAZA, BLOOMINGTON, IL 61710-0001 OR CALL US
AT (800) 447-4930.
PUBLIC INFORMATION. You can review and copy information about the Trust and each
Fund, including the SAI, at the Securities and Exchange Commission's Public
Reference Room in Washington D.C. You may obtain information on the operation of
the public reference room by calling the Commission at 1-202-942-8090. Reports
and other information about the Trust and the Funds also are available on the
EDGAR Database on the Commission's Internet site at http://www.sec.gov. You may
obtain copies of this information, upon payment of a duplicating fee, by
electronic request at the following e-mail address: [email protected], or by
writing the Public Reference Section of the Securities and Exchange Commission,
Washington, D.C. 20549-6009.
INVESTMENT CO. ACT FILE NO. 811-10027
54
<PAGE>
================================================================================
STATE FARM MUTUAL FUND TRUST
STATE FARM EQUITY FUND
STATE FARM SMALL CAP EQUITY FUND
STATE FARM INTERNATIONAL EQUITY FUND
STATE FARM S&P 500 INDEX FUND
STATE FARM SMALL CAP INDEX FUND
STATE FARM INTERNATIONAL INDEX FUND
STATE FARM EQUITY AND BOND FUND
STATE FARM BOND FUND
STATE FARM TAX ADVANTAGED BOND FUND
STATE FARM MONEY MARKET FUND
One State Farm Plaza
Bloomington, Illinois 61710-0001
(309) 766-2029
STATEMENT OF ADDITIONAL INFORMATION
December 18, 2000
This Statement of Additional Information is not a prospectus but provides
information that you should read in conjunction with the State Farm Mutual
Fund Trust prospectus (the "Prospectus") dated the same date as this
Statement of Additional Information. You may obtain a copy of the Prospectus
at no charge by writing or telephoning State Farm Mutual Fund Trust at the
address or telephone number shown above.
i
<PAGE>
<TABLE>
<CAPTION>
TABLE OF CONTENTS
PAGE
<S> <C>
INFORMATION ABOUT THE FUNDS.......................................................................................1
INVESTMENT OBJECTIVES.............................................................................................1
INVESTMENT TECHNIQUES AND RISKS...................................................................................2
Equity Securities........................................................................................2
Debt Securities..........................................................................................3
Convertible Securities...................................................................................4
U.S. Government Securities...............................................................................4
Floating- and Variable-Rate Obligations..................................................................5
Letters of Credit........................................................................................6
Foreign Securities.......................................................................................6
Stock Index Futures and Options On Stock Index Futures Contracts........................................13
Interest Rate Futures Contracts and Related Options.....................................................15
Warrants................................................................................................17
Municipal Bonds.........................................................................................18
Mortgage-Backed Securities..............................................................................18
Asset-Backed Securities.................................................................................20
Money Market Fund.......................................................................................20
Foreign Money Market Instruments........................................................................21
Cash and Cash Equivalents...............................................................................22
Repurchase Agreements...................................................................................22
Privately Issued Securities.............................................................................22
Forward Commitments, When-Issued And Delayed Delivery Securities........................................23
Loans Of Portfolio Securities...........................................................................24
Defensive Investments...................................................................................24
INVESTMENT POLICIES AND RESTRICTIONS.............................................................................25
Fundamental Restrictions................................................................................25
Non-Fundamental Restrictions............................................................................27
Fundamental Operating Policies of the Master Portfolios.................................................28
MORE ABOUT THE EQUITY INDEX FUNDS................................................................................32
Master/Feeder Structure.................................................................................32
Selection of Investments for the Master Portfolio.......................................................34
Tracking Error..........................................................................................34
Relationship With the Index Providers...................................................................35
Standard & Poor's.......................................................................................35
Russell 2000............................................................................................35
EAFE Index..............................................................................................36
TRUSTEES AND OFFICERS............................................................................................37
INVESTMENT ADVISORY AGREEMENTS...................................................................................46
Between the Trust and the Manager.......................................................................46
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<PAGE>
Between Barclays and the Master Portfolios..............................................................48
Between the Manager and Capital Guardian................................................................49
SECURITIES ACTIVITIES OF THE MANAGER, CAPITAL GUARDIAN AND BARCLAYS..............................................50
PORTFOLIO TRANSACTIONS AND BROKERAGE.............................................................................51
The Equity Fund, Equity and Bond Fund, Bond Fund, Tax Advantaged Bond Fund and Money Market Fund........51
Equity Index Funds......................................................................................52
Small Cap Equity Fund and International Equity Fund.....................................................52
PORTFOLIO TURNOVER...............................................................................................52
DETERMINATION OF NET ASSET VALUE.................................................................................53
PERFORMANCE INFORMATION..........................................................................................55
PURCHASE AND REDEMPTION OF FUND SHARES...........................................................................58
DISTRIBUTION EXPENSES............................................................................................59
DISTRIBUTION PLANS...............................................................................................60
Class A Shares..........................................................................................60
Class B Shares..........................................................................................61
General.................................................................................................61
OTHER SERVICE PROVIDERS..........................................................................................62
Custodians..............................................................................................62
Transfer Agent..........................................................................................62
Independent Auditors....................................................................................62
TAXES............................................................................................................63
General Tax Information.................................................................................63
CODE OF ETHICS...................................................................................................68
SHARES...........................................................................................................68
Voting Rights...........................................................................................69
FINANCIAL STATEMENTS.............................................................................................70
APPENDIX A: DESCRIPTION OF BOND RATINGS..........................................................................1
</TABLE>
iii
<PAGE>
INFORMATION ABOUT THE FUNDS
State Farm Mutual Fund Trust (the "Trust") is an open-end
management investment company organized as a business trust under the laws of
the State of Delaware on June 8, 2000. The Trust consists of ten separate
funds, each of which has its own investment objective, investment policies,
restrictions and risks (each a "Fund," and collectively, the "Funds").
The Trust issues a separate series of shares of beneficial interest
for each Fund representing fractional undivided interests in that Fund. By
investing in a Fund, you become entitled to a pro-rata share of all dividends
and distributions arising from the net income and capital gains on the
investments of that Fund. Likewise, you share pro-rata in any losses of that
Fund. Each Fund offers three classes of shares: Class A, Class B and
Institutional shares.
Three of the Funds - State Farm S&P 500 Index Fund, State Farm Small
Cap Index Fund and State Farm International Index Fund (together, the "Equity
Index Funds") - seek to achieve their respective investment objectives by
investing all of their assets in the S&P 500 Index Master Portfolio, Russell
2000 Index Master Portfolio and International Index Master Portfolio (each a
"Master Portfolio"), respectively, each of which is a series of Master
Investment Portfolio (the "Master Fund"), an open-end, management investment
company. Each Master Portfolio has substantially the same investment
objective as the corresponding Equity Index Fund. Any Equity Index Fund may
withdraw its investment in a corresponding Master Portfolio at any time if
the Board of Trustees of the Trust determines that such action is in the best
interests of the respective Equity Index Fund and its shareholders. Upon such
withdrawal, the Board of Trustees would consider alternative investments,
including investing all of an Equity Index Fund's assets in another
investment company with the same investment objective as the Equity Index
Fund or hiring an investment adviser to manage the Equity Index Fund's assets
in accordance with the investment policies and restrictions described in the
Trust's prospectus and this Statement of Additional Information.
Each Fund (including the Equity Index Funds through their investment
in the Master Portfolios, and the Equity and Bond Fund through its investment
in the Equity Fund and the Bond Fund) is "diversified" as that term is
defined in the Investment Company Act of 1940, as amended (the "1940 Act").
State Farm Investment Management Corp. (the "Manager") is the investment
adviser to each of the Funds.
INVESTMENT OBJECTIVES
The investment objective of each Fund is set forth and described in
the Prospectus. The investment objective of each Fund may be changed by the
Board of Trustees of the Trust without the approval of a "majority of the
outstanding voting securities" (as defined in the 1940 Act) of each Fund.
Should the investment objective of any Fund change, the Trust will provide
investors with thirty days' prior notice of the change.
<PAGE>
INVESTMENT TECHNIQUES AND RISKS
In addition to the investment objective of each Fund, the policies
and certain techniques by which the Funds pursue their objectives are
generally set forth in the Prospectus. This section is intended to augment
the explanation set forth in the Prospectus.
To the extent set forth in this Statement of Additional Information,
each Equity Index Fund through its investment in a corresponding Master
Portfolio may invest in the securities described below. To avoid the need to
refer to both the Equity Index Funds and the Master Portfolio in every
instance, the following sections generally refer to the Funds or Equity Index
Funds only.
EQUITY SECURITIES
Each of the Equity Fund, Small Cap Equity Fund, International Equity
Fund, Equity and Bond Fund (through the Equity Fund), and Equity Index Funds
invest in common stocks, which represent an equity interest (ownership) in a
business. This ownership interest often gives these Funds the right to vote
on measures affecting the company's organization and operations. These Funds
also invest in other types of equity securities, including preferred stocks
and securities convertible into common stocks (discussed below). Over time,
common stocks historically have provided superior long-term capital growth
potential. However, stock prices may decline over short or even extended
periods. Stock markets tend to move in cycles, with periods of rising stock
prices and periods of falling stock prices. As a result, these Funds should
be considered long-term investments, designed to provide the best results
when held for several years or more. These Funds may not be suitable
investments if you have a short-term investment horizon or are uncomfortable
with an investment whose value is likely to vary substantially.
The Small Cap Equity Fund's and the Small Cap Index Fund's
investments in smaller capitalization stocks can involve greater risk than is
customarily associated with investing in stocks of larger, more established
companies. For example, smaller companies often have limited product lines,
markets, or financial resources, may be dependent for management on one or a
few key persons, and can be more susceptible to losses. Also, their
securities may be thinly traded (and therefore have to be sold at a discount
from current prices or sold in small lots over an extended period of time),
may be followed by fewer investment research analysts, and may be subject to
wider price swings, thus creating a greater chance of loss than securities of
larger capitalization companies. In addition, transaction costs in stocks of
smaller capitalization companies may be higher than those of larger
capitalization companies.
Because the Small Cap Equity Fund and Small Cap Index Fund emphasize
the stocks of issuers with smaller market capitalizations, each can be
expected to have more difficulty obtaining information about the issuers or
valuing or disposing of its securities than it would if it were to
concentrate on more widely held stocks.
2
<PAGE>
DEBT SECURITIES
Under normal circumstances, the Bond Fund, Equity and Bond Fund
(through its investment in the Bond Fund) and Tax Advantaged Bond Fund may
invest in debt securities of corporate and governmental issuers, including
"investment grade" securities (securities within the four highest grades
(AAA/Aaa to BBB/Baa) assigned by Moody's Investor Services, Inc. ("Moody's")
or Standard and Poor's Corporation ("S&P")) and lower-rated securities
(securities rated BB or lower by S&P or Ba or lower by Moody's, commonly
called "junk bonds"), and securities that are not rated, but are of
comparable quality. See APPENDIX A for a Description of Bond Ratings.
The risks inherent in debt securities depend primarily on the term
and quality of the obligations in a Fund's portfolio as well as on market
conditions. In general, a decline in the prevailing levels of interest rates
generally increases the value of debt securities, while an increase in rates
usually reduces the value of those securities.
Investment in lower grade securities involves greater investment
risk, including the possibility of issuer default or bankruptcy. An economic
downturn could severely disrupt the market for such securities and adversely
affect the value of such securities. In addition, such securities are less
sensitive to interest rate changes than higher-quality instruments and
generally are more sensitive to adverse economic changes or individual
corporate developments. During a period of adverse economic changes,
including a period of rising interest rates, issuers of such bonds may
experience difficulty in making their principal and interest payments.
In addition, lower grade securities may be less marketable than
higher-quality debt securities because the market for them is less broad. The
market for unrated debt securities is even narrower. During periods of thin
trading in these markets, the spread between bid and ask prices is likely to
increase significantly, and a Fund may have greater difficulty selling its
portfolio securities. Adverse publicity and investor perceptions may
negatively affect the market value and liquidity of these securities.
The S&P 500 Index Fund may purchase debt securities that are not
rated if, in the opinion of Barclays Global Fund Advisors ("Barclays"), the
investment adviser for the S&P 500 Index Master Portfolio, such obligation is
of investment quality comparable to other rated investments that are
permitted to be purchased by the S&P 500 Index Fund. After purchase by the
S&P 500 Index Fund, a security may cease to be rated or its rating may be
reduced below the minimum required for purchase by the S&P 500 Index Fund.
Neither event will require a sale of such security by the S&P 500 Index Fund,
provided that the amount of such securities held by the S&P 500 Index Fund
does not exceed 5% of the S&P 500 Index Fund's net assets. To the extent the
ratings given by Moody's or by S&P may change as a result of changes in such
organizations or their rating systems, the S&P 500 Index Fund will attempt to
use comparable ratings as standards for investments in accordance with the
investment policies contained in the Prospectus and in this Statement of
Additional Information.
3
<PAGE>
The S&P 500 Index Fund is not required to sell downgraded
securities, and it could hold up to 5% of its net assets in debt securities
rated below "Baa" by Moody's or below "BBB" by S&P or if unrated, low quality
(below investment grade) securities.
CONVERTIBLE SECURITIES
The Bond Fund may invest up to 20% of its total assets in
convertible securities. Convertible securities may include corporate notes or
preferred stock, but are ordinarily a long-term debt obligation of the issuer
convertible at a stated exchange rate into common stock of the issuer. As
with all debt securities, the market value of convertible securities tends to
decline as interest rates increase and, conversely, to increase as interest
rates decline. Convertible securities generally offer lower interest or
dividend yields than non-convertible securities of similar quality. However,
when the market price of the common stock underlying a convertible security
exceeds the conversion price, the price of the convertible security tends to
reflect the value of the underlying common stock. As the market price of the
underlying common stock declines, the convertible security tends to trade
increasingly on a yield basis, and thus may not depreciate to the same extent
as the underlying common stock.
Convertible securities generally rank senior to common stock in an
issuer's capital structure and may entail less risk of declines in market
value than the issuer's common stock. However, 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. In evaluating a
convertible security, the Manager usually gives primary emphasis to the
attractiveness of the underlying common stock.
U.S. GOVERNMENT SECURITIES
Each of the Funds may purchase securities issued or guaranteed as to
principal and interest by the U.S. Government, its agencies, authorities or
instrumentalities ("U.S. Government Securities"). Some U.S. Government
Securities, such as Treasury bills, notes and bonds, which differ only in
their interest rates, maturities and times of issuance, are supported by the
full faith and credit of the United States. Others, such as obligations
issued or guaranteed by U.S. Government agencies, authorities or
instrumentalities are supported either by (a) the full faith and credit of
the U.S. Government (such as securities of the Small Business
Administration), (b) the right of the issuer to borrow from the Treasury
(such as securities of the Federal Home Loan Banks), (c) the discretionary
authority of the U.S. Government to purchase the agency's obligations (such
as securities of the Federal National Mortgage Association), or (d) only the
credit of the issuer. No assurance can be given that the U.S. Government will
provide financial support to U.S. Government agencies, authorities or
instrumentalities in the future. Accordingly, securities issued by an agency
are subject to default, and are also subject to interest rate and prepayment
risks.
U.S. Government Securities may also include zero coupon securities.
Zero coupon securities are issued and traded at a discount and do not entitle
the holder to any periodic payments of interest prior to maturity and, for this
reason, may trade at a deep discount from their face or par value and may be
subject to greater fluctuations in market value than ordinary
4
<PAGE>
debt obligations of comparable maturity. With zero coupon securities there
are no cash distributions to reinvest, so investors bear no reinvestment risk
if they hold the zero coupon securities to maturity; holders of zero coupon
securities, however, forego the possibility of reinvesting at a higher yield
than the rate paid on the originally issued security. With zero coupon
securities there is no reinvestment risk on the principal amount of the
investment. When held to maturity, the entire return from such instruments is
determined by the difference between such instrument's purchase price and its
value at maturity.
Securities guaranteed as to principal and interest by the U.S.
Government, its agencies, authorities or instrumentalities are considered to
include (a) securities for which the payment of principal and interest is
backed by a guarantee of, or an irrevocable letter of credit issued by, the
U.S. Government, its agencies, authorities or instrumentalities and (b)
participation in loans made to foreign governments or their agencies that are
so guaranteed. The secondary market for certain of these participations is
limited. Such participations may therefore be regarded as illiquid.
FLOATING- AND VARIABLE-RATE OBLIGATIONS
The Equity Index Funds may purchase floating- and variable-rate
demand notes and bonds, which are obligations ordinarily having stated
maturities in excess of thirteen months, but which permit the holder to
demand payment of principal at any time, or at specified intervals not
exceeding thirteen months. Variable rate demand notes include master demand
notes that are obligations that permit a Fund to invest fluctuating amounts,
which may change daily without penalty, pursuant to direct arrangements
between the Fund, as lender, and the borrower. The interest rates on these
notes fluctuate from time to time. The issuer of such obligations ordinarily
has a corresponding right, after a given period, to prepay in its discretion
the outstanding principal amount of the obligations plus accrued interest
upon a specified number of days' notice to the holders of such obligations.
The interest rate on a floating-rate demand obligation is based on a known
lending rate, such as a bank's prime rate, and is adjusted automatically each
time such rate is adjusted. The interest rate on a variable-rate demand
obligation is adjusted automatically at specified intervals. Frequently, such
obligations are secured by letters of credit or other credit support
arrangements provided by banks. Because these obligations are direct lending
arrangements between the lender and borrower, it is not contemplated that
such instruments generally will be traded, and there generally is no
established secondary market for these obligations, although they are
redeemable at face value. Accordingly, where these obligations are not
secured by letters of credit or other credit support arrangements, a Fund's
right to redeem is dependent on the ability of the borrower to pay principal
and interest on demand. Such obligations frequently are not rated by credit
rating agencies and the Fund may invest in obligations which are not so rated
only if Barclays determines that, at the time of investment, the obligations
are of comparable quality to the other obligations in which the Fund may
invest. Barclays, on behalf of each Equity Index Fund, considers on an
ongoing basis the creditworthiness of the issuers of the floating- and
variable-rate demand obligations in each Fund's portfolio. The Equity Index
Fund will not invest more than 10% of the value of its total net assets in
floating- or variable-rate demand obligations whose demand feature is not
5
<PAGE>
exercisable within seven days. Such obligations may be treated as liquid,
provided that an active secondary market exists.
The Tax Advantaged Bond Fund may purchase variable rate demand
notes, which are obligations containing a floating or variable interest rate
adjustment formula and which are subject to a right of demand for payment of
the principal balance plus accrued interest either at any time or at
specified intervals. The interest rate on a variable rate demand note may be
based on a known lending rate, such as bank's prime rate, and may be adjusted
when such rate changes, or the interest rate may be a market rate that is
adjusted at specified intervals. The adjustment formula attempts to maintain
the value of the variable rate demand note at approximately the par value of
such note at the adjustment date.
In addition, the Tax Advantaged Bond Fund may invest in inverse
floaters. An inverse floater is a floating rate debt instrument, the interest
rate on which resets in the opposite direction from the market rate of
interest to which the inverse floater is indexed. An inverse floater may be
considered to be leveraged to the extent that its interest rate varies by a
magnitude that exceeds the magnitude of the change in the index rate of
interest. The higher the degree of leverage inherent in inverse floaters is
associated with greater volatility in market value, such that, during periods
of rising interest rates, the market values of inverse floaters will tend to
decrease more rapidly than those of fixed rate securities. In addition, the
duration of an inverse floater may exceed its stated final maturity. Certain
inverse floaters may be deemed illiquid securities for purposes of the Funds'
limitations on investment in such securities.
LETTERS OF CREDIT
Certain of the debt obligations (including municipal securities,
certificates of participation, commercial paper and other short-term
obligations) which the S&P 500 Index Fund may purchase may be backed by an
unconditional and irrevocable letter of credit of a bank, savings and loan
association or insurance company which assumes the obligation for payment of
principal and interest in the event of default by the issuer. Letters of
credit are not federally insured instruments. Only banks, savings and loan
associations and insurance companies which, in the opinion of Barclays, are
of comparable quality to issuers of other permitted investments of the S&P
500 Index Fund may be used for letter of credit-backed investments. However,
such banks may be unable to honor the letter of credit.
FOREIGN SECURITIES
Each of Equity Fund, Small Cap Equity Fund, Equity and Bond Fund
(through its investment in the Equity Fund), International Equity Fund and
International Index Fund invest in foreign securities not publicly traded in
the United States. Each of these may invest in foreign securities directly or
in the form of American Depositary Receipts ("ADRs"), Canadian Depositary
Receipts ("CDRs"), European Depositary Receipts ("EDRs"), International
Depositary Receipts ("IDRs") and Global Depositary Receipts ("GDRs") or other
similar securities convertible into securities of foreign issuers. These
securities may not necessarily be denominated in the same currency as the
securities into which they may be converted. ADRs (sponsored or unsponsored)
are receipts typically issued by a U.S. Bank or trust company and
6
<PAGE>
traded on a U.S. stock exchange, and CDRs are receipts typically issued by a
Canadian bank or trust company that evidence ownership of underlying foreign
securities. Issuers of unsponsored ADRs are not contractually obligated to
disclose material information in the U.S. and, therefore, such information
may not correlate to the market value of the unsponsored ADR. EDRs and IDRs
are receipts typically issued by European banks and trust companies, and GDRs
are receipts issued by either a U.S. or non-U.S. banking institution, that
evidence ownership of the underlying foreign securities. Generally, ADRs in
registered form are designed for use in U.S. securities markets and EDRs and
IDRs in bearer form are designed primarily for use in Europe.
With respect to portfolio securities that are issued by foreign
issuers or denominated in foreign currencies, the investment performance of a
Fund is affected by the strength or weakness of the U.S. dollar against those
currencies. For example, if the dollar falls in value relative to the
Japanese yen, the dollar value of a yen-denominated stock held in the
portfolio will rise even though the price of the stock remains unchanged.
Conversely, if the dollar rises in value relative to the yen, the dollar
value of the yen-denominated stock will fall.
Shareowners should understand and consider carefully the risks
involved in foreign investing. Investments in foreign securities are
generally denominated in foreign currencies and involve certain
considerations comprising both risk and opportunity not typically associated
with investing in U.S. securities. These considerations include: fluctuations
in exchange rates of foreign currencies; possible imposition of exchange
control regulation or currency restrictions that would prevent cash from
being brought back into the United States; the inability of a Fund to convert
foreign currency into U.S. dollars, which would cause the Fund continued
exposure to fluctuating exchange rates; less public information with respect
to issuers of securities; less governmental supervision of stock exchanges,
securities brokers, and issuers of securities; lack of uniform accounting,
auditing, and financial reporting standards; lack of uniform settlement
periods and trading practices; less liquidity and frequently greater price
volatility; possible imposition of foreign taxes; possible investment in
securities of companies in developing as well as developed countries; and
sometimes less advantageous legal, operational, and financial protections
applicable to foreign sub-custodial arrangements.
Although the Funds try to invest in companies of countries having
stable political environments, there is the possibility of expropriation or
confiscatory taxation, seizure or nationalization of foreign bank deposits or
other assets, establishment of exchange controls, the adoption of foreign
government restrictions, or other political, social or diplomatic
developments that could adversely affect investment in these countries.
EMERGING MARKETS. Investments in emerging markets securities include
special risks in addition to those generally associated with foreign
investing. Many investments in emerging markets can be considered
speculative, and the value of those investments can be more volatile than in
more developed foreign markets. This difference reflects the greater
uncertainties of investing in less established markets and economies.
Emerging markets also have different clearance and settlement procedures, and
in certain markets there have been times when settlements have not kept pace
with the volume of securities transactions, making it difficult to conduct
such transactions. Delays in settlement could result in temporary periods
when a portion
7
<PAGE>
of a Fund's assets is uninvested and no return is earned thereon. The
inability to make intended security purchases due to settlement problems
could cause a Fund to miss attractive investment opportunities. Inability to
dispose of portfolio securities due to settlement problems could result
either in losses to a Fund due to subsequent declines in the value of those
securities or, if a Fund has entered into a contract to sell a security, in
possible liability to the purchaser. Costs associated with transactions in
emerging markets securities are typically higher than costs associated with
transactions in U.S. securities. Such transactions also involve additional
costs for the purchase or sale of foreign currency.
Certain foreign markets (including emerging markets) may require
governmental approval for the repatriation of investment income, capital or
the proceeds of sales of securities by foreign investors. In addition, if
deterioration occurs in an emerging market's balance of payments or for other
reasons, a country could impose temporary restrictions on foreign capital
remittances. A Fund could be adversely affected by delays in, or a refusal to
grant, required governmental approval for repatriation of capital, as well as
by the application to the Fund of any restrictions on investments.
The risk also exists that an emergency situation may arise in one or
more emerging markets. As a result, trading of securities may cease or may be
substantially curtailed and prices for a Fund's securities in such markets
may not be readily available. A Fund may suspend redemption of its shares for
any period during which an emergency exists, as determined by the U.S.
Securities and Exchange Commission (the "Commission"). Accordingly, if a Fund
believes that appropriate circumstances exist, it will promptly apply to the
Commission for a determination that such an emergency is present. During the
period commencing from a Fund's identification of such condition until the
date of Commission action, that Fund's securities in the affected markets
will be valued at fair value determined in good faith by or under the
direction of the Board of Trustees of the Trust or the Board of Trustees of
the Master Fund.
Income from securities held by a Fund could be reduced by taxes
withheld from that income, or other taxes that may be imposed by the emerging
market countries in which the Fund invests. Net asset value of a Fund may
also be affected by changes in the rates or methods of taxation applicable to
the Fund or to entities in which the Fund has invested. Many emerging markets
have experienced substantial rates of inflation for many years. Inflation and
rapid fluctuations in inflation rates have had, and may continue to have,
adverse effects on the economies and securities markets of certain emerging
market countries. In an attempt to control inflation, certain emerging market
countries have imposed wage and price controls. Of these countries, some, in
recent years, have begun to control inflation through prudent economic
policies.
Emerging market governmental issuers are among the largest debtors
to commercial banks, foreign governments, international financial
organizations and other financial institutions. Certain emerging market
governmental issuers have not been able to make payments of interest or
principal on debt obligations as those payments have come due. Obligations
arising from past restructuring agreements may affect the economic
performance and political and social stability of those issuers.
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Governments of many emerging market countries have exercised and
continue to exercise substantial influence over many aspects of the private
sector through ownership or control of many companies. The future actions of
those governments could have a significant effect on economic conditions in
emerging markets, which, in turn, may adversely affect companies in the
private sector, general market conditions and prices and yields of certain of
the securities in a Fund's portfolio. Expropriation, confiscatory taxation,
nationalization, political, economic and social instability have occurred
throughout the history of certain emerging market countries and could
adversely affect Fund assets should any of those conditions recur.
CURRENCY EXCHANGE TRANSACTIONS. The Funds may enter into currency
exchange transactions either on a spot (i.e., cash) basis at the spot rate
for purchasing or selling currency prevailing in the foreign exchange market,
through a forward currency exchange contract ("forward contract") or through
foreign currency futures contracts.
FORWARD CONTRACTS. A forward contract is an agreement to purchase or
sell a specified currency at a specified future date (or within a specified
time period) and price set at the time of the contract. Forward contracts are
usually entered into with banks, foreign dealers or broker-dealers, are not
traded on an exchange and are usually for less than one year, but may be
longer or renewed.
Forward currency transactions may involve currencies of the
different countries in which a Fund may invest, and serve as hedges against
possible variations in the exchange rate between these currencies. A currency
transaction for a Fund is limited to transaction hedging and portfolio
hedging involving either specific transactions or actual or anticipated
portfolio positions. Transaction hedging is the purchase or sale of a forward
contract with respect to specific receivables or payables of a Fund accruing
in connection with the purchase or sale of portfolio securities. Portfolio
hedging is the use of a forward contract with respect to an actual or
anticipated portfolio security position denominated or quoted in a particular
currency. When a Fund owns or anticipates owning securities in countries
whose currencies are linked, the Fund may aggregate such positions as to the
currency hedged.
If a Fund enters into a forward contract hedging an anticipated or
actual holding of portfolio securities, liquid assets of the Fund, having a
value at least as great as the amount of the excess, if any, of the Fund's
commitment under the forward contract over the value of the portfolio
position being hedged, will be segregated on the books of the Fund and held
by the Fund's custodian and marked to market daily, while the contract is
outstanding.
At the maturity of a forward contract to deliver a particular
currency, a Fund may sell the portfolio security related to such contract and
make delivery of the currency received from the sale, or it may retain the
security and either purchase the currency on the spot market or terminate its
contractual obligation to deliver the currency by entering into an offsetting
contract with the same currency trader for the purchase on the same maturity
date of the same amount of the currency.
It is impossible to forecast precisely the market value of a portfolio
security being hedged with a forward currency contract. Accordingly, at the
maturity of a contract it may be necessary
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for a Fund to purchase additional currency on the spot market (and bear the
expense of such purchase) if the market value of the security is less than
the amount of currency the Fund is obligated to deliver under the forward
contract and if a decision is made to sell the security and make delivery of
the currency. Conversely, it may be necessary to sell on the spot market some
of the currency received upon the sale of the portfolio security if the sale
proceeds exceed the amount of currency the Fund is obligated to deliver.
If the Fund retains the portfolio security and engages in an
offsetting transaction, the Fund will incur a gain or a loss to the extent
that there has been movement in forward contract prices. If the Fund engages
in an offsetting transaction, it may subsequently enter into a new forward
contract to sell the currency. If forward prices decline during the period
between entering into a forward contract for the sale of a currency and the
date it enters into an offsetting contract for the purchase of the currency,
the Fund will realize a gain to the extent the price of the currency it has
agreed to sell exceeds the price of the currency it has agreed to purchase.
If forward prices increase, the Fund will suffer a loss to the extent the
price of the currency it has agreed to purchase exceeds the price of the
currency it has agreed to sell. A default on the contract would deprive the
Fund of unrealized profits or force it to cover its commitments for purchase
or sale of currency, if any, at the current market price.
FOREIGN CURRENCY FUTURES CONTRACTS. A foreign currency futures
contract is an agreement between two parties for the future delivery of a
specified currency at a specified time and at a specified price. The
International Index Fund will engage in foreign currency futures contracts. A
"sale" of a futures contract means the contractual obligation to deliver the
currency at a specified price on a specified date, or to make the cash
settlement called for by the contract. Futures contracts have been designed
by exchanges which have been designated "contract markets" by the Commodity
Futures Trading Commission ("CFTC") and must be executed through a brokerage
firm, known as a futures commission merchant (an "FCM"), which is a member of
the relevant contract market. Futures contracts trade on these markets, and
the exchanges, through their clearing organizations, guarantee that the
contracts will be performed as between the clearing members of the exchange.
Barclays, on a consistent basis, uses the following FCMs on behalf of the
Trust: UBS Warburg LLC, Stamford, CT, J.P. Morgan Futures Inc., New York, New
York, Morgan Stanley & Co. Incorporated, New York, New York, Merrill Lynch
Futures Inc., San Francisco, CA, Lehman Brothers Inc., New York, New York,
Salomon Smith Barney Inc., New York, New York, Goldman Sachs & Co. Futures
Services, New York, New York, Carr Futures Inc., Chicago, Illinois, Deutsche
Bank Securities Inc., New York, New York.
While futures contracts based on currencies do provide for the
delivery and acceptance of a particular currency, such deliveries and
acceptances are very seldom made. Generally, a futures contract is terminated
by entering into an offsetting transaction. The International Index Fund will
incur brokerage fees when it purchases and sells futures contracts. At the
time such a purchase or sale is made, the International Index Fund must
provide cash or money market securities as a deposit known as "margin." The
initial deposit required will vary, but may be as low as 2% or less of a
contract's face value. Daily thereafter, the futures contract is valued
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through a process known as "marking to market," and the International Index
Fund may receive or be required to pay "variation margin" as the futures
contract becomes more or less valuable.
To hedge its portfolio and to protect it against possible variations
in foreign exchange rates pending the settlement of securities transactions,
the International Index Fund may buy or sell currency futures contracts. If a
fall in exchange rates for a particular currency is anticipated, the
International Index Fund may sell a currency futures contract as a hedge. If
it is anticipated that exchange rates will rise, the International Index Fund
may purchase a currency futures contract to protect against an increase in
the price of securities denominated in a particular currency the
International Index Fund intends to purchase. These futures contracts will be
used only as a hedge against anticipated currency rate changes.
The effective use of futures strategies depends on, among other
things, the International Index Fund's ability to terminate futures positions
at times when Barclays deems it desirable to do so. Although the
International Index Fund will not enter into a futures position unless
Barclays believes that a liquid secondary market exists for such future,
there is no assurance that the International Index Fund will be able to
effect closing transactions at any particular time or at an acceptable price.
The International Index Fund generally expects that its futures transactions
will be conducted on recognized U.S. and foreign securities and commodity
exchanges.
Futures markets can be highly volatile and transactions of this type
carry a high risk of loss. Moreover, a relatively small adverse market
movement with respect to these transactions may result not only in loss of
the original investment but also in unquantifiable further loss exceeding any
margin deposited.
The use of futures involves the risk of imperfect correlation
between movements in futures prices and movements in the price of currencies
which are the subject of the hedge. The successful use of futures strategies
also depends on the ability of Barclays to correctly forecast interest rate
movements, currency rate movements and general stock market price movements.
The International Index Fund's ability effectively to hedge currency
risk through transactions in foreign currency futures depends on the degree
to which movements in the value of the currency underlying such hedging
instrument correlate with movements in the value of the relevant securities
held by the International Index Fund. If the values of the securities being
hedged do not move in the same amount or direction as the underlying
currency, the hedging strategy for the International Index Fund might not be
successful and the International Index Fund could sustain losses on its
hedging transactions which would not be offset by gains on its portfolio. It
is also possible that there may be a negative correlation between the
currency underlying a futures contract and the portfolio securities being
hedged, which could result in losses both on the hedging transaction and the
portfolio securities. In such instances, the International Index Fund's
overall return could be less than if the hedging transactions had not been
undertaken.
Under certain extreme market conditions, it is possible that the
International Index Fund will not be able to establish hedging positions, or
that any hedging strategy adopted will be insufficient to completely protect
the International Index Fund.
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The International Index Fund will purchase or sell futures contracts
only if, in Barclays' judgment, there is expected to be a sufficient degree
of correlation between movements in the value of such instruments and changes
in the value of the relevant portion of the International Index Fund's
portfolio for the hedge to be effective. There can be no assurance that
Barclays' judgment will be accurate.
The ordinary spreads between prices in the cash and futures markets,
due to differences in the natures of those markets, are subject to
distortions. First, all participants in the futures market are subject to
initial deposit and variation margin requirements. This could require the
International Index Fund to post additional cash or cash equivalents as the
value of the position fluctuates. Further, rather than meeting additional
variation margin requirements, investors may close futures contracts through
offsetting transactions which could distort the normal relationship between
the cash and futures markets. Second, the liquidity of the futures market may
be lacking. Prior to exercise or expiration, a futures position may be
terminated only by entering into a closing purchase or sale transaction,
which requires a secondary market on the exchange on which the position was
originally established. While the International Index Fund will establish a
futures position only if there appears to be a liquid secondary market
therefor, there can be no assurance that such a market will exist for any
particular futures contract at any specific time. In such event, it may not
be possible to close out a position held by the International Index Fund,
which could require the International Index Fund to purchase or sell the
instrument underlying the position, make or receive a cash settlement, or
meet ongoing variation margin requirements. The inability to close out
futures positions also could have an adverse impact on the International
Index Fund's ability effectively to hedge its securities, or the relevant
portion thereof.
The liquidity of a secondary market in a futures contract may be
adversely affected by "daily price fluctuation limits" established by the
exchanges, which limit the amount of fluctuation in the price of a contract
during a single trading day and prohibit trading beyond such limits once they
have been reached. The trading of futures contracts also is subject to the
risk of trading halts, suspensions, exchange or clearing house equipment
failures, government intervention, insolvency of the brokerage firm or
clearing house or other disruptions of normal trading activity, which could
at times make it difficult or impossible to liquidate existing positions or
to recover excess variation margin payments.
Each contract market on which futures contracts are traded has
established a number of limitations governing the maximum number of positions
which may be held by a trader, whether acting alone or in concert with
others. Barclays does not believe that these trading and position limits will
have an adverse impact on the hedging strategies regarding the International
Index Fund's investments.
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. Hedging transactions
preclude the opportunity for gain if the value of the hedged currency should
rise. Moreover, it may not be possible for a Fund to hedge against a
devaluation that is so generally
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anticipated that it is not able to contract to sell the currency at a price
above the devaluation level it anticipates.
The cost to the International Index Fund engaging in currency
exchange transactions varies with such factors as the currency involved, the
length of the contract period and prevailing market conditions. Since
currency exchange transactions are usually conducted on a principal basis, no
fees or commissions are involved.
EUROPEAN CURRENCY UNIFICATION. Effective January 1, 1999, eleven of
the fifteen member countries of the European Union adopted a single European
currency, the Euro. The countries participating in the Economic and Monetary
Union ("EMU") are Austria, Belgium, Finland, France, Germany, Ireland, Italy,
Luxembourg, the Netherlands, Portugal and Spain. The four European Union
countries not currently participating in the EMU are Great Britain, Denmark,
Sweden and Greece. A new European Central Bank manages the monetary policy of
the new unified region, and the exchange rates among the EMU member countries
are permanently fixed. National currencies will continue to circulate until
they are replaced by Euro coins and bank notes by the middle of 2002.
STOCK INDEX FUTURES AND OPTIONS ON STOCK INDEX FUTURES CONTRACTS
The Equity Index Funds may invest in stock index futures and options
on stock index futures as a substitute for a comparable market position in
the underlying securities. A stock index future obligates the seller to
deliver (and the purchaser to take), effectively, an amount of cash equal to
a specific dollar amount times the difference between the value of a specific
stock index at the close of the last trading day of the contract and the
price at which the agreement is made. For stock indexes that are permitted
investments, the Equity Index Funds intend to purchase and sell futures
contracts on the index for which it can obtain the best price with
consideration also given to liquidity. The Equity Index Funds may purchase
call and put options on stock index futures contracts of the type which the
particular Equity Index Fund is authorized to enter into. Each Equity Index
Fund may invest in such options for the purpose of closing out a futures
position that has become illiquid.
Options on futures contracts are traded on exchanges that are
licensed and regulated by the CFTC. A call option on a futures contract gives
the purchaser the right in return for the premium paid (but not the
obligation), to purchase a futures contract (assume a "long" position) at a
specified exercise price at any time before the option expires. A put option
gives the purchaser the right (but not the obligation), in return for the
premium paid, to sell a futures contract (assume a "short" position), for a
specified exercise price, at any time before the option expires.
Unlike entering into a futures contract itself, purchasing options
on futures contracts allows a buyer to decline to exercise the option,
thereby avoiding any loss beyond forgoing the purchase price (or "premium")
paid for the options. Whether an Equity Index Fund enters into a stock index
futures contract, on the one hand, or an option contract on a stock index
futures contract, on the other, will depend on all the circumstances,
including the particular objective to be achieved and the relative costs,
liquidity, availability and capital requirements of such futures
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and options contracts. Each Equity Index Fund will consider the relative
risks involved, which may be quite different. These factors, among others,
will be considered in light of market conditions.
The use of stock index futures contracts and options on such futures
contracts may entail the following risks. First, although such instruments
when used by a Equity Index Fund are intended to correlate with portfolio
securities, in many cases the futures contracts or options on futures
contracts used may be based on stock indices, the components of which are not
identical to the portfolio securities owned or intended to be acquired by the
Equity Index Fund. Second, due to supply and demand imbalances and other
market factors, the price movements of stock index futures contracts and
options thereon may not necessarily correspond exactly to the price movements
of the stock indices on which such instruments are based. Accordingly, there
is a risk that transactions in those instruments will not in fact offset the
impact on the Equity Index Fund of adverse market developments in the manner
or to the extent contemplated or that such transactions will result in losses
which are not offset by gains with respect to corresponding portfolio
securities owned or to be purchased by that Equity Index Fund.
To some extent, these risks can be minimized by careful management
of these strategies. For example, where price movements in a futures contract
are expected to be less volatile than price movements in the related
portfolio securities owned or intended to be acquired by an Equity Index
Fund, the Equity Index Fund may compensate for this difference by using an
amount of futures contracts which is greater than the amount of such
portfolio securities. Similarly, where the price movement of a futures
contract is anticipated to be more volatile, an Equity Index Fund may use an
amount of such contracts which is smaller than the amount of portfolio
securities to which such contracts relate.
The risk that the hedging technique used will not actually or
entirely offset an adverse change in the value of an Equity Index Fund's
securities is particularly relevant to futures contracts. An Equity Index
Fund, in entering into a futures purchase contract, potentially could lose
any or all of the contract's settlement price. In addition, because stock
index futures contracts require delivery at a future date of an amount of
cash equal to a multiple of the difference between the value of a specified
stock index on that date and the settlement price, an algebraic relationship
exists between any price movement in the underlying index and the potential
cost of settlement to an Equity Index Fund. A small increase or decrease in
the value of the underlying index can, therefore, result in a much greater
increase or decrease in the cost to the Equity Index Fund.
Although the Equity Index Funds intend to establish positions in
these instruments only when there appears to be an active market, there is no
assurance that a liquid market for such instruments will exist when it seeks
to "close out" (i.e., terminate) a particular stock index futures contract
position. Trading in such instruments could be interrupted, for example,
because of a lack of either buyers or sellers. In addition, the futures
exchanges may suspend trading after the price of such instruments has risen
or fallen more than the maximum amount specified by the exchange.
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An Equity Index Fund may be able, by adjusting investment strategy
in the cash or other contract markets, to offset to some extent any adverse
effects of being unable to liquidate a futures position. Nevertheless, in
some cases, an Equity Index Fund may experience losses as a result of such
inability. Therefore it may have to liquidate other more advantageous
investments to meet its cash needs.
FCMs or brokers in certain circumstances will have access to
Equity Index Fund assets posted as margin in connection with transactions in
stock index futures contracts and options, as permitted under the 1940 Act.
An Equity Index Fund will use only FCMs or brokers in whom it has full
confidence. Barclays will adopt certain procedures and limitations to reduce
the risk of loss of any Equity Index Fund assets which such FCM's or brokers
hold or have access. Nevertheless, in the event of a FCM's or broker's
insolvency or bankruptcy, it is possible that a Fund could experience a delay
or incur costs in recovering such assets or might recover less than the full
amount due. Also the value of such assets could decline by the time the
Equity Index Fund could effect such recovery.
The success of any Equity Index Fund in using these techniques
depends, among other things, on the ability of Barclays to predict the
direction and volatility of price movements in the futures markets as well as
the securities markets and on its ability to select the proper type, time,
and duration of futures contracts. There can be no assurance that these
techniques will produce their intended results. In any event, Barclays will
use stock index futures contracts and options thereon only when it believes
the overall effect is to reduce, rather than increase, the risks to which the
Equity Index Fund is exposed.
INTEREST RATE FUTURES CONTRACTS AND RELATED OPTIONS
The Bond Fund, Tax Advantaged Bond Fund and the Equity and Bond Fund
(through the Bond Fund) may invest in interest rate futures contracts and
options on such contracts that are traded on a domestic exchange or board of
trade. Such investments may be made by a Fund solely for the purpose of
hedging against changes in the value of its portfolio securities due to
anticipated changes in interest rates and market conditions, and not for
purposes of speculation. A public market exists for interest rate futures
contracts covering a number of debt securities, including long-term U.S.
Treasury Bonds, ten-year U.S. Treasury Notes, three-month U.S. Treasury
Bills, Eurobonds, and three-month domestic bank certificates of deposit.
Other financial futures contracts may be developed and traded. The purpose of
the acquisition or sale of an interest rate futures contract by a Fund, as
the holder of municipal or other debt securities, is to protect the Fund from
fluctuations in interest rates on securities without actually buying or
selling such securities.
Unlike the purchase or sale of a security, no consideration is paid or
received by a Fund upon the purchase or sale of a futures contract. Initially, a
Fund will be required to deposit with the broker an amount of cash or cash
equivalents equal to approximately 10% of the contract amount (this amount is
subject to change by the board of trade on which the contract is traded and
members of such board of trade may charge a higher amount). This amount is known
as initial margin and is in the nature of a performance bond or good faith
deposit on the contract
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which is returned to the Fund upon termination of the futures contract,
assuming that all contractual obligations have been satisfied. Subsequent
payments, known as variation margin, to and from the broker, will be made on
a daily basis as the price of the index fluctuates, making the long and short
positions in the futures contract more or less valuable, a process known as
marking-to-market. At any time prior to the expiration of the contract, a
Fund may elect to close the position by taking an opposite position, which
will operate to terminate the Fund's existing position in the futures
contract.
A Fund may not purchase or sell futures contracts or purchase
options on futures contracts if, immediately thereafter, more than one-third
of its net assets would be hedged, or the sum of the amount of margin
deposits on the Fund's existing futures contracts and premiums paid for
options would exceed 5% of the value of the Fund's total assets. When a Fund
enters into futures contracts to purchase an index or debt security or
purchase call options, an amount of cash or appropriate liquid securities
equal to the national market value of the underlying contract will be
segregated to cover the positions, thereby insuring that the use of the
contract is unleveraged.
Although a Fund will enter into futures contracts only if an active
market exists for such contracts, there can be no assurance that an active
market will exist for the contract at any particular time. Most domestic
futures exchanges and boards of trade limit the amount of fluctuation
permitted in futures contract prices during a single trading day. The daily
limit establishes the maximum amount the price of a futures contract may vary
either up or down from the previous day's settlement price at the end of a
trading session. Once the daily limit has been reached in a particular
contract, no trades may be made that day at a price beyond that limit. The
daily limit governs only price movement during a particular trading day and
therefore does not limit potential losses because the limit may prevent the
liquidation of unfavorable positions. It is possible that futures contract
prices could move to the daily limit for several consecutive trading days
with little or no trading, thereby preventing prompt liquidation of futures
positions and subjecting some futures traders to substantial losses. In such
event, it will not be possible to close a futures position and, in the event
of adverse price movements, a Fund would be required to make daily cash
payments of variation margin. In such circumstances, an increase in the value
of the portion of the portfolio being hedged, if any, may partially or
completely offset losses on the futures contract. As described above,
however, there is no guarantee the price of municipal bonds or of other debt
securities will, in fact, correlate with the price movements in the futures
contract and thus provide an offset to losses on a futures contract.
If a Fund has hedged against the possibility of an increase in
interest rates that would adversely affect the value of municipal bonds or
other debt securities held in its portfolio, and rates decrease instead, the
Fund will lose part or all of the benefit of the increased value of the
securities it has hedged because it will have offsetting losses in its
futures positions. In addition, in such situations, if a Fund has
insufficient cash, it may have to sell securities to meet daily variation
margin requirements. Such sales of securities may, but will not necessarily,
be at increased prices which reflect the decline in interest rates. A Fund
may have to sell securities at a time when it may be disadvantageous to do so.
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In addition, the ability of a Fund to trade in futures contracts and
options on futures contracts may be materially limited by the requirements of
the Internal Revenue Code of 1986, as amended (the "Code"), applicable to a
regulated investment company. See "Taxes" below.
A Fund may purchase put and call options on interest rate futures
contracts which are traded on a domestic exchange or board of trade as a
hedge against changes in interest rates, and may enter into closing
transactions with respect to such options to terminate existing positions.
There is no guarantee such closing transactions can be effected.
Options on futures contracts, as contrasted with the direct
investment in such contracts, give the purchaser the right, in return for the
premium paid, to assume a position in futures contracts at a specified
exercise price at any time prior to the expiration date of the options. Upon
exercise of an option, the delivery of the futures position by the writer of
the option to the holder of the option will be accompanied by delivery of the
accumulated balance in the writer's futures margin account, which represents
the amount by which the market price of the futures contract exceeds, in the
case of a call, or is less than, in the case of a put, the exercise price of
the option on the futures contracts. The potential loss related to the
purchase of an option on interest rate futures contracts is limited to the
premium paid for the option (plus transaction costs). Because the value of
the option is fixed at the point of sale, there are no daily cash payments to
reflect changes in the value of the underlying contract; however, the value
of the option does change daily and that change would be reflected in the net
asset value of a Fund.
There are several risks in connection with the use of interest rate
futures contracts and options on such futures contracts as hedging devices.
Successful use of these derivative securities by a Fund is subject to the
Manager's ability to predict correctly the direction of movements in interest
rates. Such predictions involve skills and techniques which may be different
from those involved in the management of a long-term bond portfolio. There
can be no assurance that there will be a correlation between price movements
in interest rate futures, or related options, on the one hand, and price
movements in the debt securities which are the subject of the hedge, on the
other hand. Positions in futures contracts and options on futures contracts
may be closed out only on an exchange or board of trade that provides an
active market; therefore, there can be no assurance that a liquid market will
exist for the contract or the option at any particular time. Consequently, a
Fund may realize a loss on a futures contract that is not offset by an
increase in the price of the debt securities being hedged or may not be able
to close a futures position in the event of adverse price movements. Any
income earned from transactions in futures contracts and options on futures
contracts will be taxable. Accordingly, it is anticipated that such
investments will be made only in unusual circumstances, such as when the
Manager anticipates an extreme change in interest rates or market conditions.
See additional risk disclosure above under "Stock Index Futures
Contracts and Options on Stock Index Futures Contracts."
WARRANTS
The Small Cap Equity Fund, International Equity Fund, Bond Fund, Equity
and Bond Fund (through its investment in the Bond Fund) and Equity Index Funds
may invest in warrants
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or rights (other than those acquired in units or attached to other
securities), which entitle the purchaser to buy equity securities at a
specific price for a specific period of time. Warrants and rights have no
voting rights, receive no dividends and have no rights with respect to the
assets of the issuer. The Bond Fund may retain up to 10% of the value of its
total assets in common stocks acquired by the exercise of warrants attached
to debt securities.
MUNICIPAL BONDS
The obligations of municipal bond issuers are subject to the laws of
bankruptcy, insolvency and other laws affecting the rights and remedies of
creditors. In addition, the obligations of such issuers may become subject to
the laws enacted in the future by Congress, state legislatures or referenda
extending the time of payment of principal and/or interest, or imposing other
constraints upon enforcement of such obligations or upon municipalities to
levy taxes. There is also the possibility that, as a result of legislation or
other conditions, the power or ability of any issuer to pay, when due, the
principal and interest on its municipal obligations may be materially
affected.
The Tax Advantaged Bond Fund will invest the assets not invested in
municipal bonds in interest-bearing demand notes, bank savings accounts, high
grade money market securities, U.S. treasury securities, or in shares of
taxable or tax-exempt money market mutual funds. Money market securities
include short-term obligations of the U.S. government and its agencies and
instrumentalities and other money market instruments such as domestic bank
certificates of deposit, bankers' acceptances and corporate commercial paper
rated in the highest grade. From time to time, the Fund may invest more than
20% of its assets in money market securities. In the alternative, the Fund
may hold such assets as cash for defensive reasons in anticipation of a
decline in the market values of debt securities, or pending the investment of
proceeds from the sale of Fund shares or from the sale of portfolio
securities, or in order to have highly liquid securities available to meet
possible redemptions.
MORTGAGE-BACKED SECURITIES
The Bond Fund and Equity and Bond Fund (through its investment in
the Bond Fund) may purchase mortgage-backed securities. Mortgage-backed
securities represent interests in pools of mortgages. The underlying
mortgages normally have similar interest rates, maturities and other terms.
Mortgages may have fixed or adjustable interest rates. Interests in pools of
adjustable rate mortgages are known as ARMs. Mortgage-backed securities come
in a variety of forms. Many have extremely complicated terms. The simplest
form of mortgage-backed securities is a "pass-through certificate." Holders
of pass-through certificates receive a pro rata share of the payments from
the underlying mortgages. Holders also receive a pro rata share of any
prepayments, so they assume all the prepayment risk of the underlying
mortgages.
Collateralized mortgage obligations (CMOs) are complicated
instruments that allocate payments and prepayments from an underlying
pass-through certificate among holders of different classes of
mortgage-backed securities. This creates different prepayment and market
risks for each CMO class.
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In addition, CMOs may allocate interest payments to one class (IOs)
and principal payments to another class (POs). POs increase in value when
prepayment rates increase. In contrast, IOs decrease in value when
prepayments increase, because the underlying mortgages generate less interest
payments. However, IOs prices tend to increase when interest rates rise (and
prepayments fall), making IOs a useful hedge against market risk.
Generally, homeowners have the option to prepay their mortgages at
any time without penalty. Homeowners frequently refinance high rate mortgages
when mortgage rates fall. This results in the prepayment of mortgage-backed
securities, which deprives holders of the securities of the higher yields.
Conversely, when mortgage rates increase, prepayments due to refinancings
decline. This extends the life of mortgage-backed securities with lower
yields. As a result, increases in prepayments of premium mortgage-backed
securities, or decreases in prepayments of discount mortgage-backed
securities, may reduce their yield and price.
This relationship between interest rates and mortgage prepayments
makes the price of mortgage-backed securities more volatile than most other
types of fixed income securities with comparable credit risks.
Mortgage-backed securities tend to pay higher yields to compensate for this
volatility.
CMOs may include planned amortization classes (PACs) and targeted
amortization classes (TACs). PACs and TACs are issued with companion classes.
PACs and TACs receive principal payments and prepayments at a specified rate.
The companion classes receive principal payments and any prepayments in
excess of this rate. In addition, PACs will receive the companion classes'
share of principal payments if necessary to cover a shortfall in the
prepayment rate. This helps PACs and TACs to control prepayment risk by
increasing the risk to their companion classes.
Another variant allocates interest payments between two classes of
CMOs. One class (Floaters) receives a share of interest payments based upon a
market index such as London-Inter Bank Offering Rate ("LIBOR"). The other
class (Inverse Floaters) receives any remaining interest payments from the
underlying mortgages. Floater classes receive more interest (and Inverse
Floater classes receive correspondingly less interest) as interest rates
rise. This shifts prepayment and market risks from the Floater to the Inverse
Floater class, reducing the price volatility of Floater class and increasing
the price volatility of the Inverse Floater class.
CMOs must allocate all payments received from the underlying
mortgages to some class. To capture any unallocated payments, CMOs generally
have an accrual (Z) class. Z classes do not receive any payments from the
underlying mortgages until all other CMO classes have been paid off. Once
this happens, holders of Z class CMOs receive all payments and prepayments.
Similarly, real estate mortgage investment conduits (REMICs) (offerings of
multiple class mortgage backed securities which qualify and elect treatment
as such under provisions of the Code) have residual interests that receive
any mortgage payments not allocated to another REMIC class.
The degree of increased or decreased prepayment risk depends upon
the structure of the CMOs. Z classes, IOs, POs, and Inverse Floaters are
among the most volatile investment grade
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fixed income securities currently traded in the United States. However, the
actual returns on any type of mortgage backed security depends upon the
performance of the underlying pool of mortgages, which no one can predict and
will vary among pools.
ASSET-BACKED SECURITIES
The Bond Fund and Equity and Bond Fund (through its investment in
the Bond Fund) may purchase asset-backed securities, which represent direct
or indirect participations in, or are secured by and payable from, assets
other than mortgage-backed assets such as installment loan contracts, leases
of various types of real and personal property, motor vehicle installment
sales contracts and receivables from revolving credit (credit card)
agreements. In accordance with guidelines established by the Board of
Trustees, asset-backed securities may be considered illiquid securities and,
therefore, may be subject to a Fund's 15% (10% with respect to the Money
Market Fund) limitation on such investments. Asset-backed securities,
including adjustable rate asset-backed securities, have yield characteristics
similar to those of mortgage-backed securities and, accordingly, are subject
to many of the same risks, including prepayment risk.
Assets are securitized through the use of trusts and special purpose
corporations that issue securities that are often backed by a pool of assets
representing the obligations of a number of different parties. Payments of
principal and interest may be guaranteed up to certain amounts and for a
certain time period by a letter of credit issued by a financial institution.
Asset-backed securities do not always have the benefit of a security interest
in collateral comparable to the security interests associated with
mortgage-backed securities. As a result, the risk that recovery on
repossessed collateral might be unavailable or inadequate to support payments
on asset-backed securities is greater for asset-backed securities than for
mortgage-backed securities. In addition, because asset-backed securities are
relatively new, the market experience in these securities is limited and the
market's ability to sustain liquidity through all phases of an interest rate
or economic cycle has not been tested.
MONEY MARKET FUND
The Money Market Fund invests only in instruments denominated in
U.S. dollars that the Manager, under the supervision of the Trust's Board of
Trustees, determines present minimal credit risk and are, at the time of
acquisition, either:
1. rated in one of the two highest rating categories for
short-term debt obligations assigned by at least two nationally recognized
statistical rating organizations (NRSROs) (i.e., S&P and Moody's), or by only
one NRSRO if only one NRSRO has issued a rating with respect to the
instrument (requisite NRSROs); or
2. in the case of an unrated instrument, determined by the
Manager, under the supervision of the Trust's Board of Trustees, to be of
comparable quality to the instruments described in paragraph 1 above; or
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3. issued by an issuer that has received a rating of the type
described in paragraph 1 above on other securities that are comparable in
priority and security to the instrument.
Pursuant to Rule 2a-7 under the 1940 Act, securities which are rated
(or that have been issued by an issuer that has been rated with respect to a
class of short-term debt obligations, or any security within that class,
comparable in priority and quality with such security) in the highest
short-term rating category by at least two NRSROs are designated "First Tier
Securities." Securities rated in the top two short-term rating categories by
at least two NRSROs, but which are not rated in the highest short-term
category by at least two NRSROs, are designated "Second Tier Securities." See
APPENDIX A for a description of the ratings used by NRSROs.
Pursuant to Rule 2a-7 under the 1940 Act, the Money Market Fund may
not invest more than 5% of its assets taken at amortized cost in the
securities of any one issuer (except the U.S. Government, including
repurchase agreements collateralized by U.S. Government Securities (discussed
above)). The Fund may, however, invest more than 5% of its assets in the
First Tier Securities of a single issuer for a period of up to three business
days after the purchase thereof, although the Fund may not make more than one
such investment at any time.
Further, the Money Market Fund will not invest more than the greater
of (i) 1% of its total assets; or (ii) one million dollars in the securities
of a single issuer that were Second Tier Securities when acquired by the
Fund. In addition, the Fund may not invest more than 5% of its total assets
in securities which were Second Tier Securities when acquired.
The foregoing policies are more restrictive than the fundamental
investment restriction number 2b (set forth below) applicable to the Money
Market Fund, which would give the Fund the ability to invest, with respect to
25% of its assets, more than 5% of its assets in any one issuer. The Fund
will operate in accordance with these policies to comply with Rule 2a-7.
FOREIGN MONEY MARKET INSTRUMENTS
Each of the Funds that invest in foreign securities may also invest
up to 25% of its assets in foreign money market instruments. Foreign money
market instruments include Eurodollar Certificates of Deposit (ECDs), Yankee
dollar Certificates of Deposit (YCDs) and Eurodollar Time Deposits (ETDs),
which are all U.S. dollar denominated certificates of deposit. ECDs are
issued by, and ETDs are deposits of, foreign banks or foreign branches of
U.S. banks. YCDs are issued in the U.S. by branches and agencies of foreign
banks. Europaper is dollar-denominated commercial paper and other short-term
notes issued in the U.S. by foreign issuers.
ECDs, ETDs, YCDs, and Europaper have many of the same risks as other
foreign securities. Examples of these risks include economic and political
developments, that may adversely affect the payment of principal or interest,
foreign withholding or other taxes on interest income, difficulties in
obtaining or enforcing a judgment against the issuing bank and the possible
impact of interruptions in the flow of international currency transactions.
Also, the issuing banks or their branches are not necessarily subject to the
same regulatory requirements that apply to domestic banks, such as reserve
requirements, loan limitations, examinations, accounting, auditing,
recordkeeping and the public availability of information.
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CASH AND CASH EQUIVALENTS
Each of the Funds may invest in cash and cash equivalents. These
securities include (1) commercial paper (short-term notes issued by
corporations or governmental bodies), (2) commercial bank obligations (e.g.
certificates of deposit (interest-bearing time deposits) and bankers'
acceptances (time drafts on a commercial bank where the bank accepts an
irrevocable obligation to pay at maturity), (3) savings association and bank
obligations (e.g. certificates of deposit issued by savings banks or savings
associations), (4) U.S. Government Securities that mature, or may be
redeemed, in one year or less, (5) corporate bonds and notes that mature, or
that may be redeemed, in one year or less, (6) money market mutual funds and
(7) short-term investment funds maintained by the Fund's custodian.
REPURCHASE AGREEMENTS
Repurchase agreements are transactions in which a Fund purchases a
security from a bank or recognized securities dealer and simultaneously
commits to resell that security to the bank or dealer at an agreed-upon
price, date, and market rate of interest unrelated to the coupon rate or
maturity of the purchased security. Although repurchase agreements carry
certain risks not associated with direct investments in securities, a Fund
will enter into repurchase agreements only with banks and dealers that either
the Manager, Barclays or Capital Guardian Trust Company ("Capital Guardian"),
the sub-adviser to Small Cap Equity Fund and International Equity Fund,
believe present minimum credit risks in accordance with guidelines approved
by the Board of Trustees. The Manager, Barclays or Capital Guardian will
review and monitor the creditworthiness of such institutions, and will
consider the capitalization of the institution, their prior dealings with the
institution, any rating of the institution's senior long-term debt by
independent rating agencies, and other relevant factors. Any of the Manager,
Barclays or Capital Guardian may cause a Fund to participate in pooled
repurchase agreement transactions with other funds advised by them.
A Fund will invest only in repurchase agreements collateralized at
all times in an amount at least equal to the repurchase price plus accrued
interest. To the extent that the proceeds from any sale of such collateral
upon a default in the obligation to repurchase were less than the repurchase
price, the Fund would suffer a loss. If the financial institution which is
party to the repurchase agreement petitions for bankruptcy or otherwise
becomes subject to bankruptcy or other liquidation proceedings there may be
restrictions on the ability to sell the collateral and the Fund could suffer
a loss. However, with respect to financial institutions whose bankruptcy or
liquidation proceedings are subject to the U.S. Bankruptcy Code, each Fund
intends to comply with provisions under such Code that would allow it
immediately to resell such collateral. None intend to invest more than 15% of
its total assets in repurchase agreements.
PRIVATELY ISSUED SECURITIES
A Fund may invest in privately issued securities, including those
that may be resold only in accordance with Rule 144A under the Securities Act
of 1933 ("Rule 144A Securities"). Rule 144A Securities are restricted
securities that are not publicly traded. Accordingly, the liquidity of the
market for specific Rule 144A Securities may vary. Delay or difficulty in
selling such
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securities may result in a loss to the Fund. Privately issued or Rule 144A
securities that are determined by the Manager, Capital Guardian or Barclays
to be "illiquid" are subject to the Trust's policy of not investing more than
15% (10% in the case of the Money Market Fund) of its net assets in illiquid
securities. The Manager, Capital Guardian or Barclays will evaluate the
liquidity characteristics of each Rule 144A Security proposed for purchase by
a Fund on a case-by-case basis and will consider the following factors, among
others, in their evaluation: (1) the frequency of trades and quotes for the
Rule 144A Security; (2) the number of dealers willing to purchase or sell the
Rule 144A Security and the number of other potential purchasers; (3) dealer
undertakings to make a market in the Rule 144A Security; and (4) the nature
of the Rule 144A Security and the nature of the marketplace trades (e.g., the
time needed to dispose of the Rule 144A Security, the method of soliciting
offers and the mechanics of transfer).
FORWARD COMMITMENTS, WHEN-ISSUED AND DELAYED DELIVERY SECURITIES
A Fund may purchase securities on a when-issued or delayed delivery
basis and make contracts to purchase or sell securities for a fixed price at
a future date beyond customary settlement time. Although the payment and
interest terms of these securities are established at the time the Fund
enters into the commitment, the securities may be delivered and paid for a
month or more after the date of purchase, when their value may have changed.
A Fund makes such commitments only with the intention of actually acquiring
the securities, but may sell the securities before the settlement date if the
Manager, Barclays or Capital Guardian deem it advisable for investment
reasons.
When-issued securities include TBA ("to be announced") securities.
TBA securities are usually mortgage-backed securities that are purchased on a
forward commitment basis with an approximate principal amount and no defined
maturity date. The actual principal amount and maturity date are determined
upon settlement when the specific mortgage pools are assigned. A Fund
generally would not pay for such securities or start earning interest on them
until they are received. However, when a Fund undertakes a when-issued or
delayed delivery obligation, it immediately assumes the risks of ownership,
including the risks of price fluctuation. Failure of the issuer to deliver a
security purchased by a Fund on a when-issued or delayed delivery basis may
result in the Fund's incurring or missing an opportunity to make an
alternative investment.
A Fund may enter into reverse repurchase agreements with banks and
securities dealers. A reverse repurchase agreement is a repurchase agreement
in which the Fund is the seller of, rather than the investor in, securities
and agrees to repurchase them at an agreed-upon time and price. Use of a
reverse repurchase agreement, may be preferable to a regular sale and later
repurchase of securities because it avoids certain market risks and
transaction costs.
At the time a Fund enters into a binding obligation to purchase
securities on a when-issued basis or enters into a reverse repurchase
agreement, assets of the Fund having a value at least as great as the
purchase price of the securities to be purchased will be segregated on the
books of the Fund and held by the custodian throughout the period of the
obligation. The use of these investment strategies, as well as any borrowing
by a Fund, may increase net asset value
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fluctuation. None of the Funds has any present intention of investing more
than 5% of its total assets in reverse repurchase agreements.
LOANS OF PORTFOLIO SECURITIES
Each Fund may from time to time lend securities that it holds to
brokers, dealers and financial institutions, up to a maximum of 33% of the
total value of each Fund's assets. This percentage may not be increased
without approval of a majority of the outstanding voting securities of the
respective Fund. Such loans will be secured by collateral in the form of cash
or United States Treasury securities, or other liquid securities as permitted
by the Commission, which at all times while the loan is outstanding, will be
maintained in an amount at least equal to the current market value of the
loaned securities. The Fund making the loan will continue to receive interest
and dividends on the loaned securities during the term of the loan, and, in
addition, will receive a fee from the borrower or interest earned from the
investment of cash collateral in short-term securities. The Fund also will
receive any gain or loss in the market value of loaned securities and of
securities in which cash collateral is invested during the term of the loan.
The right to terminate a loan of securities, subject to appropriate
notice, will be given to either party. When a loan is terminated, the
borrower will return the loaned securities to the appropriate Fund. No Fund
will have the right to vote securities on loan, but each would terminate a
loan and regain the right to vote if the Board of Trustees deems it to be
necessary in a particular instance.
For tax purposes, the dividends, interest and other distributions
which a Fund receives on loaned securities may be treated as other than
qualified income for the 90% test. (See TAXES--GENERAL TAX INFORMATION.) Each
Fund intends to lend portfolio securities only to the extent that this
activity does not jeopardize its status as a regulated investment company
under the Code.
The primary risk involved in lending securities is that the borrower
will fail financially and return the loaned securities at a time when the
collateral is insufficient to replace the full amount of the loan. The
borrower would be liable for the shortage, but the Fund making the loan would
be an unsecured creditor with respect to such shortage and might not be able
to recover all or any of it. In order to minimize this risk, each Fund will
make loans of securities only to firms the Manager, Capital Guardian or
Barclays (under the supervision of the Board of Trustees) deems creditworthy.
DEFENSIVE INVESTMENTS
Under ordinary circumstances, each Fund is substantially fully
invested. However, except for the Money Market Fund and the Equity Index
Funds, each Fund may also hold cash, cash equivalents, or money market
instruments if the Manager or Capital Guardian determine that a temporary
defensive position is advisable. During those periods, a Fund's assets may
not be invested in accordance with its strategy and the Fund may not achieve
its investment objective.
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INVESTMENT POLICIES AND RESTRICTIONS
FUNDAMENTAL RESTRICTIONS
The Funds are subject to certain fundamental restrictions on their
investments. These restrictions may not be changed without the approval of
the holders of a majority of the outstanding voting shares of the Funds
affected by the change.
1. DIVERSIFICATION. No Fund will make any investment inconsistent with the
Fund's classification as a diversified company under the 1940 Act. This
restriction does not apply to any Fund classified as a non-diversified
company under the 1940 Act.
2a. INDUSTRY CONCENTRATION - EQUITY FUND, SMALL CAP EQUITY FUND,
INTERNATIONAL EQUITY FUND, EQUITY AND BOND FUND AND BOND FUND. The
Equity Fund, Small Cap Equity Fund, International Equity Fund, Equity
and Bond Fund and Bond Fund will not invest 25% or more of their total
assets (taken at market value at the time of each investment) in the
securities of issuers primarily engaged in the same industry (excluding
the U.S. Government or any of its agencies or instrumentalities).
2b. INDUSTRY CONCENTRATION - MONEY MARKET FUND. The Money Market Fund will
not invest 25% or more of its assets (taken at market value at the time
of each investment), other than U.S. Government securities, obligations
(other than commercial paper) issued or guaranteed by U.S. banks and
U.S. branches of foreign banks, and repurchase agreements and
securities loans collateralized by U.S. Government securities or such
bank obligations, in the securities of issuers primarily engaged in the
same industry.
2c. INDUSTRY CONCENTRATION - EQUITY INDEX FUNDS. The Equity Index Funds
will concentrate their investments in an industry or industries if, and
approximately to the extent that, their benchmark indices concentrate
in such industry or industries, except where the concentration of the
relevant index is the result of a single stock.
2d. INDUSTRY CONCENTRATION - TAX ADVANTAGED BOND FUND. The Tax Advantaged
Bond Fund may not invest in securities other than municipal securities,
except that it may make temporary investments (up to 20% of its total
assets under normal circumstances) in certain short-term taxable
securities issued by or on behalf of municipal or corporate issuers,
obligations of the United States Government and its agencies or
instrumentalities, commercial paper, bank certificates of deposit, and
any such items subject to short-term repurchase agreements.
3. INTERESTS IN REAL ESTATE. No Fund will purchase real estate or any
interest therein, except through the purchase of corporate or certain
government securities (including securities secured by a mortgage or a
leasehold interest or other interest in real estate). A security issued
by a real estate or mortgage investment trust is not treated as an
interest in real estate.
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4. UNDERWRITING. No Fund will underwrite securities of other issuers
except insofar as the Trust may be deemed an underwriter under the
Securities Act of 1933 in selling portfolio securities.
5. BORROWING. No Fund will borrow money, except that, for temporary
purposes,: (a) a Fund may borrow from banks (as defined in the 1940
Act) or through reverse repurchase agreements in amounts up to 33 1/3%
of its total assets (including the amount borrowed), taken at market
value at the time of the borrowing; (b) a Fund may, to the extent
permitted by applicable law, borrow up to an additional 5% of its total
assets (including the amount borrowed), taken at market value at the
time of the borrowing; and (c) a Fund may obtain such short-term
credits as may be necessary for clearance of purchases and sales of
portfolio securities. An Equity Index Fund may not borrow money for any
purpose.
6. LENDING. No Fund will lend any security or make any other loan, except
through: (a) the purchase of debt obligations in accordance with the
Fund's investment objective or objectives and policies; (b) repurchase
agreements with banks, brokers, dealers, and other financial
institutions; and (c) loans of securities as permitted by applicable
law.
7. COMMODITIES. No Fund will purchase or sell commodities or commodity
contracts, except that a Fund may (a) enter into futures, options and
options on futures, (b) forward contracts and (c) other financial
transactions not requiring the delivery of physical commodities.
8. SENIOR SECURITIES. No Fund will issue senior securities except to the
extent the activities permitted in Fundamental Restrictions Nos. 5 and
7 may be deemed to give rise to a senior security.
9a. INVESTMENTS - TAX ADVANTAGED BOND FUND. The Tax Advantaged Bond Fund
will (i) invest at least 80% of its assets in tax-exempt securities; or
(ii) invest its assets so that at least 80% of the income will be
tax-exempt.
9b. EQUITY INDEX FUNDS. Each of the Equity Index Funds may, notwithstanding
any other fundamental policy or restrictions invest all of its assets
in the securities of a single open-end management investment company
with substantially the same fundamental investment objective, policies
and restrictions of such Equity Index Fund.
9c. INVESTMENTS - EQUITY AND BOND FUND. The Equity and Bond Fund will not
invest in securities other than securities of other registered
investment companies or registered unit investment trusts that are part
of the State Farm group of investment companies, U.S. Government
securities, or short-term paper.
For the purposes of the restrictions relating to industry
concentration, the restrictions noted above in Item 2 do not apply to
securities issued or guaranteed by the U.S. government or its agencies or
instrumentalities.
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NON-FUNDAMENTAL RESTRICTIONS
The Trust also has adopted the following additional investment
restrictions applicable (except as noted) to all Funds. These are not
fundamental and may be changed by the Board of Trustees without shareholder
approval.
1. FINANCIAL FUTURES CONTRACTS. No Fund may enter into a financial futures
contract (by exercise of any option or otherwise) or acquire any
options thereon, if, immediately thereafter, the total of the initial
margin deposits required with respect to all open futures positions, at
the time such positions were established, plus the sum of the premiums
paid for all unexpired options on futures contracts would exceed 5% of
the value of its total assets.
2. MARGIN PURCHASES. No Fund may purchase any securities on margin except
in connection with investments of certain Funds in futures contracts or
options on futures contracts.
3. PLEDGING ASSETS. No Fund may mortgage, pledge, hypothecate or in any
manner transfer, as security for indebtedness, any securities owned or
held by such Fund except: (a) as may be necessary in connection with
borrowings mentioned in fundamental restriction number 5 above, and
then such mortgaging, pledging or hypothecating may not exceed 10% of
the Fund's total assets, taken at market value at the time thereof, or
(b) in connection with investments of certain Funds in futures
contracts or options on futures contracts.
4a. ILLIQUID SECURITIES AND REPURCHASE AGREEMENTS. No Fund may purchase
securities or enter into a repurchase agreement if, as a result, more
than 15% of its net assets would be invested in any combination of:
(i) repurchase agreements not entitling the holder to payment of
principal and interest within seven days, and
(ii) securities that are illiquid by virtue of legal or contractual
restrictions on resale or the absence of a readily available
market.
4b. ILLIQUID SECURITIES AND REPURCHASE AGREEMENTS - MONEY MARKET FUND. In
addition to the non-fundamental restriction in 4a above, the Money
Market Fund will not invest in illiquid securities, including certain
repurchase agreements or time deposits maturing in more than seven
days, if, as a result thereof, more than 10% of the value of its net
assets would be invested in assets that are either illiquid or are not
readily marketable.
5. INVESTMENTS IN OTHER INVESTMENT COMPANIES. No Fund may invest more than
5% of its total assets in the securities of any single investment
company or more than 10% of its total assets in the securities of other
investment companies in the aggregate, or hold more than 3% of the
total outstanding voting stock of any single investment company. These
restrictions do not apply to the Equity and Bond Fund.
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Non-fundamental restriction #5 does not apply to the Equity Index
Funds because each Equity Index Fund seeks to achieve its investment
objective by investing substantially all of its assets in a Master Portfolio.
OPERATING POLICIES OF THE S&P 500 INDEX MASTER PORTFOLIO AND INTERNATIONAL
INDEX MASTER PORTFOLIO
The S&P 500 Index Master Portfolio and the International Index
Master Portfolio is subject to the following fundamental investment
limitations which cannot be changed without approval by the holders of a
majority (as defined in the 1940 Act) of the Master Portfolio's outstanding
voting securities. To obtain approval, a majority of the Master Portfolio's
outstanding voting securities means the vote of the lesser of: (1) 67% or
more of the voting securities present, if more than 50% of the outstanding
voting securities are present or represented, or (2) more than 50% of the
outstanding voting shares.
Neither of these Master Portfolios may:
1. Invest more than 5% of its assets in the obligations
of any single issuer, except that up to 25% of the
value of its total assets may be invested, and
securities issued or guaranteed by the U.S.
government, or its agencies or instrumentalities may
be purchased, without regard to any such limitation.
With respect to the International Index Master
Portfolio, this limitation does not apply to foreign
currency transactions, including, without limitation,
forward currency contracts.
2. Hold more than 10% of the outstanding voting
securities of any single issuer. This investment
restriction applies only with respect to 75% of its
total assets.
3. Invest in commodities, except that a Master Portfolio
may purchase and sell (i.e., write) options, forward
contracts, futures contracts, including those
relating to indexes, and options on futures contracts
or indexes.
4. Purchase, hold or deal in real estate, or oil, gas or
other mineral leases or exploration or development
programs, but a Master Portfolio may purchase and
sell securities that are secured by real estate or
issued by companies that invest or deal in real
estate.
5. Borrow money, except to the extent permitted under
the 1940 Act, provided that the Master Portfolio may
borrow up to 20% of the current value of its net
assets for temporary purposes only to meet
redemptions, and these borrowings may be secured by
the pledge of up to 20% of the current value of its
net assets (but, with respect to the S&P 500 Index
Master Portfolio, investment may not be purchased
while any such outstanding borrowing in excess of 5%
of its net assets exists). For purposes of this
investment restriction, a Master Portfolio's entry
into
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options, forward contracts, futures contracts,
including those relating to indexes, and options on
futures contracts or indexes shall not constitute
borrowing to the extent certain segregated accounts
are established and maintained by such Master
Portfolio.
6. Make loans to others, except through the purchase of
debt obligations and the entry into repurchase
agreements. However, a Master Portfolio may lend its
portfolio securities in an amount not to exceed
one-third of the value of its total assets. Any loans
of portfolio securities will be made according to
guidelines established by the Commission and the
Master Fund's Board of Trustees.
7. Act as an underwriter of securities or other issuers,
except to the extent that a Master Portfolio may be
deemed an underwriter under the Securities Act of
1933, as amended, by virtue of disposing of portfolio
securities.
8. Invest 25% of more of its total assets in the
securities of issuers in any particular industry or
group of closely related industries except that there
shall be no limitation with respect to investments in
(i) obligations of the U.S. government, its agencies
or instrumentalities; (ii) in the case of the S&P 500
Index Master Portfolio, any industry in which the S&P
500 Index becomes concentrated to the same degree
during the same period, the Master Portfolio will be
concentrated as specified above only to the extent
the percentage of its assets invested in those
categories of investments is sufficiently large that
25% or more of its total assets would be invested in
a single industry; or (iii) in the case of
International Index Master Portfolio any industry in
which EAFE Free Index becomes concentrated to the
same degree during the same period, the Master
Portfolio will be concentrated as specified above
only to the extent the percentage of assets invested
in those categories of investments is sufficiently
large that 25% or more of its total assets would be
invested in a single industry.
9. Issue any senior security (as such term is defined in
Section 18(f) of the 1940 Act), except to the extent
the activities permitted in the Master Portfolio's
fundamental policies (3) and (5) may be deemed to
give rise to a senior security.
10. In the case of the S&P 500 Index Master Portfolio,
purchase securities on margin, but the Master
Portfolio may make margin deposits in connection with
transactions in options, forward contracts, futures
contracts, including those related to indexes, and
options on futures contracts or indexes.
The S&P 500 Index Master Portfolio and the International Index
Master Portfolio are subject to the following non-fundamental operation
policies which may be changed by the Board
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<PAGE>
of Trustees of the Master Fund without the approval of the holders of the
Master Portfolio's outstanding securities. The Master Portfolios may:
1. invest in shares of other open-end management
investment companies, subject to the limitations of
Section 12(d)(1) of the 1940 Act. Under the 1940 Act,
a Master Portfolio's investment in such securities
currently is limited, subject to certain exceptions,
to (i) 3% of the total voting stock of any one
investment company, (ii) 5% of such Master
Portfolio's net assets with respect to any one
investment company, and (iii) 10% of such Master
Portfolio's net assets in the aggregate. Other
investment companies in which a Master Portfolio
invests can be expected to charge fees for operating
expenses, such as investment advisory and
administration fees, that would be in addition to
those charged by the Master Portfolio.
2. not invest more than 15% of its net assets in
illiquid securities. For this purpose, illiquid
securities include, among others, (i) securities that
are illiquid by virtue of the absence of a readily
available market or legal or contractual restrictions
on resale, (ii) fixed time deposits that are subject
to withdrawal penalties and that have maturities of
more than seven days, and (iii) repurchase agreements
not terminable within seven days.
3. lend securities from its portfolio to brokers,
dealers and financial institutions, in amounts not to
exceed (in the aggregate) one-third of the Master
Portfolio's total assets. Any such loans of portfolio
securities will be fully collateralized based on
values that are marked to market daily. The Master
Portfolio will not enter into any portfolio security
lending arrangement having a duration of longer than
one year.
If a percentage restriction is adhered to at the time of investment,
a later change in percentage resulting from a change in values or assets will
not constitute a violation of such restriction.
OPERATING POLICIES OF THE RUSSELL 2000 MASTER PORTFOLIO
The Russell 2000 Master Portfolio is subject to the following
fundamental investment limitations which cannot be changed without approval
by the holders of a majority (as defined in the 1940 Act) of the Master
Portfolio's outstanding voting securities. To obtain approval, a majority of
the Master Portfolio's outstanding voting securities means the vote of the
lesser of: (1) 67% or more of the voting securities present, if more than 50%
of the outstanding voting securities are present or represented, or (2) more
than 50% of the outstanding voting shares.
The Russell 2000 Index Master Portfolio may not:
1. Purchase the securities of issuers conducting their
principal business activity in the same industry if,
immediately after the purchase and as a result
thereof, the value of the Master Portfolio's
investments in that
30
<PAGE>
industry would equal or exceed 25% of the current
value of the Master Portfolio's total assets,
provided that this restriction does not limit the
Master Portfolio's: (i) investments in securities of
other investment companies, (ii) investments in
securities issued or guaranteed by the U.S.
Government, its agencies or instrumentalities, or
(iii) investments in repurchase agreements provided
further that the Master Portfolio reserves the right
to concentrate in the obligations of domestic banks
(as such term is interpreted by the SEC or its
staff); and provided further that the Master
Portfolio reserves the right to concentrate in any
industry in which the Russell 2000 Index becomes
concentrated to the same degree during the same
period.
2. Purchase securities of any issuer if, as a result,
with respect to 75% of the Master Portfolio's total
assets, more than 5% of the value of its total assets
would be invested in the securities of any one issuer
or the Master Portfolio's ownership would be more
than 10% of the outstanding voting securities of such
issuer, provided that this restriction does not limit
the Master Portfolio's investments in securities
issued or guaranteed by the U.S. Government, its
agencies and instrumentalities, or investments in
securities of other investment companies.
3. Borrow money, except to the extent permitted under
the 1940 Act, including the rules, regulations and
any orders obtained thereunder.
4. Issue senior securities, except to the extent
permitted under the 1940 Act, including the rules,
regulations and any orders obtained thereunder.
5. Make loans to other parties if, as a result, the
aggregate value of such loans would exceed one-third
of the Master Portfolio's total assets. For the
purposes of this limitation, entering into repurchase
agreements, lending securities and acquiring any debt
securities are not deemed to be the making of loans.
6. Underwrite securities of other issuers, except to the
extent that the purchase of permitted investments
directly from the issuer thereof or from an
underwriter for an issuer and the later disposition
of such securities in accordance with a Master
Portfolio's investment program may be deemed to be an
underwriting.
7. Purchase or sell real estate unless acquired as a
result of ownership of securities or other
instruments (but this shall not prevent the Master
Portfolio from investing in securities or other
instruments backed by real estate or securities of
companies engaged in the real estate business).
8. Purchase or sell commodities, provided that (i)
currency will not be deemed to be a commodity for
purposes of this restriction, (ii) this
31
<PAGE>
restriction does not limit the purchase or sale of
futures contracts, forward contracts or options, and
(iii) this restriction does not limit the purchase or
sale of securities or other instruments backed by
commodities or the purchase or sale of commodities
acquired as a result of ownership of securities or
other instruments.
The Russell 2000 Index Master Portfolio has adopted the following
investment restrictions as non-fundamental policies. These restrictions may
be changed without interestholder approval by vote of a majority of the
Trustees of the Master Fund, at any time. The Master Portfolio is subject to
the following investment restrictions, all of which are non-fundamental
policies.
1. The Master Portfolio may invest in shares of other
open-end management investment companies, subject to
the limitations of Section 12(d)(1) of the 1940 Act.
Under the 1940 Act, the Master Portfolio's investment
in such securities currently is limited, subject to
certain exceptions, to (i) 3% of the total voting
stock of any one investment company, (ii) 5% of the
Master Portfolio's total assets with respect to any
one investment company, and (iii) 10% of the Master
Portfolio's total assets in the aggregate. Other
investment companies in which the Master Portfolio
invests can be expected to charge fees for operating
expenses, such as investment advisory and
administrative fees, that would be in addition to
those charge by the Master Portfolio.
2. The Master Portfolio may not invest more than 15% of
its net assets in illiquid securities. For this
purpose, illiquid securities include, among others,
(a) securities that are illiquid by virtue of the
absence of a readily available market or legal or
contractual restrictions on resale, (b) fixed time
deposits that are subject to withdrawal penalties and
that have maturities of more than seven days, and (c)
repurchase agreements not terminable within seven
days.
3. The Master Portfolio may lend securities from its
portfolio to brokers, dealers and financial
institutions, in amounts not to exceed (in the
aggregate) one-third of the Master Portfolio's total
assets. Any such loans of portfolio securities will
be fully collateralized based on values that are
marked to market daily. The Master Portfolio will not
enter into any portfolio security lending arrangement
having a duration of longer than one year.
MORE ABOUT THE EQUITY INDEX FUNDS
MASTER/FEEDER STRUCTURE
The Equity Index Funds seek to achieve their investment objective by
investing all of their assets into Master Portfolios of the Master Fund. The
Equity Index Funds and other entities
32
<PAGE>
investing in Master Portfolios are each liable for all obligations of the
Master Portfolio. However, the risk of the Equity Index Funds incurring
financial loss on account of such liability is limited to circumstances in
which both inadequate insurance existed and the Master Fund itself is unable
to meet its obligations. Accordingly, the Trust's Board of Trustees believes
that neither the Equity Index Funds nor their respective shareholders will be
adversely affected by investing assets in the Master Portfolios. However, if
a mutual fund or other investor withdraws its investment from a Master
Portfolio, the economic efficiencies (e.g., spreading fixed expenses among a
larger asset base) that the Trust's Board believes may be available through
investment in a Master Portfolio may not be fully achieved. In addition,
given the relative novelty of the master/feeder structure, accounting or
operational difficulties, although unlikely, could arise.
An Equity Index Fund may withdraw its investment in the Master
Portfolios only if the Trust's Board of Trustees determines that such action
is in the best interests of the Equity Index Fund and its shareholders. Upon
any such withdrawal, the Trust's Board would consider alternative
investments, including investing all of the Fund's assets in another
investment company with the same investment objective as the Fund or hiring
an investment adviser to manage the Fund's assets in accordance with the
investment policies described below with respect to a Master Portfolio.
The investment objective and other fundamental policies of a Master
Portfolio cannot be changed without approval by the holders of a majority (as
defined in the 1940 Act) of the Master Portfolio's outstanding interests.
Whenever an Equity Index Fund, as an interestholder of a Master Portfolio, is
requested to vote on any matter submitted to interestholders of the Master
Portfolio, the Equity Index Fund will either (1) hold a meeting of its
shareholders to consider such matters, and cast its votes in proportion to
the votes received from its shareholders (shares for which the Equity Index
Fund receives no voting instructions will be voted in the same proportion as
the votes received from the other Equity Index Fund shareholders); or (2)
cast its votes, as an interestholder of the Master Portfolio, in proportion
to the votes received by the Master Portfolio from all other interestholders
of the Master Portfolio.
Certain policies of the Master Portfolios which are non-fundamental
may be changed by vote of a majority of the Master Fund's Trustees without
interestholder approval. If the Master Portfolio's investment objective or
fundamental or non-fundamental policies are changed, the Equity Index Fund
may elect to change its objective or policies to correspond to those of the
Master Portfolio. The Equity Index Fund also may elect to redeem its
interests in the Master Portfolio and either seek a new investment company
with a matching objective in which to invest or retain its own investment
adviser to manage the Equity Index Fund's portfolio in accordance with its
objective. In the latter case, the Equity Index Fund's inability to find a
substitute investment company in which to invest or equivalent management
services could adversely affect shareholders' investments in the Equity Index
Fund. The Equity Index Fund will provide shareholders with 30 days' written
notice prior to the implementation of any change in the investment objective
of the Equity Index Fund or the Master Portfolio, to the extent possible.
33
<PAGE>
SELECTION OF INVESTMENTS FOR THE MASTER PORTFOLIO
The manner in which stocks are chosen for each of the Equity Index
Fund differs from the way securities are chosen in most other mutual funds.
Unlike other mutual funds where the portfolio securities are chosen by an
investment adviser based upon the adviser's research and evaluations, stocks
are selected for inclusion in a Master Portfolio's portfolio to have
aggregate investment characteristics (based on market capitalization and
industry weightings), fundamental characteristics (such as return
variability, earnings valuation and yield) and liquidity measures similar to
those of the benchmark index taken in its entirety.
As briefly discussed in the Prospectus, the S&P 500 Index Master
Portfolio generally holds every stock in the S&P 500. However, each of the
Russell 2000 Index Master Portfolio and International Index Master Portfolio
generally do not hold all of the issues that comprise their respective
benchmark index, due in part to the costs involved and, in certain instances,
the potential illiquidity of certain securities. Instead, the Russell 2000
Index Master Portfolio attempts to hold a representative sample of the
securities in its benchmark index, which are selected by Barclays utilizing
quantitative analytical models in a technique known as "portfolio sampling."
Under this technique, each stock is considered for inclusion in the Master
Portfolio based on its contribution to certain capitalization, industry and
fundamental investment characteristics. The International Index Master
Portfolio holds securities selected by Barclays utilizing a quantitative
model known as minimum variance optimization. Under this technique, stocks
are selected for inclusion if the fundamental investment characteristics of
the security reduce the portfolio's predicted tracking error against the
benchmark index. Barclays seeks to construct the portfolio of each of the
Russell 2000 Index Master Portfolio and International Index Master Portfolio
so that, in the aggregate, their capitalization, industry and fundamental
investment characteristics perform like those of their benchmark index.
Over time, the portfolio composition of each Master Portfolio may be
altered (or "rebalanced") to reflect changes in the characteristics of its
benchmark index or, for the Russell 2000 Index Master Portfolio and the
International Index Master Portfolio, with a view to bringing the performance
and characteristics more in line with that of their benchmark index. Such
rebalancings will require the Master Portfolios to incur transaction costs
and other expenses. Each of the Russell 2000 Index Master Portfolio and
International Index Master Portfolio reserve the right to invest in all of
the securities in their benchmark index.
TRACKING ERROR
Barclays uses the "expected tracking error" of a Master Portfolio as
a way to measure the Master Portfolio's performance relative to the
performance of its benchmark index. An expected tracking error of 5% means
that there is a 68% probability that the net asset value of the Master
Portfolio will be between 95% and 105% of the subject index level after one
year, without rebalancing the portfolio composition. A tracking error of 0%
would indicate perfect tracking, which would be achieved when the net asset
value of the Master Portfolio increases or decreases in exact proportion to
changes in its benchmark index. Factors such as expenses of the Master
Portfolio, taxes, the need to comply with the diversification and other
requirements of the Code
34
<PAGE>
and other requirements may adversely impact the tracking of the performance
of a Master Portfolio to that of its benchmark index. In the event that
tracking error exceeds 5%, the Board of Trustees of the Trust will consider
what action might be appropriate to reduce the tracking error.
RELATIONSHIP WITH THE INDEX PROVIDERS
STANDARD & POOR'S
The S&P 500 Index Fund and the S&P 500 Index Master Portfolio seek to
match the performance of the Standard & Poor's Index of 500 stocks ("S&P 500").
"Standard & Poor's-Registered Trademark-," "S&P-Registered Trademark-," "S&P
500-Registered Trademark-," "Standard and Poor's 500" and "500"are trademarks
of The McGraw-Hill Companies, Inc. and have been licensed for use by the Trust.
Neither the S&P 500 Index Fund nor the S&P 500 Index Master Portfolio is
sponsored, endorsed sold or promoted by Standard & Poor's, a division of the
McGraw-Hill Companies, Inc. ("S&P").
S&P makes no representation or warranty, express or implied, to the
owners of the S&P 500 Index Fund, the S&P 500 Index Master Portfolio or any
member of the public regarding the advisability of investing in securities
generally or in the S&P 500 Index Fund particularly or the ability of the S&P
500 Index to track general stock market performance. S&P's only relationship
to the Trust is the licensing of certain trademarks and trade names of S&P
and of the S&P 500 Index which is determined, composed and calculated by S&P
without regard to the Trust or the S&P 500 Index Fund. S&P has no obligation
to take the needs of the Trust or the owners of the S&P 500 Index Fund into
consideration in determining, composing or calculating the S&P 500 Index. S&P
is not responsible for and has not participated in the determination of the
prices and amount of the S&P 500 Index Fund or the timing of the issuance or
sale of the S&P 500 Index Fund or in the determination or calculation of the
equation by which the S&P 500 Index Fund is to be converted into cash. S&P
has no obligation or liability in connection with the administration,
marketing or trading of the S&P 500 Index Fund.
S&P DOES NOT GUARANTEE THE ACCURACY AND/OR THE COMPLETENESS OF THE
S&P 500 INDEX OR ANY DATA INCLUDED THEREIN AND S&P SHALL HAVE NO LIABILITY
FOR ANY ERRORS, OMISSIONS, OR INTERRUPTIONS THEREIN. S&P MAKES NO WARRANTY,
EXPRESS OR IMPLIED, AS TO RESULTS TO BE OBTAINED BY THE TRUST, OWNERS OF THE
FUND, OR ANY OTHER PERSON OR ENTITY FROM THE USE OF THE S&P 500 INDEX OR ANY
DATA INCLUDED THEREIN. S&P MAKES NO EXPRESS OR IMPLIED WARRANTIES, AND
EXPRESSLY DISCLAIMS ALL WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A
PARTICULAR PURPOSE OR USE WITH RESPECT TO THE S&P 500 INDEX OR ANY DATA
INCLUDED THEREIN. WITHOUT LIMITING ANY OF THE FOREGOING, IN NO EVENT SHALL
S&P HAVE ANY LIABILITY FOR ANY SPECIAL, PUNITIVE, INDIRECT OR CONSEQUENTIAL
DAMAGES (INCLUDING LOST PROFITS), EVEN IF NOTIFIED OF THE POSSIBILITY OF SUCH
DAMAGES.
RUSSELL 2000 35
<PAGE>
The Small Cap Index Fund and the Russell 2000 Index Master Portfolio
seek to match the performance of the Russell 2000 Small Stock Index (the
"Russell 2000"). The Russell 2000 tracks the common stock performance of the
2000 smallest U.S. companies in the Russell 3000 Index, representing about
10% in the aggregate of the capitalization of the Russell 3000 Index. The
Russell 2000 and the Russell 3000 are trademarks/service marks, and "Russell"
is a trademark, of Frank Russell Company. Neither the Small Cap Index Fund
nor the Russell 2000 Index Master Portfolio is promoted, sponsored or
endorsed by, nor in any way affiliated with Frank Russell Company. Frank
Russell Company is not responsible for and has not reviewed the Small Cap
Index Fund nor any associated literature or publications and makes no
representation or warranty, express or implied, as to their accuracy or
completeness, or otherwise.
Frank Russell Company reserves the right, at any time and without
notice, to alter, amend, terminate or in any way change the Russell 2000.
Frank Russell Company has no obligation to take the needs of any particular
fund or its participants or any other product or person into consideration in
determining, composing or calculating the Russell 2000.
Frank Russell Company's publication of the Russell 2000 in no way
suggests or implies an opinion by Frank Russell Company as to the
attractiveness or appropriateness of investment in any or all securities upon
which the index is based. FRANK RUSSELL COMPANY MAKES NO REPRESENTATION,
WARRANTY, OR GUARANTEE AS TO THE ACCURACY, COMPLETENESS, RELIABILITY, OR
OTHERWISE OF THE RUSSELL 2000 OR ANY DATA INCLUDED IN THE RUSSELL 2000. FRANK
RUSSELL COMPANY MAKES NO REPRESENTATION OR WARRANTY REGARDING THE USE, OR THE
RESULTS OF USE, OF THE RUSSELL 2000 OR ANY DATA INCLUDED THEREIN, OR ANY
SECURITY (OR COMBINATION THEREOF) COMPRISING THE RUSSELL 2000. FRANK RUSSELL
COMPANY MAKES NO OTHER EXPRESS OR IMPLIED WARRANTY, AND EXPRESSLY DISCLAIMS
ANY WARRANTY, OF ANY KIND, INCLUDING, WITHOUT MEANS OF LIMITATION, ANY
WARRANTY OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE WITH RESPECT
TO THE RUSSELL 2000 OR ANY DATA OR ANY SECURITY (OR COMBINATION THEREOF)
INCLUDED THEREIN.
EAFE INDEX
The International Index Fund and the International Index Master
Portfolio seek to match the performance of the Morgan Stanley Capital
International Europe, Australia, and Far East Free Index ("EAFE Free"). EAFE
Free is the property of Morgan Stanley & Co. Incorporated ("Morgan Stanley").
Morgan Stanley Capital International is a service mark of Morgan Stanley and
has been licensed for use by the Trust. Neither the International Index Fund
nor the International Index Master Portfolio is sponsored, endorsed, sold or
promoted by Morgan Stanley. Morgan Stanley makes no representation or
warranty, express or implied, to the owners of shares of the International
Index Fund, the International Index Master Portfolio or any member of the
public regarding the advisability of investing in securities generally or in
the shares of the International Index Fund or International Index Master
Portfolio particularly or the ability of EAFE Free to track general stock
market performance. Morgan Stanley is the licensor of certain trademarks,
service marks and trade names of Morgan Stanley and of the EAFE Free,
36
<PAGE>
which is determined, composed and calculated by Morgan Stanley without regard
to the International Index Fund. Morgan Stanley has no obligation to take the
needs of the International Index Fund or International Index Master Portfolio
or the owners of the International Index Fund into consideration in
determining, composing or calculating the EAFE Free. Morgan Stanley is not
responsible for and has not participated in the determination of the timing
of, prices at, or quantities of the International Index Fund to be issued or
in the determination or calculation of the equation by which the
International Index Fund is redeemable for cash. Morgan Stanley has no
obligation or liability to owners of the International Index Fund in
connection with the administration, marketing or trading of the International
Index Fund.
ALTHOUGH MORGAN STANLEY SHALL OBTAIN INFORMATION FOR INCLUSION IN OR FOR USE
IN THE CALCULATION OF THE INDEX FROM SOURCES WHICH MORGAN STANLEY CONSIDERS
RELIABLE, NEITHER MORGAN STANLEY NOR ANY OTHER PARTY GUARANTEES THE ACCURACY
AND/OR THE COMPLETENESS OF THE EAFE FREE OR ANY DATA INCLUDED THEREIN.
NEITHER MORGAN STANLEY NOR ANY OTHER PARTY MAKES ANY WARRANTY, EXPRESS OR
IMPLIED, AS TO RESULTS TO BE OBTAINED BY THE TRUST, THE TRUST'S CUSTOMERS AND
COUNTERPARTIES, OWNERS OF THE INTERNATIONAL INDEX FUND, OR ANY OTHER PERSON
OR ENTITY FROM THE USE OF THE EAFE FREE OR ANY DATA INCLUDED THEREIN IN
CONNECTION WITH THE RIGHTS LICENSED HEREUNDER OR FOR ANY OTHER USE. NEITHER
MORGAN STANLEY NOR ANY OTHER PARTY MAKES ANY EXPRESS OR IMPLIED WARRANTIES,
AND MORGAN STANLEY HEREBY EXPRESSLY DISCLAIMS ALL WARRANTIES OF
MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE WITH RESPECT TO THE EAFE
FREE OR ANY DATA INCLUDED THEREIN. WITHOUT LIMITING ANY OF THE FOREGOING, IN
NO EVENT SHALL MORGAN STANLEY OR ANY OTHER PARTY HAVE ANY LIABILITY FOR ANY
DIRECT, INDIRECT, SPECIAL PUNITIVE, CONSEQUENTIAL OR ANY OTHER DAMAGES
(INCLUDING LOST PROFITS) EVEN IF NOTIFIED OF THE POSSIBILITY OF SUCH DAMAGES.
TRUSTEES AND OFFICERS
The Board of Trustees has overall responsibility for the conduct of the
Trust's affairs. It is possible that the interests of the Equity and Bond
Fund could diverge from the interests of one or more of the underlying Funds
in which it invests. If such interests were ever to become divergent, it is
possible that a conflict of interest could arise and affect how the Trustees
and officers fulfill their fiduciary duties to each Fund. The Trustees
believe they have structured each Fund to avoid these concerns. However,
conceivably, a situation could occur where proper action for the Equity and
Bond Fund could be adverse to the interests of an underlying Fund, or the
reverse could occur. If such a possibility arises, the Manager and the
Trustees and officers of the Trust will carefully analyze the situation and
take all steps they believe reasonable to minimize and, where possible,
eliminate the potential conflict. Moreover, close and continuous monitoring
will be exercised to avoid, insofar as possible, these concerns.
37
<PAGE>
The Trustees and officers of the Trust, their ages at December 1,
2000, their principal occupations for the last five years and their
affiliations, if any, with the Manager and State Farm VP Management Corp.,
the Trust's principal underwriter, are listed below. Unless otherwise noted,
the address of each is One State Farm Plaza, Bloomington, Illinois 61710-0001.
<TABLE>
<CAPTION>
POSITION(S) HELD
NAME, AGE AND ADDRESS WITH THE FUNDS PRINCIPAL OCCUPATION(S) DURING PAST FIVE YEARS
--------------------- ---------------- ----------------------------------------------
<S> <C> <C>
Edward B. Rust, Jr.*, Trustee and President CHAIRMAN OF THE BOARD, CEO, AND DIRECTOR - State
Age 50 Farm Mutual Automobile Insurance Company;
PRESIDENT, CEO, AND DIRECTOR - State Farm
Life Insurance Company, State Farm Life and
Accident Assurance Company, State Farm
Annuity and Life Insurance Company, State
Farm General Insurance Company, State Farm
Fire and Casualty Company, State Farm
Investment Management Corp.; TRUSTEE,
CHAIRMAN OF THE BOARD AND PRESIDENT (SINCE
1997) - State Farm Variable Product Trust;
CHAIRMAN OF THE BOARD AND DIRECTOR (since
1999) - State Farm Federal Savings Bank;
PRESIDENT, CEO, AND DIRECTOR (SINCE 1997) -
State Farm VP Management Corp.; PRESIDENT -
State Farm County Mutual Insurance Company of
Texas; DIRECTOR - State Farm Lloyds, Inc.,
State Farm International Services, Inc.;
CHAIRMAN OF THE BOARD, PRESIDENT, AND
TREASURER - State Farm Companies Foundation;
PRESIDENT AND DIRECTOR - State Farm Interim
Fund, Inc., State Farm Municipal Bond Fund,
Inc., State Farm Balanced Fund Inc., State
Farm Growth Fund, Inc.
38
<PAGE>
POSITION(S) HELD
NAME, AGE AND ADDRESS WITH THE FUNDS PRINCIPAL OCCUPATION(S) DURING PAST FIVE YEARS
--------------------- ---------------- ----------------------------------------------
Roger S. Joslin*, Trustee, Senior Vice President VICE CHAIRMAN, CHIEF FINANCIAL OFFICER, SENIOR
Age 64 and Treasurer VICE PRESIDENT, TREASURER, AND DIRECTOR - State
Farm Mutual Automobile Insurance Company; DIRECTOR -
State Farm Life Insurance Company, State Farm Life
and Accident Assurance Company, State Farm Annuity
and Life Insurance Company; DIRECTOR, SENIOR VICE
PRESIDENT, AND TREASURER - State Farm General
Insurance Company, State Farm Lloyds, Inc., State
Farm International Services, Inc.; SENIOR VICE
PRESIDENT AND TREASURER - State Farm Investment
Management Corp.; TRUSTEE, VICE PRESIDENT AND
TREASURER (SINCE 1997) - State Farm Variable Product
Trust; DIRECTOR, SENIOR VICE PRESIDENT, CHIEF
FINANCIAL OFFICER AND TREASURER (SINCE 1997) - State
Farm VP Management Corp.; DIRECTOR, VICE PRESIDENT
AND TREASURER (since 1999) - State Farm Federal
Savings Bank; CHAIRMAN OF THE BOARD, TREASURER, AND
DIRECTOR - State Farm Fire and Casualty Company;
TREASURER - State Farm County Mutual Insurance
Company of Texas; ASSISTANT TREASURER - State Farm
Companies Foundation; SENIOR VICE PRESIDENT,
TREASURER AND DIRECTOR - State Farm Interim Fund,
Inc., State Farm Municipal Bond Fund, Inc., State
Farm Balanced Fund, Inc., State Farm Growth Fund,
Inc.
Thomas M. Mengler, Trustee DEAN, UNIVERSITY OF ILLINOIS COLLEGE OF LAW
Age 47 (SINCE 1993); TRUSTEE - State Farm Variable
Swanland Building Product Trust (since 1997); DIRECTOR - State
601 E. John St. Farm Interim Fund, Inc., State Farm Municipal
Champaign, IL 61820 Bond Fund, Inc., State Farm Balanced Fund, Inc.,
State Farm Growth Fund, Inc.
James A. Shirk, Trustee DIRECTOR AND PRESIDENT - Beer Nuts, Inc.;
Age 56 TRUSTEE - State Farm Variable Product Trust
103 North Robinson (since 1997); DIRECTOR - State Farm Interim
Bloomington, IL 61701 Fund, Inc., State Farm Municipal Bond Fund,
Inc., State Farm Balanced Fund, Inc., State Farm
Growth Fund, Inc.
39
<PAGE>
POSITION(S) HELD
NAME, AGE AND ADDRESS WITH THE FUNDS PRINCIPAL OCCUPATION(S) DURING PAST FIVE YEARS
--------------------- ---------------- ----------------------------------------------
Victor J. Boschini, Trustee PRESIDENT, Illinois State University (since
Age 44 1999); VICE PRESIDENT, Illinois State University
100 Gregory St., (1997 to 1999); ASSOCIATE PROVOST, Butler
Normal, Illinois 61761 University 1990-1997).
David L. Vance Trustee PRESIDENT, Caterpillar University (since 2000);
Age 48 CHIEF ECONOMIST AND MANAGER of the Business
100 N.E.Adams St. Intelligence Group, Caterpillar, Inc. (since 1994).
Peoria, Illinois 61629
Donald A. Altorfer Trustee CHAIRMAN, Altorfer, Inc. (dealer in heavy machinery
Age 57 and equipment, since 1998);
4200 Rodger St. PRESIDENT, Capitol Machine Company (1981-1998).
Springfield, Illinois 62703
Kurt G. Moser, Age 55 Senior Vice President SENIOR VICE PRESIDENT - INVESTMENTS (SINCE 1998)
VICE PRESIDENT - INVESTMENTS - State Farm Mutual
Automobile Insurance Company, State Farm County
Mutual Insurance Company of Texas, State Farm
Lloyds, Inc.; SENIOR VICE PRESIDENT -
INVESTMENTS (SINCE 1998), VICE PRESIDENT -
INVESTMENTS, AND DIRECTOR - State Farm Life
Insurance Company, State Farm Life and Accident
Assurance Company, State Farm Annuity and Life
Insurance Company, State Farm Fire and Casualty
Company, State Farm General Insurance Company;
SENIOR VICE PRESIDENT - INVESTMENTS (SINCE
1998), INVESTMENT OFFICER - State Farm Indemnity
Company; VICE PRESIDENT - INVESTMENTS (since
1998) - State Farm Florida Insurance Company;
VICE PRESIDENT (SINCE 1997), VICE PRESIDENT, AND
DIRECTOR (PRIOR TO 1997) - State Farm Investment
Management Corp.; VICE PRESIDENT (SINCE 1997)
-State Farm Variable Product Trust; DIRECTOR
(SINCE 1997) - State Farm VP Management Corp.;
VICE PRESIDENT - INVESTMENTS - State Farm
International Services, Inc.; UNDERWRITER -
State Farm Lloyds, Inc.; SENIOR VICE PRESIDENT -
State Farm Interim Fund, Inc., State Farm
Municipal Bond Fund, Inc., State Farm Balanced
Fund, Inc., State Farm Growth Fund, Inc.
40
<PAGE>
POSITION(S) HELD
NAME, AGE AND ADDRESS WITH THE FUNDS PRINCIPAL OCCUPATION(S) DURING PAST FIVE YEARS
--------------------- ---------------- ----------------------------------------------
Paul N. Eckley, Senior Vice President SENIOR VICE PRESIDENT - INVESTMENTS AND
Age 46 ASSISTANT SECRETARY-TREASURER (SINCE 1998), VICE
PRESIDENT - COMMON STOCKS - State Farm Mutual
Automobile Insurance Company, State Farm Fire
and Casualty Company; SENIOR VICE PRESIDENT -
INVESTMENTS AND ASSISTANT SECRETARY-TREASURER
(SINCE 1998) - State Farm General Insurance
Company, State Farm Life Insurance Company,
State Farm Life and Accident Assurance Company,
State Farm Annuity and Life Insurance Company,
State Farm Indemnity Company, State Farm County
Mutual Insurance Company of Texas, State Farm
Lloyds, Inc.; SENIOR VICE PRESIDENT (SINCE
1997), AND INVESTMENT OFFICER (PRIOR TO 1997) -
State Farm Investment Management Corp.; VICE
PRESIDENT (SINCE 1997) - State Farm Variable
Product Trust; SENIOR VICE PRESIDENT - State
Farm Balanced Fund, Inc., State Farm Growth
Fund, Inc.
Susan D. Waring Vice President VICE PRESIDENT (SINCE 2000) - State Farm Mutual
Age 51 Automobile Insurance Company, State Farm
Investment Management Corp., State Farm Variable
Product Trust, State Farm Growth Fund, Inc.,
State Farm Balanced Fund, Inc., State Farm
Interim Fund, Inc., State Farm Municipal Bond
Fund, Inc.; VICE PRESIDENT - AGENCY -
(1997-2000) - State Farm Mutual Automobile
Insurance Company; EXECUTIVE ASSISTANT
(1995-1997) - State Farm Mutual Automobile
Insurance Company
41
<PAGE>
POSITION(S) HELD
NAME, AGE AND ADDRESS WITH THE FUNDS PRINCIPAL OCCUPATION(S) DURING PAST FIVE YEARS
--------------------- ---------------- ----------------------------------------------
Donald E. Heltner, Vice President VICE PRESIDENT (SINCE 1998) - State Farm
Age 53 Variable Product Trust; State Farm Balanced
Fund, Inc. and State Farm Interim Fund, Inc.,
VICE PRESIDENT - FIXED INCOME AND ASSISTANT
SECRETARY-TREASURER (SINCE 1998), State Farm
Life Insurance Company, State Farm Life and
Accident Assurance Company, and State Farm
Annuity and Life Insurance Company (SINCE
1998); VICE PRESIDENT - FIXED INCOME, State
Farm Mutual Automobile Insurance Company, State
Farm Fire and Casualty Company, State Farm
General Insurance Company, State Farm Indemnity
Company, and State Farm Lloyds, Inc. (SINCE
1998); prior to 1998, VICE PRESIDENT, Century
Investment Management Co.
Julian R. Bucher, Vice President VICE PRESIDENT State Farm Municipal Bond Fund,
Age 58 Inc.; VICE PRESIDENT - MUNICIPAL SECURITIES AND
ASSISTANT SECRETARY-TREASURER (SINCE 1997), State
Farm Mutual Automobile Insurance Company, State Farm
Fire and Casualty Company, State Farm Life Insurance
Company, State Farm Life and Accident Assurance
Company, and State Farm General Insurance Company;
VICE PRESIDENT - MUNICIPAL SECURITIES (SINCE 1997),
State Farm Indemnity Company and State Farm Lloyds,
Inc. (SINCE 1997); prior to 1997, INVESTMENT OFFICER,
State Farm Investment Management Corp.
Duncan Funk, Assistant Vice President INVESTMENT OFFICER AND ASSISTANT SECRETARY -
Age 39 TREASURER (SINCE 1997) - State Farm Life
Insurance Company, State Farm Life and Accident
Assurance Company, and State Farm Annuity and Life
Insurance Company; INVESTMENT OFFICER (SINCE 1997) -
State Farm Mutual Automobile Insurance Company, State
Farm Fire and Casualty Company, State Farm General
Insurance Company, State Farm Indemnity Company, and
State Farm Lloyds, Inc.; PRIOR TO 1997, INVESTMENT
ANALYST; ASSISTANT VICE PRESIDENT - State Farm
Variable Product Trust
42
<PAGE>
POSITION(S) HELD
NAME, AGE AND ADDRESS WITH THE FUNDS PRINCIPAL OCCUPATION(S) DURING PAST FIVE YEARS
--------------------- ---------------- ----------------------------------------------
David R. Grimes, Assistant Vice President and ASSISTANT VICE PRESIDENT OF ACCOUNTING - State
Age 58 Secretary Farm Mutual Automobile Insurance Company; VICE
PRESIDENT AND SECRETARY - State Farm Investment
Management Corp.; VICE PRESIDENT AND SECRETARY
(SINCE 1997) - State Farm Variable Product
Trust; VICE PRESIDENT AND SECRETARY (SINCE 1997)
- State Farm VP Management Corp.; VICE PRESIDENT
AND SECRETARY - State Farm Municipal Bond Fund,
Inc., State Farm Balanced Fund, Inc., State Farm
Growth Fund, Inc., State Farm Interim Fund, Inc.
Jerel S. Chevalier, Assistant Secretary - Treasurer DIRECTOR OF MUTUAL FUNDS - State Farm Mutual
Age 62 Automobile Insurance Company; ASSISTANT
SECRETARY - TREASURER - State Farm Investment
Management Corp.; ASSISTANT SECRETARY-TREASURER
(SINCE 1997) - State Farm Variable Product
Trust; ASSISTANT SECRETARY - TREASURER - State
Farm Interim Fund, Inc., State Farm Municipal
Bond Fund, Inc., State Farm Balanced Fund, Inc.,
State Farm Growth Fund, Inc.
Howard A. Thomas, Assistant Secretary-Treasurer DIRECTOR OF MUTUAL FUNDS (SINCE 1998) - State
Age 52 Farm Mutual Automobile Insurance Company;
MANAGER OF ACCOUNTING BENEFITS (1988 - 1998) -
State Farm Mutual Automobile Insurance Company;
ASSISTANT SECRETARY - TREASURER (SINCE 1998) -
State Farm Investment Management Corp., State
Farm Variable Product Trust; ASSISTANT SECRETARY
- TREASURER - State Farm Interim Fund, Inc.,
State Farm Municipal Bond Fund, Inc., State Farm
Balanced Fund, Inc., State Farm Growth Fund, Inc.
43
<PAGE>
POSITION(S) HELD
NAME, AGE AND ADDRESS WITH THE FUNDS PRINCIPAL OCCUPATION(S) DURING PAST FIVE YEARS
--------------------- ---------------- ----------------------------------------------
Donald O. Jaynes, Assistant Secretary ASSOCIATE GENERAL COUNSEL - State Farm Mutual
Age 52 Automobile Insurance Company; ASSISTANT
SECRETARY (SINCE 1998) - State Farm Investment
Management Corp., State Farm Variable Product
Trust; ASSISTANT SECRETARY - State Farm Interim
Fund, Inc., State Farm Municipal Bond Fund,
Inc., State Farm Balanced Fund, Inc., State Farm
Growth Fund, Inc.
Stephen L. Horton, Assistant Secretary COUNSEL - State Farm Mutual Automobile Insurance
Age 43 Company; COUNSEL AND ASSISTANT SECRETARY (SINCE
1999) - State Farm VP Management Corp; ASSISTANT
SECRETARY (SINCE 2000) - State Farm Interim
Fund, Inc., Municipal Bond Fund, Inc., State
Farm Balanced Fund, Inc., State Farm Growth
Fund, Inc., State Farm Variable Product Trust
and State Farm Investment Management Corp.
David M. Moore, Assistant Secretary COUNSEL (SINCE 1997), ASSISTANT TAX COUNSEL
Age 38 (1995-1997) - State Farm Mutual Automobile
Insurance Company; ASSISTANT SECRETARY (SINCE
2000)- State Farm Investment Management Corp.,
State Farm Interim Fund, Inc., Municipal Bond
Fund, Inc., State Farm Balanced Fund, Inc.,
State Farm Growth Fund, Inc., State Farm
Variable Product Trust
Michael L. Tipsord, Assistant Secretary VICE PRESIDENT AND ASSISTANT TREASURER (SINCE
Age 42 1998), EXECUTIVE ASSISTANT - OPERATIONS (SINCE
1997), ASSISTANT CONTROLLER (1996-1997),
DIRECTOR OF ACCOUNTING (1995-1996) - State Farm
Mutual Automobile Insurance Company; ASSISTANT
SECRETARY - State Farm Investment Management
Corp., ASSISTANT SECRETARY (SINCE 1997) - State
Farm Variable Product Trust; TREASURER (SINCE
1996) - Insurance Placement Services, Inc.;
ASSISTANT SECRETARY - State Farm Municipal Bond
Fund, Inc., State Farm Balanced Fund, Inc.,
State Farm Growth Fund, Inc., State Farm Interim
Fund, Inc.
</TABLE>
*Trustee who is an "interested person" of the Trust or of the Manager, as
defined in the 1940 Act.
44
<PAGE>
Trustees or officers who are interested persons do not receive any
compensation from any Fund for their services to the Fund. The Trustees who
are not interested persons of any Fund will receive a monthly retainer equal
to $1,750.00, and a fee for each board meeting attended at a rate of $750.00
per meeting. These fees are paid to the Turstees on behalf of the Trust and
on behalf of ten other mutual funds advised by the Manager. Each fund managed
by the Manager shares in the expenses pro-rata based upon the relative net
assets of each fund as of the end of the most recently completed calendar
quarter. In addition, Trustees who are not interested persons of the Funds
will be reimbursed for any out-of-pocket expenses incurred in connection with
the affairs of the Trust.
Trustees and officers of the Trust do not receive any benefits from
the Trust upon retirement nor does the Trust accrue any expenses for pension
or retirement benefits. Officers of the Trust and Trustees who are interested
persons of the Trust are also employees of the State Farm Insurance
Companies. As such, these persons may purchase Class A shares of the Funds
without paying an initial sales charge. The purpose of this program is to
encourage these persons to purchase Fund shares.
<TABLE>
<CAPTION>
AGGREGATE TOTAL COMPENSATION
COMPENSATION FROM THE TRUST AND OTHER STATE FARM
NAME FROM THE TRUST (1) MUTUAL FUNDS (1)(2)
---- ------------------ -------------------
<S> <C> <C>
Edward B. Rust, Jr. None (3) None (3)
Roger S. Joslin None (3) None (3)
Thomas M. Mengler $5,500 $16,350
James A. Shirk $5,500 $19,950
Donald Altorfer $2,400 $2,400
Victor Boschini $2,400 $2,400
David L. Vance $2,400 $2,400
</TABLE>
(1) For the fiscal year ended December 31, 2000.
(2) The "other State Farm Mutual Funds" are State Farm Growth Fund, Inc.,
State Farm Balanced Fund, Inc., State Farm Interim Fund, Inc., State
Farm Municipal Bond Fund, Inc. and State Farm Variable Product Trust
(3) Non-compensated interested trustee.
INVESTMENT ADVISORY AGREEMENTS
BETWEEN THE TRUST AND THE MANAGER
The Manager is a wholly-owned subsidiary of State Farm Mutual
Automobile Insurance Company ("Auto Company"). The duties and
responsibilities of the Manager are specified in the
45
<PAGE>
Investment Advisory and Management Services Agreement between the Trust and
the Manager and the separate Service Agreement among the Trust, the Manager
and Auto Company (collectively, the "Management Agreements"). The Management
Agreements were approved for each Fund by the Board of Trustees of the Trust
(including a majority of Trustees who are not parties to the Management
Agreements or interested persons, as defined by the 1940 Act, of any such
party) at a meeting held for that purpose on October 30, 2000 and
subsequently were approved by the sole shareholder of each Fund. The
Management Agreements are not assignable and each may be terminated without
penalty upon 60 days written notice at the option of the Trust, the Manager
or Auto Company, as appropriate, or by a vote of shareholders. Each
Management Agreement provides that it shall continue in effect for two years
and can thereafter be continued for each applicable Fund from year to year so
long as such continuance is specifically approved annually (a) by the Board
of Trustees of the Trust or by a majority of the outstanding voting shares of
the Fund and (b) by a majority vote of the Trustees who are not parties to
the Agreement, or interested persons of any such party, cast in person at a
meeting held for that purpose.
The Manager (under the supervision of the Board of Trustees)
continuously furnishes an investment program for the Funds (other than the
Small Cap Equity Fund and International Equity Fund and the Equity Index
Funds), is responsible for monitoring the performance of the Equity Index
Funds, is responsible for managing the investments of such Funds, and has
responsibility for making decisions governing whether to buy, sell or hold
any particular security. In carrying out its obligations to manage the
investment and reinvestment of the assets of these Funds, the Manager
performs research and obtains and evaluates pertinent economic, statistical
and financial data relevant to the investment policies of these Funds.
The Trust pays the Manager monthly compensation in the form of an
investment advisory and management services fee. The fee is based upon
average daily net assets and is accrued daily and paid to the Manager
quarterly at the following annual rates for each of the Funds:
<TABLE>
<S> <C>
Equity Fund 0.60% of net assets
Small Cap Equity Fund 0.80% of net assets
International Equity Fund 0.80% of net assets
S&P 500 Index Fund 0.15% of net assets
Small Cap Index Fund 0.25% of net assets
International Index Fund 0.25% of net assets
Equity and Bond Fund 0.40% of net assets
Bond Fund 0.10% of net assets
Tax Advantaged Bond Fund 0.10% of net assets
Money Market Fund 0.10% of net assets
</TABLE>
The Manager has agreed not to be paid an investment advisory and
management services fee for performing services for the Equity and Bond Fund.
The investment advisory and management services for the Equity Fund and Bond
Fund is based on the fees that the Equity Fund and Bond Fund pay to the
Manager, which has agreed to reimburse the Equity and Bond Fund for all other
expenses incurred. This expense limitation is voluntary and the Manager may
46
<PAGE>
eliminate it at any time. However, the Manager will receive fees for
performing services for the underlying funds in which the Equity and Bond
Fund invests. The Manager will reimburse each Fund, if and to the extent, the
Fund's total annual operating expenses exceed the following percentages of
the Fund's average net assets.
<TABLE>
<CAPTION>
CLASS A CLASS B
------- -------
<S> <C> <C>
Equity Fund 1.20% 1.60%
Small Cap Equity Fund 1.40% 1.80%
International Equity Fund 1.50% 1.90%
S&P 500 Index Fund 0.80% 1.20%
Small Cap Index Fund 0.95% 1.35%
International Index Fund 1.15% 1.55%
Equity and Bond Fund None None
Bond Fund 0.70% 1.10%
Tax Advantaged Bond Fund 0.70% 1.10%
Money Market Fund 0.60% 1.00%
</TABLE>
The reimbursement arrangement set forth above and the reimbursement
arrangement for the Equity and Bond Fund are voluntary and may be eliminated
by the Manager at any time.
As described below, the Manager has engaged Capital Guardian as the
investment sub-adviser for the Small Cap Equity Fund and International Equity
Fund.
The Manager is responsible for payment of all expenses it may incur
in performing the services described. These expenses include costs incurred
in providing investment advisory services, compensating and furnishing office
space for officers and employees of the Manager connected with investment and
economic research, trading and investment management of the Trust and the
payment of any fees to interested Trustees of the Trust. The Manager provides
all executive, administrative, clerical and other personnel necessary to
operate the Trust and pays the salaries and other employment related costs of
employing those persons. The Manager furnishes the Trust with office space,
facilities and equipment and pays the day-to-day expenses related to the
operation and maintenance of such office space facilities and equipment. All
other expenses incurred in the organization of the Trust or of new Funds of
the Trust, including legal and accounting expenses and costs of the initial
registration of securities of the Trust under federal and state securities
laws, are also paid by the Manager.
Pursuant to the Service Agreement, Auto Company provides the Manager
with certain personnel, services and facilities to enable the Manager to
perform its obligations to the Trust. The Manager reimburses Auto Company for
such costs, direct and indirect, as are fairly attributable to the services
performed and the facilities provided by Auto Company under the separate
service agreement. Accordingly, the Trust makes no payment to Auto Company
under the Service Agreement.
The Trust is responsible for payment of all expenses it may incur in
its operation and all of its general administrative expenses except those
expressly assumed by the Manager as
47
<PAGE>
described in the preceding paragraphs. These include (by way of description
and not of limitation), any share redemption expenses, expenses of portfolio
transactions, shareholder servicing costs, pricing costs (including the daily
calculation of net asset value), interest on borrowings by the Trust, charges
of the custodian and transfer agent, cost of auditing services,
non-interested Trustees' fees, legal expenses, all taxes and fees, investment
advisory fees, certain insurance premiums, cost of maintenance of corporate
existence, investor services (including allocable personnel and telephone
expenses), costs of printing and mailing updated Trust prospectuses to
shareholders, costs of preparing, printing, and mailing proxy statements and
shareholder reports to shareholders, the cost of paying dividends, capital
gains distribution, costs of Trustee and shareholder meetings, dues to trade
organizations, and any extraordinary expenses, including litigation costs in
legal actions involving the Trust, or costs related to indemnification of
Trustees, officers and employees of the Trust.
The Board of Trustees of the Trust determines the manner in which
expenses are allocated among the Funds of the Trust. The Board allocates
those expenses associated to a specific Fund to that Fund. Those expenses
which are paid for the benefit of all the Funds are allocated by the Board
pro-rata based upon each Fund's net assets.
The Management Agreements also provide that the Manager shall not be
liable to the Trust or to any shareholder or contract owner for any error of
judgment or mistake of law or for any loss suffered by the Trust or by any
shareholder in connection with matters to which the such Agreements relate,
except for a breach of fiduciary duty or a loss resulting from willful
misfeasance, bad faith, gross negligence, or reckless disregard on the part
of the Manager in the performance of its duties thereunder.
BETWEEN BARCLAYS AND THE MASTER PORTFOLIOS
Barclays is investment adviser to the Master Portfolios. Barclays is
an indirect subsidiary of Barclays Bank PLC. Pursuant to Investment Advisory
Contracts ("Master Portfolio Advisory Contracts") with the Master Fund,
Barclays provides investment guidance and policy direction in connection with
the management of the Master Portfolios' assets. Pursuant to the Master
Portfolio Advisory Contracts, Barclays furnishes to the Master Fund's Boards
of Trustees periodic reports on the investment strategy and performance of
the Master Portfolios. The Master Portfolio Advisory Contracts are required
to be approved annually (i) by the holders of a majority of the Master Fund's
outstanding voting securities or by the Master Fund's Boards of Trustees and
(ii) by a majority of the Trustees of the Master Fund who are not parties to
the Master Portfolio Advisory Contract or "interested persons" (as defined in
the 1940 Act) of any such party. The Master Portfolio Advisory Contracts may
be terminated on 60 days' written notice by either party and will terminate
automatically if assigned.
Barclays is entitled to receive monthly fees as compensation for its
advisory services to each Master Portfolio as described below:
<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------
FUND ANNUAL MANAGEMENT FEE
-------------------------------------------------------------------------------------------
<S> <C>
S&P 500 Index Master Portfolio 0.05% of average daily net assets
-------------------------------------------------------------------------------------------
</TABLE>
48
<PAGE>
<TABLE>
<S> <C>
-------------------------------------------------------------------------------------------
Russell 2000 Index Master Portfolio 0.10% of average daily net assets, which includes
a 0.02% administrative fee
-------------------------------------------------------------------------------------------
International Index Master Portfolio 0.25% of the average daily net assets up
to $1 billion, which includes a
0.10% administrative fee, and
0.17% of the average daily net
assets thereafter, which
includes a 0.07% administrative fee
------------------------------------------------------------------------------------------
</TABLE>
The Master Portfolio Advisory Contracts provide that the advisory fee is
accrued daily and paid monthly. This advisory fee is an expense of the Master
Portfolios borne proportionately by their interestholders, such as the Equity
Index Funds. The administration fee is designed to compensate Barclays for
custody costs and administration expenses.
Barclays has agreed to provide to the Master Portfolios, among other
things, money market security and fixed-income research, analysis and
statistical and economic data and information concerning interest rate and
security market trends, portfolio composition, credit conditions and average
maturities of the Master Portfolio's investment portfolio.
BETWEEN THE MANAGER AND CAPITAL GUARDIAN
Pursuant to the separate sub-advisory agreement described below, the
Manager has engaged Capital Guardian as the investment sub-adviser to provide
day-to-day portfolio management for the Small Cap Equity Fund and the
International Equity Fund. Capital Guardian manages the investments of the
Small Cap Equity Fund and the International Equity Fund, determining which
securities or other investments to buy and sell for each, selecting the
brokers and dealers to effect the transactions, and negotiating commissions.
In placing orders for securities transactions, Capital Guardian follows the
Manager's policy of seeking to obtain the most favorable price and efficient
execution available.
For its services, the Manager pays Capital Guardian an investment
sub-advisory fee equal to a percentage of the average daily net assets of
each of Small Cap Equity Fund and International Equity Fund at the rates set
forth below. The fee is accrued daily and paid to Capital Guardian quarterly.
The rates upon which the fee is based are as follows:
<TABLE>
<CAPTION>
---------------------------------------------------------------------------------
ANNUAL MANAGEMENT FEE, BASED ON AVERAGE
FUND DAILY NET ASSETS
---------------------------------------------------------------------------------
<S> <C> <C>
Small Cap Equity Fund On the first $25 million - 0.75%
$25 million to $50 million - 0.60%
$50 million to $100 million - 0.425%
Over $100 million - 0.375%
---------------------------------------------------------------------------------
International Equity Fund On the first $25 million - 0.75%
$25 million to $50 million - 0.60%
$50 million to $250 million - 0.425%
---------------------------------------------------------------------------------
</TABLE>
49
<PAGE>
--------------------------------------------------------------------------------
Over $250 million - 0.375%
--------------------------------------------------------------------------------
The sub-advisory agreement was approved for each of Small Cap Equity
Fund and International Equity Fund by the Board of Trustees of the Trust
(including a majority of Trustees who are not parties to such agreements or
interested persons, as defined by the 1940 Act, of any such party) at a
meeting held for that purpose on October 30, 2000 and subsequently was
approved by the sole shareholder of each of those Funds. The sub-advisory
agreement is not assignable and may be terminated without penalty upon 60
days written notice at the option of the Manager or Capital Guardian, or by
the Board of Trustees of the Trust or by a vote of a majority of the
outstanding shares of the class of stock representing an interest in the
appropriate Fund. The sub-advisory agreement provides that it shall continue
in effect for two years and can thereafter be continued for each Fund from
year to year so long as such continuance is specifically approved annually
(a) by the Board of Trustees of the Trust or by a majority of the outstanding
shares of the Fund and (b) by a majority vote of the Trustees who are not
parties to the agreement, or interested persons of any such party, cast in
person at a meeting held for that purpose.
SECURITIES ACTIVITIES OF THE MANAGER, CAPITAL GUARDIAN AND BARCLAYS
Securities held by the Trust may also be held by separate accounts
or mutual funds for which the Manager, Barclays or Capital Guardian acts as
an adviser, some of which may be affiliated with them. Because of different
investment objectives, cash flows or other factors, a particular security may
be bought by the Manager, Barclays or Capital Guardian for one or more of its
clients, when one or more other clients are selling the same security.
Pursuant to procedures adopted by the Board of Trustees, the Manager,
Barclays or Capital Guardian may cause a Fund to buy or sell a security from
another Fund or another account. Any such transaction would be executed at a
price determined in accordance with those procedures and without sales
commissions. Transactions executed pursuant to such procedures are reviewed
by the Board of Trustees quarterly.
If purchases or sales of securities for a Fund or other client of
the Manager, Barclays or Capital Guardian arise for consideration at or about
the same time, transactions in such securities will be allocated as to amount
and price, insofar as feasible, for the Fund and other clients in a manner
deemed equitable to all. To the extent that transactions on behalf of more
than one client of the Manager, Barclays or Capital Guardian during the same
period may increase the demand for securities being purchased or the supply
of securities being sold, there may be an adverse effect on price. It is the
opinion of the Board of Trustees of the Trust, however, that the benefits
available to the Trust outweigh any possible disadvantages that may arise
from such concurrent transactions.
On occasions when the Manager, Barclays or Capital Guardian (under the
supervision of the Board of Trustees) deem the purchase or sale of a security to
be in the best interests of the Trust as well as other accounts or companies, it
may, to the extent permitted by applicable laws
50
<PAGE>
and regulations, but will not be obligated to, aggregate the securities to be
sold or purchased for the Trust with those to be sold or purchased for other
accounts or companies in order to obtain favorable execution and low
brokerage commissions. In that event, allocation of the securities purchased
or sold, as well as the expenses incurred in the transaction, will be made by
the Manager, Barclays or Capital Guardian in the manner each considers to be
most equitable and consistent with its fiduciary obligations to the Trust and
to such other accounts or companies. In some cases this procedure may
adversely affect the size of the position obtainable for a Fund.
PORTFOLIO TRANSACTIONS AND BROKERAGE
THE EQUITY FUND, EQUITY AND BOND FUND, BOND FUND, TAX ADVANTAGED BOND FUND
AND MONEY MARKET FUND.
As described above, the Manager determines which securities to buy
and sell for these Funds, selects brokers and dealers to effect the
transactions, and negotiates commissions. Transactions in equity securities
will usually be executed through brokers who will receive a commission paid
by the Fund. Fixed income securities are generally traded with dealers acting
as principals for their own accounts without a stated commission. The
dealer's margin is reflected in the price of the security. Money market
obligations may be traded directly with the issuer. Underwritten offerings of
stock may be purchased at a fixed price including an amount of compensation
to the underwriter. Upon commencement of operations, the Trust will disclose
brokerage commissions paid.
In placing orders for securities transactions, the Manager's policy
is to attempt to obtain the most favorable price and efficient execution
available. These entities, subject to the review of the Trust's Board of
Trustees, may pay higher than the lowest possible commission on agency
trades, not principal trades, to obtain better than average execution of
transactions and/or valuable investment research information described below,
if, in their opinion, improved execution and investment research information
will benefit the performance of each of the Funds.
When selecting broker-dealers to execute portfolio transactions, the
Manager considers factors including the rate of commission or size of the
broker-dealer's "spread", the size and difficulty of the order, the nature of
the market for the security, the willingness of the broker-dealer to
position, the reliability, financial condition and general execution and
operational capabilities of the broker-dealer, and the research, statistical
and economic data furnished by the broker-dealer to the Manager. In some
cases, the Manager may use such information to advise other investment
accounts that it advises. Brokers or dealers which supply research may be
selected for execution of transactions for such other accounts, while the
data may be used by the Manager in providing investment advisory services to
the Fund. In addition, the Manager may select broker-dealers to execute
portfolio transactions who are affiliated with the Fund or the Manager.
However, all such directed brokerage will be subject to the Manager's policy
to attempt to obtain the most favorable price and efficient execution
possible.
51
<PAGE>
EQUITY INDEX FUNDS
Barclays assumes general supervision over placing orders on behalf
of each Master Portfolio for the purchase or sale of portfolio securities.
Allocation of brokerage transactions, including their frequency, is made in
the best judgment of Barclays and in a manner deemed fair and reasonable to
shareholders. In executing portfolio transactions and selecting brokers or
dealers, Barclays seeks to obtain the best overall terms available for each
Master Portfolio. In assessing the best overall terms available for any
transaction, Barclays considers factors deemed relevant, including the
breadth of the market in the security, the price of the security, the
financial condition and execution capability of the broker or dealer, and the
reasonableness of the commission, if any, both for the specific transaction
and on a continuing basis. The primary consideration is prompt execution of
orders at the most favorable net price. Certain of the brokers or dealers
with whom the Master Portfolios may transact business offer commission
rebates to the Master Portfolios. Barclays considers such rebates in
assessing the best overall terms available for any transaction. The overall
reasonableness of brokerage commissions paid is evaluated by Barclays based
upon its knowledge of available information as to the general level of
commissions paid by other institutional investors for comparable services.
S&P 500 INDEX MASTER PORTFOLIO. Brokers also are selected because of
their ability to handle special executions such as are involved in large
block trades or broad distributions, provided the primary consideration is
met. Portfolio turnover my vary from year to year, as well as within a year.
High turnover rates over 100% are likely to result in comparatively greater
brokerage expenses.
SMALL CAP EQUITY FUND AND INTERNATIONAL EQUITY FUND
Capital Guardian strives to obtain the best available prices in its
portfolio transactions taking into account the costs and quality of
executions. When, in the opinion of Capital Guardian, two or more brokers
(either directly or through their correspondent clearing agents) are in a
position to obtain the best price and execution, preference may be given to
brokers who have provided investment research, statistical, or other related
services to Capital Guardian. This research may be used for other Capital
Guardian clients in addition to the Funds. The Funds do not consider that
they have an obligation to obtain the lowest available commission rate to the
exclusion of price, service and qualitative considerations.
PORTFOLIO TURNOVER
Because of the Equity Fund's, Small Cap Equity Fund's and International
Equity Fund's flexibility of investment and emphasis on growth of capital,
these Funds may have greater portfolio turnover than that of mutual funds
that have primary objectives of income or maintenance of a balanced
investment position. The Equity and Bond Fund's portfolio turnover is
expected to be low. The Equity and Bond Fund will purchase or sell securities
to: (i) accommodate purchases and sales of its shares; (ii) change the
percentages of its assets invested in each of the underlying Funds in
response to market conditions; and (iii) maintain or modify the allocation of
its assets among the underlying Funds within the percentage limits described
in the Prospectus.
52
<PAGE>
Consistent with the Equity Index Funds' investment objectives, each
will attempt to minimize portfolio turnover. There are no fixed limitations
regarding the portfolio turnover rate for the Bond Fund, and securities
initially satisfying the objectives and policies of this Fund may be disposed
of when they are no longer deemed suitable.
In periods of relatively stable interest rate levels, Tax Advantaged
Bond Fund does not expect its annual portfolio turnover rate to exceed 50%
for issues with maturities longer than one year at the time of purchase. In
years of sharp fluctuations in interest rates, however, the annual portfolio
turnover rate may exceed 50%. Most of the sales in the Fund's portfolio will
occur when the proportion of securities owned with longer term maturities is
reduced in anticipation of a bond market decline (rise in interest rates), or
increased in anticipation of a bond market rise (decline in interest rates).
The rate of portfolio turnover will not be a limiting factor and,
accordingly, will always be incidental to transactions undertaken with the
view of achieving the Fund's investment objective.
Since short term instruments are excluded from the calculation of a
portfolio turnover rate, no meaningful portfolio turnover rate can be
estimated or calculated for the Money Market Fund. Turnover rates may vary
greatly from year to year as well as within a particular year and may also be
affected by cash requirements for redemptions of a Fund's shares and by
requirements, the satisfaction of which enable the Trust to receive certain
favorable tax treatment.
DETERMINATION OF NET ASSET VALUE
The Net Asset Value (NAV) for each Fund is determined as of the time
of the close of regular session trading on the New York Stock Exchange
("NYSE") (currently at 4:00 p.m., Eastern Time), on each day when the NYSE is
open for business. Shares of the Funds will not be priced on days when the
NYSE is closed.
ALL FUNDS EXCEPT MONEY MARKET FUND
Equity securities (including common stocks, preferred stocks,
convertible securities and warrants) and call options written on all
portfolio securities, listed or traded on a national exchange are valued at
their last sale price on that exchange prior to the time when assets are
valued. In the absence of any exchange sales on that day, such securities are
valued at the last sale price on the exchange on which it is traded.
Securities traded only on over-the-counter markets generally are valued at
the closing bid price.
Debt securities traded on a national exchange are valued at their last
sale price on that exchange prior to the time when assets are valued, or,
lacking any sales, at the last reported bid price. Debt securities other than
money market instruments traded in the over-the-counter market are valued at the
last reported bid price or at yield equivalent as obtained from one or more
dealers that make markets in the securities. If the market quotations described
above are not available, debt securities, other than short-term debt securities,
may be valued at a fair value as determined by one or more independent pricing
services (each, a "Service"). The Service may use available market quotations
and employ electronic data processing techniques and/or a
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matrix system to determine valuations. Each Service's procedures are reviewed
by the officers of the Trust under the general supervision of the Boards of
Trustees of the Trust and the Master Fund.
Money market instruments held with a remaining maturity of 60 days
or less (other than U.S. Treasury bills) are generally valued on an amortized
cost basis. Under the amortized cost basis method of valuation, the security
is initially valued at its purchase price (or in the case of securities
purchased with more than 60 days remaining to maturity, the market value on
the 61st day prior to maturity), and thereafter by amortizing any premium or
discount uniformly to maturity. If for any reason the amortized cost method
of valuation does not appear to fairly reflect the fair value of any
security, a fair value will be determined in good faith by or under the
direction of the Boards of Trustees of the Trust or the Master Fund, as the
case may be, as in the case of securities having a maturity of more than 60
days.
Securities that are primarily traded on foreign securities exchanges
are generally valued at the last sale price on the exchange where they are
primarily traded. All foreign securities traded on the over-the-counter
market are valued at the last sale quote, if market quotes are available, or
the last reported bid price if there is no active trading in a particular
security on a given day. Quotations of foreign securities in foreign
currencies are converted, at current exchange rates, to their U.S. dollar
equivalents in order to determine their current value. Forward currency
contracts are valued at the current cost of offsetting the contract. Because
foreign securities (other than American Depositary Receipts) are valued as of
the close of trading on various exchanges and over-the-counter markets
throughout the world, the net asset value of Funds investing in foreign
securities generally includes values of foreign securities held by those
Funds that were effectively determined several hours or more before the time
NAV is calculated. In addition, foreign securities held by Funds may be
traded actively in securities markets which are open for trading on days when
the Funds do not calculate their net asset value. Accordingly, there may be
occasions when a Fund holding foreign securities does not calculate its net
asset value but when the value of such Fund's portfolio securities is
affected by such trading activity.
Exchange listed options that are written or purchased by a Fund are
valued on the primary exchange on which they are traded. Over-the-counter
options written or purchased by a Fund are valued based upon prices provided
by market-makers in such securities. Exchange-traded financial futures
contracts are valued at their settlement price established each day by the
board of trade or exchange on which they are traded.
Securities for which market quotations are not readily available, or
for which the procedures described above do not produce a fair value, are
valued at a fair value as determined in good faith in accordance with
procedures approved by the Boards of Trustees of the Trust or the Master
Fund, as the case may be. The effect of this will be that NAV will not be
based on the last quoted price on the security, but on a price with the Board
of Trustees or its delegate believes reflects the current and true price of
the security.
MONEY MARKET FUND 54
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All of the assets of the Money Market Fund are valued on the basis
of amortized cost in an effort to maintain a constant net asset value of
$1.00 per share. The Board of Trustees of the Trust has determined this to be
in the best interests of the Money Market Fund and its shareholders. Under
the amortized cost method of valuation, securities are valued at cost on the
date of their acquisition, and thereafter as adjusted for amortization of
premium or accretion of discount, regardless of the impact of fluctuating
interest rates on the market value of the security. While this method
provides certainty in valuation, it may result in periods in which value as
determined by amortized cost is higher or lower than the price the Fund would
receive if it sold the security. During such periods, the quoted yield to
investors may differ somewhat from that obtained by a similar fund or
portfolio which uses available market quotations to value all of its
portfolio securities.
The Board has established procedures reasonably designed, taking
into account current market conditions and the Money Market Fund's investment
objectives, to stabilize the net asset value per share for purposes of sales
and redemptions at $1.00. These procedures include review by the Board, at
such intervals as it deems appropriate, to determine the extent, if any, to
which the net asset value per share calculated by using available market
quotations deviates from $1.00 per share. In the event such deviation should
exceed one half of one percent, the Board will promptly consider initiating
corrective action. If the Board believes that the extent of any deviation
from a $1.00 amortized cost price per share may result in material dilution
or other unfair results to new or existing shareholders, it will take such
steps as it considers appropriate to eliminate or reduce these consequences
to the extent reasonably practicable. Such steps may include: selling
portfolio securities prior to maturity; shortening the average maturity of
the portfolio; withholding or reducing dividends; or utilizing a net asset
value per share determined from available market quotations. Even if these
steps were taken, the Money Market Fund's net asset value might still decline.
GENERAL
Computation of NAV (and the sale and redemption of fund shares) may
be suspended or postponed during any period when (a) trading on the NYSE is
restricted, as determined by the Commission, or the NYSE is closed for other
than customary weekend and holiday closings, (b) the Commission has by order
permitted such suspension, or (c) an emergency, as determined by the
Commission, exists making disposal of portfolio securities or valuation of
the net assets of the funds not reasonably practicable.
PERFORMANCE INFORMATION
The Trust may from time to time quote or otherwise use average
annual total return information for the Funds in advertisements, shareholder
reports or sales literature. Average annual total return values are computed
pursuant to equations specified by the Commission as follows:
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Average Annual Total Return will be computed as follows:
(n)
ERV = P(1+T)
Where: P = the amount of an assumed initial investment in Fund shares
T = average annual total return
n = number of years from initial investment to the end of
the period
ERV = ending redeemable value of shares held at the end of
the period
Average annual total return for a specified period is derived by
calculating the actual dollar amount of the investment return on a $1,000
investment in a Fund made at the beginning of the period, and then
calculating the annual compounded rate of return which would produce that
amount, assuming a redemption at the end of the period. This calculation
assumes a complete redemption of the investment. It also assumes that all
dividends and distributions are reinvested at net asset value on the
reinvestment dates during the period. The Trust also may from time to time
quote or otherwise use year-by-year total return, cumulative total return and
yield information for the Funds in advertisements, shareholder reports or
sales literature. Year-by-year total return and cumulative total return for a
specified period are each derived by calculating the percentage rate required
to make a $1,000 investment in a Fund (assuming that all distributions are
reinvested) at the beginning of such period equal to the actual total value
of such investment at the end of such period.
Yield is computed by dividing net investment income earned during a
recent 30 day period by the product of the average daily number of shares
outstanding and entitled to receive dividends during the period and the price
per share on the last day of the relevant period. The results are compounded
on a bond equivalent (semi-annual) basis and then annualized. Net investment
income is equal to the dividends and interest earned during the period,
reduced by accrued expenses for the period. The calculation of net investment
income for these purposes may differ from the net investment income
determined for accounting purposes. The SEC's yield formula is as follows:
(6)
The Yield formula is as follows: YIELD = 2[((a-b/cd)+1) -1].
Where: a = dividends and interest earned during the period. (For
this purpose, a Fund will recalculate the yield to
maturity based on market value of each portfolio
security on each business day on which net asset value
is calculated.)
b = expenses accrued for the period (net of reimbursements).
c = the average daily number of shares outstanding during
the period that were entitled to receive dividends.
d = the ending net asset value of a Fund for the period.
The Money Market Fund may also quote its current yield and effective
yield. Current yield is an annualized yield based on the actual total return
for a seven-day period. Effective yield is an annualized yield based on a
daily compounding of the current yield.
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Any performance data quoted for a Fund will represent historical
performance and the investment return and principal value of an investment
will fluctuate so that shares, when redeemed, may be worth more or less than
original cost.
From time to time the Trust may publish an indication of the Funds'
past performance as measured by independent sources such as (but not limited
to) Lipper, Inc., Weisenberger Investment Companies Service, Donoghue's Money
Fund Report, Barron's, Business Week, Changing Times, Financial World,
Forbes, Fortune, Money, Personal Investor, Sylvia Porter's Personal Finance
and The Wall Street Journal. The Trust may also advertise information which
has been provided to the NASD for publication in regional and local
newspapers. In addition, the Trust may from time to time advertise its
performance relative to certain indices and benchmark investments, including
(a) the Lipper, Inc. Mutual Fund Performance Analysis, Fixed-Income Analysis
and Mutual Fund Indices (which measure total return and average current yield
for the mutual fund industry and rank mutual fund performance); (b) the CDA
Mutual Fund Report published by CDA Investment Technologies, Inc. (which
analyzes price, risk and various measures of return for the mutual fund
industry); (c) the Consumer Price Index published by the U.S. Bureau of Labor
Statistics (which measures changes in the price of goods and services); (d)
Stocks, Bonds, Bills and Inflation published by Ibbotson Associates (which
provides historical performance figures for stocks, government securities and
inflation); (e) the Hambrecht & Quist Growth Stock Index; (f) the NASDAQ OTC
Composite Prime Return; (g) the Russell Midcap Index; (h) the Russell 2000
Index-Total Return; (i) the ValueLine Composite-Price Return; (j) the
Wilshire 4600 Index; (k) the Salomon Brothers' World Bond Index (which
measures the total return in U.S. dollar terms of government bonds, Eurobonds
and foreign bonds of ten countries, with all such bonds having a minimum
maturity of five years); (1) the Shearson Lehman Brothers Aggregate Bond
Index or its component indices (the Aggregate Bond Index measures the
performance of Treasury, U.S. Government agencies, mortgage and Yankee
bonds); (m) the S&P Bond indices (which measure yield and price of corporate,
municipal and U.S. Government bonds); (n) the J.P. Morgan Global Government
Bond Index; (o) Donoghue's Money Market Fund Report (which provides industry
averages of 7-day annualized and compounded yields of taxable, tax-free and
U.S. Government money market funds); (p) other taxable investments including
certificates of deposit, money market deposit accounts, checking accounts,
savings accounts, money market mutual funds and repurchase agreements; (q)
historical investment data supplied by the research departments of Goldman
Sachs, Lehman Brothers, First Boston Corporation, Morgan Stanley (including
EAFE "Free"), Salomon Brothers, Merrill Lynch, Donaldson Lufkin and Jenrette
or other providers of such data; (r) the FT-Actuaries Europe and Pacific
Index; (s) mutual fund performance indices published by Variable Annuity
Research & Data Service; and (t) mutual fund performance indices published by
Morningstar, Inc. The composition of the investments in such indices and the
characteristics of such benchmark investments are not identical to, and in
some cases are very different from, those of a Fund's portfolio. These
indices and averages are generally unmanaged and the items included in the
calculations of such indices and averages may be different from those of the
equations used by the Trust to calculate a Fund's performance figures.
The Trust may from time to time summarize the substance of
discussions contained in shareholder reports in advertisements and publish
the views as to markets of the Manager,
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Barclays or Capital Guardian, the rationale for a Fund's investments and
discussions of the Fund's current asset allocation.
From time to time, advertisements or information may include a
discussion of certain attributes or benefits to be derived by an investment
in a particular Fund. Such advertisements or information may include symbols,
headlines or other material which highlight or summarize the information
discussed in more detail in the communication.
Such performance data will be based on historical results and will
not be intended to indicate future performance. The total return or yield of
a Fund will vary based on market conditions, portfolio expenses, portfolio
investments and other factors. The value of a Fund's shares will fluctuate
and your shares may be worth more or less than their original cost upon
redemption.
PURCHASE AND REDEMPTION OF FUND SHARES
Purchases of Fund shares are discussed fully in the Prospectus under
the heading "Shareholder Information - How to Buy Shares." Redemptions of
Fund Shares are discussed fully in the Prospectus under the heading
"Shareholder Information - How to Redeem Fund Shares."
SPECIAL WAIVERS. Class A shares are purchased without a sales charge
in the situations specified in the Prospectus. However, in certain specific
situations, redemptions of such shares within 12 months of purchase are
subject to a contingent deferred sales charge of 0.50% of the lesser of the
value of the shares redeemed or the total cost of the shares.
RIGHTS OF ACCUMULATION. Each Fund offers to all qualifying investors
a cumulative discount under which investors are permitted to purchase Class A
shares of any Fund at the price applicable to the total of (a) the dollar
amount then being purchased plus (b) an amount equal to the then current net
asset value of the purchaser's holdings of shares of any Fund. Acceptance of
the purchase order is subject to confirmation of qualification. The
cumulative discount may be amended or terminated at any time as to subsequent
purchases.
SYSTEMATIC WITHDRAWAL PLAN. The Systematic Withdrawal Plan ("SWP")
is designed to provide a convenient method of receiving fixed payments at
regular intervals from shares deposited by the applicant under the SWP. The
applicant must deposit or purchase for deposit shares of the Fund having a
total value of not less than $5,000. Periodic checks of $100 or more will be
sent to the applicant, or any person designated by him, monthly or quarterly.
Any income dividends or capital gains distributions on shares under
the SWP will be credited to the SWP account on the payment date in full and
fractional shares at the net asset value per share in effect on the record
date.
SWP payments are made from the proceeds of the redemption of shares
deposited in a SWP account. Redemptions are potentially taxable transactions
to shareholders. To the extent that such redemptions for periodic withdrawals
exceed dividend income reinvested in the SWP
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account, such redemptions will reduce and ultimately may exhaust the number
of shares deposited in the SWP account. In addition, the amounts received by
a shareholder cannot be considered as an actual yield or income on his or her
investment because part of such payments may be a return of his or her
capital.
The SWP may be terminated at any time (1) by written notice to the
Fund or from the Fund to the shareholder; (2) upon receipt by the Fund of
appropriate evidence of the shareholder's death; or (3) when all shares under
the SWP have been redeemed. The fees of the Fund for maintaining SWPs are
paid by the Fund.
SPECIAL REDEMPTIONS. Although it would not normally do so, each Fund
has the right to pay the redemption price of shares of the Fund in whole or
in part in portfolio securities as prescribed by the Board of Trustees of the
Trust. When the shareholder sells portfolio securities received in this
fashion, he would incur a brokerage charge. Any such securities would be
valued for the purposes of making such payment at the same value as used in
determining net asset value. The Funds have elected to be governed by Rule
18f-1 under the 1940 Act, pursuant to which each Fund is obligated to redeem
shares solely in cash up to $500,000 of the applicable Fund during any 90 day
period for any one account.
SUSPENSION OF REDEMPTIONS. A Fund may not suspend a shareholder's
right of redemption, or postpone payment for a redemption for more than seven
days, unless the NYSE is closed for other than customary weekends or
holidays, or trading on the NYSE is restricted, or for any period during
which an emergency exists as a result of which (1) disposal by a Fund of
securities owned by it is not reasonably practicable, or (2) it is not
reasonably practicable for a Fund to fairly determine the value of its
assets, or for such other periods as the Commission may permit for the
protection of investors.
DISTRIBUTION EXPENSES
State Farm VP Management Corp. ("Management Corp.") serves as the
principal underwriter for the Trust pursuant to an Underwriting Agreement
initially approved by the Board of Trustees of the Trust. Management Corp. is
a registered broker-dealer and a member of the National Association of
Securities Dealers, Inc. ("NASD"). Shares of each Fund will be continuously
offered and will be sold by registered representatives of Management Corp.
which receives sales charges and distribution plan fees from each Fund under
the Underwriting Agreement.
Management Corp. bears all the expenses of providing services
pursuant to the Underwriting Agreement, including the payment of the expenses
relating to the distribution of Prospectuses for sales purposes as well as
any advertising or sales literature. The Trust bears the expenses of
registering its shares with the Commission and paying the fees required to be
paid by state regulatory authorities. The Underwriting Agreement continues in
effect for two years from initial approval and for successive one-year
periods thereafter, provided that each such continuance is specifically
approved (i) by vote of a majority of the Board of Trustees of the Trust,
including a majority of the Trustees who are not parties to the Underwriting
Agreement or interested persons of any such party, (as the term interested
person is defined in the 1940 Act); or
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<PAGE>
(ii) by the vote of a majority of the outstanding voting securities of a
Fund. Management Corp. is not obligated to sell any specific amount of shares
of any Fund.
Management Corp.'s business and mailing address is One State Farm
Plaza, Bloomington, Illinois 61710. Management Corp. was organized as a
Delaware corporation in November 1996 and is a wholly-owned subsidiary of
Auto Company.
DISTRIBUTION PLANS
State Farm Mutual Fund Trust has adopted separate distribution plans
(the "Plans") for Class A and Class B shares of each Fund, in accordance with
the requirements of Rule 12b-1 under the 1940 Act and the requirements of the
applicable rule of the NASD regarding asset based sales charges. The Trust
has also entered into a Shareholder Services Agreement with Management Corp.
for both Class A and Class B shares of each Fund.
CLASS A SHARES
Pursuant to the Class A Plan, each Fund other than the Money Market
Fund will pay Management Corp. 0.25% of the Fund's average daily net assets
attributable to Class A shares for its expenditures in financing any activity
primarily intended to result in the sale of Fund shares. For the Money Market
Fund, the amount is 0.15% of the Fund's average net assets attributable to
Class A shares. There is no 12b-1 fee for the Equity and Bond Fund. The
expenses of a Fund pursuant to the Class A Plan are accrued on a fiscal year
basis. The purpose of the fee is to compensate Management Corp. for its
distribution services to the Funds. Management Corp. pays commissions to
registered representatives as well as reimbursement of expenses of printing
prospectuses and reports used for sales purposes, expenses with respect to
the preparation and printing of sales literature and other distribution
related expenses, including without limitation, the cost necessary to provide
distribution-related services, or personnel, travel, office expenses and
equipment.
The Funds also will compensate the Manager under the Shareholder
Services Agreement for maintenance and personal service provided to existing
Class A shareholders. The expenses of a Fund under the Shareholder Services
Agreement are accrued on a fiscal year basis and will equal 0.25% of the
Fund's average daily net assets attributable to Class A shares. The Equity
and Bond Fund does not pay such a fee.
CLASS B SHARES
Pursuant to the Class B Plan, each Fund, other than the Money Market
Fund, will pay Management Corp. a fee of 0.65% of the average daily net
assets attributable to Class B shares for distribution financing activities.
For the Money Market Fund, the amount is 0.55% of the Fund's average daily
net asset attributable to Class B shares. There is no 12b-1 fee for the
Equity and Bond Fund.
The purpose of the fee is to compensate Management Corp. for its
distribution services to the Funds. Management Corp. pays commissions to
registered representatives as well as
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reimbursement of expenses of printing prospectuses and reports used for sales
purposes, expenses with respect to the preparation and printing of sales
literature and other distribution related expenses, including without
limitation, the cost necessary to provide distribution-related services, or
personnel, travel, office expenses and equipment.
The Funds will compensate the Manager under the Shareholder Services
Agreement for shareholder account services at the rate of 0.25% of the
average daily net assets of the Fund attributable to Class B shares. The
Equity and Bond Fund does not pay such a fee.
GENERAL
In accordance with the terms of the Plans, Management Corp. will
provide to each Fund, for review by the Board of Trustees, a quarterly
written report of the amounts expended under the respective Plans and the
purpose for which such expenditures were made. Each quarter, the Board of
Trustees will review the level of compensation the Plans provide in
considering the continued appropriateness of the Plans.
The Plans were adopted by a majority vote of the Board of Trustees,
including at least a majority of Trustees who are not, and were not at the
time they voted, interested persons of the Fund as defined in the 1940 Act
and do not and did not have any direct or indirect financial interest in the
operation of the Plans, cast in person at a meeting called for the purpose of
voting on the Plans. In approving the Plans, the Trustees identified and
considered a number of potential benefits which the Plans may provide. The
Board of Trustees believes that there is a reasonable likelihood that the
Plans will benefit each Fund and its current and future shareholders. Under
their terms, the Plans remain in effect from year to year, provided such
continuance is approved annually by vote of the Board of Trustees in the
manner described above. The Plans may not be amended to increase materially
the amount to be spent for distribution without approval of the shareholders
of the Fund affected thereby, and material amendments to the Plans must also
be approved by the Board of Trustees in the manner described above. A Plan
may be terminated at any time, without payment of any penalty, by vote of the
majority of the Board of Trustees who are not interested persons of the Fund
and have no direct or indirect financial interest in the operations of the
Plan, or by a vote of a "majority of the outstanding voting securities" (as
defined in the 1940 Act) of the Fund affected thereby. A Plan will
automatically terminate in the event of its assignment (as defined in the
1940 Act).
The anticipated benefits to the Funds and their shareholders that
may result from the Plans are as follows. First, the Plans allow more
flexibility to the prospective shareholder in choosing how to pay sales
loads, either through Class A or Class B shares. Second, they provide an
attractive compensation package for the sales force to sell the Funds which
is necessary to attract assets. Third, they provide an incentive for the
sales force to provide a higher level of service and compensate them
accordingly. This in turn should lead to improved retention and a higher
amount of assets, which in turn will benefit all shareholders by lowering
costs per share in the future.
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OTHER SERVICE PROVIDERS
CUSTODIANS
Chase Manhattan Trust Company of Illinois, c/o Chase Manhattan Bank,
North American Insurance Securities Services, 3 Chase MetroTech Center, 6th
Floor, Brooklyn, New York 11245 ("Chase Manhattan"), acts as custodian of the
assets of each Fund, except the Equity Index Funds and the International
Equity Fund. Investors Bank and Trust Company, 200 Clarendon Street, Boston,
Massachusetts 02116 ("IBT"), is the Trust's custodian for the Equity Index
Funds and the International Equity Fund.
Chase Manhattan and IBT (the "custodians") may hold securities of
the Funds in amounts sufficient to cover put and call options written on
futures contracts in a segregated account by transferring (upon the Trust's
instructions) assets from a Fund's general (regular) custody account. The
custodians also will hold certain assets of certain of the Funds or Master
Portfolios constituting margin deposits with respect to financial futures
contracts at the disposal of FCMs through which such transactions are
effected. The Manager performs fund accounting services, including the
valuation of portfolio securities and the calculation of net asset value, for
each Fund other than the International Equity Fund and the International
Index Fund. IBT performs fund accounting services for these Funds.
TRANSFER AGENT
The Transfer Agent Agreements between the Trust and the Manager
appoints the Manager as the Funds' transfer agent and dividend disbursing
agent. Under the terms of the agreement, the Manager: (1) prepares and mails
transaction confirmations, annual records of investments and tax information
statements; (2) effects transfers of Fund shares; (3) prepares annual
shareowner meeting lists; (4) prepares, mails and tabulates proxies; (5)
mails shareowner reports; and (6) disburses dividend and capital gains
distributions. These services are performed by the Manager at a fee
determined by the Board of Trustees to be reasonable in relation to the
services provided and no less favorable to the Funds than would have been
available from a third party.
IBT acts as transfer agent and dividend disbursing agent for the
Master Portfolios.
INDEPENDENT AUDITORS
The Funds' independent auditors are Ernst & Young LLP, 233 South
Wacker Drive, Chicago, Illinois 60606. The firm audits each Fund's annual
financial statements, reviews certain regulatory reports and each Fund's
federal income tax returns, and performs other professional accounting,
auditing, tax and advisory services when engaged to do so by the Funds.
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TAXES
GENERAL TAX INFORMATION
The Trust intends for each Fund to qualify as a regulated investment
company under the Subchapter M of the Code. If a Fund qualifies as a
regulated investment company and distributes substantially all of its net
income and gains to its shareholders (which the Funds intend to do), then
under the provisions of Subchapter M, that Fund should have little or no
income taxable to it under the Code.
Each Fund must meet several requirements to maintain its status as a
regulated investment company. These requirements include the following: (1)
at least 90% of the Fund's gross income must be derived from dividends,
interest, payments with respect to securities loans and gains from the sale
or disposition of securities of foreign currencies; and (2) at the close of
each quarter of the Fund taxable year, (a) at least 50% of the value of the
Fund's total assets must consist of cash, U.S. Government securities and
other securities, such that no more than 5% of the value of the Fund consists
of such other securities of any one issuer and the Fund must not hold more
than 10% of the outstanding voting stock of any such issuer, and (b) the Fund
must not invest more than 25% of the value of its total assets in the
securities of any one issuer (other than U.S. Government securities) or two
or more issuers which the Fund controls and which are engaged in the same,
similar or related trades or businesses.
In order to maintain the qualification of a Fund's status as a
regulated investment company, the Trust may, in its business judgment,
restrict a Fund's ability to invest in certain financial instruments. For the
same reason, the Trust may, in its business judgment, require a Fund to
maintain or dispose of an investment in certain types of financial
instruments beyond the time when it might otherwise be advantageous to do so.
Each Fund will be subject to a 4% non-deductible federal excise tax
on certain amounts not distributed (and not treated as having been
distributed) on a timely basis in accordance with annual minimum distribution
requirement. The Funds intend under normal circumstances to avoid liability
for such tax by satisfying such distribution requirements.
If a Fund acquires stock in certain non-U.S. corporations that
receive at least 75% of their annual gross income from passive sources (such
as interest, dividends, rents, royalties or capital gain) or hold at least
50% of their assets in investments producing such passive income ("passive
foreign investment companies"), that Fund could be subject to federal income
tax and additional interest charges on "excess distributions" received from
such companies or gain from the sale of stock in such companies, even if all
income or gain actually received by the Fund is timely distributed to its
shareholders. The Fund would not be able to pass through to its shareholders
any credit or deduction for such a tax. Certain elections may, if available,
ameliorate these adverse tax consequences, but any such election would
require the applicable Fund to recognize taxable income or gain without the
concurrent receipt of cash. Any Fund that is permitted to acquire stock in
foreign corporations may limit and/or manage its holdings in passive foreign
investment companies to minimize its tax liability or maximize its return
from these investments.
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Foreign exchange gains and losses realized by a Fund in connection
with certain transactions involving foreign currency-denominated debt
securities, certain foreign currency futures and options, foreign currency
forward contracts, foreign currencies, or payables or receivables denominated
in a foreign currency are subject to Section 988 of the Code, which generally
causes such gains and losses to be treated as ordinary income and losses and
may affect the amount, timing and character of distributions to shareholders.
Any such transactions that are not directly related to a Fund's investment in
stock or securities, possibly including speculative currency positions or
currency derivatives not used for hedging purposes, could under future
Treasury regulations produce income not among the types of "qualifying
income" from which the Fund must derive at least 90% of its annual gross
income.
Some Funds may be subject to withholding and other taxes imposed by
foreign countries with respect to their investments in foreign securities.
Tax conventions between certain countries and the U.S. may reduce or
eliminate such taxes. For the International Equity Fund and International
Index Fund, if more than 50% of the Fund's assets at year-end consists of the
debt and equity securities of foreign corporations, the Fund may elect to
permit shareholders to claim a credit or deduction on their income tax
returns for their pro rata portion of qualified taxes paid by the Fund to
foreign countries. In such a case, shareholders will include in gross income
from foreign sources their pro rata shares of such taxes. A shareholder's
ability to claim a foreign tax credit or deduction in respect of foreign
taxes paid by the Fund may be subject to certain limitations imposed by the
Code, as a result of which a shareholder may not receive a full credit or
deduction for the amount of such taxes. Shareholders who do not itemize on
their federal income tax returns may claim a credit (but no deduction) for
such foreign taxes. The Funds, other than the International Equity Fund and
the International Index Fund, anticipate that they generally will not qualify
to pass such foreign taxes and any associated tax deductions or credits
through to their shareholders, who therefore generally will not report such
amounts on their tax returns.
For Federal income tax purposes, each Fund is permitted to carry
forward a net capital loss in any year to offset its own capital gains, if
any, during the eight years following the year of the loss. To the extent
subsequent capital gains are offset by such losses, they would not result in
federal income tax liability to the applicable Fund and would not be
distributed as such to shareholders.
Investment in debt obligations that are at risk or in default
presents special tax issues for any Fund that may hold such obligations. Tax
rules are not entirely clear about issues such as when the Fund may cease to
accrue interest, original issue discount, or market discount, when and to
what extent deductions may be taken for bad debts or worthless securities,
how payments received on obligations in default should be allocated between
principal and income, and whether exchanges of debt obligations in a workout
context are taxable. These and other issues will be addressed by any Fund
that may hold such obligations in order to reduce the risk of distributing
insufficient income to preserve its status as a regulated investment company
and avoid becoming subject to federal income or excise tax.
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Limitations imposed by the Code on regulated investment companies
like the Funds may restrict a Fund's ability to enter into futures, options,
and forward transactions.
Certain options, futures and forward foreign currency transactions
undertaken by a Fund may cause the Fund to recognize gains or losses from
marking to market even though its positions have not been sold or terminated
and affect the character as long-term or short-term (or, in the case of
certain currency forwards, options and futures, as ordinary income or loss)
and timing of some capital gains and losses realized by the Fund. Also,
certain of a Fund's losses on its transactions involving options, futures or
forward contracts and/or offsetting portfolio positions may be deferred
rather than being taken into account currently in calculating the Fund's
taxable income. Certain of the applicable tax rules may be modified if a Fund
is eligible and chooses to make one or more of certain tax elections that may
be available. These transactions may therefore affect the amount, timing and
character of a Fund's distributions to shareholders. The Funds will take into
account the special tax rules (including consideration of available
elections) applicable to options, futures or forward contracts in order to
minimize any potential adverse tax consequences.
Distributions from a Fund's current or accumulated earnings and
profits ("E&P"), as computed for federal income tax purposes, will be taxable
as described in the Fund's prospectus whether taken in shares or in cash.
Distributions, if any, in excess of E&P will constitute a return of capital,
which will first reduce an investor's tax basis in a Fund's shares and
thereafter (after such basis is reduced to zero) will generally give rise to
capital gains. Shareholders electing to receive distributions in the form of
additional shares will have a cost basis for federal income tax purposes in
each share so received equal to the amount of cash they would have received
had they elected to receive the distributions in cash, divided by the number
of shares received.
At the time of an investor's purchase of shares of a Fund, a portion
of the purchase price is often attributable to realized or unrealized
appreciation in the Fund's portfolio or undistributed taxable income of the
Fund. Consequently, subsequent distributions from such appreciation or income
may be taxable to such investor even if the net asset value of the investor's
shares is, as a result of the distributions, reduced below the investor's
cost for such shares, and the distributions in reality represent a return of
a portion of the purchase price.
Upon a redemption of shares of a Fund (including by exercise of the
exchange privilege), a shareholder may realize a taxable gain or loss
depending upon his basis in his shares. Such gain or loss will be treated as
capital gain or loss if the shares are capital assets in the shareholder's
hands and will be long-term or short-term, depending upon that shareholder's
tax holding period for the shares. A sales charge paid in purchasing shares
of a Fund cannot be taken into account for purposes of determining gain or
loss on the redemption or exchange of such shares within 90 days after their
purchase to the extent shares of the Fund are subsequently acquired without
payment of a sales charge pursuant to the increase in the shareholder's tax
basis in the shares subsequently acquired. Also, any loss realized on a
redemption or exchange will be disallowed to the extent the shares disposed
of are replaced with shares of the same Fund within a period of 61 days
beginning 30 days before and ending 30 days after the shares are disposed of,
such as pursuant to an election to reinvest dividends of capital gain
distributions automatically. In such a case, the basis of the shares acquired
will be adjusted to reflect
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the disallowed loss. Any loss realized upon redemption of shares with a tax
holding period of six months or less will be treated as a long-term capital
loss to the extent of any amounts treated as distributions of long-term
capital gain with respect to such shares.
For purposes of the dividends received deduction available to
corporations, dividends received by a Fund, if any, from U.S. domestic
corporations in respect of the stock of such corporations held by the Fund,
for federal income tax purposes, for at least 46 days (91 days in the case of
certain preferred stock) and distributed and designated by the Fund may be
treated as qualifying dividends. Corporate shareholders must meet the minimum
holding period requirement stated above (46 or 91 days) with respect to their
shares of the applicable Fund in order to qualify for the deduction and, if
they borrow to acquire such shares, may be denied a portion of the dividends
received deduction. The entire qualifying dividend, including the otherwise
deductible amount, will be included in determining the excess (if any) of a
corporate shareholder's adjusted current earnings over its alternative
minimum taxable income, which may increase its alternative minimum tax
liability. Additionally, any corporate shareholder should consult its tax
adviser regarding the possibility that its basis in its shares may be
reduced, for federal income tax purposes, by reason of "extraordinary
dividends" received with respect to the shares, for the purpose of computing
its gain or loss on redemption or other disposition of the shares.
Different tax treatment, including penalties on certain excess
contributions and deferrals, certain pre-retirement and post-retirement
distributions and certain prohibited transactions, is accorded to shareholder
accounts maintained as qualified retirement plans. Shareholders should
consult their tax advisers for more information.
The foregoing discussion relates solely to U.S. Federal income tax
law as applicable to U.S. persons (i.e., U.S. citizens or residents and U.S.
domestic corporations, partnerships, trusts or estates) subject to tax under
such law. The discussion does not address special tax rules applicable to
certain classes of investors, such as tax-exempt entities, insurance
companies, and financial institutions. Dividends, capital gain distributions,
and ownership of or gains realized on the redemption (including an exchange)
of the shares of a Fund may also be subject to state and local taxes.
Shareholders should consult their own tax advisers as to the federal, state
or local tax consequences of ownership of shares of, and receipt of
distributions from, the Funds in their particular circumstances.
Non-U.S. investors not engaged in a U.S. trade or business with
which their investment in a Fund is effectively connected will be subject to
U.S. Federal income tax treatment that is different from that described
above. These investors may be subject to non-resident alien withholding tax
at the rate of 30% (or a lower rate under an applicable tax treaty) on
amounts treated as ordinary dividends from a Fund and, unless an effective
IRS Form W-8 (or equivalent form) or authorized substitute is on file, to 31%
backup withholding on certain other payments from the Fund. Non-U.S.
investors should consult their tax advisers regarding such treatment and the
application of foreign taxes to an investment in any Fund. The Funds do not
generally accept investments by non-U.S. investors.
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TAX ADVANTAGED BOND FUND. The Tax Advantaged Bond Fund will be
qualified to pay exempt-interest dividends to its shareholders only if, at
the close of each quarter of the Fund's taxable year, at least 50% of the
total value of the Fund's assets consists of obligations the interest on
which is exempt from federal income tax. Distributions that the Fund properly
designates as exempt-interest dividends are treated by shareholders as
interest excludable from their gross income for federal income tax purposes
but may be taxable for federal alternative minimum tax purposes and for state
and local purposes. Because the Fund intends to be qualified to pay
exempt-interest dividends, the Fund may be limited in its ability to enter
into taxable transactions involving forward commitments, repurchase
agreements, financial futures, and options contracts on financial futures,
tax-exempt bond indices, and other assets.
The Fund uses the "average annual" method to determine the
designated percentage of dividends that qualifies as tax-exempt income. This
designation is made annually in January. The percentage of a particular
dividend that is designated as tax-exempt income may be substantially
different from the percentage of the Fund's income that was tax-exempt during
the period from which the distribution was made.
Exempt-interest dividends are exempt from regular federal income
tax, but they may affect the tax liabilities of taxpayers who are subject to
the AMT. Exempt-interest dividends are also includible in the modified income
of shareholders who receive Social Security benefits for purposes of
determining the extent to which such benefits may be taxable.
Part or all of the interest on indebtedness, if any, incurred or
continued by a shareholder to purchase or carry shares of the Tax Advantaged
Bond Fund is not deductible. The portion of interest that is not deductible
is equal to the total interest paid or accrued on the indebtedness,
multiplied by the percentage of the Fund's total distributions (not including
distributions from net long-term capital gains) paid to the shareholder that
are exempt-interest dividends. Under rules used by the Internal Revenue
Service for determining when borrowed funds are considered used for the
purpose of purchasing or carrying particular assets, the purchase of shares
may be considered to have been made with borrowed funds even though such
funds are not directly traceable to the purchase of the shares.
In general, exempt-interest dividends, if any, attributable to
interest received on certain private activity obligations and certain
industrial development bonds will not be tax-exempt to any shareholders who
are "substantial users" of the facilities financed by such obligations or
bonds or who are "related persons" of such substantial users.
If a shareholder sells shares at a loss within six months of
purchase, any loss will be disallowed for Federal income tax purposes to the
extent of any exempt-interest dividends received on such shares.
STATE AND LOCAL. Each Fund may be subject to state or local taxes in
jurisdictions in which such Fund may be deemed to be doing business. In
addition, in those states or localities which have income tax laws, the
treatment of such Fund and its shareholders under such laws may differ from
their treatment under federal income tax laws, and investment in such Fund may
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have different tax consequences for shareholders than would direct investment
in such Fund's portfolio securities. Shareholders should consult their own
tax advisers concerning these matters.
CODES OF ETHICS
The Manager intends that: all of its activities function exclusively
for the benefit of the owners or beneficiaries of the assets it manages;
assets under management or knowledge as to current or prospective
transactions in managed assets are not utilized for personal advantage or for
the advantage of anyone other than the owners or beneficiaries of those
assets; persons associated with the Manager and the Trust avoid situations
involving actual or potential conflicts of interest with the owners or
beneficiaries of managed assets; and situations appearing to involve actual
or potential conflicts of interest or impairment of objectivity are avoided
whenever doing so does not run counter to the interests of the owners or
beneficiaries of the managed assets. The Board of Trustees of the Trust has
adopted a Code of Ethics which imposes certain prohibitions, restrictions,
preclearance requirements and reporting rules on the personal securities
transactions of subscribers to the Code, who include the Trust's officers and
Trustees and the employees of the Manager. Barclays and Capital Guardian have
adopted similar Codes of Ethics relating to their employees, and the Board of
Trustees of the Trust has adopted Barclays and Capital Guardian's Code of
Ethics insofar as it relates to their respective employees' activities in
connection with the Trust. The Board of Trustees believes that the provisions
of its Code of Ethics and Barclays' and Capital Guardian's Code of Ethics are
reasonably designed to prevent subscribers from engaging in conduct that
violates these principles.
SHARES
The Trust was organized as a business trust pursuant to the laws of
the State of Delaware on June 8, 2000. The Trust is authorized to issue an
unlimited number of shares of beneficial interest in the Trust, all without
par value. Shares are divided into and may be issued in a designated series
representing beneficial interests in one of the Trust's Funds. There are
currently ten series of shares.
Each share of a series issued and outstanding is entitled to
participate equally in dividends and distributions declared by such series
and, upon liquidation or dissolution, in net assets allocated to such series
remaining after satisfaction of outstanding liabilities. The shares of each
series, when issued, will be fully paid and non-assessable and have no
preemptive or conversion rights.
Auto Company provided the initial capital for the Trust by
purchasing $100,000 of Class A shares of the Bond Fund. Such shares were
acquired for investment.
As of the date of this Statement of Additional Information, Auto
Company owned 100% of each Fund's outstanding shares.
The Master Portfolios are series of the Master Fund, an open-end,
series management investment company organized as Delaware business trust.
The Master Fund was organized
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October 21, 1993. The Master Fund currently consists of twelve series,
including the Master Portfolios.
VOTING RIGHTS
Each share (including fractional shares) is entitled to one vote for
each dollar of net asset value represented by that share on all matters to
which the holder of that share is entitled to vote. Only shares representing
interests in a particular Fund will be entitled to vote on matters affecting
only that Fund. The shares do not have cumulative voting rights. Accordingly,
owners having shares representing more than 50% of the assets of the Trust
voting for the election of Trustees could elect all of the Trustees of the
Trust if they choose to do so, and in such event, shareowners having voting
interests in the remaining shares would not be able to elect any Trustees.
Matters requiring separate shareholder voting by Fund shall have
been effectively acted upon with respect to any Fund if a majority of the
outstanding voting interests of that Fund vote for approval of the matter,
notwithstanding that: (1) the matter has not been approved by a majority of
the outstanding voting interests of any other Fund; or (2) the matter has not
been approved by a majority of the outstanding voting interests of the Trust.
In a situation where an Equity Index Fund does not receive
instruction from certain of its shareholders on how to vote the corresponding
shares of a Master Portfolio, such Equity Index Fund will vote such shares in
the same proportion as the shares of which the Equity Index Fund does receive
voting instructions.
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FINANCIAL STATEMENTS
REPORT OF INDEPENDENT AUDITORS
The Board of Trustees and Shareholder
State Farm Mutual Fund Trust-- Bond Fund
We have audited the accompanying statement of net assets of State Farm Mutual
Fund Trust--Bond Fund as of October 30, 2000. The statement of net assets is
the responsibility of the Trust's management. Our responsibility is to
express an opinion on the statement of net assets based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards in the United States. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the statement
of net assets is free of material misstatement. An audit includes examining,
on a test basis, evidence supporting the amounts and disclosures in the
statement of net assets. An audit also 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, the statement of net assets referred to above presents
fairly, in all material respects, the financial position of State Farm Mutual
Fund Trust--Bond Fund at October 30, 2000, in conformity with generally
accepted accounting principles in the United States.
ERNST & YOUNG LLP
Chicago, Illinois
October 30, 2000
STATE FARM MUTUAL FUND TRUST - BOND FUND
STATEMENT OF NET ASSETS, OCTOBER 30, 2000
ASSETS
Cash $100,000
LIABILITIES
None ---
NET ASSETS
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Net assets, applicable to $10,000 Class A shares
of beneficial interest outstanding, equivalent to $10.00 per share
(unlimited number of shares authorized, no par value) $100,000
PRICING OF SHARES
Net asset value and redemption price per share $10.00
($100,000/10,000 Class A shares outstanding)
Maximum offering price per share (net asset value $10.31
Plus 3.09% of net asset value)
State Farm Mutual Fund Trust
Notes to the Financial Statement
As of October 30, 2000
Note 1 - Organization and Registration
State Farm Mutual Fund Trust (the "Trust") was established on June 8, 2000 as a
Delaware business trust and is registered under the Investment Company Act of
1940 as an open-ended management investment company. The Bond Fund (the "Fund")
is a separate investment portfolio of the Trust. The Fund has had no operations
other than those relating to organizational matters, including the sale of
10,000 Class A shares of beneficial interest to capitalize the Fund which were
sold to State Farm Mutual Automobile Insurance Company on October 30, 2000 for
cash in the amount of $100,000.
Note 2 - Significant Accounting Policies
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The following is a summary of significant accounting policies consistently
followed by the Fund in the preparation of its financial statements. The
policies are in conformity with generally accepted accounting principles.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities at the date of the financial statements and the reported
changes in net assets during the reporting period. Actual results could
differ from those estimates.
Organizational and Registration Expenses
State Farm Investment Management Corp., the Fund's investment advisor,
has incurred and paid expenses in connection with the organization of
the Trust. The Trust has not incurred any expenses.
Federal Income Taxes
The Fund intends to qualify annually for treatment as a regulated
investment company under Subchapter M of the Internal Revenue Code and,
if so qualified, will not be liable for federal income taxes to the
extent earnings are distributed to shareholders on a timely basis.
Note 3 - Investment Advisory and Other Agreements
As compensation for its services to the Fund, the Advisor will receive an
investment advisory fee at an annual rate of 0.10% of the average daily net
assets of the Fund, which is accrued daily and paid quarterly. The Advisor has
also agreed to reimburse the Fund for expenses on Class A shares that exceed
0.70% of average daily net assets. This expense reimbursement arrangement is
voluntary and may be discontinued by the Advisor at any time.
The Trust has entered into a shareholder services agreement with State Farm
Investment Management Corp. providing a fee at the annual rate of 0.25% of the
average net assets for Class A and B shares.
The Trust has entered into a distribution agreement with State Farm VP
Management Corp. Under terms of the agreement, State Farm VP Management Corp.
shall offer shares of the Fund on a continuous basis and may engage in sales and
promotional activities in connection therewith.
The Trust has also established a plan for the payment of distribution expense
pursuant to Rule 12b-1 under the Investment Company Act of 1940. Under the 12b-1
Plan for Class A shares, the Fund pays an amount up to 0.25% of its average
daily net assets on an annual basis to State Farm
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VP Management Corp. as compensation for distribution expenses incurred by
State Farm VP Management Corp.
Note 4 - Capital Stock
The Fund is authorized to issue an unlimited number of shares with no par value.
The Fund has three separate classes: Class A, Class B, and Institutional Shares.
Each class of shares has a different combination of sales charges, fees, and
eligibility requirements. As of October 30, 2000, Class A shares are the only
class of shares outstanding.
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APPENDIX A
DESCRIPTION OF BOND RATINGS
A rating of a rating service represents the service's opinion as to the
credit quality of the security being rated. However, the ratings are general and
are not absolute standards of quality or guarantees as to the creditworthiness
of an issuer. Consequently, the Manager and Capital Guardian believe that the
quality of debt securities in which a Fund invests should be continuously
reviewed and that individual analysts give different weightings to the various
factors involved in credit analysis. A rating is not a recommendation to
purchase, sell or hold a security, because it does not take into account market
value or suitability for a particular investor. When a security has received a
rating from more than one service, each rating should be evaluated
independently. Ratings are based on current information furnished by the issuer
or obtained by the ratings services from other sources which they consider
reliable. Ratings may be changed, suspended or withdrawn as a result of changes
in or unavailability of such information, or for other reasons.
The following is a description of the characteristics of ratings used
by Moody's Investors Service, Inc. ("Moody's") and Standard & Poor's Corporation
("S&P").
RATINGS BY MOODY'S
Aaa--Bonds rated Aaa are judged to be 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. Although the various protective elements are likely to
change, such changes are not likely to impair the fundamentally strong position
of such bonds.
Aa--Bonds rated Aa are judged to be 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 bonds or fluctuation of protective elements may be
of greater amplitude or there may be other elements present which make the long
term risk appear somewhat larger than in Aaa bonds.
A--Bonds rated A possess many favorable investment attributes and are
to be considered as upper medium grade obligations. Factors giving security to
principal and interest are considered adequate but elements may be present which
suggest a susceptibility to impairment sometime in the future.
Baa--Bonds 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.
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Ba--Bonds 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 rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
Caa--Bonds rated Caa are of poor standing. Such bonds may be in default
or there may be present elements of danger with respect to principal or
interest.
Ca--Bonds rated Ca represent obligations which are speculative in a
high degree. Such bonds are often in default or have other marked shortcomings.
C--Bonds 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.
Conditional Ratings. The designation "Con." followed by a rating
indicated bonds for which the security depends upon the completion of some act
or the fulfillment of some condition. These are bonds secured by (a) earnings of
projects under construction, (b) earnings of projects unseasoned in operating
experience, (c) rentals which begin when facilities are completed, or (d)
payments to which some other limiting condition attaches. Parenthetical rating
denotes probable credit stature upon completion of construction or elimination
of basis of condition.
Note: Those bonds in the Aa, A, Baa, Ba and B groups which Moody's
believes possess the strongest investment attributes are designated by the
symbols Aa 1, A 1, Baa 1, Ba 1, and B 1.
MUNICIPAL NOTES:
MIG 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. This designation denotes high quality. Margins of protection are
ample although not so large as in the preceding group.
MIG 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 established.
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COMMERCIAL PAPER:
Moody's employs the following three designations, all judged to be
investment grade, to indicate the relative repayment capacity of rated issuers:
Prime-1 Highest Quality
Prime 2 Higher Quality
Prime-3 High Quality
If an issuer represents to Moody's that its commercial paper
obligations are supported by the credit of another entity or entities, Moody's,
in assigning ratings to such issuers, evaluates the financial strength of the
indicated affiliated corporations, commercial banks, insurance companies,
foreign governments, or other entities, but only as one factor in the total
rating assessment.
S&P RATINGS
AAA--Bonds rated AAA have the highest rating. Capacity to pay principal
and interest is extremely strong.
AA--Bonds rated AA have a very strong capacity to pay principal and
interest and differ from AAA bonds only in small degree.
A--Bonds rated A have a strong capacity to pay principal and interest,
although they are somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions than bonds in higher rated categories.
BBB--Bonds rated BBB are regarded as having an adequate capacity to pay
principal and interest. Whereas they normally exhibit protection parameters,
adverse economic conditions or changing circumstances are more likely to lead to
a weakened capacity to pay principal and interest for bonds in this capacity
than for bonds in higher rated categories.
BB--B--CCC--CC--Bonds rated BB, B, CCC and CC are regarded, on balance,
as predominantly speculative with respect to the issuer's capacity to pay
interest and repay principal in accordance with the terms of the obligation. BB
indicates the lowest degree of speculation among such bonds and CC the highest
degree of speculation. Although such bonds will likely have some quality and
protective characteristics, these are outweighed by large uncertainties or major
risk exposures to adverse conditions.
C--The rating C is reserved for income bonds on which no interest is
being paid.
In order to provide more detailed indications of credit quality, S&P's
bond letter ratings described above (except for AAA category) may be modified by
the addition of a plus or a minus sign to show relative standing within the
rating category.
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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, although addressing
credit quality subsequent to completion of the project, makes no comment on the
likelihood of, or the risk of default upon the failure of, such completion. The
investor should exercise his own judgment with respect to such likelihood and
risk.
MUNICIPAL NOTES:
SP-1. Notes rated SP-1 have very strong capacity to pay principal and
interest. Those issues determined to possess overwhelming safety characteristics
are designated SP-1+.
SP-2. Notes rated SP-2 have satisfactory capacity to pay principal and
interest.
Notes due in three years or less normally receive a note rating. Notes
maturing beyond three years normally receive a bond rating, although the
following criteria are used in making that assessment:
- Amortization schedule (the larger the final maturity relative
to other maturities, the more likely the issue will be rated
as a note).
- Source of payment (the more dependent the issue is on the
market for its refinancing, the more likely it will be rated
as a note).
COMMERCIAL PAPER:
A. Issues assigned this highest rating are regarded as having the
greatest capacity for timely payment. Issues in this category are further
refined with the designations 1, 2 and 3 to indicate the relative degree of
safety.
A-1. This designation indicates that the degree of safety regarding
timely payment is either overwhelming or very strong. Those issues determined to
possess overwhelming safety characteristics are designated A-1+.
4
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================================================================================
PROSPECTUS
================================================================================
STATE FARM MUTUAL FUND TRUST
Institutional Shares
================================================================================
DECEMBER 18, 2000
STATE FARM EQUITY FUND
STATE FARM SMALL CAP EQUITY FUND
STATE FARM INTERNATIONAL EQUITY FUND
STATE FARM S&P 500 INDEX FUND
STATE FARM SMALL CAP INDEX FUND
STATE FARM INTERNATIONAL INDEX FUND
STATE FARM EQUITY AND BOND FUND
STATE FARM BOND FUND
STATE FARM TAX ADVANTAGED BOND FUND
STATE FARM MONEY MARKET FUND
THE SECURITIES AND EXCHANGE COMMISSION HAS NOT APPROVED OR DISAPPROVED THE
SHARES OF THE FUNDS OR PASSED UPON THE ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
-1-
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
<S> <C>
FUNDS AT A GLANCE..............................................................2
STATE FARM EQUITY FUND................................................2
STATE FARM SMALL CAP EQUITY FUND......................................4
STATE FARM INTERNATIONAL EQUITY FUND..................................6
STATE FARM S&P 500 INDEX FUND.........................................8
STATE FARM SMALL CAP INDEX FUND......................................10
STATE FARM INTERNATIONAL INDEX FUND..................................12
STATE FARM EQUITY AND BOND FUND......................................14
STATE FARM BOND FUND.................................................16
STATE FARM TAX ADVANTAGED BOND FUND..................................18
STATE FARM MONEY MARKET FUND.........................................20
ANNUAL INVESTMENT RETURNS.....................................................22
EXPENSE INFORMATION...........................................................22
HOW THE FUNDS INVEST..........................................................25
GENERAL POLICIES APPLICABLE TO ALL FUNDS.............................25
FUND SUMMARIES.......................................................25
OTHER RISKS OF INVESTING IN THE FUNDS................................31
MANAGING THE INVESTMENTS OF THE FUNDS.........................................32
SHAREHOLDER INFORMATION.......................................................36
HOW TO BUY AND SELL SHARES...........................................36
DIVIDENDS, DISTRIBUTIONS AND TAXES............................................37
APPENDIX A....................................................................39
ADDITIONAL INFORMATION ABOUT THE FUNDS........................................41
</TABLE>
-i-
<PAGE>
THIS PROSPECTUS PROVIDES INFORMATION ABOUT STATE FARM MUTUAL FUND TRUST
(THE "TRUST"). THE TRUST HAS TEN SEPARATE FUNDS, EACH OF WHICH IS A SEPARATE
INVESTMENT PORTFOLIO WITH ITS OWN INVESTMENT OBJECTIVE, INVESTMENT POLICIES,
RESTRICTIONS, AND RISKS. STATE FARM INVESTMENT MANAGEMENT CORP. (THE "MANAGER")
IS THE INVESTMENT ADVISER TO EACH FUND. EACH FUND OFFERS THREE CLASSES OF
SHARES: CLASS A, CLASS B AND INSTITUTIONAL SHARES. THIS PROSPECTUS OFFERS
INSTITUTIONAL SHARES. ADDITIONAL INFORMATION CONCERNING EACH FUND APPEARS
FOLLOWING FUNDS AT A GLANCE.
FUNDS AT A GLANCE
--------------------------------------------------------------------------------
This section discusses each Fund's investment objectives, strategies and risks.
Each Fund summary also describes who should consider investing in the Fund in
the "Investor Profile" section. Please refer to the detailed description of the
Funds' policies in "How the Funds Invest" (beginning on p. 25) for those Funds
you wish to purchase.
STATE FARM EQUITY FUND
INVESTMENT OBJECTIVE -- The State Farm Equity Fund (the "Equity Fund") seeks
long-term growth of capital.
PRINCIPAL INVESTMENT STRATEGIES
HOW DOES THIS FUND PURSUE ITS INVESTMENT OBJECTIVE?
The Equity Fund invests under normal circumstances at least 80% of its assets in
common stocks and other equity securities of U.S. companies with market
capitalizations of at least $1.5 billion. The Manager chooses stocks for the
Fund's portfolio for their long-term potential to generate capital gains.
In making investment decisions on specific securities, the Manager looks for
companies with one or more of the following characteristics:
- Strong cash flow and a recurring revenue stream
- A strong industry position
- A strong financial position
- Strong management with a clearly defined strategy
- Capability to develop new or superior products or services
The Manager may sell securities the Fund holds for a variety of reasons, such as
to secure gains, limit losses, or redeploy assets into more promising
opportunities.
The Fund may invest up to 25% of its assets in equity securities and depositary
receipts of foreign companies.
--------------------------------------------------------------------------------
INVESTOR PROFILE
Who should consider investing in the Equity Fund?
YOU MAY WANT TO INVEST IN THE EQUITY FUND IF YOU:
- can tolerate the price fluctuations and volatility that are inherent
in investing in a broad based large cap stock mutual fund
- want to diversify your investments
- are seeking a growth investment as part of an asset allocation program
OR
- are investing for retirement or other goals that are many years in
the future
YOU MAY NOT WANT TO INVEST IN THE EQUITY FUND IF YOU:
- are investing with a shorter investment time horizon in mind
- are seeking income rather than capital appreciation
OR
- are uncomfortable with an investment whose value is likely to vary
substantially
--------------------------------------------------------------------------------
-2-
<PAGE>
RISKS
WHAT ARE THE MAIN RISKS OF INVESTING IN THIS FUND?
EDGAR REPRESENTATION OF THE PRINTED GRAPHIC
<TABLE>
<CAPTION>
Lower Moderate Higher
-------------------------------------------------------
RISK
-------------------------------------------------------
<S> <C> <C> <C>
Money Bond Balanced Stock
Market Funds Funds Funds
Funds
Equity Fund
</TABLE>
- MARKET RISK. The Fund invests mostly in common stocks, which represent an
equity interest (ownership) in a business. Stock prices may fluctuate
widely over short or even extended periods in response to company, market,
or economic news. Stock markets also tend to move in cycles, with periods
of rising stock prices and periods of falling stock prices.
- FOREIGN INVESTING RISK. Investing in foreign securities involves higher
trading and custody costs than investing in U.S. companies. Accounting,
legal and reporting practices are different than in the U.S. and regulation
is often less stringent. Potential political or economic instability
presents risks, as does the fluctuation in currency exchange rates, as well
as the possible imposition of exchange control regulation or currency
restrictions that could prevent the conversion of local currencies into
U.S. dollars.
- MANAGEMENT RISK. The Manager's assessment of companies held in the Fund may
prove incorrect, resulting in losses or poor performance, even in a rising
market.
AN INVESTMENT IN THE EQUITY FUND IS NOT A DEPOSIT OF ANY BANK OR OTHER
INSURED DEPOSITORY INSTITUTION AND IS NOT INSURED OR GUARANTEED BY THE
FDIC OR ANY OTHER GOVERNMENT AGENCY. YOU CAN LOSE MONEY BY INVESTING IN
THE FUND.
-3-
<PAGE>
STATE FARM SMALL CAP EQUITY FUND
INVESTMENT OBJECTIVE -- The State Farm Small Cap Equity Fund (the "Small Cap
Equity Fund") seeks long-term growth of capital.
INVESTMENT SUB-ADVISER - Capital Guardian Trust Company ("Capital Guardian").
PRINCIPAL INVESTMENT STRATEGIES
HOW DOES THIS FUND PURSUE ITS INVESTMENT OBJECTIVE?
The Small Cap Equity Fund invests most of its assets in equity securities of
companies with relatively small market capitalizations located in the U.S. The
companies in which Small Cap Equity Fund invests typically have market
capitalizations of $50 million to $1.5 billion at the time the Fund purchases
the securities.
The Fund invests in securities that Capital Guardian thinks are undervalued and
represent good long-term investment opportunities. Capital Guardian may sell
securities when it believes they no longer represent good long-term value.
The Fund may invest up to 25% of its assets in equity securities and depositary
receipts of foreign companies.
RISKS
WHAT ARE THE MAIN RISKS OF INVESTING IN THIS FUND?
EDGAR REPRESENTATION OF THE PRINTED GRAPHIC
<TABLE>
<CAPTION>
Lower Moderate Higher
-------------------------------------------------------
RISK
-------------------------------------------------------
<S> <C> <C> <C>
Money Bond Balanced Stock
Market Funds Funds Funds
Funds
Small Cap
Equity Fund
</TABLE>
--------------------------------------------------------------------------------
INVESTOR PROFILE
Who should consider investing in the Small Cap Equity Fund?
YOU MAY WANT TO INVEST IN THE SMALL CAP EQUITY FUND IF YOU:
- can tolerate the price fluctuations and volatility that are inherent in
investing in a broad based small cap stock mutual fund
- want to diversify your investments
- are seeking a growth investment as part of an asset allocation program
OR
- are investing for retirement or other goals that are many years in the
future
YOU MAY NOT WANT TO INVEST IN THE SMALL CAP EQUITY FUND IF YOU:
- are investing with a shorter investment time horizon in mind
- are seeking income rather than capital appreciation
OR
- are uncomfortable with an investment whose value is likely to vary
substantially
--------------------------------------------------------------------------------
-4-
<PAGE>
- MARKET RISK. The Fund invests mostly in common stocks, which represent an
equity interest (ownership) in a business. Stock prices may fluctuate
widely over short or even extended periods in response to company, market,
or economic news. Stock markets also tend to move in cycles, with periods
of rising stock prices and periods of falling stock prices.
- SMALLER COMPANY SIZE. The Fund invests a large portion of its assets in
smaller capitalization companies. The securities of small capitalization
companies are often more difficult to value or dispose of, more difficult
to obtain information about, and more volatile than stocks of larger, more
established companies. In addition, the markets for the Fund's investments
may not be actively traded, which increases the risk that Capital Guardian
may have difficulty selling securities the Fund holds.
- FOREIGN INVESTING RISK. Investing in foreign securities involves higher
trading and custody costs than investing in U.S. companies. Accounting,
legal and reporting practices are different than in the U.S. and regulation
is often less stringent. Potential political or economic instability
presents risks, as does the fluctuation in currency exchange rates, as well
as the possible imposition of exchange control regulation or currency
restrictions that could prevent the conversion of local currencies into
U.S. dollars.
- MANAGEMENT RISK. Capital Guardian's assessment of companies held in the
Fund may prove incorrect, resulting in losses or poor performance, even in
a rising market.
AN INVESTMENT IN THE SMALL CAP EQUITY FUND IS NOT A DEPOSIT OF ANY BANK
OR OTHER INSURED DEPOSITORY INSTITUTION AND IS NOT INSURED OR
GUARANTEED BY THE FDIC OR ANY OTHER GOVERNMENT AGENCY. YOU CAN LOSE
MONEY BY INVESTING IN THE FUND.
-5-
<PAGE>
STATE FARM INTERNATIONAL EQUITY FUND
INVESTMENT OBJECTIVE --The State Farm International Equity Fund (the
"International Equity Fund") seeks long-term growth of capital.
INVESTMENT SUB-ADVISER -- Capital Guardian Trust Company ("Capital Guardian")
PRINCIPAL INVESTMENT STRATEGIES
HOW DOES THIS FUND PURSUE ITS INVESTMENT OBJECTIVE?
The International Equity Fund invests its assets primarily in common stocks of
companies located in 15 European countries (Austria, Belgium, Denmark, Finland,
France, Germany, Ireland, Italy, the Netherlands, Norway, Portugal, Spain,
Sweden, Switzerland and the United Kingdom), Australia, New Zealand, Hong Kong,
Japan and Singapore. The Fund may also invest in companies located in emerging
markets. There is no restriction on the size of the companies in which the Fund
invests.
The Fund invests in securities that Capital Guardian thinks are undervalued and
represent good long-term investment opportunities. Capital Guardian may sell
securities when it believes they no longer represent good long-term value.
RISKS
WHAT ARE THE MAIN RISKS OF INVESTING IN THIS FUND?
EDGAR REPRESENTATION OF THE PRINTED GRAPHIC
<TABLE>
<CAPTION>
Lower Moderate Higher
-------------------------------------------------------
RISK
-------------------------------------------------------
<S> <C> <C> <C>
Money Bond Balanced Stock
Market Funds Funds Funds
Funds
International
Equity Fund
</TABLE>
--------------------------------------------------------------------------------
INVESTOR PROFILE
Who should consider investing in the International Equity Fund?
YOU MAY WANT TO INVEST IN THE INTERNATIONAL EQUITY FUND IF YOU:
- can tolerate the price fluctuations and volatility that are inherent in
investing in an international stock mutual fund
- want to diversify your investments
- are seeking a growth investment as part of an asset allocation program
OR
- are investing for retirement or other goals that are many years in the
future
YOU MAY NOT WANT TO INVEST IN THE INTERNATIONAL EQUITY FUND IF YOU:
- are investing with a shorter investment time horizon in mind
- are seeking income rather than capital appreciation
- are uncomfortable investing in companies that are not located in the United
States
OR
- are uncomfortable with an investment whose value is likely to vary
substantially
--------------------------------------------------------------------------------
-6-
<PAGE>
- MARKET RISK. The Fund invests mostly in common stocks, which represent an
equity interest (ownership) in a business. Stock prices may fluctuate
widely over short or even extended periods in response to company, market,
or economic news. Stock markets also tend to move in cycles, with periods
of rising stock prices and periods of falling stock prices.
- FOREIGN INVESTING RISK. Investing in foreign securities involves higher
trading and custody costs than investing in U.S. companies. Accounting,
legal and reporting practices are different than in the U.S. and regulation
is often less stringent. Potential political or economic instability
presents risks, as does the fluctuation in currency exchange rates, as well
as the possible imposition of exchange control regulation or currency
restrictions that could prevent the conversion of local currencies into
U.S. dollars. These risks are heightened for emerging or developing
countries, which may experience substantial rates of inflation, may be
adversely affected by barriers and may experience rapid depreciation in
their currencies.
- MANAGEMENT RISK. Capital Guardian's assessment of companies held in the
Fund may prove incorrect, resulting in losses or poor performance, even in
a rising market.
AN INVESTMENT IN THE INTERNATIONAL EQUITY FUND IS NOT A DEPOSIT OF ANY
BANK OR OTHER INSURED DEPOSITORY INSTITUTION AND IS NOT INSURED OR
GUARANTEED BY THE FDIC OR ANY OTHER GOVERNMENT AGENCY. YOU CAN LOSE
MONEY BY INVESTING IN THE FUND.
-7-
<PAGE>
STATE FARM S&P 500 INDEX FUND
INVESTMENT OBJECTIVE -- The State Farm S&P 500 Index Fund (the "S&P 500 Index
Fund") seeks to provide investment results that correspond to the total return
of publicly traded common stocks in the aggregate, as represented by the
Standard & Poor's 500 Stock Index (the "S&P 500-Registered Trademark-* Index").
PRINCIPAL INVESTMENT STRATEGIES
HOW DOES THIS FUND PURSUE ITS INVESTMENT OBJECTIVES?
The S&P 500 Index Fund invests all of its assets in a separate series of an
unaffiliated mutual fund called Master Investment Portfolio (the "Master Fund").
That series, called the S&P 500 Index Master Portfolio, holds each of the stocks
that make up the S&P 500 Index. The S&P 500 Index Master Portfolio and the S&P
500 Index Fund have substantially similar investment objectives. Barclays Global
Fund Advisors ("Barclays") is the investment adviser to the S&P 500 Index Master
Portfolio.
Barclays seeks to achieve investment performance that is similar to the S&P 500
Index (the Fund's target benchmark). The S&P 500 Index is a widely used measure
of large U.S. company stock performance. S&P selects stocks for the S&P 500
Index based upon the following factors:
- market value
- industry group classification (so that the S&P 500 Index represents a broad
range of industry segments within the U.S. economy)
- trading activity, to ensure ample liquidity and efficient share pricing
- fundamental analysis, to ensure that companies in the Index are stable
The S&P 500 Index Master Portfolio pursues its investment objective by:
- investing in all of the securities that make up the S&P 500 Index
- investing in these securities in proportions that match the weightings of
the S&P 500 Index
Under normal operating conditions, the S&P 500 Index Master Portfolio seeks to
invest at least 90% of its total assets in stocks that are represented in the
S&P 500 Index.
--------------------------------------------------------------------------------
INVESTOR PROFILE
Who should consider investing in the S&P 500 Index Fund?
YOU MAY WANT TO INVEST IN THE S&P 500 INDEX FUND IF YOU:
- can tolerate the price fluctuations and volatility that are inherent in
investing in a broad based stock mutual fund
- want to invest in stocks, but with an indexing approach
- want to diversify your investments
- are seeking a growth investment as part of an asset allocation program
OR
- are investing for retirement or other goals that are many years in the
future
YOU MAY NOT WANT TO INVEST IN THE S&P 500 INDEX FUND IF YOU:
- are investing with a shorter investment time horizon in mind
- are seeking income rather than capital appreciation
OR
- are uncomfortable with an investment whose value is likely to vary
substantially
-----------------------------
* "Standard & Poor's-Registered Trademark-," "S&P-Registered Trademark-,"
"S&P 500-Registered Trademark-," "Standard & Poor's 500" and "500" are
trademarks of The McGraw-Hill Companies, Inc. that the S&P 500 Index Fund
has licensed for use. The S&P 500 Index Fund is not sponsored, endorsed,
sold or promoted by Standard & Poor's, and Standard & Poor's makes no
representations regarding the advisability of investing in the
S&P 500 Index Fund. For more information regarding the S&P 500 Index, see
the Trust's Statement of Additional Information.
--------------------------------------------------------------------------------
-8-
<PAGE>
RISKS
THE MAIN RISKS OF INVESTING IN THE S&P 500 INDEX FUND ARE THE SAME AS THE MAIN
RISKS OF INVESTING IN S&P 500 INDEX MASTER PORTFOLIO. WHAT ARE THE MAIN RISKS OF
INVESTING IN THE S&P 500 INDEX MASTER PORTFOLIO?
[EDGAR REPRESENTATION OF THE PRINTED GRAPHIC]
<TABLE>
<CAPTION>
Lower Moderate Higher
-------------------------------------------------------
RISK
-------------------------------------------------------
<S> <C> <C> <C>
Money Bond Balanced Stock
Market Funds Funds Funds
Funds
S&P 500
Index Fund
</TABLE>
- MARKET RISK. The S&P 500 Index Master Portfolio invests mostly in common
stocks, which represent an equity interest (ownership) in a business. Stock
prices may fluctuate widely over short or even extended periods in response
to company, market, or economic news. Stock markets also tend to move in
cycles, with periods of rising stock prices and periods of falling stock
prices.
- INDEXING RISK. The S&P 500 Index Master Portfolio attempts to match the
performance of the S&P 500 Index, but there is no guarantee that it will be
able to do so. The degree to which the S&P 500 Index Master Portfolio fails
to track the performance of the index is referred to as "tracking error,"
which Barclays expects to be less than 5% over time. The S&P 500 Index
Master Portfolio tries to stay fully invested at all times in assets that
will help it achieve its investment objective. Even when stock prices are
falling, the S&P 500 Index Master Portfolio will stay fully invested and
may decline more than its benchmark index. An index is not a mutual fund
and you cannot invest in an index. The composition and weighting of
securities in an index can, and often do, change.
- MANAGEMENT RISK. BARCLAYS' ASSESSMENT OF THE RELATIVE WEIGHTINGS OF THE
COMPANIES HELD IN THE S&P 500 INDEX MASTER PORTFOLIO MAY PROVE INCORRECT,
RESULTING IN LOSSES OR POOR PERFORMANCE, EVEN IN A RISING MARKET.
AN INVESTMENT IN THE S&P 500 INDEX FUND IS NOT A DEPOSIT OF ANY BANK OR
OTHER INSURED DEPOSITORY INSTITUTION AND IS NOT INSURED OR GUARANTEED
BY THE FDIC OR ANY OTHER GOVERNMENT AGENCY. YOU CAN LOSE MONEY BY
INVESTING IN THE FUND.
-9-
<PAGE>
STATE FARM SMALL CAP INDEX FUND
INVESTMENT OBJECTIVE -- The State Farm Small Cap Index Fund (the "Small Cap
Index Fund") seeks to match as closely as practicable, before fees and
expenses, the performance of the Russell 2000 Small Stock Index-Registered
Trademark-* (the "Russell 2000 Index").
PRINCIPAL INVESTMENT STRATEGIES
HOW DOES THIS FUND PURSUE ITS INVESTMENT OBJECTIVES?
The Small Cap Index Fund invests all of its assets in a separate series of the
Master Fund, called the Russell 2000 Index Master Portfolio. The Russell 2000
Index Master Portfolio and the Small Cap Index Fund have substantially similar
investment objectives. Barclays is the investment adviser to the Russell 2000
Index Master Portfolio. Barclays seeks to achieve investment performance for the
Russell 2000 Index Master Portfolio that is similar to the Russell 2000 Index.
The Russell 2000 Index is an unweighted index of 2,000 small companies that is
created by taking the largest 3,000 companies in the U.S. and eliminating the
largest 1,000 of those companies.
The Russell 2000 Index Master Portfolio pursues its investment objective by
investing in a representative sample of the securities contained in the Russell
2000 Index based upon sampling and modeling techniques.
Under normal operating conditions, the Russell 2000 Index Master Portfolio seeks
to invest at least 90% of its total assets in stocks that are represented in the
Russell 2000 Index.
--------------------------------------------------------------------------------
INVESTOR PROFILE
Who should consider investing in the Small Cap Index Fund?
YOU MAY WANT TO INVEST IN THE SMALL CAP INDEX FUND IF YOU:
- can tolerate the price fluctuations and volatility that are inherent in
investing in a broad based small cap stock mutual fund
- want to invest in stocks, but with an indexing approach
- want to diversify your investments
- are seeking a growth investment as part of an asset allocation program
OR
- are investing for retirement or other goals that are many years in the
future
YOU MAY NOT WANT TO INVEST IN THE SMALL CAP INDEX FUND IF YOU:
- are investing with a shorter investment time horizon in mind
- are seeking income rather than capital appreciation
OR
- are uncomfortable with an investment whose value is likely to vary
substantially
-----------------------------
* The Russell 2000-Registered Trademark- Index is a trademark/service
mark, and Russell-TM- is a trademark, of the Frank Russell Company. The
Small Cap Index Fund is not sponsored, endorsed, sold or promoted by the
Frank Russell Company, and the Frank Russell Company makes no
representation regarding the advisability of investing in the Small Cap
Index Fund. For more information regarding the Russell 2000 Index, see the
Trust's Statement of Additional Information.
--------------------------------------------------------------------------------
-10-
<PAGE>
RISKS
THE MAIN RISKS OF INVESTING IN THE SMALL CAP INDEX FUND ARE THE SAME AS THE MAIN
RISKS OF INVESTING IN THE RUSSELL 2000 INDEX MASTER PORTFOLIO. WHAT ARE THE MAIN
RISKS OF INVESTING IN THE RUSSELL 2000 INDEX MASTER PORTFOLIO?
[EDGAR REPRESENTATION OF THE PRINTED GRAPHIC]
<TABLE>
<CAPTION>
Lower Moderate Higher
-------------------------------------------------------
RISK
-------------------------------------------------------
<S> <C> <C> <C>
Money Bond Balanced Stock
Market Funds Funds Funds
Funds
Small Cap
Index Fund
</TABLE>
- MARKET RISK. The Russell 2000 Index Master Portfolio invests mostly in
common stocks, which represent an equity interest (ownership) in a
business. Stock prices may fluctuate widely over short or even extended
periods in response to company, market, or economic news. Stock markets
also tend to move in cycles, with periods of rising stock prices and
periods of falling stock prices.
- SMALLER COMPANY SIZE. The Russell 2000 Index Master Portfolio invests a
large portion of its assets in smaller capitalization companies. The
securities of small capitalization companies are often more difficult to
value or dispose of, more difficult to obtain information about, and more
volatile than stocks of larger, more established companies. In addition,
the markets for the Russell 2000 Index Master Portfolio's investments may
not be actively traded, which increases the risk that Barclays may have
difficulty selling securities the Russell 2000 Index Master Portfolio
holds.
- INDEXING RISK. The Russell 2000 Index Master Portfolio attempts to match
the performance of the Russell 2000 Index, but there is no guarantee that
it will be able to do so. The degree to which the Russell 2000 Index Master
Portfolio fails to track the performance of the index is referred to as
"tracking error," which Barclays expects to be less than 5% over time. The
Russell 2000 Index Master Portfolio tries to stay fully invested at all
times in assets that will help it achieve its investment objective. Even
when stock prices are falling, the Russell 2000 Index Master Portfolio will
stay fully invested and may decline more than its benchmark index. An index
is not a mutual fund and you cannot invest in an index. The composition and
weighting of securities in an index can, and often do, change.
AN INVESTMENT IN THE SMALL CAP INDEX FUND IS NOT A DEPOSIT OF ANY BANK
OR OTHER INSURED DEPOSITORY INSTITUTION AND IS NOT INSURED OR
GUARANTEED BY THE FDIC OR ANY OTHER GOVERNMENT AGENCY. YOU CAN LOSE
MONEY BY INVESTING IN THE FUND.
-11-
<PAGE>
STATE FARM INTERNATIONAL INDEX FUND
INVESTMENT OBJECTIVE -- The State Farm International Index Fund (the
"International Index Fund") seeks to match as closely as practicable, before
fees and expenses, the performance of an international portfolio of common
stocks represented by the Morgan Stanley Capital International Europe,
Australia, and Far East Free Index ("EAFE-Registered Trademark- Free Index").*
PRINCIPAL INVESTMENT STRATEGIES
HOW DOES THIS FUND PURSUE ITS INVESTMENT OBJECTIVES?
The International Index Fund invests all of its assets in a separate series of
the Master Fund, called the International Index Master Portfolio. The
International Index Master Portfolio and the International Index Fund have
substantially similar investment objectives. Barclays is the investment adviser
to the International Index Master Portfolio.
The International Index Fund and International Index Master Portfolio seek to
match the performance of foreign stocks by investing in common stocks included
in the EAFE Free Index (the target benchmark). The EAFE Free Index is a
capitalization-weighted index that currently includes stocks of companies
located in 15 European countries (Austria, Belgium, Denmark, Finland, France,
Germany, Ireland, Italy, the Netherlands, Norway, Portugal, Spain, Sweden,
Switzerland and the United Kingdom), Australia, New Zealand, Hong Kong, Japan
and Singapore. The International Index Master Portfolio selects a representative
sample of the securities contained in the EAFE Free Index based upon sampling
and modeling techniques.
The International Index Master Portfolio attempts to remain as fully invested as
practicable in a pool of stocks and other equity securities that are found in
the EAFE Free Index in a manner that is expected to approximate the performance
of the EAFE Free Index. Under normal operating conditions, the International
Index Master Portfolio seeks to invest at least 90% of its total assets in
stocks that are represented in the EAFE Free Index.
--------------------------------------------------------------------------------
INVESTOR PROFILE
Who should consider investing in the International Index Fund?
YOU MAY WANT TO INVEST IN THE INTERNATIONAL INDEX FUND IF YOU:
- can tolerate the price fluctuations and volatility that are inherent
in investing in a broad based international stock mutual fund
- want to invest in stocks, but with an indexing approach
- want to diversify your investments
- are seeking a growth investment as part of an asset allocation program
OR
- are investing for retirement or other goals that are many years in
the future
YOU MAY NOT WANT TO INVEST IN THE INTERNATIONAL INDEX FUND IF YOU:
- are investing with a shorter investment time horizon in mind
- are seeking income rather than capital appreciation
- are uncomfortable investing in companies that are not located in the
United States
OR
- are uncomfortable with an investment whose value is likely to vary
substantially
-----------------------------
* The EAFE-Registered Trademark- Free Index is the exclusive property of
Morgan Stanley & Co. Incorporated ("Morgan Stanley"). Morgan Stanley
Capital International is a service mark of Morgan Stanley and has been
licensed for use by the International Index Fund. The International Index
Fund is not sponsored, endorsed, sold or promoted by Morgan Stanley.
Morgan Stanley makes no representation or warranty regarding the
advisability of investing in the International Index Fund. For more
information regarding the EAFE-Registered Trademark- Free Index, see the
Trust's Statement of Additional Information.
--------------------------------------------------------------------------------
-12-
<PAGE>
RISKS
THE MAIN RISKS OF INVESTING IN THE INTERNATIONAL INDEX FUND ARE THE SAME AS THE
MAIN RISKS OF INVESTING IN THE INTERNATIONAL INDEX MASTER PORTFOLIO. WHAT ARE
THE MAIN RISKS OF INVESTING IN THE INTERNATIONAL INDEX MASTER PORTFOLIO?
[EDGAR REPRESENTATION OF THE PRINTED GRAPHIC]
<TABLE>
<CAPTION>
Lower Moderate Higher
-------------------------------------------------------
RISK
-------------------------------------------------------
<S> <C> <C> <C>
Money Bond Balanced Stock
Market Funds Funds Funds
Funds
International
Index Fund
</TABLE>
- MARKET RISK. The International Index Master Portfolio invests mostly in
common stocks, which represent an equity interest (ownership) in a
business. Stock prices may fluctuate widely over short or even extended
periods in response to company, market, or economic news. Stock markets
also tend to move in cycles, with periods of rising stock prices and
periods of falling stock prices.
- FOREIGN INVESTING RISK. Investing in foreign securities involves higher
trading and custody costs than investing in U.S. companies. Accounting,
legal and reporting practices are different than in the U.S. and regulation
is often less stringent. Potential political or economic instability
presents risks as does the fluctuation in currency exchange rates, as well
as the possible imposition of exchange control regulation or currency
restrictions that could prevent the conversion of local currencies into
U.S. dollars. These risks are heightened for emerging or developing
countries, which may experience substantial rates of inflation, may be
adversely affected by barriers and may experience rapid depreciation in
their currencies.
- INDEXING RISK. The International Index Master Portfolio attempts to match
the performance of the EAFE Free Index, but there is no guarantee that it
will be able to do so. The degree to which the International Index Master
Portfolio fails to track the performance of the index is referred to as
"tracking error," which Barclays expects to be less than 5% over time. The
International Index Master Portfolio tries to stay fully invested at all
times in assets that will help it achieve its investment objective. Even
when stock prices are falling, the International Index Master Portfolio
will stay fully invested and may decline more than the Fund's benchmark
index. An index is not a mutual fund and you cannot invest in an index. The
composition and weighting of securities in an index can, and often do,
change.
AN INVESTMENT IN THE INTERNATIONAL INDEX FUND IS NOT A DEPOSIT OF ANY
BANK OR OTHER INSURED DEPOSITORY INSTITUTION AND IS NOT INSURED OR
GUARANTEED BY THE FDIC OR ANY OTHER GOVERNMENT AGENCY. YOU CAN LOSE
MONEY BY INVESTING IN THE FUND.
-13-
<PAGE>
STATE FARM EQUITY AND BOND FUND
INVESTMENT OBJECTIVE -- The State Farm Equity and Bond Fund (the "Equity and
Bond Fund") seeks long-term growth of principal while providing some current
income.
PRINCIPAL INVESTMENT STRATEGIES
HOW DOES THIS FUND PURSUE ITS INVESTMENT OBJECTIVE?
The Equity and Bond Fund invests all of its assets in shares of the State Farm
Equity Fund and the State Farm Bond Fund. Generally, the Equity and Bond Fund
attempts to maintain approximately 60% of its net assets in shares of the State
Farm Equity Fund and approximately 40% of its net assets in shares of the State
Farm Bond Fund. The Equity and Bond Fund never invests more than 75% of its net
assets in either underlying Fund. Though the Equity and Bond Fund is not an
asset allocation or market timing mutual fund, it does, from time to time,
adjust the amount of its assets invested in each underlying Fund as economic,
market and financial conditions warrant. Please refer to the descriptions of the
investments of the State Farm Equity Fund and the State Farm Bond Fund for a
discussion of the portfolio securities of these Funds and the risks associated
with each.
--------------------------------------------------------------------------------
INVESTOR PROFILE
Who should consider investing in the Equity and Bond Fund?
YOU MAY WANT TO INVEST IN THE EQUITY AND BOND FUND IF YOU ARE SEEKING:
- long-term growth potential;
- some current income;
OR
- the convenience of a balanced portfolio of stocks and bonds in a single
investment.
YOU MAY NOT WANT TO INVEST IN THE EQUITY AND BOND FUND IF YOU:
- have a short-term investment horizon
- want the greater growth potential of an investment entirely in equity
securities
OR
- are unwilling to accept share price fluctuations
--------------------------------------------------------------------------------
RISKS
WHAT ARE THE MAIN RISKS OF INVESTING IN THIS FUND?
[EDGAR REPRESENTATION OF THE PRINTED GRAPHIC]
<TABLE>
<CAPTION>
Lower Moderate Higher
-------------------------------------------------------
RISK
-------------------------------------------------------
<S> <C> <C> <C>
Money Bond Balanced Stock
Market Funds Funds Funds
Funds
Equity and
Bond Fund
</TABLE>
- IN GENERAL. Because the Equity and Bond Fund invests all of its assets in
the State Farm Equity Fund and the State Farm Bond Fund, the risks of
investing in the Equity and Bond Fund are the same as investing in those
underlying Funds.
- MARKET RISK. The Fund invests all of its assets in the State Farm Equity
Fund and the State Farm Bond Fund. The prices of shares of these underlying
funds may fluctuate widely over short or even extended periods in
-14-
<PAGE>
response to company, market, or economic news. The markets in which the
underlying funds invest also tend to move in cycles, with periods of
rising prices and periods of falling prices.
- FOREIGN INVESTING RISK. The underlying Funds permit investments in foreign
securities. Investing in foreign securities involves higher trading and
custody costs than investing in U.S. companies. Accounting, legal and
reporting practices are different than in the U.S. and regulation is often
less stringent. Potential political or economic instability presents risks,
as does the fluctuation in currency exchange rates, as well as the possible
imposition of exchange control regulation or currency restrictions that
could prevent the conversion of local currencies into U.S. dollars.
- RISK ASSOCIATED WITH INVESTING IN BONDS. The Equity and Bond Fund may
invest up to 75% of its assets in the State Farm Bond Fund. An investment
in the State Farm Bond Fund is subject to risks associated with investing
in fixed income securities, such as bonds, which include:
- INTEREST RATE RISK. The risk that the bonds that the State Farm Bond
Fund holds may decline in market value due to an increase in interest
rates. Another risk associated with interest rate changes is call
risk. Call risk is the risk that during periods of falling interest
rates, a bond issuer will "call" or repay a higher yielding bond
before the maturity date of the bond. Under these circumstances, the
State Farm Bond Fund may have to reinvest the proceeds in an
investment that provides a lower yield than the called bond.
- INCOME RISK. The risk that the income from the bonds the State Farm
Bond Fund holds will decline due to falling interest rates.
- CREDIT RISK. The risk that a bond issuer fails to make principal or
interest payments when due to the State Farm Bond Fund, or that the
credit quality of the issuer falls.
- MANAGEMENT RISK. The Manager's assessment of investments and companies held
in the underlying Funds may prove incorrect, resulting in losses or poor
performance, even in a rising market.
AN INVESTMENT IN THE EQUITY AND BOND FUND IS NOT A DEPOSIT OF ANY BANK
OR OTHER INSURED DEPOSITORY INSTITUTION AND IS NOT INSURED OR GUARANTEED
BY THE FDIC OR ANY OTHER GOVERNMENT AGENCY. YOU CAN LOSE MONEY BY
INVESTING IN THE FUND.
-15-
<PAGE>
STATE FARM BOND FUND
INVESTMENT OBJECTIVE -- The State Farm Bond Fund (the "Bond Fund") seeks to
realize over a period of years the highest yield consistent with investing in
investment grade bonds.
PRINCIPAL INVESTMENT STRATEGIES
HOW DOES THIS FUND PURSUE ITS INVESTMENT OBJECTIVE?
The Bond Fund invests primarily in investment grade bonds issued by U.S.
companies. Under normal circumstances, the Bond Fund invests at least 80% of its
assets in investment grade bonds or in bonds that are not rated, but that the
Manager has determined to be of comparable quality. A bond is investment grade
if Moody's Investors Service, Inc. ("Moody's") or S&P have rated the bond in one
of their respective four highest rating categories. Non-investment grade bonds
are commonly referred to as "junk bonds." The Bond Fund may invest in the
following instruments:
- CORPORATE DEBT SECURITIES: investment grade securities issued by domestic
and foreign corporations and to a limited extent (up to 20% of its assets),
in lower rated securities;
- U.S. GOVERNMENT DEBT SECURITIES: securities issued or guaranteed by the
U.S. Government or its agencies or instrumentalities;
- FOREIGN GOVERNMENT DEBT SECURITIES: investment grade securities issued or
guaranteed by a foreign government or its agencies or instrumentalities,
payable in U.S. dollars;
- ASSET BACKED AND MORTGAGE BACKED SECURITIES: investment grade securities
backed by mortgages, consumer loans and other assets; or
- OTHER ISSUER DEBT SECURITIES: the Fund may invest up to 20% of its assets
in debt securities and preferred stocks that are convertible into common
stocks as well as nonconvertible preferred stocks or securities.
--------------------------------------------------------------------------------
INVESTOR PROFILE
Who should consider investing in the Bond Fund?
YOU MAY WANT TO INVEST IN THE BOND FUND IF YOU:
- are seeking higher potential returns than money market funds and are
willing to accept the price volatility of bonds with longer maturities
- want to diversify your investments
- are seeking an income mutual fund for an asset allocation program
OR
- are retired or nearing retirement
YOU MAY NOT WANT TO INVEST IN THE BOND FUND IF YOU:
- are investing for maximum return over a long time horizon
- want the greater growth potential of an investment in equity securities
OR
- require stability of your principal
--------------------------------------------------------------------------------
RISKS
WHAT ARE THE MAIN RISKS OF INVESTING IN THIS FUND?
[EDGAR REPRESENTATION OF THE PRINTED GRAPHIC]
<TABLE>
<CAPTION>
Lower Moderate Higher
-------------------------------------------------------
RISK
-------------------------------------------------------
<S> <C> <C> <C>
Money Bond Balanced Stock
Market Funds Funds Funds
Funds
Bond Fund
</TABLE>
-16-
<PAGE>
- RISKS ASSOCIATED WITH INVESTING IN BONDS. The Fund invests primarily in
investment grade bonds. An investment in the Fund is subject to risks
associated with investing in bonds, which include:
- INTEREST RATE RISK. The risks that the bonds the Fund holds may
decline in value due to an increase in interest rates. Another risk
associated with interest rate changes is call risk. Call risk is the
risk that during periods of falling interest rates, a bond issuer
will "call" or repay a higher yielding bond before the maturity date
of the bond. Under these circumstances, the Fund may have to reinvest
the proceeds in an investment that provides a lower yield than the
called bond.
- PREPAYMENT RISK. The risk that homeowners or consumers may repay
mortgage or consumer loans, which may effect the yield of mortgage-
or asset-backed securities that are backed by such loans.
- CREDIT RISK. The risk that a bond issuer fails to make principal or
interest payments when due to the Fund, or that the credit quality of
the issuer falls.
- MANAGEMENT RISK. The Manager's assessment of the bonds held in the Fund may
prove incorrect, resulting in losses of our poor performance, even in a
rising market.
- LIQUIDITY RISK. The Manager may have difficulty selling securities the Fund
holds at the time it would like to sell, and at the value the Fund has
placed on those securities.
AN INVESTMENT IN THE BOND FUND IS NOT A DEPOSIT IN ANY BANK OR OTHER
INSURED DEPOSITORY INSTITUTION AND IS NOT INSURED OR GUARANTEED BY THE
FDIC OR ANY OTHER GOVERNMENT AGENCY. YOU CAN LOSE MONEY BY INVESTING IN
THE FUND.
-17-
<PAGE>
STATE FARM TAX ADVANTAGED BOND FUND
INVESTMENT OBJECTIVE - The State Farm Tax Advantaged Bond Fund (the "Tax
Advantaged Bond Fund") seeks as high a rate of income exempt from federal income
taxes as is consistent with prudent investment management.
PRINCIPAL INVESTMENT STRATEGIES
HOW DOES THIS FUND PURSUE ITS INVESTMENT OBJECTIVE?
The Tax Advantaged Bond Fund normally invests so that either (1) 80% or more of
the Fund's net investment income is exempt from regular federal income tax or
(2) 80% or more of the Fund's net assets is invested in securities that produce
income exempt from regular federal income tax.
The Tax Advantaged Bond Fund invests primarily in a diversified selection of
municipal bonds (for example, general obligation bonds of a state or bonds
financing a specific project). Dividends from the Fund largely will be exempt
from federal income tax, but a portion of those dividends may be subject to
alternative minimum tax. The Fund may hold bonds with maturities of one to
thirty years, although a majority of the Fund's investments are in bonds with
maturities longer than five years.
--------------------------------------------------------------------------------
INVESTOR PROFILE
Who should consider investing in the Tax Advantaged Bond Fund?
YOU MAY WANT TO INVEST IN THE TAX ADVANTAGED BOND FUND IF YOU WANT:
- regular tax-free dividends
OR
- to reduce taxes on your investment income
YOU MAY NOT WANT TO INVEST IN THE TAX ADVANTAGED BOND FUND IF YOU:
- are seeking long term capital growth
- want the greater growth potential of an investment in equity securities
- require stability of your principal
OR
- if you are investing through an IRA, 401(k) plan or some other kind of
tax-deferred account.
--------------------------------------------------------------------------------
The Fund normally invests at least 80% of its total assets in municipal bonds
within the highest four rating categories of Moody's or S&P, meaning that the
Fund may invest up to 20% of the Fund's total assets in medium and lower-quality
bonds.
The Fund tends to hold most municipal bonds until they mature or are called. The
Fund may sell a bond when the proportion of bonds with longer maturities is
reduced in anticipation of a bond market decline (a result of rising interest
rates), or increased in anticipation of a bond market rise (resulting from a
decline in interest rates), or to meet cash flow needs. The Manager may also
sell a bond if its credit risk increases significantly or if market conditions
have changed so that more attractive investment opportunities are available.
RISKS
WHAT ARE THE MAIN RISKS OF INVESTING IN THE TAX ADVANTAGED BOND FUND?
EDGAR REPRESENTATION OF THE PRINTED GRAPHIC
<TABLE>
<CAPTION>
Lower Moderate Higher
-------------------------------------------------------
RISK
-------------------------------------------------------
<S> <C> <C> <C>
Money Bond Balanced Stock
Market Funds Funds Funds
Funds
Tax-Advantaged
Bond Fund
</TABLE>
-18-
<PAGE>
- RISKS ASSOCIATED WITH INVESTING IN BONDS. The Fund usually invests
exclusively in municipal bonds. The risks associated with municipal bond
investments include:
- INTEREST RATE RISK. The risk that the municipal bonds the Fund holds
may decline in market value due to an increase in interest rates.
Another risk associated with interest rate changes is call risk. Call
risk is the risk that during periods of falling interest rates, a
bond issuer will "call" or repay a higher yielding bond before the
maturity date of the bond. Under these circumstances, the Fund may
have to reinvest the proceeds in an investment that provides a lower
yield than the called bond.
- INCOME RISK. The risk that the income from the bonds the Fund holds
will decline in value due to falling interest rates.
- CREDIT RISK. The risk that the issuer of the municipal bond fails to
make principal or interest payments when due to the Fund, or that
the credit quality of the issuer falls.
- MANAGEMENT RISK. The Manager's assessment of the municipal bonds held in
the Fund may prove incorrect, resulting in losses or poor performance, even
in a rising market.
- LIQUIDITY RISK. The Manager may have difficulty selling securities the Fund
holds at the time it would like to sell, and at the value the Fund has
placed on those securities.
- MUNICIPAL BOND RISK. Municipal securities can be significantly affected by
political changes as well as uncertainties related to taxation, legislative
changes or the rights of municipal security holders. Because many municipal
securities are issued to finance similar projects (for example, education,
healthcare or transportation), conditions in those sectors can affect the
overall municipal market.
AN INVESTMENT IN THE TAX ADVANTAGED BOND FUND IS NOT A DEPOSIT OF ANY
BANK OR OTHER INSURED DEPOSITORY INSTITUTION AND IS NOT INSURED OR
GUARANTEED BY THE FDIC OR ANY OTHER GOVERNMENT AGENCY. YOU CAN LOSE
MONEY BY INVESTING IN THE FUND.
-19-
<PAGE>
STATE FARM MONEY MARKET FUND
INVESTMENT OBJECTIVE -- The State Farm Money Market Fund (the "Money Market
Fund") seeks to maximize current income to the extent consistent with the
preservation of capital and maintenance of liquidity.
PRINCIPAL INVESTMENT STRATEGIES
HOW DOES THIS FUND PURSUE ITS INVESTMENT OBJECTIVE?
Unlike the other Funds, the Money Market Fund seeks to maintain a stable net
asset value of $1.00 per share. The Fund invests exclusively in short-term, U.S.
dollar-denominated money market securities, including those issued by U.S. and
foreign financial institutions, corporate issuers, the U.S. Government and its
agencies and instrumentalities, municipalities, foreign governments, and
multi-national organizations, such as the World Bank.
RISKS
WHAT ARE THE MAIN RISKS OF INVESTING IN THE MONEY MARKET FUND?
EDGAR REPRESENTATION OF THE PRINTED GRAPHIC
<TABLE>
<CAPTION>
Lower Moderate Higher
-------------------------------------------------------
RISK
-------------------------------------------------------
<S> <C> <C> <C>
Money Bond Balanced Stock
Market Funds Funds Funds
Funds
Money Market
Fund
</TABLE>
--------------------------------------------------------------------------------
INVESTOR PROFILE
Who should consider investing in the Money Market Fund?
YOU MAY WANT TO INVEST IN THE MONEY MARKET FUND IF YOU:
- require stability of principal
- are seeking an investment for the cash portion of an asset allocation
program
- are looking for an investment with a lower degree of risk during uncertain
economic times or periods of stock market volatility
OR
- consider yourself a saver rather than an investor
YOU MAY NOT WANT TO INVEST IN THE MONEY MARKET FUND IF YOU:
- are seeking an investment that is likely to significantly outpace inflation
- are investing for retirement or other longer term goals
OR
- are investing for growth or maximum current income
--------------------------------------------------------------------------------
Because of the types of securities that the Money Market Fund invests in and
their short-term nature, the level of risk associated with the Money Market Fund
is lower than most other types of mutual funds. However, an investment in the
Fund involves the following risks:
- INTEREST RATE RISK - As with any investment whose yield reflects current
interest rates, the Fund's yield will change over time. The value of the
securities the Fund holds may decline in value due to an increase in
interest rates.
- INCOME RISK - The risk that the income from the securities the Fund holds
will decline in value due to falling interest rates.
- CREDIT RISK - The risk that an issuer, or a party to a repurchase agreement
that the Fund has entered into, defaults on its obligations.
- INFLATION RISK - The risk that the value of the assets or income from an
investment will be worth less in the future as inflation decreases the
value of money.
-20-
<PAGE>
- MANAGEMENT RISK. The Manager's assessment of investments held in the Fund
may prove incorrect, resulting in losses or poor performance, even in a
rising market.
AN INVESTMENT IN THE MONEY MARKET FUND IS NOT A DEPOSIT OF ANY BANK OR
OTHER INSURED DEPOSITORY INSTITUTION AND IS NOT INSURED OR GUARANTEED
BY THE FDIC OR ANY OTHER GOVERNMENT AGENCY. ALTHOUGH THE MONEY MARKET
FUND SEEKS TO PRESERVE THE VALUE OF YOUR INVESTMENT BY MAINTAINING A
STABLE NET ASSET VALUE OF $1.00 PER SHARE, THE FUND MAY NOT SUCCEED AND
YOU MAY STILL LOSE MONEY BY INVESTING IN THE FUND.
-21-
<PAGE>
ANNUAL INVESTMENT RETURNS
--------------------------------------------------------------------------------
After the Funds have been in operation for a full calendar year, the Funds will
provide performance information to investors to assist them in understanding
that the Funds' returns may vary and that there are possible risks associated
with investing in the Funds. However, past performance will not necessarily
indicate how the Funds will perform in the future.
EXPENSE INFORMATION
--------------------------------------------------------------------------------
The following tables describe the fees and expenses you would pay if you buy and
hold Institutional shares of the Funds.
<TABLE>
<CAPTION>
SHAREHOLDER TRANSACTION EXPENSES - FOR ALL FUNDS.
(FEES PAID DIRECTLY FROM YOUR INVESTMENT)
<S> <C>
Maximum sales charge (load) imposed on purchases None
Maximum deferred sales charge (load) None
Maximum sales charge (load) imposed on
Reinvested dividends None
Redemption Fee None
Exchange Fee None
Maximum Account Fee(1) None
</TABLE>
-22-
<PAGE>
(1) If an account balance falls below $500 on the last day of any quarter, the
account may be charged a low balance account fee of $2.50.
ESTIMATED FUND ANNUAL OPERATING EXPENSES
(AS A PERCENTAGE OF AVERAGE NET ASSETS)
<TABLE>
<CAPTION>
--------------------------------------------------------------------------------------------------------------------------
SMALL CAP EQUITY INTERNATIONAL
EQUITY FUND FUND EQUITY FUND
--------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Management fees 0.60% 0.80% 0.80%
Shareholder Servicing Fee None None None
12b-1 Distribution Fee None None None
Other expenses(1) 0.16% 0.14% 0.29%
Total Annual Fund Operating Expenses(2) 0.76% 0.94% 1.09%
--------------------------------------------------------------------------------------------------------------------------
<CAPTION>
--------------------------------------------------------------------------------------------------------------------------
S&P 500 INDEX FUND(3) SMALL CAP INTERNATIONAL INDEX
INDEX FUND(3) FUND(3)
--------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Management fees 0.20% 0.33% 0.40%
Shareholder Servicing Fee None None None
12b-1 Distribution Fee None None None
Other expenses(1) 0.23% 0.33% 0.45%
Total Annual Fund Operating Expenses(2) 0.43% 0.66% 0.85%
--------------------------------------------------------------------------------------------------------------------------
<CAPTION>
--------------------------------------------------------------------------------------------------------------------------
EQUITY AND BOND FUND(4) BOND FUND TAX ADVANTAGED BOND
FUND
--------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Management fees 0.40% 0.10% 0.10%
Shareholder Servicing Fee None None None
12b-1 Distribution Fee None None None
Other expenses(1) 0.29% 0.13% 0.21%
Total Annual Fund Operating Expenses(2) 0.69% 0.23% 0.31%
--------------------------------------------------------------------------------------------------------------------------
<CAPTION>
-------------------------------------------------------------------------------
MONEY MARKET FUND
-------------------------------------------------------------------------------
<S> <C>
Management fees 0.10%
Shareholder Servicing Fee None
12b-1 Distribution Fees None
Other expenses(1) 0.14%
Total Annual Fund Operating Expenses(2) 0.24%
-------------------------------------------------------------------------------
</TABLE>
-----------------------------------
(1) Based on estimated amounts for the current fiscal year.
(2) The Manager has agreed to reimburse each Fund if, and to the extent, the
Fund's total annual operating expenses exceed the following percentage of
each Fund's average net assets:
-23-
<PAGE>
<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
FUND EXPENSE REIMBURSEMENT THRESHOLD
--------------------------------------------------------------------------------
<S> <C>
Equity Fund 0.70%
Small Cap Equity Fund 0.90%
International Equity Fund 1.00%
S&P 500 Index Fund 0.30%
Small Cap Index Fund 0.45%
International Index Fund 0.65%
Equity and Bond Fund None
Bond Fund 0.20%
Tax Advantaged Bond Fund 0.20%
Money Market Fund 0.20%
--------------------------------------------------------------------------------
</TABLE>
This reimbursement arrangement is voluntary and may be eliminated by the
Manager at any time.
(3) For the S&P 500 Index Fund, Small Cap Index Fund and International Index
Fund (the "Equity Index Funds"), total annual operating expenses include
the Fund's and the Master Portfolio's expenses.
(4) The Manager has agreed not to be paid an investment advisory and
management services fee for performing services for the Equity and Bond
Fund. However, the Manager and State Farm VP Management Corp., the
distributor of the Funds, will receive fees for performing services for
the underlying funds in which the Equity Fund and Bond Fund invests. The
management fee, shareholder servicing fee and 12b-1 fee indicated in the
expense table is based on the fees that the Equity Fund and Bond Fund pay
to the Manager and State Farm VP Management Corp. The Manager has agreed
to reimburse the Equity and Bond Fund for other expenses incurred. This
expense limitation is voluntary and the Manager may eliminate it at any
time.
EXPENSE EXAMPLE
This example is intended to help you compare the cost of investing in a Fund
with the cost of investing in other mutual funds. The example assumes you invest
$10,000 for the time periods indicated, earn a 5% return each year, redeem your
shares at the end of the period and that operating expenses remain constant at
the level above for "Total Annual Fund Operating Expenses." Your actual returns
and costs may be higher or lower than those shown, but based on these
assumptions, your expenses will be:
-24-
<PAGE>
<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
FUND 1 YEAR 3 YEARS
--------------------------------------------------------------------------------
<S> <C> <C>
Equity Fund $78 $243
Small Cap Equity Fund $96 $300
International Equity Fund $111 $347
S&P 500 Index Fund $44 $138
Small Cap Index Fund $67 $211
International Index Fund $87 $271
Equity and Bond Fund $70 $221
Bond Fund $24 $74
Tax Advantaged Bond Fund $32 $100
Money Market Fund $25 $77
--------------------------------------------------------------------------------
</TABLE>
HOW THE FUNDS INVEST
--------------------------------------------------------------------------------
GENERAL POLICIES APPLICABLE TO ALL FUNDS
Under ordinary circumstances, each Fund is substantially fully invested. Except
for the S&P 500 Index Fund, Small Cap Index Fund and the International Index
Fund (collectively, the "Equity Index Funds"), and the Money Market Fund, each
Fund may take a temporary defensive position in attempting to respond to adverse
market, economic, political or other conditions. If the Manager or Capital
Guardian determine that market or economic conditions warrant a temporary
defensive position, the Funds each manage may hold up to 100% of their assets in
cash, cash equivalents or other temporary investments such as short-term
government or corporate obligations. During those periods, a Fund's assets may
not be invested in accordance with its strategy and the Fund may not achieve its
investment objective.
Each Fund may also:
- Lend securities to financial institutions, enter into repurchase
agreements and purchase securities on a when-issued or forward
commitment basis; and
- Invest in U.S. dollar-denominated foreign money market
securities, although no more than 25% of a Fund's assets may be
invested in foreign money market securities unless such
securities are backed by a U.S. parent financial institution.
Except for the Equity Index Funds, each Fund may, from time to time, borrow
money in amounts up to 33 1/3% of its total assets (including the amount
borrowed) for temporary purposes to pay for redemptions. A Fund may not purchase
additional securities when borrowings exceed 5% of its total assets (including
the amount borrowed).
FUND SUMMARIES
Each Fund has its own investment objective. The Trust's Board may change these
investment objectives without a vote of the Trust's shareholders. The types of
securities and investment techniques and practices in which each Fund may engage
to achieve its objective, including the principal investment techniques and
practices described for each Fund as described below, are identified in Appendix
A to this Prospectus, and are discussed, together with their risks, in the
Trust's Statement of Additional Information.
EQUITY FUND
In managing the Equity Fund, the Manager seeks to purchase the common
stocks of large U.S. companies that the Manager considers well run and able to
generate long term capital appreciation. Common stocks, in general,
-25-
<PAGE>
offer a way to invest for long-term growth of capital. The Manager looks for
companies with one or more of the following characteristics:
- Strong cash flows and a recurring revenue stream.
- A strong industry position.
- A strong financial position.
- Strong management with a clearly defined strategy.
- Capability to develop new or superior products or services.
The Fund may invest up to 25% of its assets in foreign equity
securities not publicly traded in the U.S. and depositary receipts (both
sponsored and unsponsored). Foreign investing provides opportunities different
from those available in the U.S. and risks that in some ways may be greater than
in U.S. investments.
SMALL CAP EQUITY FUND
The Small Cap Equity Fund invests its assets primarily in equity
securities of companies with relatively small market capitalizations located in
the U.S. These companies typically will have market capitalizations of $50
million to $1.5 billion at the time the Fund purchases these securities. The
basic investment philosophy of Capital Guardian is to seek undervalued
securities that represent good long-term investment opportunities. Capital
Guardian generally will sell securities when it believes they no longer
represent good long-term value. The Fund may invest up to 25% of its assets in
the equity securities of foreign companies with relatively small market
capitalizations and depositary receipts (both sponsored and unsponsored).
INTERNATIONAL EQUITY FUND
The International Equity Fund invests its assets primarily in common
stocks of companies located in 15 European countries (Austria, Belgium, Denmark,
Finland, France, Germany, Ireland, Italy, the Netherlands, Norway, Portugal,
Spain, Sweden, Switzerland and the United Kingdom), Australia, New Zealand, Hong
Kong, Japan and Singapore. The Fund may also invest in companies located in
emerging markets. The basic investment philosophy of Capital Guardian is to seek
undervalued securities that represent good long-term investment opportunities.
Capital Guardian generally will sell securities when it believes they no longer
represent good long-term value. Foreign investing provides opportunities
different from those available in the U.S. and risks, which in some ways may be
greater than in U.S. investments.
The Fund may also buy and sell foreign currencies (either for current
or future delivery) to facilitate settlements in local markets and to hedge
against currency fluctuations.
S&P 500 INDEX FUND, SMALL CAP INDEX FUND AND INTERNATIONAL INDEX FUND
Each Equity Index Fund invests all of its assets in a separate series
of the Master Fund. Each Master Portfolio has substantially similar investment
objectives, strategies, and policies as the corresponding individual Equity
Index Fund. Barclays serves as investment adviser to each Master Portfolio. The
Master Portfolios may accept investments from other feeder funds. Certain
actions involving other feeder funds, such as a substantial withdrawal, could
affect the Master Portfolio. Barclays and its affiliates invest for their own
accounts in the types of securities in which a Master Portfolio may also invest.
Each Master Portfolio invests mostly in stocks, although each may also
invest in stock index futures contracts and options on futures contracts. By
investing in stocks within its benchmark index, each Master Portfolio avoids the
risks of individual stock selection and, instead, tries to match the performance
of its respective benchmark index, whether that index goes up or down.
-26-
<PAGE>
Each Master Portfolio attempts to remain as fully invested as
practicable in the stocks that are represented in its benchmark index. Under
normal operating conditions, a Master Portfolio seeks to invest at least 90% of
its total assets in stocks that are represented in its benchmark index.
Barclays does not manage the Master Portfolios according to traditional
methods of "active" investment management, which involves the buying and selling
of securities based on economic, financial and market analysis and investment
judgment. Instead, Barclays utilizes a "passive" or indexing investment approach
for each Master Portfolio, attempting to approximate the investment performance
of the appropriate benchmark index. Barclays selects stocks for each Master
Portfolio so that the overall investment characteristics of each Master
Portfolio (based on market capitalization and industry weightings), fundamental
characteristics (such as return variability, earnings valuation and yield) and
liquidity measures are similar to those of its respective benchmark index.
Each Master Portfolio may invest any assets not invested in stocks that
are represented in its benchmark index in:
- the same type of short-term high quality debt securities in which
the Money Market Fund invests (described below);
- other equity securities that are similar to the stocks making up
its benchmark index or that are awaiting disposition after a
change in composition of the benchmark index or a rebalancing of
the portfolio;
- stock index futures contracts, options on such futures contracts;
and/or
- cash.
Each Master Portfolio may invest in those financial instruments to find a
short-term investment for uninvested cash balances or to provide liquid assets
for anticipated redemptions by shareholders.
The International Index Master Portfolio may also buy and sell foreign
currencies (either for current or future delivery) to facilitate settlements in
local markets, in connection with stock index futures positions, and to protect
against currency exposure in connection with its distributions to shareholders,
but may not enter into such contracts for speculative purposes or to avoid the
effects of anticipated adverse changes in exchange rates between foreign
currencies and the U.S. dollar. The International Index Master Portfolio's
currency transactions might not achieve their hedging purpose and the Fund could
lose money on these transactions.
The S&P 500 Index Master Portfolio invests in all of the securities that
make up the S&P 500 Index. However, neither the Russell 2000 Index Master
Portfolio nor the International Index Master Portfolio generally hold all of the
issues that comprise their respective benchmark index, due in part to the costs
involved and, in certain instances, the potential illiquidity of certain
securities. Instead, both the Russell 2000 Index Master Portfolio and the
International Index Master Portfolio attempt to hold a representative sample of
the securities in the appropriate benchmark index, which Barclays will select
utilizing certain sampling and modeling techniques. These sampling and modeling
techniques may not be successful. As a result of these sampling and modeling
techniques, the Master Portfolios and the Equity Index Funds may not have the
identical capitalization, industry and fundamental characteristics as their
benchmarks. Please refer to the Trust's Statement of Additional Information for
a more detailed discussion of the techniques that Barclays employs in selecting
the portfolio securities for each of these Master Portfolios.
From time to time, the portfolio composition of the Master Portfolios may
be altered (or "rebalanced") to reflect changes in the characteristics of its
benchmark index or, for the Russell 2000 Index Master Portfolio or International
Index Master Portfolio, with a view to bringing the performance and
characteristics of each Master Portfolio more closely in line with that of its
benchmark index.
Barclays attempts to track the performance of each Master Portfolio's
benchmark index, but there is no assurance that Barclays will be successful. The
degree to which a Master Portfolio fails to track the performance of
-27-
<PAGE>
its benchmark index is referred to as the "tracking error." Barclays expects
that, over time, the tracking error of each Master Portfolio will be less than
5%. Barclays monitors the tracking error of each Master Portfolio on an ongoing
basis and seeks to minimize tracking error to the extent possible. There can be
no assurance that a Master Portfolio will achieve any particular level of
tracking error. For an explanation of "expected tracking error" and more
information on this subject, see the Trust's Statement of Additional
Information.
Another reason why the performance of the Master Portfolios (and the
Equity Index Funds) may not always equal the performance of their benchmark
index is because the performance of each benchmark index does not take into
account management fees or the other expenses that each Master Portfolio and
each Equity Index Fund incurs.
Each Master Portfolio may purchase stock index futures contracts on its
benchmark index or a comparable stock index to simulate investment in its
benchmark index. This may be done to rapidly gain exposure to the securities
comprising its benchmark index in anticipation of purchasing such securities
over time, to reduce transaction costs, or to gain exposure to such securities
at a lower cost than by making direct investments in the cash market. If a
Master Portfolio cannot sell a futures contract that it holds, it may write call
and buy put options on the contract to effectively close out or offset the
contract. No Master Portfolio will use futures contracts or options on futures
contracts for speculation.
EQUITY AND BOND FUND
The Equity and Bond Fund invests in shares of the Equity Fund and the
Bond Fund. The Equity and Bond Fund may hold a portion of its assets in U.S.
Government securities, short-term paper, or may invest in the Money Market Fund
or another money market mutual fund to provide flexibility in meeting
redemptions, expenses, and the timing of new investments, and to serve as a
short-term defense during periods of unusual volatility.
BOND FUND
The Bond Fund invests primarily in investment grade bonds (e.g., those
bonds that S&P or Moody's have rated within their respective four highest rating
categories), and in the same types of securities as the Money Market Fund. Under
normal circumstances, at least 80% of the Fund's total assets will be invested
in investment grade bonds or unrated debt securities that the Manager determines
to be of equivalent quality. The Bond Fund may also invest in investment grade
mortgage-backed and asset-backed securities, including those representing pools
of mortgage, commercial or consumer loans originated by financial institutions.
The Bond Fund emphasizes investment grade bonds and usually maintains a
duration target of less than 7 years based on expectations about the direction
of interest rates and other economic factors. Duration is a measure of
sensitivity of bond prices to interest rate movements. The longer the duration
of a debt obligation, the more sensitive its value is to changes in interest
rates.
In selecting bonds for the Fund, the Manager seeks to maximize current
income while minimizing risk and volatility through prudent investment
management. Accordingly, the Fund seeks to limit its exposure to very risky or
speculative investments by investing primarily in investment grade bonds that
offer the potential for attractive returns.
The Fund may also invest up to 20% of its assets in the following
securities:
- Debt securities that S&P or Moody's have rated lower than the
four highest rating categories or comparable unrated debt
securities. Bonds that are rated lower than BBB by S&P or Baa by
Moody's are often referred to as "junk bonds." Rating agencies
consider junk bonds to have varying degrees of speculative
characteristics. Consequently, although they can be expected
to provide higher yields, such securities may be subject to
greater market value fluctuations and greater risk of loss of
income and principal than lower-yielding, higher-rated
fixed-income securities. For more information, see "Description
of Bond Ratings" in the Statement of Additional Information.
-28-
<PAGE>
- Convertible debt securities, convertible preferred stocks and
nonconvertible preferred stocks. Convertible securities are fixed
income securities that are convertible into common stock at a
specified price or conversion ratio. Convertible securities will
at times be priced in the market like other fixed income
securities: that is, their prices will tend to rise when interest
rates decline and will tend to fall when interest rates rise.
However, because a convertible security provides an option to the
holder to exchange the security for either a specified number of
the issuer's common shares at a stated price per share or the cash
value of such common shares, the security market price will tend
to fluctuate in relationship to the price of the common shares
into which it is convertible. Because convertible securities are
usually viewed by the issuer as future common stock, they are
generally subordinated to other senior securities and therefore
are rated one category lower than the issuer's non-convertible
debt obligations or preferred stock.
- Bond futures contracts, options, credit swaps, interest rate
swaps, and other types of derivatives. Losses (or gains) involving
futures contracts can sometimes be substantial - in part because a
relatively small price movement in a futures contact may result in
an immediate and substantial loss (or gain) for the Fund. Similar
risks exist for other types of derivatives. For this reason, the
Fund will not use futures, options, or other derivatives for
speculative purposes or as leveraged investments that magnify the
gains or losses of an investment. The Fund will invest in futures
and options to (i) keep cash on hand to meet shareholder
redemptions or other needs, while simulating full investment in
bonds and/or (ii) reduce the Fund's transaction costs, for
hedging purposes or to add value when these instruments are
favorably priced.
TAX ADVANTAGED BOND FUND
Tax Advantaged Bond Fund invests primarily in a diversified selection
of municipal bonds. Municipal bonds generally are designed to meet longer-term
capital needs and have maturities of more than one year when issued. States,
territories, local governments and municipalities issue municipal bonds to raise
money for various purposes (for example, to pay for a road construction project,
or to build an airport). The interest on a municipal bond is generally exempt
from federal income tax, but may be subject to the federal alternative minimum
tax and state income taxes.
The two principal classifications of municipal bonds are "general
obligation" and "revenue" bonds. General obligation bonds are secured by the
issuer's pledge of its faith, credit, and taxing powers for the payment of
principal and interest. The taxes that can be levied for the payment of debt
service may be limited or unlimited as to the rate or amount of special
assessments. In many cases, voter approval is required before an issuer may sell
this type of bond. Revenue bonds are usually payable only from the revenues
derived from a particular facility or class of facilities or, in some cases,
from the proceeds of a special excise tax or other special revenue source.
Although the principal security behind these bonds may vary, many (but not all
issuers) provide further security in the form of a mortgage or debt service
reserve fund. Some authorities provide further security in the form of the
state's ability (without obligation) to make up deficiencies in the debt service
reserve fund.
Under current tax law, all municipal debt is divided into two groups:
government purpose bonds (discussed above) and private activity bonds. Private
activity bonds are bonds that are issued by a state or local government or
public authority, but principally benefit private users and generally are
considered taxable unless a specific exemption is provided. Some, but not all,
private activity bonds are subject to alternative minimum tax.
The Fund normally invests so that either (1) at least 80% of the Fund's
net investment income is exempt from regular federal income tax or (2) at least
80% of the Fund's net assets are invested in securities that produce income
exempt from regular federal income tax.
The Fund tends to hold its municipal bonds until they mature or are
called. The Fund may sell a bond when the proportion of bonds with longer
maturities is reduced in anticipation of a bond market decline (a result of
rising interest rates) or increased in anticipation of a bond market rise
(resulting from a decline in interest rates). The Fund may sell a bond if its
credit risk increases significantly.
-29-
<PAGE>
Under ordinary circumstances at least 80% of the Fund's total assets
will consist of investment grade municipal bonds (e.g., municipal bonds rated
within the four highest rating categories of Moody's or S&P), and money market
securities and cash. Up to 20% of the Fund's total assets may be invested in
municipal bonds that are unrated or rated below investment grade by Moody's or
by S&P.
Lower-rated municipal bonds and fixed income securities generally carry
a greater degree of risk than higher-rated municipal bonds. Bonds rated below
BBB by S&P and below Baa by Moody's have speculative characteristics, and are
commonly referred to as "junk bonds" and present a higher degree of credit risk.
In addition, the Fund may purchase municipal bonds that represent lease
obligations. These carry special risks because the issuer of the bonds may not
be obligated to appropriate money annually to make payments under the lease. To
reduce this risk, the Fund will only purchase these bonds if the Manager
believes the issuer has a strong incentive to continue making appropriations
until maturity.
The Fund may invest in bond (interest rate) futures and options
contracts and other types of derivatives. Losses (or gains) involving futures
can sometimes be substantial - in part because relatively small price movement
in a futures contract may result in an immediate and substantial loss (or gain)
for the Fund. The Fund will not use futures for speculative purposes or as
leveraged investments that magnify the gains or losses of an investment. The
Fund's obligation to purchase securities under futures contracts will not exceed
20% of its total assets. The reasons for which the Fund may use futures and
options are to: (i) keep cash on hand to meet shareholder redemptions or other
needs, while simulating full investment in bonds and/or (ii) reduce the Fund's
transaction costs or add value when these instruments are favorably priced.
The Fund invests primarily in a diversified selection of municipal
bonds with maturities of one to thirty years. A majority of the Fund's
investments are in issues with maturities longer than five years.
The Fund will hold assets not invested in municipal bonds in (i)
interest-bearing demand notes, (ii) bank savings accounts, (iii) high-grade
money market securities (iv) U.S. Treasury securities or (v) securities of
taxable or tax-exempt money market mutual funds. To the extent the Manager
invests the Fund's asset in securities of money market mutual funds, you will
pay fund operating expenses at both the Fund level and at the money market
mutual fund level.
The Fund may also invest in variable rate securities, such as inverse
floaters, whose rates vary inversely with changes in market rates of interest.
Investments in such securities involve special risks as compared to a fixed rate
municipal security. The extent of increases and decreases in the value of such
securities and the corresponding change to the net asset value of the Fund
generally will be larger than comparable changes in value of an equal principal
amount of a fixed rate municipal security having similar credit quality,
redemption provisions and maturity.
MONEY MARKET FUND
In selecting securities for the Money Market Fund, the Manager seeks
highly liquid investments that present minimal credit risk. The Fund primarily
invests in high quality short-term money market instruments. At least 95% of the
Fund's assets must be rated in the highest short-term category by at least two
nationally recognized statistical rating organizations ("NRSROs") (or one NRSRO,
if only one has issued a rating), and 100% of the Fund's assets must be invested
in securities rated in the two highest rating categories.
The Fund may invest in securities that are not rated by an NRSRO if the
Manager determines that such securities are of comparable quality to, and
present a comparable amount of risk as, similar securities that have received a
rating from an NRSRO.
--------------------------------------------------------------------------------
WHAT IS A NATIONALLY RECOGNIZED STATISTICAL RATING ORGANIZATION (NRSRO)?
An NRSRO, such as Moody's or S&P, assigns ratings to securities based on its
assessment of the creditworthiness of the issuers. The Statement of Additional
Information has a detailed description of the various rating categories.
--------------------------------------------------------------------------------
Among the securities that the Money Market Fund may invest in are the
following:
-30-
<PAGE>
- Securities issued or guaranteed by the U.S. Government or its agencies,
including Treasury Bills, notes, and securities issued by U.S. government
agencies such as the Federal National Mortgage Association.
- Commercial paper issued or guaranteed by U.S. corporations and certain
other entities that are rated in the two highest rating categories of a
NRSRO.
- Repurchase agreements with certain parties.
- Certain obligations of large (more than $1 billion in total assets) U.S.
banks and their subsidiaries (including, certain Canadian affiliates),
including, but not limited to, bank notes, commercial paper, and
certificates of deposit.
- Other short-term obligations issued by or guaranteed by U.S. corporations,
state and municipal governments, or other entities.
- Securities backed by mortgages, consumer loans and other assets.
Given the types of securities that the Fund invests in, the level of
risk associated with the Fund is lower than most other types of mutual funds.
However every investment involves some kind of risk. To the extent that the Fund
invests in certain securities (for example, repurchase agreements, when-issued
securities or foreign money market securities), the Fund may be affected by
additional risks.
OTHER RISKS OF INVESTING IN THE FUNDS
FOREIGN SECURITIES
Investments in foreign securities, including those of foreign governments,
involve additional risks not normally present when investing in comparable
domestic securities.
Some securities of foreign companies and governments may be traded in the U.S.,
such as American Depository Receipts ("ADRs"), but most are traded primarily in
foreign markets. The risks of investing in foreign securities include:
CURRENCY RISK. For securities that are based in value on foreign currencies
(including ADRs), a Fund must buy the local currency to buy a foreign security
and sell the same local currency after it sells the security. Therefore, the
value of that security to a Fund is affected by the value of the local currency
relative to the U.S. currency. As a result, if the value of the local currency
falls relative to U.S. currency, the value of that security falls, even if the
security has not decreased in value in its home country.
POLITICAL AND ECONOMIC RISK. Foreign investments can be subject to greater
political and economic risks. In some countries, there is the risk that the
government may take over assets or operations of the company or impose taxes or
place limits on the removal of assets that would adversely affect the value of
the security. The possibility of default in foreign government securities,
political or social instability or diplomatic developments generally are more of
a concern in developing countries, where the possibility of political
instability (including revolution) and dependence on foreign economic assistance
may be greater than in developed countries.
REGULATORY RISK. In many countries there is less publicly available information
about issuers than is available for companies in the U.S. Foreign companies may
not be subject to uniform accounting, auditing and financial reporting
standards, and auditing practices and requirements may not be comparable to
those applicable to the U.S. companies. In many foreign countries there is less
government supervision and regulation of business and industry practices, and it
may be more difficult to obtain or enforce judgments against foreign entities.
-31-
<PAGE>
MARKET RISKS. Foreign securities often trade with less frequency and volume than
domestic securities and are therefore less liquid and more volatile than
securities of comparable domestic issuers. Further, the settlement period of
securities transactions in foreign markets may be longer than in domestic
markets.
TRANSACTION COSTS. Commission rates in foreign countries, which are generally
fixed rather than subject to negotiation as in the U.S., are likely to be
higher. In addition, other costs, such as tax and custody costs, are generally
higher than for domestic transactions.
PARTICULAR RISKS FOR DEVELOPING COUNTRIES. In general, the risks noted above are
heightened for developing countries. In addition, certain developing countries
have experienced substantial, and in some cases, rapidly fluctuating rates of
inflation for a number of years. Inflation has, and may continue to have, a
debilitating effect on the underlying economies of these countries. Many
developing countries are heavily dependent on international trade and can be
adversely affected by trade barriers and protectionist measures, as well as the
depreciation or devaluation of their currencies.
HIGH YIELD/HIGH RISK SECURITIES (JUNK BONDS)
These securities tend to offer higher yields than higher-rated securities of
comparable maturities because the historical financial condition of the issuers
of these securities is usually not as strong as that of other issuers.
High yield fixed-income securities usually present greater risk of loss of
income and principal than higher-rated securities. For example, because
investors generally perceive that there are greater risks associated with
investing in medium- or lower-rated securities, the yields and price of such
securities may tend to fluctuate more than those of higher-rated securities.
Moreover, in the lower-quality segments of the fixed income securities market,
changes in perception of the creditworthiness of individual issuers tend to
occur more frequently and in a more pronounced manner than do changes in
higher-quality segments of the fixed-income securities market. The yield and
price of medium-to lower-rated securities therefore may experience greater
volatility than is the case with higher-rated securities.
Under adverse market or economic conditions, the secondary market for high
yield/high risk securities could contract further, independent of any specific
adverse changes in the condition of a particular issuer. As a result, the Funds
could find it more difficult to sell such securities or may be able to sell the
securities only at prices lower than if such securities were widely traded.
Prices realized upon the sale of such lower-rated securities therefore may be
less than the prices used in calculating the Fund's net asset value.
MANAGING THE INVESTMENTS OF THE FUNDS
--------------------------------------------------------------------------------
INVESTMENT ADVISER
State Farm Investment Management Corp. (the "Manager") serves as the
investment adviser to each Fund. Subject to the supervision of the Board of the
Trust, the Manager is responsible for overseeing the day to day operations and
business affairs of the Trust, including monitoring the performance of each
Master Portfolio. The Manager's principal office is located at Three State Farm
Plaza, Bloomington, Illinois 61791-0001. The Manager is wholly-owned by State
Farm Mutual Automobile Insurance Company. The Manager acts as investment adviser
to a variety of other registered investment companies, and, as of September 30,
2000, was responsible for the management of in excess of $5.3 billion in assets.
The Manager also provides all executive, administrative, clerical and
other personnel necessary to operate the Trust and pays the salaries and other
costs of employing all these persons. The Manager furnishes the Trust with
office space, facilities, and equipment and pays the day-to-day expenses related
to the operating and maintenance of
-32-
<PAGE>
such office space, facilities and equipment. Except for those expenses the
Manager expressly assumes, including those noted above, each Fund otherwise
pays for all of its own expenses.
The Equity Fund, Equity and Bond Fund, Bond Fund, Tax Advantaged Bond
Fund and the Money Market Fund are each managed by a team of the Manager's
employees (each an "Advisory Team"). Each Advisory Team makes the investment
decisions for these Funds, subject to the oversight of the Board of the Trust.
INVESTMENT MANAGEMENT OF THE EQUITY INDEX FUNDS
Each Equity Index Fund invests all of its assets in a Master Portfolio,
each of which has substantially similar investment objectives, strategies and
risks to the corresponding Equity Index Fund. Barclays is the investment adviser
to the Master Portfolios. Barclays and its predecessors have been managing index
mutual funds since 1973. Barclays is an indirect subsidiary of Barclays Bank PLC
and is located at 45 Fremont Street, San Francisco, California 94105. As of
March 31, 2000, Barclays and its affiliates provided investment advisory
services for over $825 billion of assets. For more information regarding
Barclays, please read the section entitled "Investment Advisory Agreements -
Between Barclays and the Master Portfolios" in the Trust's Statement of
Additional Information.
INVESTMENT SUB-ADVISER FOR THE SMALL CAP EQUITY FUND AND INTERNATIONAL
EQUITY FUND
The Manager has engaged Capital Guardian as the investment sub-adviser
to provide day-to-day portfolio management for the Small Cap Equity Fund and the
International Equity Fund. As of September 30, 2000, Capital Guardian provided
investment advisory services for over $124 billion of assets. Capital Guardian,
an experienced investment management organization founded in 1968, serves as
investment adviser to these funds and other funds. Capital Guardian, a wholly
owned subsidiary of The Capital Group Companies, Inc., is headquartered at 333
South Hope Street, Los Angeles, California 90071. For more information regarding
Capital Guardian, please read the section entitled "Investment Advisory
Agreements - Between the Manager and Capital Guardian" in the Trust's Statement
of Additional Information.
Capital Guardian manages the Small Cap Equity Fund and International
Equity Fund using a system of multiple portfolio managers for each Fund. Under
this approach, the portfolio of each Fund is divided into segments, each of
which is managed by an individual manager. Managers decide how their respective
segments will be invested, within the limits provided by a Fund's objective(s)
and policies and by Capital Guardian's investment committee. In addition,
Capital Guardian's research professionals may make investment decisions for a
portion of a Fund's portfolio. The investment decisions for the Small Cap Equity
Fund and the International Equity Fund are made by Capital Guardian, subject to
the oversight of the Board of the Trust.
COMPENSATING THE MANAGER FOR ITS SERVICES
Each Fund pays the Manager an investment advisory and management
services fee based upon that Fund's average daily net assets. The fee is accrued
daily and paid to the Manager quarterly at the following annual rates:
<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
FUND RATE OF
ADVISORY FEE
--------------------------------------------------------------------------------
<S> <C>
Equity Fund 0.60% of average daily net assets
--------------------------------------------------------------------------------
Small Cap Equity Fund 0.80% of average daily net assets
--------------------------------------------------------------------------------
International Equity Fund 0.80% of average daily net assets
--------------------------------------------------------------------------------
S&P 500 Index Fund 0.20% of average daily net assets
--------------------------------------------------------------------------------
Small Cap Index Fund 0.35% of average daily net assets
--------------------------------------------------------------------------------
International Index Fund 0.50% of average daily net assets
--------------------------------------------------------------------------------
Equity and Bond Fund None
</TABLE>
-33-
<PAGE>
<TABLE>
<S> <C>
--------------------------------------------------------------------------------
Bond Fund 0.10% of average daily net assets
--------------------------------------------------------------------------------
Tax Advantaged Bond Fund 0.10% of average daily net assets
--------------------------------------------------------------------------------
Money Market Fund 0.10% of average daily net assets
--------------------------------------------------------------------------------
</TABLE>
The Investment Advisory and Management Services Fee for the Equity
Index Funds include the operating expenses of their corresponding Master
Portfolio.
COMPENSATING CAPITAL GUARDIAN FOR ITS SERVICES
The Manager pays Capital Guardian for its services to the Funds it
manages at the rates shown in the table below:
<TABLE>
<CAPTION>
SMALL CAP EQUITY FUND:
<S> <C>
--------------------------------------------------------------------------------------------
On the first $25 million......................... 0.75% of average daily net assets
--------------------------------------------------------------------------------------------
$25 million to $50 million....................... 0.60% of average daily net assets
--------------------------------------------------------------------------------------------
$50 million to $100 million...................... 0.425% of average daily net assets
--------------------------------------------------------------------------------------------
Over $100 million................................ 0.375% of average daily net assets
--------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
INTERNATIONAL EQUITY FUND:
<S> <C>
--------------------------------------------------------------------------------------------
On the first $25 million......................... 0.75% of average daily net assets
--------------------------------------------------------------------------------------------
$25 million to $50 million....................... 0.60% of average daily net assets
--------------------------------------------------------------------------------------------
$50 million to $250 million...................... 0.425% of average daily net assets
--------------------------------------------------------------------------------------------
Over $250 million................................ 0.375% of average daily net assets
--------------------------------------------------------------------------------------------
</TABLE>
For purposes of calculating the fees under the above schedules, other assets
managed by Capital Guardian for companies associated with the Manager are taken
into consideration according to Capital Guardian's fee aggregation and discount
policies.
-34-
<PAGE>
EQUITY INDEX FUNDS - COMPENSATION IN THE MASTER/FEEDER MUTUAL FUND STRUCTURE
The Equity Index Funds are feeder funds that invest all of their assets in
Master Portfolios with substantially similar investment objectives, strategies
and risks. Barclays provides investment guidance and policy direction for each
Master Portfolio. For its services to the Master Portfolios, Barclays receives
annual fees based on the following annual rates:
<TABLE>
<CAPTION>
------------------------------------------------------------------------------------------------------------
FUND ANNUAL MANAGEMENT FEE
------------------------------------------------------------------------------------------------------------
<S> <C>
S&P 500 Index Master Portfolio 0.05% of average daily net assets
------------------------------------------------------------------------------------------------------------
Russell 2000 Index Master Portfolio 0.10% of the average daily net assets, which
includes a 0.02% administrative fee
------------------------------------------------------------------------------------------------------------
International Index Master Portfolio 0.25% of the average daily net assets, up to $1
billion, which includes a 0.10% administrative fee,
and 0.17% of the average daily net assets
thereafter, which includes a 0.07% administrative fee
------------------------------------------------------------------------------------------------------------
</TABLE>
Unlike many traditional actively managed investment funds, there is no single
portfolio manager who makes investment decisions for the Master Portfolios.
Instead, the Master Portfolios track their respective indexes.
FEEDER FUND EXPENSES. Each Equity Index Fund bears its corresponding Master
Portfolio's expenses in proportion to the amount of assets it invests in the
corresponding Master Portfolio. Each Equity Index Fund can set its own
transaction minimums, fund-specific expenses and conditions.
FEEDER FUND RIGHTS. Under the master/feeder structure, the Board of the Trust
retains the right to withdraw the assets of an Equity Index Fund from a Master
Portfolio if it believes doing so is in the best interests of the Equity Index
Fund and its shareholders. If the Board withdraws assets of any Equity Index
Fund, it would then consider whether that Fund should invest in another master
portfolio or take other action.
-35-
<PAGE>
SHAREHOLDER INFORMATION
--------------------------------------------------------------------------------
MINIMUM INVESTMENTS
Your initial investment in any Fund must be at least $250, and any
subsequent investment must be at least $50. The Funds may change the minimum
investment amounts.
CALCULATING NET ASSET VALUE
The offering price of the shares of each Fund is its Net Asset Value
(NAV). NAV is calculated by adding all of the assets of a Fund, subtracting the
Fund's liabilities, then dividing by the number of outstanding shares. A
separate NAV is calculated for each class of each Fund. We calculate the NAV of
the Equity Index Funds based on the NAVs of each corresponding Master Portfolio.
Each are calculated on the same day.
The NAV for each Fund is determined as of the time of the close of
regular session trading on the New York Stock Exchange ("NYSE") (currently at
4:00 p.m., Eastern Time), on each day when the NYSE is open for business. Shares
of the Funds will not be priced on days when the NYSE is closed. Each Fund
values its assets at their current market value when market quotations are
readily available. If a market value cannot be established, the Board of the
Trust values assets in accordance with procedures approved by the Board of
Trustees. Money market securities, other than U.S. Treasury securities, that
mature within 60 days or less are valued using the amortized cost method, unless
the Board of Trustees determines that this does not represent fair value.
All investments by the International Equity Fund and International
Index Fund are valued in U.S. dollars based on the then prevailing exchange
rate. Because each of these international funds invest in securities that are
listed on foreign exchanges that trade on days when the Fund does not price its
shares, the value of the foreign securities owned by these Funds may change on
days when you will not be able to purchase or redeem the shares. Specific
information about how the Funds value certain assets is set forth in the
Statement of Additional Information.
Investments in a Master Portfolio are valued based on an
interestholder's proportionate ownership interest in the Master Portfolio's
aggregate net assets as next determined after an order is received in proper
form. The aggregate NAV of each Master Portfolio (i.e., the value of it's assets
less liabilities) is determined as of 4:00 p.m. (Eastern time) on each day the
New York Stock Exchange is open for business. The Master Portfolio's investments
are valued each business day, typically by using available market quotations or
at fair value determined in good faith by the Master Fund's Board of Trustees.
HOW TO BUY AND SELL SHARES
Shares of the Funds currently are offered only to institutional
investors such as insurance companies, defined contribution plans and defined
benefit plans. Retirement plan participants should refer to materials provided
by their plan sponsor or plan administrator for information on how to invest in
and redeem shares of the Funds.
Plan sponsors or administrators who have made arrangements with the
Trust may receive orders from their plan participants to purchase or redeem
shares of the Funds, generally on each business day. That night, all orders
received by that plan sponsor or plan administrator prior to 4:00 p.m. Eastern
time on that day are aggregated, and the plan sponsor or plan administrator
generally places a net purchase and/or redemption order(s) for shares of the
Funds on the morning of the next business day. These orders are normally
executed at the NAV that was computed for each Fund as of 4:00 p.m. Eastern time
the previous day.
Plan sponsors and plan administrators who choose not to enter into
arrangements of the type described above will need to transmit orders for
receipt by the Trust prior to 4:00 p.m. Eastern time in order for those orders
to be executed at the NAV computed for that day.
The Trust normally will wire redemption proceeds to the plan sponsor or
plan administrator on the next business day after receipt of the redemption
instructions by the Trust, but in no event later than seven days following
receipt of such instructions. Redemptions of more than $500,000 of a Fund's
assets during any 90-day period by one
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<PAGE>
shareowner will normally be paid in cash, but may be paid wholly or partly by
a distribution in-kind of securities. If a redemption is paid in-kind, the
redeeming shareowner may incur brokerage fees in selling the securities
received.
Each Fund may suspend the right of redemption or postpone a redemption
payment more than seven days during any period when (a) the NYSE is closed for
other than customary weekend and holiday closings, (b) trading on the NYSE is
restricted, (c) there are emergency circumstances as determined by the
Securities and Exchange Commission, or (d) the Securities and Exchange
Commission has by order permitted such suspension for the protection of
shareowners of the Fund; provided that applicable rules and regulations of the
Securities and Exchange Commission shall govern as to whether any condition
prescribed in (b) through (d) exists.
In addition, the following are additional restrictions relating to
redemptions for the Funds:
- If your account value falls below the minimum investment amount (see
p.36), the Fund may redeem your shares. You will receive notice that we
intend to do this at least 30 days in advance so that you may increase the
balance in your account if you choose. If your account falls below $10, we
may redeem your shares and send you the proceeds, without notice to you.
- Because servicing smaller accounts is very expensive, if your account
balance falls below $500 on the last day of the calendar quarter through
redemptions or any other reason, your account will be charged a low balance
fee of $2.50 per quarter. The Funds may waive the fee, in their discretion,
in the event of a significant market correction.
DIVIDENDS, DISTRIBUTIONS AND TAXES
--------------------------------------------------------------------------------
Each Fund intends to distribute substantially all of its net investment
income and any net capital gain realized from sales of its portfolio securities.
The Equity Fund, Equity Index Funds, Small Cap Equity Fund, Equity and
Bond Fund and International Equity Fund declare and pay dividends and capital
gain distributions, if any, at least annually.
The Bond Fund, the Money Market Fund, and the Tax Advantaged Bond Fund
declare dividends daily and pay dividends monthly on the last business day of
the month. Capital gain distributions on these Funds, if any, are generally paid
annually.
All dividends and capital gain distributions from a Fund are
automatically reinvested in shares of that Fund on the reinvestment date, unless
you previously have elected to receive dividends and distributions in cash. If
the total dividend is less than $10 for an account owner of a Fund, the dividend
will automatically be reinvested in additional shares of the Fund.
TAXES ON DISTRIBUTIONS. Distributions from each Fund, other than the
Tax Advantaged Bond Fund, are generally subject to federal income tax, and may
be subject to state or local taxes. If you are a U.S. citizen residing outside
the United States, your distributions may also be taxed by the country in which
you reside. Your distributions are taxable when they are paid, whether you take
them in cash or reinvest them in additional shares.
The dividends from the Tax Advantaged Bond Fund will largely be exempt
from regular federal income tax, because the Tax Advantaged Bond Fund invests
primarily in municipal bonds. A portion of the Tax Advantaged Bond Fund's
dividends may be subject to the federal alternative minimum tax (AMT). Tax
Advantaged Bond Fund dividends may be subject to state and local taxes. Tax
Advantaged Bond Fund will provide you annually with the state-by-state sources
of its income.
For federal tax purposes, a Fund's income and short-term capital gain
distributions are taxed as dividends; long-term capital gain distributions are
taxed as long-term capital gains, no matter how long you have held your Fund
shares.
-37-
<PAGE>
Every January, the Funds will send you and the IRS a statement called
Form 1099 showing the sources and amounts of taxable distributions you received
in the previous calendar year.
FOREIGN TAXES. A Fund may receive income from sources in foreign
countries, and that income may be subject to foreign taxes at its source. If
your Fund pays non-refundable taxes to foreign governments during the year,
those taxes will reduce that Fund's dividend, but will still be included in your
taxable income. You may be able to claim an offsetting credit or deduction on
your tax return for your share of foreign taxes paid by a Fund for a particular
year if more than 50% of its total assets consists of stock or securities in
foreign corporations and the Fund makes a special tax election for such year
whereby each of its shareholders includes in his gross income and treats as paid
by him his proportionate share of such foreign taxes. It is expected that only
International Equity Fund and International Index Fund may qualify for this
election. We will send you detailed information about the foreign tax credit or
deduction each year.
TAXES ON TRANSACTIONS. A redemption is a sale for federal income tax
purposes. Your redemption proceeds may be more or less than your cost depending
upon the net asset value at the time of the redemption and, as a result, you may
realize a capital gain or loss. Gain or loss is computed on the difference
between the amount you receive in exchange for the shares redeemed and their
basis.
An exchange of any Fund's shares for shares of another Fund will be
treated as a sale of the Fund's shares at their fair market value and any gain
on the transaction may be subject to federal income tax.
Whenever you sell shares of a Fund, you will receive a confirmation
statement showing how many shares you sold and at what price. You also will
receive a year-end statement every January. This will allow you or your tax
preparer to determine the tax consequences of each redemption. However, be sure
to keep your regular account statements; their information will be essential in
calculating the amount of your capital gains or losses.
To invest in any of the Funds, you must be a U.S. resident with a
social security or taxpayer identification number. When you sign your account
application, you must certify that your social security or taxpayer
identification number is correct and that you are not subject to backup
withholding. If you fail to comply with this procedure, the Fund must withhold
31% of your taxable distributions and redemptions.
Participants in tax-qualified retirement plans generally will not be
subject to federal tax liability on either dividend and capital gain
distributions from the Funds or redemption of shares of the Funds. Rather,
participants in such plans will be taxed when they begin taking distributions
from their retirement plans. There are various restrictions on eligibility,
contributions and withdrawals, depending on the type of tax-qualified retirement
plan. You should consult with a tax professional on the specific rules governing
your own plan.
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<PAGE>
APPENDIX A
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------------
Small Small Equity
Cap Cap and Tax Money
Equity Equity International S&P 500 Index International Bond Bond Advantaged Market
Fund Fund Equity Fund Index Fund Fund Index Fund Fund Fund Bond Fund Fund
-----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
SYMBOLS y - PERMITTED n - NOT PERMITTED
-----------------------------------------------------------------------------------------------------------------------------------
Debt Securities n n n y n n y y y n
-----------------------------------------------------------------------------------------------------------------------------------
Asset-Backed Securities n n n n n n y y n n
-----------------------------------------------------------------------------------------------------------------------------------
Collateralized Mortgage Obligations
and Multiclass Pass-Through Securities n n n n n n y y n n
-----------------------------------------------------------------------------------------------------------------------------------
Corporate Asset-Backed Securities n n n n n n n n n n
-----------------------------------------------------------------------------------------------------------------------------------
Mortgage Pass-Through Securities n n n n n n y y n n
-----------------------------------------------------------------------------------------------------------------------------------
Stripped Mortgage-Backed Securities n n n n n n n n n n
-----------------------------------------------------------------------------------------------------------------------------------
Corporate Securities y y y y y y y y y y
-----------------------------------------------------------------------------------------------------------------------------------
Loans and Other Direct Indebtedness n n n n n n n n n n
-----------------------------------------------------------------------------------------------------------------------------------
Lower Rated Bonds n n n n n n y y y n
-----------------------------------------------------------------------------------------------------------------------------------
Municipal Bonds n n n n n n n n y n
-----------------------------------------------------------------------------------------------------------------------------------
Speculative Bonds n n n n n n y y y n
-----------------------------------------------------------------------------------------------------------------------------------
U.S. Government Securities y y y y y y y y y n
-----------------------------------------------------------------------------------------------------------------------------------
Variable and Floating Rate Obligations n n n y y y n n y n
-----------------------------------------------------------------------------------------------------------------------------------
Zero Coupon Bonds n n n n n n y y y n
-----------------------------------------------------------------------------------------------------------------------------------
Equity Securities y y y y y y y y n n
-----------------------------------------------------------------------------------------------------------------------------------
Foreign Securities Exposure y y y n n y y n n n
-----------------------------------------------------------------------------------------------------------------------------------
Depositary Receipts y y y n n y y n n n
-----------------------------------------------------------------------------------------------------------------------------------
Dollar-Denominated Foreign Money
Market Securities y y y y y y y y y y
-----------------------------------------------------------------------------------------------------------------------------------
Emerging Markets n n y n n y n n n n
-----------------------------------------------------------------------------------------------------------------------------------
Foreign Securities y y y n n y y n n n
-----------------------------------------------------------------------------------------------------------------------------------
Forward Contracts y y y n n y y n n n
-----------------------------------------------------------------------------------------------------------------------------------
Futures Contracts n n n y y y y y y n
-----------------------------------------------------------------------------------------------------------------------------------
Indexed Securities/Structured Products n n n n n n n n n n
-----------------------------------------------------------------------------------------------------------------------------------
Inverse Floating Rate Obligations n n n n n n n n y n
-----------------------------------------------------------------------------------------------------------------------------------
Investment in Other Investment Companies
-----------------------------------------------------------------------------------------------------------------------------------
Open-End y y y y y y y y y y
-----------------------------------------------------------------------------------------------------------------------------------
Closed-End y y y y y y y y y y
-----------------------------------------------------------------------------------------------------------------------------------
Lending of Portfolio Securities y y y y y y y y y y
-----------------------------------------------------------------------------------------------------------------------------------
Leveraging Transactions y y y y y y y y y y
-----------------------------------------------------------------------------------------------------------------------------------
Bank Borrowings y y y n n n y y y y
-----------------------------------------------------------------------------------------------------------------------------------
Mortgage "Dollar-Roll" Transactions n n n n n n n n n n
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------------------------------------------------------
Small Small Equity
Cap Cap and Tax Money
Equity Equity International S&P 500 Index International Bond Bond Advantaged Market
Fund Fund Equity Fund Index Fund Fund Index Fund Fund Fund Bond Fund Fund
-----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
SYMBOLS y - PERMITTED n - NOT PERMITTED
-----------------------------------------------------------------------------------------------------------------------------------
-----------------------------------------------------------------------------------------------------------------------------------
Reverse Repurchase Agreements y y y y y y y y y y
-----------------------------------------------------------------------------------------------------------------------------------
Options n n N y y y y y y n
-----------------------------------------------------------------------------------------------------------------------------------
Options on Foreign Currencies n n N n n n n n n n
-----------------------------------------------------------------------------------------------------------------------------------
Options on Futures Contracts n n N y y y y y y n
-----------------------------------------------------------------------------------------------------------------------------------
Options on Securities n n N n n n n n n n
-----------------------------------------------------------------------------------------------------------------------------------
Options on Stock Indices n n N y y y n n n n
-----------------------------------------------------------------------------------------------------------------------------------
Reset Options n n N n n n n n n n
-----------------------------------------------------------------------------------------------------------------------------------
"Yield Curve" Options n n N n n n n n n n
-----------------------------------------------------------------------------------------------------------------------------------
Repurchase Agreements y y y y y y y y y y
-----------------------------------------------------------------------------------------------------------------------------------
Restricted Securities y y y y y y y y y y
-----------------------------------------------------------------------------------------------------------------------------------
Short Sales n n N n n n n n n n
-----------------------------------------------------------------------------------------------------------------------------------
Short Sales Against the Box n n N n n n n n n n
-----------------------------------------------------------------------------------------------------------------------------------
Short Term Instruments y y y y y y y y y y
-----------------------------------------------------------------------------------------------------------------------------------
Swaps and Related Derivative Instruments n n N n n n y y y n
-----------------------------------------------------------------------------------------------------------------------------------
Temporary Borrowings y y y n n n y y y y
-----------------------------------------------------------------------------------------------------------------------------------
Temporary Defensive Positions y y y n n n y y y n
-----------------------------------------------------------------------------------------------------------------------------------
Warrants n y y y y y y y n n
-----------------------------------------------------------------------------------------------------------------------------------
"When-issued" Securities y y y y y y y y y y
-----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
<PAGE>
ADDITIONAL INFORMATION ABOUT THE FUNDS
--------------------------------------------------------------------------------
For investors who would like more information about the Funds, the
following documents are available free upon request.
STATEMENT OF ADDITIONAL INFORMATION (SAI). The SAI contains additional
information about all aspects of the Funds. A current SAI has been filed with
the Securities and Exchange Commission and is incorporated in this prospectus by
reference.
TO OBTAIN THE SAI WITHOUT CHARGE, YOU MAY WRITE TO
STATE FARM INVESTMENT MANAGEMENT CORP. AT ONE STATE
FARM PLAZA, BLOOMINGTON, IL 61710-0001 OR CALL US AT
1-800-447-4930.
PUBLIC INFORMATION. You can review and copy information about the Trust
and each Fund, including the SAI, at the Securities and Exchange Commission's
Public Reference Room in Washington D.C. You may obtain information on the
operation of the public reference room by calling the Commission at
1-202-942-8090. Reports and other information about the Trust and the Funds also
are available on the EDGAR Database on the Commission's Internet site at
http://www.sec.gov. You may obtain copies of this information, upon payment of a
duplicating fee, by electronic request at the following e-mail address:
[email protected], or by writing the Public Reference Section of the Securities
and Exchange Commission, Washington, D.C. 20549-6009.
INVESTMENT CO. ACT FILE NO. 811-10027
<PAGE>
================================================================================
STATE FARM MUTUAL FUND TRUST
STATE FARM EQUITY FUND
STATE FARM SMALL CAP EQUITY FUND
STATE FARM INTERNATIONAL EQUITY FUND
STATE FARM S&P 500 INDEX FUND
STATE FARM SMALL CAP INDEX FUND
STATE FARM INTERNATIONAL INDEX FUND
STATE FARM EQUITY AND BOND FUND
STATE FARM BOND FUND
STATE FARM TAX ADVANTAGED BOND FUND
STATE FARM MONEY MARKET FUND
One State Farm Plaza
Bloomington, Illinois 61710-0001
(309) 766-2029
STATEMENT OF ADDITIONAL INFORMATION
December 18, 2000
This Statement of Additional Information is not a prospectus but provides
information that you should read in conjunction with the State Farm Mutual Fund
Trust prospectus (the "Prospectus") dated the same date as this Statement of
Additional Information. You may obtain a copy of the Prospectus at no charge by
writing or telephoning State Farm Mutual Fund Trust at the address or telephone
number shown above.
i
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
INFORMATION ABOUT THE FUNDS.......................................................................................1
INVESTMENT OBJECTIVES.............................................................................................1
INVESTMENT TECHNIQUES AND RISKS...................................................................................2
Equity Securities........................................................................................2
Debt Securities..........................................................................................3
Convertible Securities...................................................................................4
U.S. Government Securities...............................................................................4
Floating- and Variable-Rate Obligations..................................................................5
Letters of Credit........................................................................................6
Foreign Securities.......................................................................................6
Stock Index Futures and Options On Stock Index Futures Contracts........................................13
Interest Rate Futures Contracts and Related Options.....................................................15
Warrants................................................................................................17
Municipal Bonds.........................................................................................18
Mortgage-Backed Securities..............................................................................18
Asset-Backed Securities.................................................................................20
Money Market Fund.......................................................................................20
Foreign Money Market Instruments........................................................................21
Cash and Cash Equivalents...............................................................................22
Repurchase Agreements...................................................................................22
Privately Issued Securities.............................................................................22
Forward Commitments, When-Issued And Delayed Delivery Securities........................................23
Loans Of Portfolio Securities...........................................................................24
Defensive Investments...................................................................................24
INVESTMENT POLICIES AND RESTRICTIONS.............................................................................25
Fundamental Restrictions................................................................................25
Non-Fundamental Restrictions............................................................................27
Fundamental Operating Policies of the Master Portfolios.................................................28
MORE ABOUT THE EQUITY INDEX FUNDS................................................................................32
Master/Feeder Structure.................................................................................32
Selection of Investments for the Master Portfolio.......................................................34
Tracking Error..........................................................................................34
Relationship With the Index Providers...................................................................35
Standard & Poor's.......................................................................................35
Russell 2000............................................................................................35
EAFE Index..............................................................................................36
TRUSTEES AND OFFICERS............................................................................................37
INVESTMENT ADVISORY AGREEMENTS...................................................................................46
Between the Trust and the Manager.......................................................................46
</TABLE>
ii
<PAGE>
<TABLE>
<S> <C>
Between Barclays and the Master Portfolios..............................................................48
Between the Manager and Capital Guardian................................................................49
SECURITIES ACTIVITIES OF THE MANAGER, CAPITAL GUARDIAN AND BARCLAYS..............................................50
PORTFOLIO TRANSACTIONS AND BROKERAGE.............................................................................51
The Equity Fund, Equity and Bond Fund, Bond Fund, Tax Advantaged Bond Fund and Money Market Fund........51
Equity Index Funds......................................................................................52
Small Cap Equity Fund and International Equity Fund.....................................................52
PORTFOLIO TURNOVER...............................................................................................52
DETERMINATION OF NET ASSET VALUE.................................................................................53
PERFORMANCE INFORMATION..........................................................................................55
PURCHASE AND REDEMPTION OF FUND SHARES...........................................................................58
DISTRIBUTION EXPENSES............................................................................................58
OTHER SERVICE PROVIDERS..........................................................................................59
Custodians..............................................................................................59
Transfer Agent..........................................................................................59
Independent Auditors....................................................................................60
TAXES............................................................................................................60
General Tax Information.................................................................................60
CODE OF ETHICS...................................................................................................65
SHARES...........................................................................................................65
Voting Rights...........................................................................................66
FINANCIAL STATEMENTS.............................................................................................67
APPENDIX A: DESCRIPTION OF BOND RATINGS..........................................................................1
</TABLE>
iii
<PAGE>
INFORMATION ABOUT THE FUNDS
State Farm Mutual Fund Trust ("the "Trust") is an open-end management
investment company organized as a business trust under the laws of the State of
Delaware on June 8, 2000. The Trust consists of ten separate funds, each of
which has its own investment objective, investment policies, restrictions and
risks (each a "Fund," and collectively, the "Funds").
The Trust issues a separate series of shares of beneficial interest for
each Fund representing fractional undivided interests in that Fund. By investing
in a Fund, you become entitled to a pro-rata share of all dividends and
distributions arising from the net income and capital gains on the investments
of that Fund. Likewise, you share pro-rata in any losses of that Fund. Each Fund
offers three classes of shares: Class A, Class B and Institutional shares.
Three of the Funds - State Farm S&P 500 Index Fund, State Farm Small
Cap Index Fund and State Farm International Index Fund (together, the "Equity
Index Funds") - seek to achieve their respective investment objectives by
investing all of their assets in the S&P 500 Index Master Portfolio, Russell
2000 Index Master Portfolio and International Index Master Portfolio (each a
"Master Portfolio"), respectively, each of which is a series of Master
Investment Portfolio (the "Master Fund"), an open-end, management investment
company. Each Master Portfolio has substantially the same investment objective
as the corresponding Equity Index Fund. Any Equity Index Fund may withdraw its
investment in a corresponding Master Portfolio at any time if the Board of
Trustees of the Trust determines that such action is in the best interests of
the respective Equity Index Fund and its shareholders. Upon such withdrawal, the
Board of Trustees would consider alternative investments, including investing
all of an Equity Index Fund's assets in another investment company with the same
investment objective as the Equity Index Fund or hiring an investment adviser to
manage the Equity Index Fund's assets in accordance with the investment policies
and restrictions described in the Trust's prospectus and this Statement of
Additional Information.
Each Fund (including the Equity Index Funds through their investment in
the Master Portfolios, and the Equity and Bond Fund through its investment in
the Equity Fund and the Bond Fund) is "diversified" as that term is defined in
the Investment Company Act of 1940, as amended (the "1940 Act"). State Farm
Investment Management Corp. (the "Manager") is the investment adviser to each of
the Funds.
INVESTMENT OBJECTIVES
The investment objective of each Fund is set forth and described in the
Prospectus. The investment objective of each Fund may be changed by the Board of
Trustees of the Trust without the approval of a "majority of the outstanding
voting securities" (as defined in the 1940 Act) of each Fund. Should the
investment objective of any Fund change, the Trust will provide investors with
thirty days' prior notice of the change.
<PAGE>
INVESTMENT TECHNIQUES AND RISKS
In addition to the investment objective of each Fund, the policies and
certain techniques by which the Funds pursue their objectives are generally set
forth in the Prospectus. This section is intended to augment the explanation set
forth in the Prospectus.
To the extent set forth in this Statement of Additional Information,
each Equity Index Fund through its investment in a corresponding Master
Portfolio may invest in the securities described below. To avoid the need to
refer to both the Equity Index Funds and the Master Portfolio in every instance,
the following sections generally refer to the Funds or Equity Index Funds only.
EQUITY SECURITIES
Each of the Equity Fund, Small Cap Equity Fund, International Equity
Fund, Equity and Bond Fund (through the Equity Fund), and Equity Index Funds
invest in common stocks, which represent an equity interest (ownership) in a
business. This ownership interest often gives these Funds the right to vote on
measures affecting the company's organization and operations. These Funds also
invest in other types of equity securities, including preferred stocks and
securities convertible into common stocks (discussed below). Over time, common
stocks historically have provided superior long-term capital growth potential.
However, stock prices may decline over short or even extended periods. Stock
markets tend to move in cycles, with periods of rising stock prices and periods
of falling stock prices. As a result, these Funds should be considered long-term
investments, designed to provide the best results when held for several years or
more. These Funds may not be suitable investments if you have a short-term
investment horizon or are uncomfortable with an investment whose value is likely
to vary substantially.
The Small Cap Equity Fund's and the Small Cap Index Fund's investments
in smaller capitalization stocks can involve greater risk than is customarily
associated with investing in stocks of larger, more established companies. For
example, smaller companies often have limited product lines, markets, or
financial resources, may be dependent for management on one or a few key
persons, and can be more susceptible to losses. Also, their securities may be
thinly traded (and therefore have to be sold at a discount from current prices
or sold in small lots over an extended period of time), may be followed by fewer
investment research analysts, and may be subject to wider price swings, thus
creating a greater chance of loss than securities of larger capitalization
companies. In addition, transaction costs in stocks of smaller capitalization
companies may be higher than those of larger capitalization companies.
Because the Small Cap Equity Fund and Small Cap Index Fund emphasize
the stocks of issuers with smaller market capitalizations, each can be expected
to have more difficulty obtaining information about the issuers or valuing or
disposing of its securities than it would if it were to concentrate on more
widely held stocks.
2
<PAGE>
DEBT SECURITIES
Under normal circumstances, the Bond Fund, Equity and Bond Fund
(through its investment in the Bond Fund) and Tax Advantaged Bond Fund may
invest in debt securities of corporate and governmental issuers, including
"investment grade" securities (securities within the four highest grades
(AAA/Aaa to BBB/Baa) assigned by Moody's Investor Services, Inc. ("Moody's") or
Standard and Poor's Corporation ("S&P")) and lower-rated securities (securities
rated BB or lower by S&P or Ba or lower by Moody's, commonly called "junk
bonds"), and securities that are not rated, but are of comparable quality. See
APPENDIX A for a Description of Bond Ratings.
The risks inherent in debt securities depend primarily on the term and
quality of the obligations in a Fund's portfolio as well as on market
conditions. In general, a decline in the prevailing levels of interest rates
generally increases the value of debt securities, while an increase in rates
usually reduces the value of those securities.
Investment in lower grade securities involves greater investment risk,
including the possibility of issuer default or bankruptcy. An economic downturn
could severely disrupt the market for such securities and adversely affect the
value of such securities. In addition, such securities are less sensitive to
interest rate changes than higher-quality instruments and generally are more
sensitive to adverse economic changes or individual corporate developments.
During a period of adverse economic changes, including a period of rising
interest rates, issuers of such bonds may experience difficulty in making their
principal and interest payments.
In addition, lower grade securities may be less marketable than
higher-quality debt securities because the market for them is less broad. The
market for unrated debt securities is even narrower. During periods of thin
trading in these markets, the spread between bid and ask prices is likely to
increase significantly, and a Fund may have greater difficulty selling its
portfolio securities. Adverse publicity and investor perceptions may negatively
affect the market value and liquidity of these securities.
The S&P 500 Index Fund may purchase debt securities that are not
rated if, in the opinion of Barclays Global Fund Advisors ("Barclays"), the
investment adviser for the S&P 500 Index Master Portfolio, such obligation is
of investment quality comparable to other rated investments that are
permitted to be purchased by the S&P 500 Index Fund. After purchase by the
S&P 500 Index Fund, a security may cease to be rated or its rating may be
reduced below the minimum required for purchase by the S&P 500 Index Fund.
Neither event will require a sale of such security by the S&P 500 Index Fund,
provided that the amount of such securities held by the S&P 500 Index Fund
does not exceed 5% of the S&P 500 Index Fund's net assets. To the extent the
ratings given by Moody's or by S&P may change as a result of changes in such
organizations or their rating systems, the S&P 500 Index Fund will attempt to
use comparable ratings as standards for investments in accordance with the
investment policies contained in the Prospectus and in this Statement of
Additional Information.
3
<PAGE>
The S&P 500 Index Fund is not required to sell downgraded securities,
and it could hold up to 5% of its net assets in debt securities rated below
"Baa" by Moody's or below "BBB" by S&P or if unrated, low quality (below
investment grade) securities.
CONVERTIBLE SECURITIES
The Bond Fund may invest up to 20% of its total assets in convertible
securities. Convertible securities may include corporate notes or preferred
stock, but are ordinarily a long-term debt obligation of the issuer convertible
at a stated exchange rate into common stock of the issuer. As with all debt
securities, the market value of convertible securities tends to decline as
interest rates increase and, conversely, to increase as interest rates decline.
Convertible securities generally offer lower interest or dividend yields than
non-convertible securities of similar quality. However, when the market price of
the common stock underlying a convertible security exceeds the conversion price,
the price of the convertible security tends to reflect the value of the
underlying common stock. As the market price of the underlying common stock
declines, the convertible security tends to trade increasingly on a yield basis,
and thus may not depreciate to the same extent as the underlying common stock.
Convertible securities generally rank senior to common stock in an
issuer's capital structure and may entail less risk of declines in market value
than the issuer's common stock. However, 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. In evaluating a
convertible security, the Manager usually gives primary emphasis to the
attractiveness of the underlying common stock.
U.S. GOVERNMENT SECURITIES
Each of the Funds may purchase securities issued or guaranteed as to
principal and interest by the U.S. Government, its agencies, authorities or
instrumentalities ("U.S. Government Securities"). Some U.S. Government
Securities, such as Treasury bills, notes and bonds, which differ only in their
interest rates, maturities and times of issuance, are supported by the full
faith and credit of the United States. Others, such as obligations issued or
guaranteed by U.S. Government agencies, authorities or instrumentalities are
supported either by (a) the full faith and credit of the U.S. Government (such
as securities of the Small Business Administration), (b) the right of the issuer
to borrow from the Treasury (such as securities of the Federal Home Loan Banks),
(c) the discretionary authority of the U.S. Government to purchase the agency's
obligations (such as securities of the Federal National Mortgage Association),
or (d) only the credit of the issuer. No assurance can be given that the U.S.
Government will provide financial support to U.S. Government agencies,
authorities or instrumentalities in the future. Accordingly, securities issued
by an agency are subject to default, and are also subject to interest rate and
prepayment risks.
U.S. Government Securities may also include zero coupon securities.
Zero coupon securities are issued and traded at a discount and do not entitle
the holder to any periodic payments of interest prior to maturity, and, for this
reason, may trade at a deep discount from their face or par value and may be
subject to greater fluctuations in market value than ordinary
4
<PAGE>
debt obligations of comparable maturity. With zero coupon securities there
are no cash distributions to reinvest, so investors bear no reinvestment risk
if they hold the zero coupon securities to maturity; holders of zero coupon
securities, however, forego the possibility of reinvesting at a higher yield
than the rate paid on the originally issued security. With zero coupon
securities there is no reinvestment risk on the principal amount of the
investment. When held to maturity, the entire return from such instruments is
determined by the difference between such instrument's purchase price and its
value at maturity.
Securities guaranteed as to principal and interest by the U.S.
Government, its agencies, authorities or instrumentalities are considered to
include (a) securities for which the payment of principal and interest is backed
by a guarantee of, or an irrevocable letter of credit issued by, the U.S.
Government, its agencies, authorities or instrumentalities and (b) participation
in loans made to foreign governments or their agencies that are so guaranteed.
The secondary market for certain of these participations is limited. Such
participations may therefore be regarded as illiquid.
FLOATING- AND VARIABLE-RATE OBLIGATIONS
The Equity Index Funds may purchase floating- and variable-rate demand
notes and bonds, which are obligations ordinarily having stated maturities in
excess of thirteen months, but which permit the holder to demand payment of
principal at any time, or at specified intervals not exceeding thirteen months.
Variable rate demand notes include master demand notes that are obligations that
permit a Fund to invest fluctuating amounts, which may change daily without
penalty, pursuant to direct arrangements between the Fund, as lender, and the
borrower. The interest rates on these notes fluctuate from time to time. The
issuer of such obligations ordinarily has a corresponding right, after a given
period, to prepay in its discretion the outstanding principal amount of the
obligations plus accrued interest upon a specified number of days' notice to the
holders of such obligations. The interest rate on a floating-rate demand
obligation is based on a known lending rate, such as a bank's prime rate, and is
adjusted automatically each time such rate is adjusted. The interest rate on a
variable-rate demand obligation is adjusted automatically at specified
intervals. Frequently, such obligations are secured by letters of credit or
other credit support arrangements provided by banks. Because these obligations
are direct lending arrangements between the lender and borrower, it is not
contemplated that such instruments generally will be traded, and there generally
is no established secondary market for these obligations, although they are
redeemable at face value. Accordingly, where these obligations are not secured
by letters of credit or other credit support arrangements, a Fund's right to
redeem is dependent on the ability of the borrower to pay principal and interest
on demand. Such obligations frequently are not rated by credit rating agencies
and the Fund may invest in obligations which are not so rated only if Barclays
determines that, at the time of investment, the obligations are of comparable
quality to the other obligations in which the Fund may invest. Barclays, on
behalf of each Equity Index Fund, considers on an ongoing basis the
creditworthiness of the issuers of the floating- and variable-rate demand
obligations in each Fund's portfolio. The Equity Index Fund will not invest more
than 10% of the value of its total net assets in floating- or variable-rate
demand obligations whose demand feature is not
5
<PAGE>
exercisable within seven days. Such obligations may be treated as liquid,
provided that an active secondary market exists.
The Tax Advantaged Bond Fund may purchase variable rate demand notes,
which are obligations containing a floating or variable interest rate adjustment
formula and which are subject to a right of demand for payment of the principal
balance plus accrued interest either at any time or at specified intervals. The
interest rate on a variable rate demand note may be based on a known lending
rate, such as bank's prime rate, and may be adjusted when such rate changes, or
the interest rate may be a market rate that is adjusted at specified intervals.
The adjustment formula attempts to maintain the value of the variable rate
demand note at approximately the par value of such note at the adjustment date.
In addition, the Tax Advantaged Bond Fund may invest in inverse
floaters. An inverse floater is a floating rate debt instrument, the interest
rate on which resets in the opposite direction from the market rate of interest
to which the inverse floater is indexed. An inverse floater may be considered to
be leveraged to the extent that its interest rate varies by a magnitude that
exceeds the magnitude of the change in the index rate of interest. The higher
the degree of leverage inherent in inverse floaters is associated with greater
volatility in market value, such that, during periods of rising interest rates,
the market values of inverse floaters will tend to decrease more rapidly than
those of fixed rate securities. In addition, the duration of an inverse floater
may exceed its stated final maturity. Certain inverse floaters may be deemed
illiquid securities for purposes of the Funds' limitations on investment in such
securities.
LETTERS OF CREDIT
Certain of the debt obligations (including municipal securities,
certificates of participation, commercial paper and other short-term
obligations) which the S&P 500 Index Fund may purchase may be backed by an
unconditional and irrevocable letter of credit of a bank, savings and loan
association or insurance company which assumes the obligation for payment of
principal and interest in the event of default by the issuer. Letters of credit
are not federally insured instruments. Only banks, savings and loan associations
and insurance companies which, in the opinion of Barclays, are of comparable
quality to issuers of other permitted investments of the S&P 500 Index Fund may
be used for letter of credit-backed investments. However, such banks may be
unable to honor the letter of credit.
FOREIGN SECURITIES
Each of Equity Fund, Small Cap Equity Fund, Equity and Bond Fund
(through its investment in the Equity Fund), International Equity Fund and
International Index Fund invest in foreign securities not publicly traded in the
United States. Each of these may invest in foreign securities directly or in the
form of American Depositary Receipts ("ADRs"), Canadian Depositary Receipts
("CDRs"), European Depositary Receipts ("EDRs"), International Depositary
Receipts ("IDRs") and Global Depositary Receipts ("GDRs") or other similar
securities convertible into securities of foreign issuers. These securities may
not necessarily be denominated in the same currency as the securities into which
they may be converted. ADRs (sponsored or unsponsored) are receipts typically
issued by a U.S. Bank or trust company and
6
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traded on a U.S. stock exchange, and CDRs are receipts typically issued by a
Canadian bank or trust company that evidence ownership of underlying foreign
securities. Issuers of unsponsored ADRs are not contractually obligated to
disclose material information in the U.S. and, therefore, such information
may not correlate to the market value of the unsponsored ADR. EDRs and IDRs
are receipts typically issued by European banks and trust companies, and GDRs
are receipts issued by either a U.S. or non-U.S. banking institution, that
evidence ownership of the underlying foreign securities. Generally, ADRs in
registered form are designed for use in U.S. securities markets and EDRs and
IDRs in bearer form are designed primarily for use in Europe.
With respect to portfolio securities that are issued by foreign issuers
or denominated in foreign currencies, the investment performance of a Fund is
affected by the strength or weakness of the U.S. dollar against those
currencies. For example, if the dollar falls in value relative to the Japanese
yen, the dollar value of a yen-denominated stock held in the portfolio will rise
even though the price of the stock remains unchanged. Conversely, if the dollar
rises in value relative to the yen, the dollar value of the yen-denominated
stock will fall.
Shareowners should understand and consider carefully the risks involved
in foreign investing. Investments in foreign securities are generally
denominated in foreign currencies and involve certain considerations comprising
both risk and opportunity not typically associated with investing in U.S.
securities. These considerations include: fluctuations in exchange rates of
foreign currencies; possible imposition of exchange control regulation or
currency restrictions that would prevent cash from being brought back into the
United States; the inability of a Fund to convert foreign currency into U.S.
dollars, which would cause the Fund continued exposure to fluctuating exchange
rates; less public information with respect to issuers of securities; less
governmental supervision of stock exchanges, securities brokers, and issuers of
securities; lack of uniform accounting, auditing, and financial reporting
standards; lack of uniform settlement periods and trading practices; less
liquidity and frequently greater price volatility; possible imposition of
foreign taxes; possible investment in securities of companies in developing as
well as developed countries; and sometimes less advantageous legal, operational,
and financial protections applicable to foreign sub-custodial arrangements.
Although the Funds try to invest in companies of countries having
stable political environments, there is the possibility of expropriation or
confiscatory taxation, seizure or nationalization of foreign bank deposits or
other assets, establishment of exchange controls, the adoption of foreign
government restrictions, or other political, social or diplomatic developments
that could adversely affect investment in these countries.
EMERGING MARKETS. Investments in emerging markets securities include
special risks in addition to those generally associated with foreign investing.
Many investments in emerging markets can be considered speculative, and the
value of those investments can be more volatile than in more developed foreign
markets. This difference reflects the greater uncertainties of investing in less
established markets and economies. Emerging markets also have different
clearance and settlement procedures, and in certain markets there have been
times when settlements have not kept pace with the volume of securities
transactions, making it difficult to conduct such transactions. Delays in
settlement could result in temporary periods when a portion
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of a Fund's assets is uninvested and no return is earned thereon. The
inability to make intended security purchases due to settlement problems
could cause a Fund to miss attractive investment opportunities. Inability to
dispose of portfolio securities due to settlement problems could result
either in losses to a Fund due to subsequent declines in the value of those
securities or, if a Fund has entered into a contract to sell a security, in
possible liability to the purchaser. Costs associated with transactions in
emerging markets securities are typically higher than costs associated with
transactions in U.S. securities. Such transactions also involve additional
costs for the purchase or sale of foreign currency.
Certain foreign markets (including emerging markets) may require
governmental approval for the repatriation of investment income, capital or the
proceeds of sales of securities by foreign investors. In addition, if
deterioration occurs in an emerging market's balance of payments or for other
reasons, a country could impose temporary restrictions on foreign capital
remittances. A Fund could be adversely affected by delays in, or a refusal to
grant, required governmental approval for repatriation of capital, as well as by
the application to the Fund of any restrictions on investments.
The risk also exists that an emergency situation may arise in one or
more emerging markets. As a result, trading of securities may cease or may be
substantially curtailed and prices for a Fund's securities in such markets may
not be readily available. A Fund may suspend redemption of its shares for any
period during which an emergency exists, as determined by the U.S. Securities
and Exchange Commission (the "Commission"). Accordingly, if a Fund believes that
appropriate circumstances exist, it will promptly apply to the Commission for a
determination that such an emergency is present. During the period commencing
from a Fund's identification of such condition until the date of Commission
action, that Fund's securities in the affected markets will be valued at fair
value determined in good faith by or under the direction of the Board of
Trustees of the Trust or the Board of Trustees of the Master Fund.
Income from securities held by a Fund could be reduced by taxes
withheld from that income, or other taxes that may be imposed by the emerging
market countries in which the Fund invests. Net asset value of a Fund may also
be affected by changes in the rates or methods of taxation applicable to the
Fund or to entities in which the Fund has invested. Many emerging markets have
experienced substantial rates of inflation for many years. Inflation and rapid
fluctuations in inflation rates have had, and may continue to have, adverse
effects on the economies and securities markets of certain emerging market
countries. In an attempt to control inflation, certain emerging market countries
have imposed wage and price controls. Of these countries, some, in recent years,
have begun to control inflation through prudent economic policies.
Emerging market governmental issuers are among the largest debtors to
commercial banks, foreign governments, international financial organizations and
other financial institutions. Certain emerging market governmental issuers have
not been able to make payments of interest or principal on debt obligations as
those payments have come due. Obligations arising from past restructuring
agreements may affect the economic performance and political and social
stability of those issuers.
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Governments of many emerging market countries have exercised and
continue to exercise substantial influence over many aspects of the private
sector through ownership or control of many companies. The future actions of
those governments could have a significant effect on economic conditions in
emerging markets, which, in turn, may adversely affect companies in the private
sector, general market conditions and prices and yields of certain of the
securities in a Fund's portfolio. Expropriation, confiscatory taxation,
nationalization, political, economic and social instability have occurred
throughout the history of certain emerging market countries and could adversely
affect Fund assets should any of those conditions recur.
CURRENCY EXCHANGE TRANSACTIONS. The Funds may enter into currency
exchange transactions either on a spot (i.e., cash) basis at the spot rate for
purchasing or selling currency prevailing in the foreign exchange market,
through a forward currency exchange contract ("forward contract") or through
foreign currency futures contracts.
FORWARD CONTRACTS. A forward contract is an agreement to purchase or
sell a specified currency at a specified future date (or within a specified time
period) and price set at the time of the contract. Forward contracts are usually
entered into with banks, foreign dealers or broker-dealers, are not traded on an
exchange and are usually for less than one year, but may be longer or renewed.
Forward currency transactions may involve currencies of the different
countries in which a Fund may invest, and serve as hedges against possible
variations in the exchange rate between these currencies. A currency transaction
for a Fund is limited to transaction hedging and portfolio hedging involving
either specific transactions or actual or anticipated portfolio positions.
Transaction hedging is the purchase or sale of a forward contract with respect
to specific receivables or payables of a Fund accruing in connection with the
purchase or sale of portfolio securities. Portfolio hedging is the use of a
forward contract with respect to an actual or anticipated portfolio security
position denominated or quoted in a particular currency. When a Fund owns or
anticipates owning securities in countries whose currencies are linked, the Fund
may aggregate such positions as to the currency hedged.
If a Fund enters into a forward contract hedging an anticipated or
actual holding of portfolio securities, liquid assets of the Fund, having a
value at least as great as the amount of the excess, if any, of the Fund's
commitment under the forward contract over the value of the portfolio position
being hedged, will be segregated on the books of the Fund and held by the Fund's
custodian and marked to market daily, while the contract is outstanding.
At the maturity of a forward contract to deliver a particular currency,
a Fund may sell the portfolio security related to such contract and make
delivery of the currency received from the sale, or it may retain the security
and either purchase the currency on the spot market or terminate its contractual
obligation to deliver the currency by entering into an offsetting contract with
the same currency trader for the purchase on the same maturity date of the same
amount of the currency.
It is impossible to forecast precisely the market value of a portfolio
security being hedged with a forward currency contract. Accordingly, at the
maturity of a contract it may be necessary
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for a Fund to purchase additional currency on the spot market (and bear the
expense of such purchase) if the market value of the security is less than
the amount of currency the Fund is obligated to deliver under the forward
contract and if a decision is made to sell the security and make delivery of
the currency. Conversely, it may be necessary to sell on the spot market some
of the currency received upon the sale of the portfolio security if the sale
proceeds exceed the amount of currency the Fund is obligated to deliver.
If the Fund retains the portfolio security and engages in an offsetting
transaction, the Fund will incur a gain or a loss to the extent that there has
been movement in forward contract prices. If the Fund engages in an offsetting
transaction, it may subsequently enter into a new forward contract to sell the
currency. If forward prices decline during the period between entering into a
forward contract for the sale of a currency and the date it enters into an
offsetting contract for the purchase of the currency, the Fund will realize a
gain to the extent the price of the currency it has agreed to sell exceeds the
price of the currency it has agreed to purchase. If forward prices increase, the
Fund will suffer a loss to the extent the price of the currency it has agreed to
purchase exceeds the price of the currency it has agreed to sell. A default on
the contract would deprive the Fund of unrealized profits or force it to cover
its commitments for purchase or sale of currency, if any, at the current market
price.
FOREIGN CURRENCY FUTURES CONTRACTS. A foreign currency futures
contract is an agreement between two parties for the future delivery of a
specified currency at a specified time and at a specified price. The
International Index Fund will engage in foreign currency futures contracts. A
"sale" of a futures contract means the contractual obligation to deliver the
currency at a specified price on a specified date, or to make the cash
settlement called for by the contract. Futures contracts have been designed by
exchanges which have been designated "contract markets" by the Commodity Futures
Trading Commission ("CFTC") and must be executed through a brokerage firm, known
as a futures commission merchant (an "FCM"), which is a member of the relevant
contract market. Futures contracts trade on these markets, and the exchanges,
through their clearing organizations, guarantee that the contracts will be
performed as between the clearing members of the exchange. Barclays, on a
consistent basis, uses the following FCMs on behalf of the Trust: UBS Warburg
LLC, Stamford, CT, J.P. Morgan Futures Inc., New York, New York, Morgan Stanley
& Co. Incorporated, New York, New York, Merrill Lynch Futures Inc., San
Francisco, CA, Lehman Brothers Inc., New York, New York, Salomon Smith Barney
Inc., New York, New York, Goldman Sachs & Co. Futures Services, New York, New
York, Carr Futures Inc., Chicago, Illinois, Deutsche Bank Securities Inc., New
York, New York.
While futures contracts based on currencies do provide for the delivery
and acceptance of a particular currency, such deliveries and acceptances are
very seldom made. Generally, a futures contract is terminated by entering into
an offsetting transaction. The International Index Fund will incur brokerage
fees when it purchases and sells futures contracts. At the time such a purchase
or sale is made, the International Index Fund must provide cash or money market
securities as a deposit known as "margin." The initial deposit required will
vary, but may be as low as 2% or less of a contract's face value. Daily
thereafter, the futures contract is valued
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through a process known as "marking to market," and the International Index
Fund may receive or be required to pay "variation margin" as the futures
contract becomes more or less valuable.
To hedge its portfolio and to protect it against possible variations in
foreign exchange rates pending the settlement of securities transactions, the
International Index Fund may buy or sell currency futures contracts. If a fall
in exchange rates for a particular currency is anticipated, the International
Index Fund may sell a currency futures contract as a hedge. If it is anticipated
that exchange rates will rise, the International Index Fund may purchase a
currency futures contract to protect against an increase in the price of
securities denominated in a particular currency the International Index Fund
intends to purchase. These futures contracts will be used only as a hedge
against anticipated currency rate changes.
The effective use of futures strategies depends on, among other things,
the International Index Fund's ability to terminate futures positions at times
when Barclays deems it desirable to do so. Although the International Index Fund
will not enter into a futures position unless Barclays believes that a liquid
secondary market exists for such future, there is no assurance that the
International Index Fund will be able to effect closing transactions at any
particular time or at an acceptable price. The International Index Fund
generally expects that its futures transactions will be conducted on recognized
U.S. and foreign securities and commodity exchanges.
Futures markets can be highly volatile and transactions of this type
carry a high risk of loss. Moreover, a relatively small adverse market movement
with respect to these transactions may result not only in loss of the original
investment but also in unquantifiable further loss exceeding any margin
deposited.
The use of futures involves the risk of imperfect correlation between
movements in futures prices and movements in the price of currencies which are
the subject of the hedge. The successful use of futures strategies also depends
on the ability of Barclays to correctly forecast interest rate movements,
currency rate movements and general stock market price movements.
The International Index Fund's ability effectively to hedge currency
risk through transactions in foreign currency futures depends on the degree to
which movements in the value of the currency underlying such hedging instrument
correlate with movements in the value of the relevant securities held by the
International Index Fund. If the values of the securities being hedged do not
move in the same amount or direction as the underlying currency, the hedging
strategy for the International Index Fund might not be successful and the
International Index Fund could sustain losses on its hedging transactions which
would not be offset by gains on its portfolio. It is also possible that there
may be a negative correlation between the currency underlying a futures contract
and the portfolio securities being hedged, which could result in losses both on
the hedging transaction and the portfolio securities. In such instances, the
International Index Fund's overall return could be less than if the hedging
transactions had not been undertaken.
Under certain extreme market conditions, it is possible that the
International Index Fund will not be able to establish hedging positions, or
that any hedging strategy adopted will be insufficient to completely protect the
International Index Fund.
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The International Index Fund will purchase or sell futures contracts
only if, in Barclays' judgment, there is expected to be a sufficient degree of
correlation between movements in the value of such instruments and changes in
the value of the relevant portion of the International Index Fund's portfolio
for the hedge to be effective. There can be no assurance that Barclays' judgment
will be accurate.
The ordinary spreads between prices in the cash and futures markets,
due to differences in the natures of those markets, are subject to distortions.
First, all participants in the futures market are subject to initial deposit and
variation margin requirements. This could require the International Index Fund
to post additional cash or cash equivalents as the value of the position
fluctuates. Further, rather than meeting additional variation margin
requirements, investors may close futures contracts through offsetting
transactions which could distort the normal relationship between the cash and
futures markets. Second, the liquidity of the futures market may be lacking.
Prior to exercise or expiration, a futures position may be terminated only by
entering into a closing purchase or sale transaction, which requires a secondary
market on the exchange on which the position was originally established. While
the International Index Fund will establish a futures position only if there
appears to be a liquid secondary market therefor, there can be no assurance that
such a market will exist for any particular futures contract at any specific
time. In such event, it may not be possible to close out a position held by the
International Index Fund, which could require the International Index Fund to
purchase or sell the instrument underlying the position, make or receive a cash
settlement, or meet ongoing variation margin requirements. The inability to
close out futures positions also could have an adverse impact on the
International Index Fund's ability effectively to hedge its securities, or the
relevant portion thereof.
The liquidity of a secondary market in a futures contract may be
adversely affected by "daily price fluctuation limits" established by the
exchanges, which limit the amount of fluctuation in the price of a contract
during a single trading day and prohibit trading beyond such limits once they
have been reached. The trading of futures contracts also is subject to the risk
of trading halts, suspensions, exchange or clearing house equipment failures,
government intervention, insolvency of the brokerage firm or clearing house or
other disruptions of normal trading activity, which could at times make it
difficult or impossible to liquidate existing positions or to recover excess
variation margin payments.
Each contract market on which futures contracts are traded has
established a number of limitations governing the maximum number of positions
which may be held by a trader, whether acting alone or in concert with others.
Barclays does not believe that these trading and position limits will have an
adverse impact on the hedging strategies regarding the International Index
Fund's investments.
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. Hedging transactions preclude the opportunity
for gain if the value of the hedged currency should rise. Moreover, it may not
be possible for a Fund to hedge against a devaluation that is so generally
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anticipated that it is not able to contract to sell the currency at a price
above the devaluation level it anticipates.
The cost to the International Index Fund engaging in currency exchange
transactions varies with such factors as the currency involved, the length of
the contract period and prevailing market conditions. Since currency exchange
transactions are usually conducted on a principal basis, no fees or commissions
are involved.
EUROPEAN CURRENCY UNIFICATION. Effective January 1, 1999, eleven of the
fifteen member countries of the European Union adopted a single European
currency, the Euro. The countries participating in the Economic and Monetary
Union ("EMU") are Austria, Belgium, Finland, France, Germany, Ireland, Italy,
Luxembourg, the Netherlands, Portugal and Spain. The four European Union
countries not currently participating in the EMU are Great Britain, Denmark,
Sweden and Greece. A new European Central Bank manages the monetary policy of
the new unified region, and the exchange rates among the EMU member countries
are permanently fixed. National currencies will continue to circulate until they
are replaced by Euro coins and bank notes by the middle of 2002.
STOCK INDEX FUTURES AND OPTIONS ON STOCK INDEX FUTURES CONTRACTS
The Equity Index Funds may invest in stock index futures and options on
stock index futures as a substitute for a comparable market position in the
underlying securities. A stock index future obligates the seller to deliver (and
the purchaser to take), effectively, an amount of cash equal to a specific
dollar amount times the difference between the value of a specific stock index
at the close of the last trading day of the contract and the price at which the
agreement is made. For stock indexes that are permitted investments, the Equity
Index Funds intend to purchase and sell futures contracts on the index for which
it can obtain the best price with consideration also given to liquidity. The
Equity Index Funds may purchase call and put options on stock index futures
contracts of the type which the particular Equity Index Fund is authorized to
enter into. Each Equity Index Fund may invest in such options for the purpose of
closing out a futures position that has become illiquid.
Options on futures contracts are traded on exchanges that are licensed
and regulated by the CFTC. A call option on a futures contract gives the
purchaser the right in return for the premium paid (but not the obligation), to
purchase a futures contract (assume a "long" position) at a specified exercise
price at any time before the option expires. A put option gives the purchaser
the right (but not the obligation), in return for the premium paid, to sell a
futures contract (assume a "short" position), for a specified exercise price, at
any time before the option expires.
Unlike entering into a futures contract itself, purchasing options on
futures contracts allows a buyer to decline to exercise the option, thereby
avoiding any loss beyond forgoing the purchase price (or "premium") paid for the
options. Whether an Equity Index Fund enters into a stock index futures
contract, on the one hand, or an option contract on a stock index futures
contract, on the other, will depend on all the circumstances, including the
particular objective to be achieved and the relative costs, liquidity,
availability and capital requirements of such futures
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and options contracts. Each Equity Index Fund will consider the relative
risks involved, which may be quite different. These factors, among others,
will be considered in light of market conditions.
The use of stock index futures contracts and options on such futures
contracts may entail the following risks. First, although such instruments when
used by a Equity Index Fund are intended to correlate with portfolio securities,
in many cases the futures contracts or options on futures contracts used may be
based on stock indices, the components of which are not identical to the
portfolio securities owned or intended to be acquired by the Equity Index Fund.
Second, due to supply and demand imbalances and other market factors, the price
movements of stock index futures contracts and options thereon may not
necessarily correspond exactly to the price movements of the stock indices on
which such instruments are based. Accordingly, there is a risk that transactions
in those instruments will not in fact offset the impact on the Equity Index Fund
of adverse market developments in the manner or to the extent contemplated or
that such transactions will result in losses which are not offset by gains with
respect to corresponding portfolio securities owned or to be purchased by that
Equity Index Fund.
To some extent, these risks can be minimized by careful management of
these strategies. For example, where price movements in a futures contract are
expected to be less volatile than price movements in the related portfolio
securities owned or intended to be acquired by an Equity Index Fund, the Equity
Index Fund may compensate for this difference by using an amount of futures
contracts which is greater than the amount of such portfolio securities.
Similarly, where the price movement of a futures contract is anticipated to be
more volatile, an Equity Index Fund may use an amount of such contracts which is
smaller than the amount of portfolio securities to which such contracts relate.
The risk that the hedging technique used will not actually or entirely
offset an adverse change in the value of an Equity Index Fund's securities is
particularly relevant to futures contracts. An Equity Index Fund, in entering
into a futures purchase contract, potentially could lose any or all of the
contract's settlement price. In addition, because stock index futures contracts
require delivery at a future date of an amount of cash equal to a multiple of
the difference between the value of a specified stock index on that date and the
settlement price, an algebraic relationship exists between any price movement in
the underlying index and the potential cost of settlement to an Equity Index
Fund. A small increase or decrease in the value of the underlying index can,
therefore, result in a much greater increase or decrease in the cost to the
Equity Index Fund.
Although the Equity Index Funds intend to establish positions in these
instruments only when there appears to be an active market, there is no
assurance that a liquid market for such instruments will exist when it seeks to
"close out" (I.E., terminate) a particular stock index futures contract
position. Trading in such instruments could be interrupted, for example, because
of a lack of either buyers or sellers. In addition, the futures exchanges may
suspend trading after the price of such instruments has risen or fallen more
than the maximum amount specified by the exchange.
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An Equity Index Fund may be able, by adjusting investment strategy in
the cash or other contract markets, to offset to some extent any adverse effects
of being unable to liquidate a futures position. Nevertheless, in some cases, an
Equity Index Fund may experience losses as a result of such inability. Therefore
it may have to liquidate other more advantageous investments to meet its cash
needs.
FCMs or brokers in certain circumstances will have access to an Equity
Index Fund assets posted as margin in connection with transactions in stock
index futures contracts and options, as permitted under the 1940 Act. An Equity
Index Fund will use only FCMs or brokers in whom it has full confidence.
Barclays will adopt certain procedures and limitations to reduce the risk of
loss of any Equity Index Fund assets which such FCM's or brokers hold or have
access. Nevertheless, in the event of a FCM's or broker's insolvency or
bankruptcy, it is possible that a Fund could experience a delay or incur costs
in recovering such assets or might recover less than the full amount due. Also
the value of such assets could decline by the time the Equity Index Fund could
effect such recovery.
The success of any Equity Index Fund in using these techniques depends,
among other things, on the ability of Barclays to predict the direction and
volatility of price movements in the futures markets as well as the securities
markets and on its ability to select the proper type, time, and duration of
futures contracts. There can be no assurance that these techniques will produce
their intended results. In any event, Barclays will use stock index futures
contracts and options thereon only when it believes the overall effect is to
reduce, rather than increase, the risks to which the Equity Index Fund is
exposed.
INTEREST RATE FUTURES CONTRACTS AND RELATED OPTIONS
The Bond Fund, Tax Advantaged Bond Fund and the Equity and Bond Fund
(through the Bond Fund) may invest in interest rate futures contracts and
options on such contracts that are traded on a domestic exchange or board of
trade. Such investments may be made by a Fund solely for the purpose of hedging
against changes in the value of its portfolio securities due to anticipated
changes in interest rates and market conditions, and not for purposes of
speculation. A public market exists for interest rate futures contracts covering
a number of debt securities, including long-term U.S. Treasury Bonds, ten-year
U.S. Treasury Notes, three-month U.S. Treasury Bills, Eurobonds, and three-month
domestic bank certificates of deposit. Other financial futures contracts may be
developed and traded. The purpose of the acquisition or sale of an interest rate
futures contract by a Fund, as the holder of municipal or other debt securities,
is to protect the Fund from fluctuations in interest rates on securities without
actually buying or selling such securities.
Unlike the purchase or sale of a security, no consideration is paid or
received by a Fund upon the purchase or sale of a futures contract. Initially, a
Fund will be required to deposit with the broker an amount of cash or cash
equivalents equal to approximately 10% of the contract amount (this amount is
subject to change by the board of trade on which the contract is traded and
members of such board of trade may charge a higher amount). This amount is known
as initial margin and is in the nature of a performance bond or good faith
deposit on the contract
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which is returned to the Fund upon termination of the futures contract,
assuming that all contractual obligations have been satisfied. Subsequent
payments, known as variation margin, to and from the broker, will be made on
a daily basis as the price of the index fluctuates, making the long and short
positions in the futures contract more or less valuable, a process known as
marking-to-market. At any time prior to the expiration of the contract, a
Fund may elect to close the position by taking an opposite position, which
will operate to terminate the Fund's existing position in the futures
contract.
A Fund may not purchase or sell futures contracts or purchase options
on futures contracts if, immediately thereafter, more than one-third of its net
assets would be hedged, or the sum of the amount of margin deposits on the
Fund's existing futures contracts and premiums paid for options would exceed 5%
of the value of the Fund's total assets. When a Fund enters into futures
contracts to purchase an index or debt security or purchase call options, an
amount of cash or appropriate liquid securities equal to the notional market
value of the underlying contract will be segregated to cover the positions,
thereby insuring that the use of the contract is unleveraged.
Although a Fund will enter into futures contracts only if an active
market exists for such contracts, there can be no assurance that an active
market will exist for the contract at any particular time. Most domestic futures
exchanges and boards of trade limit the amount of fluctuation permitted in
futures contract prices during a single trading day. The daily limit establishes
the maximum amount the price of a futures contract may vary either up or down
from the previous day's settlement price at the end of a trading session. Once
the daily limit has been reached in a particular contract, no trades may be made
that day at a price beyond that limit. The daily limit governs only price
movement during a particular trading day and therefore does not limit potential
losses because the limit may prevent the liquidation of unfavorable positions.
It is possible that futures contract prices could move to the daily limit for
several consecutive trading days with little or no trading, thereby preventing
prompt liquidation of futures positions and subjecting some futures traders to
substantial losses. In such event, it will not be possible to close a futures
position and, in the event of adverse price movements, a Fund would be required
to make daily cash payments of variation margin. In such circumstances, an
increase in the value of the portion of the portfolio being hedged, if any, may
partially or completely offset losses on the futures contract. As described
above, however, there is no guarantee the price of municipal bonds or of other
debt securities will, in fact, correlate with the price movements in the futures
contract and thus provide an offset to losses on a futures contract.
If a Fund has hedged against the possibility of an increase in interest
rates that would adversely affect the value of municipal bonds or other debt
securities held in its portfolio, and rates decrease instead, the Fund will lose
part or all of the benefit of the increased value of the securities it has
hedged because it will have offsetting losses in its futures positions. In
addition, in such situations, if a Fund has insufficient cash, it may have to
sell securities to meet daily variation margin requirements. Such sales of
securities may, but will not necessarily, be at increased prices which reflect
the decline in interest rates. A Fund may have to sell securities at a time when
it may be disadvantageous to do so.
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In addition, the ability of a Fund to trade in futures contracts and
options on futures contracts may be materially limited by the requirements of
the Internal Revenue Code of 1986, as amended (the "Code"), applicable to a
regulated investment company. See "Taxes" below.
A Fund may purchase put and call options on interest rate futures
contracts which are traded on a domestic exchange or board of trade as a hedge
against changes in interest rates, and may enter into closing transactions with
respect to such options to terminate existing positions. There is no guarantee
such closing transactions can be effected.
Options on futures contracts, as contrasted with the direct investment
in such contracts, give the purchaser the right, in return for the premium paid,
to assume a position in futures contracts at a specified exercise price at any
time prior to the expiration date of the options. Upon exercise of an option,
the delivery of the futures position by the writer of the option to the holder
of the option will be accompanied by delivery of the accumulated balance in the
writer's futures margin account, which represents the amount by which the market
price of the futures contract exceeds, in the case of a call, or is less than,
in the case of a put, the exercise price of the option on the futures contracts.
The potential loss related to the purchase of an option on interest rate futures
contracts is limited to the premium paid for the option (plus transaction
costs). Because the value of the option is fixed at the point of sale, there are
no daily cash payments to reflect changes in the value of the underlying
contract; however, the value of the option does change daily and that change
would be reflected in the net asset value of a Fund.
There are several risks in connection with the use of interest rate
futures contracts and options on such futures contracts as hedging devices.
Successful use of these derivative securities by a Fund is subject to the
Manager's ability to predict correctly the direction of movements in interest
rates. Such predictions involve skills and techniques which may be different
from those involved in the management of a long-term bond portfolio. There can
be no assurance that there will be a correlation between price movements in
interest rate futures, or related options, on the one hand, and price movements
in the debt securities which are the subject of the hedge, on the other hand.
Positions in futures contracts and options on futures contracts may be closed
out only on an exchange or board of trade that provides an active market;
therefore, there can be no assurance that a liquid market will exist for the
contract or the option at any particular time. Consequently, a Fund may realize
a loss on a futures contract that is not offset by an increase in the price of
the debt securities being hedged or may not be able to close a futures position
in the event of adverse price movements. Any income earned from transactions in
futures contracts and options on futures contracts will be taxable. Accordingly,
it is anticipated that such investments will be made only in unusual
circumstances, such as when the Manager anticipates an extreme change in
interest rates or market conditions.
See additional risk disclosure above under "Stock Index Futures
Contracts and Options on Stock Index Futures Contracts."
WARRANTS
The Small Cap Equity Fund, International Equity Fund, Bond Fund, Equity
and Bond Fund (through its investment in the Bond Fund) and Equity Index Funds
may invest in warrants
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or rights (other than those acquired in units or attached to other
securities), which entitle the purchaser to buy equity securities at a
specific price for a specific period of time. Warrants and rights have no
voting rights, receive no dividends and have no rights with respect to the
assets of the issuer. The Bond Fund may retain up to 10% of the value of its
total assets in common stocks acquired by the exercise of warrants attached
to debt securities.
MUNICIPAL BONDS
The obligations of municipal bond issuers are subject to the laws of
bankruptcy, insolvency and other laws affecting the rights and remedies of
creditors. In addition, the obligations of such issuers may become subject to
the laws enacted in the future by Congress, state legislatures or referenda
extending the time of payment of principal and/or interest, or imposing other
constraints upon enforcement of such obligations or upon municipalities to levy
taxes. There is also the possibility that, as a result of legislation or other
conditions, the power or ability of any issuer to pay, when due, the principal
and interest on its municipal obligations may be materially affected.
The Tax Advantaged Bond Fund will invest the assets not invested in
municipal bonds in interest-bearing demand notes, bank savings accounts, high
grade money market securities, U.S. treasury securities, or in shares of taxable
or tax-exempt money market mutual funds. Money market securities include
short-term obligations of the U.S. government and its agencies and
instrumentalities and other money market instruments such as domestic bank
certificates of deposit, bankers' acceptances and corporate commercial paper
rated in the highest grade. From time to time, the Fund may invest more than 20%
of its assets in money market securities. In the alternative, the Fund may hold
such assets as cash for defensive reasons in anticipation of a decline in the
market values of debt securities, or pending the investment of proceeds from the
sale of Fund shares or from the sale of portfolio securities, or in order to
have highly liquid securities available to meet possible redemptions.
MORTGAGE-BACKED SECURITIES
The Bond Fund and Equity and Bond Fund (through its investment in the
Bond Fund) may purchase mortgage-backed securities. Mortgage-backed securities
represent interests in pools of mortgages. The underlying mortgages normally
have similar interest rates, maturities and other terms. Mortgages may have
fixed or adjustable interest rates. Interests in pools of adjustable rate
mortgages are known as ARMs. Mortgage-backed securities come in a variety of
forms. Many have extremely complicated terms. The simplest form of
mortgage-backed securities is a "pass-through certificate." Holders of
pass-through certificates receive a pro rata share of the payments from the
underlying mortgages. Holders also receive a pro rata share of any prepayments,
so they assume all the prepayment risk of the underlying mortgages.
Collateralized mortgage obligations (CMOs) are complicated instruments
that allocate payments and prepayments from an underlying pass-through
certificate among holders of different classes of mortgage-backed securities.
This creates different prepayment and market risks for each CMO class.
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In addition, CMOs may allocate interest payments to one class (IOs) and
principal payments to another class (POs). POs increase in value when prepayment
rates increase. In contrast, IOs decrease in value when prepayments increase,
because the underlying mortgages generate less interest payments. However, IOs
prices tend to increase when interest rates rise (and prepayments fall), making
IOs a useful hedge against market risk.
Generally, homeowners have the option to prepay their mortgages at any
time without penalty. Homeowners frequently refinance high rate mortgages when
mortgage rates fall. This results in the prepayment of mortgage-backed
securities, which deprives holders of the securities of the higher yields.
Conversely, when mortgage rates increase, prepayments due to refinancings
decline. This extends the life of mortgage-backed securities with lower yields.
As a result, increases in prepayments of premium mortgage-backed securities, or
decreases in prepayments of discount mortgage-backed securities, may reduce
their yield and price.
This relationship between interest rates and mortgage prepayments makes
the price of mortgage-backed securities more volatile than most other types of
fixed income securities with comparable credit risks. Mortgage-backed securities
tend to pay higher yields to compensate for this volatility.
CMOs may include planned amortization classes (PACs) and targeted
amortization classes (TACs). PACs and TACs are issued with companion classes.
PACs and TACs receive principal payments and prepayments at a specified rate.
The companion classes receive principal payments and any prepayments in excess
of this rate. In addition, PACs will receive the companion classes' share of
principal payments if necessary to cover a shortfall in the prepayment rate.
This helps PACs and TACs to control prepayment risk by increasing the risk to
their companion classes.
Another variant allocates interest payments between two classes of
CMOs. One class (Floaters) receives a share of interest payments based upon a
market index such as London-Inter Bank Offering Rate ("LIBOR"). The other class
(Inverse Floaters) receives any remaining interest payments from the underlying
mortgages. Floater classes receive more interest (and Inverse Floater classes
receive correspondingly less interest) as interest rates rise. This shifts
prepayment and market risks from the Floater to the Inverse Floater class,
reducing the price volatility of Floater class and increasing the price
volatility of the Inverse Floater class.
CMOs must allocate all payments received from the underlying mortgages
to some class. To capture any unallocated payments, CMOs generally have an
accrual (Z) class. Z classes do not receive any payments from the underlying
mortgages until all other CMO classes have been paid off. Once this happens,
holders of Z class CMOs receive all payments and prepayments. Similarly, real
estate mortgage investment conduits (REMICs) (offerings of multiple class
mortgage backed securities which qualify and elect treatment as such under
provisions of the Code) have residual interests that receive any mortgage
payments not allocated to another REMIC class.
The degree of increased or decreased prepayment risk depends upon the
structure of the CMOs. Z classes, IOs, POs, and Inverse Floaters are among the
most volatile investment grade
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fixed income securities currently traded in the United States. However, the
actual returns on any type of mortgage backed security depends upon the
performance of the underlying pool of mortgages, which no one can predict and
will vary among pools.
ASSET-BACKED SECURITIES
The Bond Fund and Equity and Bond Fund (through its investment in the
Bond Fund) may purchase asset-backed securities, which represent direct or
indirect participations in, or are secured by and payable from, assets other
than mortgage-backed assets such as installment loan contracts, leases of
various types of real and personal property, motor vehicle installment sales
contracts and receivables from revolving credit (credit card) agreements. In
accordance with guidelines established by the Board of Trustees, asset-backed
securities may be considered illiquid securities and, therefore, may be subject
to a Fund's 15% (10% with respect to the Money Market Fund) limitation on such
investments. Asset-backed securities, including adjustable rate asset-backed
securities, have yield characteristics similar to those of mortgage-backed
securities and, accordingly, are subject to many of the same risks, including
prepayment risk.
Assets are securitized through the use of trusts and special purpose
corporations that issue securities that are often backed by a pool of assets
representing the obligations of a number of different parties. Payments of
principal and interest may be guaranteed up to certain amounts and for a certain
time period by a letter of credit issued by a financial institution.
Asset-backed securities do not always have the benefit of a security interest in
collateral comparable to the security interests associated with mortgage-backed
securities. As a result, the risk that recovery on repossessed collateral might
be unavailable or inadequate to support payments on asset-backed securities is
greater for asset-backed securities than for mortgage-backed securities. In
addition, because asset-backed securities are relatively new, the market
experience in these securities is limited and the market's ability to sustain
liquidity through all phases of an interest rate or economic cycle has not been
tested.
MONEY MARKET FUND
The Money Market Fund invests only in instruments denominated in U.S.
dollars that the Manager, under the supervision of the Trust's Board of
Trustees, determines present minimal credit risk and are, at the time of
acquisition, either:
1. rated in one of the two highest rating categories for
short-term debt obligations assigned by at least two nationally recognized
statistical rating organizations (NRSROs) (i.e., S&P and Moody's), or by only
one NRSRO if only one NRSRO has issued a rating with respect to the instrument
(requisite NRSROs); or
2. in the case of an unrated instrument, determined by the
Manager, under the supervision of the Trust's Board of Trustees, to be of
comparable quality to the instruments described in paragraph 1 above; or
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3. issued by an issuer that has received a rating of the type
described in paragraph 1 above on other securities that are comparable in
priority and security to the instrument.
Pursuant to Rule 2a-7 under the 1940 Act, securities which are rated
(or that have been issued by an issuer that has been rated with respect to a
class of short-term debt obligations, or any security within that class,
comparable in priority and quality with such security) in the highest short-term
rating category by at least two NRSROs are designated "First Tier Securities."
Securities rated in the top two short-term rating categories by at least two
NRSROs, but which are not rated in the highest short-term category by at least
two NRSROs, are designated "Second Tier Securities." See APPENDIX A for a
description of the ratings used by NRSROs.
Pursuant to Rule 2a-7 under the 1940 Act, the Money Market Fund may not
invest more than 5% of its assets taken at amortized cost in the securities of
any one issuer (except the U.S. Government, including repurchase agreements
collateralized by U.S. Government Securities (discussed above)). The Fund may,
however, invest more than 5% of its assets in the First Tier Securities of a
single issuer for a period of up to three business days after the purchase
thereof, although the Fund may not make more than one such investment at any
time.
Further, the Money Market Fund will not invest more than the greater of
(i) 1% of its total assets; or (ii) one million dollars in the securities of a
single issuer that were Second Tier Securities when acquired by the Fund. In
addition, the Fund may not invest more than 5% of its total assets in securities
which were Second Tier Securities when acquired.
The foregoing policies are more restrictive than the fundamental
investment restriction number 2b (set forth below) applicable to the Money
Market Fund, which would give the Fund the ability to invest, with respect to
25% of its assets, more than 5% of its assets in any one issuer. The Fund will
operate in accordance with these policies to comply with Rule 2a-7.
FOREIGN MONEY MARKET INSTRUMENTS
Each of the Funds that invest in foreign securities may also invest up
to 25% of its assets in foreign money market instruments. Foreign money market
instruments include Eurodollar Certificates of Deposit (ECDs), Yankee dollar
Certificates of Deposit (YCDs) and Eurodollar Time Deposits (ETDs), which are
all U.S. dollar denominated certificates of deposit. ECDs are issued by, and
ETDs are deposits of, foreign banks or foreign branches of U.S. banks. YCDs are
issued in the U.S. by branches and agencies of foreign banks. Europaper is
dollar-denominated commercial paper and other short-term notes issued in the
U.S. by foreign issuers.
ECDs, ETDs, YCDs, and Europaper have many of the same risks as other
foreign securities. Examples of these risks include economic and political
developments, that may adversely affect the payment of principal or interest,
foreign withholding or other taxes on interest income, difficulties in obtaining
or enforcing a judgment against the issuing bank and the possible impact of
interruptions in the flow of international currency transactions. Also, the
issuing banks or their branches are not necessarily subject to the same
regulatory requirements that apply to domestic banks, such as reserve
requirements, loan limitations, examinations, accounting, auditing,
recordkeeping and the public availability of information.
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CASH AND CASH EQUIVALENTS
Each of the Funds may invest in cash and cash equivalents. These
securities include (1) commercial paper (short-term notes issued by corporations
or governmental bodies), (2) commercial bank obligations (e.g. certificates of
deposit (interest-bearing time deposits) and bankers' acceptances (time drafts
on a commercial bank where the bank accepts an irrevocable obligation to pay at
maturity), (3) savings association and bank obligations (e.g. certificates of
deposit issued by savings banks or savings associations), (4) U.S. Government
Securities that mature, or may be redeemed, in one year or less, (5) corporate
bonds and notes that mature, or that may be redeemed, in one year or less, (6)
money market mutual funds and (7) short-term investment funds maintained by the
Fund's custodian.
REPURCHASE AGREEMENTS
Repurchase agreements are transactions in which a Fund purchases a
security from a bank or recognized securities dealer and simultaneously commits
to resell that security to the bank or dealer at an agreed-upon price, date, and
market rate of interest unrelated to the coupon rate or maturity of the
purchased security. Although repurchase agreements carry certain risks not
associated with direct investments in securities, a Fund will enter into
repurchase agreements only with banks and dealers that either the Manager,
Barclays or Capital Guardian Trust Company ("Capital Guardian"), the sub-adviser
to Small Cap Equity Fund and International Equity Fund, believe present minimum
credit risks in accordance with guidelines approved by the Board of Trustees.
The Manager, Barclays or Capital Guardian will review and monitor the
creditworthiness of such institutions, and will consider the capitalization of
the institution, their prior dealings with the institution, any rating of the
institution's senior long-term debt by independent rating agencies, and other
relevant factors. Any of the Manager, Barclays or Capital Guardian may cause a
Fund to participate in pooled repurchase agreement transactions with other funds
advised by them.
A Fund will invest only in repurchase agreements collateralized at all
times in an amount at least equal to the repurchase price plus accrued interest.
To the extent that the proceeds from any sale of such collateral upon a default
in the obligation to repurchase were less than the repurchase price, the Fund
would suffer a loss. If the financial institution which is party to the
repurchase agreement petitions for bankruptcy or otherwise becomes subject to
bankruptcy or other liquidation proceedings there may be restrictions on the
ability to sell the collateral and the Fund could suffer a loss. However, with
respect to financial institutions whose bankruptcy or liquidation proceedings
are subject to the U.S. Bankruptcy Code, each Fund intends to comply with
provisions under such Code that would allow it immediately to resell such
collateral. None intend to invest more than 15% of its total assets in
repurchase agreements.
PRIVATELY ISSUED SECURITIES
A Fund may invest in privately issued securities, including those that
may be resold only in accordance with Rule 144A under the Securities Act of 1933
("Rule 144A Securities"). Rule 144A Securities are restricted securities that
are not publicly traded. Accordingly, the liquidity of the market for specific
Rule 144A Securities may vary. Delay or difficulty in selling such
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securities may result in a loss to the Fund. Privately issued or Rule 144A
securities that are determined by the Manager, Capital Guardian or Barclays
to be "illiquid" are subject to the Trust's policy of not investing more than
15% (10% in the case of the Money Market Fund) of its net assets in illiquid
securities. The Manager, Capital Guardian or Barclays will evaluate the
liquidity characteristics of each Rule 144A Security proposed for purchase by
a Fund on a case-by-case basis and will consider the following factors, among
others, in their evaluation: (1) the frequency of trades and quotes for the
Rule 144A Security; (2) the number of dealers willing to purchase or sell the
Rule 144A Security and the number of other potential purchasers; (3) dealer
undertakings to make a market in the Rule 144A Security; and (4) the nature
of the Rule 144A Security and the nature of the marketplace trades (e.g., the
time needed to dispose of the Rule 144A Security, the method of soliciting
offers and the mechanics of transfer).
FORWARD COMMITMENTS, WHEN-ISSUED AND DELAYED DELIVERY SECURITIES
A Fund may purchase securities on a when-issued or delayed delivery
basis and make contracts to purchase or sell securities for a fixed price at a
future date beyond customary settlement time. Although the payment and interest
terms of these securities are established at the time the Fund enters into the
commitment, the securities may be delivered and paid for a month or more after
the date of purchase, when their value may have changed. A Fund makes such
commitments only with the intention of actually acquiring the securities, but
may sell the securities before the settlement date if the Manager, Barclays or
Capital Guardian deem it advisable for investment reasons.
When-issued securities include TBA ("to be announced") securities. TBA
securities are usually mortgage-backed securities that are purchased on a
forward commitment basis with an approximate principal amount and no defined
maturity date. The actual principal amount and maturity date are determined upon
settlement when the specific mortgage pools are assigned. A Fund generally would
not pay for such securities or start earning interest on them until they are
received. However, when a Fund undertakes a when-issued or delayed delivery
obligation, it immediately assumes the risks of ownership, including the risks
of price fluctuation. Failure of the issuer to deliver a security purchased by a
Fund on a when-issued or delayed delivery basis may result in the Fund's
incurring or missing an opportunity to make an alternative investment.
A Fund may enter into reverse repurchase agreements with banks and
securities dealers. A reverse repurchase agreement is a repurchase agreement in
which the Fund is the seller of, rather than the investor in, securities and
agrees to repurchase them at an agreed-upon time and price. Use of a reverse
repurchase agreement, may be preferable to a regular sale and later repurchase
of securities because it avoids certain market risks and transaction costs.
At the time a Fund enters into a binding obligation to purchase
securities on a when-issued basis or enters into a reverse repurchase agreement,
assets of the Fund having a value at least as great as the purchase price of the
securities to be purchased will be segregated on the books of the fund and held
by the custodian throughout the period of the obligation. The use of these
investment strategies, as well as any borrowing by a Fund, may increase net
asset value
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fluctuation. None of the Funds has any present intention of investing more
than 5% of its total assets in reverse repurchase agreements.
LOANS OF PORTFOLIO SECURITIES
Each Fund may from time to time lend securities that it holds to
brokers, dealers and financial institutions, up to a maximum of 33% of the total
value of each Fund's assets. This percentage may not be increased without
approval of a majority of the outstanding voting securities of the respective
Fund. Such loans will be secured by collateral in the form of cash or United
States Treasury securities, or other liquid securities as permitted by the
Commission, which at all times while the loan is outstanding, will be maintained
in an amount at least equal to the current market value of the loaned
securities. The Fund making the loan will continue to receive interest and
dividends on the loaned securities during the term of the loan, and, in
addition, will receive a fee from the borrower or interest earned from the
investment of cash collateral in short-term securities. The Fund also will
receive any gain or loss in the market value of loaned securities and of
securities in which cash collateral is invested during the term of the loan.
The right to terminate a loan of securities, subject to appropriate
notice, will be given to either party. When a loan is terminated, the borrower
will return the loaned securities to the appropriate Fund. No Fund will have the
right to vote securities on loan, but each would terminate a loan and regain the
right to vote if the Board of Trustees deems it to be necessary in a particular
instance.
For tax purposes, the dividends, interest and other distributions which
a Fund receives on loaned securities may be treated as other than qualified
income for the 90% test. (See TAXES--GENERAL TAX INFORMATION.) Each Fund intends
to lend portfolio securities only to the extent that this activity does not
jeopardize its status as a regulated investment company under the Code.
The primary risk involved in lending securities is that the borrower
will fail financially and return the loaned securities at a time when the
collateral is insufficient to replace the full amount of the loan. The borrower
would be liable for the shortage, but the Fund making the loan would be an
unsecured creditor with respect to such shortage and might not be able to
recover all or any of it. In order to minimize this risk, each Fund will make
loans of securities only to firms the Manager, Capital Guardian or Barclays
(under the supervision of the Board of Trustees) deems creditworthy.
DEFENSIVE INVESTMENTS
Under ordinary circumstances, each Fund is substantially fully
invested. However, except for the Money Market Fund and the Equity Index Funds,
each Fund may also hold cash, cash equivalents, or money market instruments if
the Manager or Capital Guardian determine that a temporary defensive position is
advisable. During those periods, a Fund's assets may not be invested in
accordance with its strategy and the Fund may not achieve its investment
objective.
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INVESTMENT POLICIES AND RESTRICTIONS
FUNDAMENTAL RESTRICTIONS
The Funds are subject to certain fundamental restrictions on their
investments. These restrictions may not be changed without the approval of the
holders of a majority of the outstanding voting shares of the Funds affected by
the change.
1. DIVERSIFICATION. No Fund will make any investment inconsistent with the
Fund's classification as a diversified company under the 1940 Act. This
restriction does not apply to any Fund classified as a non-diversified
company under the 1940 Act.
2a. INDUSTRY CONCENTRATION - EQUITY FUND, SMALL CAP EQUITY FUND, INTERNATIONAL
EQUITY FUND, EQUITY AND BOND FUND AND BOND FUND. The Equity Fund, Small Cap
Equity Fund, International Equity Fund, Equity and Bond Fund and Bond Fund
will not invest 25% or more of their total assets (taken at market value at
the time of each investment) in the securities of issuers primarily engaged
in the same industry (excluding the U.S. Government or any of its agencies
or instrumentalities).
2b. INDUSTRY CONCENTRATION - MONEY MARKET FUND. The Money Market Fund will not
invest 25% or more of its assets (taken at market value at the time of each
investment), other than U.S. Government securities, obligations (other than
commercial paper) issued or guaranteed by U.S. banks and U.S. branches of
foreign banks, and repurchase agreements and securities loans
collateralized by U.S. Government securities or such bank obligations, in
the securities of issuers primarily engaged in the same industry.
2c. INDUSTRY CONCENTRATION - EQUITY INDEX FUNDS. The Equity Index Funds will
concentrate their investments in an industry or industries if, and
approximately to the extent that, their benchmark indices concentrate in
such industry or industries, except where the concentration of the relevant
index is the result of a single stock.
2d. INDUSTRY CONCENTRATION - TAX ADVANTAGED BOND FUND. The Tax Advantaged Bond
Fund may not invest in securities other than municipal securities, except
that it may make temporary investments (up to 20% of its total assets under
normal circumstances) in certain short-term taxable securities issued by or
on behalf of municipal or corporate issuers, obligations of the United
States Government and its agencies or instrumentalities, commercial paper,
bank certificates of deposit, and any such items subject to short-term
repurchase agreements.
3. INTERESTS IN REAL ESTATE. No Fund will purchase real estate or any interest
therein, except through the purchase of corporate or certain government
securities (including securities secured by a mortgage or a leasehold
interest or other interest in real estate). A security issued by a real
estate or mortgage investment trust is not treated as an interest in real
estate.
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4. UNDERWRITING. No Fund will underwrite securities of other issuers except
insofar as the Trust may be deemed an underwriter under the Securities Act
of 1933 in selling portfolio securities.
5. BORROWING. No Fund will borrow money, except that, for temporary purposes,:
(a) a Fund may borrow from banks (as defined in the 1940 Act) or through
reverse repurchase agreements in amounts up to 33 1/3% of its total assets
(including the amount borrowed), taken at market value at the time of the
borrowing; (b) a Fund may, to the extent permitted by applicable law,
borrow up to an additional 5% of its total assets (including the amount
borrowed), taken at market value at the time of the borrowing; and (c) a
Fund may obtain such short-term credits as may be necessary for clearance
of purchases and sales of portfolio securities. An Equity Index Fund may
not borrow money for any purpose.
6. LENDING. No Fund will lend any security or make any other loan, except
through: (a) the purchase of debt obligations in accordance with the Fund's
investment objective or objectives and policies; (b) repurchase agreements
with banks, brokers, dealers, and other financial institutions; and (c)
loans of securities as permitted by applicable law.
7. COMMODITIES. No Fund will purchase or sell commodities or commodity
contracts, except that a Fund may (a) enter into futures, options and
options on futures, (b) forward contracts and (c) other financial
transactions not requiring the delivery of physical commodities.
8. SENIOR SECURITIES. No Fund will issue senior securities except to the
extent the activities permitted in Fundamental Restrictions Nos. 5 and 7
may be deemed to give rise to a senior security.
9a. INVESTMENTS - TAX ADVANTAGED BOND FUND. The Tax Advantaged Bond Fund will
(i) invest at least 80% of its assets in tax-exempt securities; or (ii)
invest its assets so that at least 80% of the income will be tax-exempt.
9b. EQUITY INDEX FUNDS. Each of the Equity Index Funds may, notwithstanding any
other fundamental policy or restrictions invest all of its assets in the
securities of a single open-end management investment company with
substantially the same fundamental investment objective, policies and
restrictions of such Equity Index Fund.
9c. INVESTMENTS - EQUITY AND BOND FUND. The Equity and Bond Fund will not
invest in securities other than securities of other registered investment
companies or registered unit investment trusts that are part of the State
Farm group of investment companies, U.S. Government securities, or
short-term paper.
For the purposes of the restrictions relating to industry
concentration, the restrictions noted above in Item 2 do not apply to securities
issued or guaranteed by the U.S. government or its agencies or
instrumentalities.
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NON-FUNDAMENTAL RESTRICTIONS
The Trust also has adopted the following additional investment
restrictions applicable (except as noted) to all Funds. These are not
fundamental and may be changed by the Board of Trustees without shareholder
approval.
1. FINANCIAL FUTURES CONTRACTS. No Fund may enter into a financial futures
contract (by exercise of any option or otherwise) or acquire any options
thereon, if, immediately thereafter, the total of the initial margin
deposits required with respect to all open futures positions, at the time
such positions were established, plus the sum of the premiums paid for all
unexpired options on futures contracts would exceed 5% of the value of its
total assets.
2. MARGIN PURCHASES. No Fund may purchase any securities on margin except in
connection with investments of certain Funds in futures contracts or
options on futures contracts.
3. PLEDGING ASSETS. No Fund may mortgage, pledge, hypothecate or in any manner
transfer, as security for indebtedness, any securities owned or held by
such Fund except: (a) as may be necessary in connection with borrowings
mentioned in fundamental restriction number 5 above, and then such
mortgaging, pledging or hypothecating may not exceed 10% of the Fund's
total assets, taken at market value at the time thereof, or (b) in
connection with investments of certain Funds in futures contracts or
options on futures contracts.
4a. ILLIQUID SECURITIES AND REPURCHASE AGREEMENTS. No Fund may purchase
securities or enter into a repurchase agreement if, as a result, more than
15% of its net assets would be invested in any combination of:
(i) repurchase agreements not entitling the holder to payment of principal
and interest within seven days, and
(ii) securities that are illiquid by virtue of legal or contractual
restrictions on resale or the absence of a readily available market.
4b. ILLIQUID SECURITIES AND REPURCHASE AGREEMENTS - MONEY MARKET FUND. In
addition to the non-fundamental restriction in 4a above, the Money Market
Fund will not invest in illiquid securities, including certain repurchase
agreements or time deposits maturing in more than seven days, if, as a
result thereof, more than 10% of the value of its net assets would be
invested in assets that are either illiquid or are not readily marketable.
5. INVESTMENTS IN OTHER INVESTMENT COMPANIES. No Fund may invest more than 5%
of its total assets in the securities of any single investment company or
more than 10% of its total assets in the securities of other investment
companies in the aggregate, or hold more than 3% of the total outstanding
voting stock of any single investment company. These restrictions do not
apply to the Equity and Bond Fund.
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Non-fundamental restriction #5 does not apply to the Equity Index Funds
because each Equity Index Fund seeks to achieve its investment objective by
investing substantially all of its assets in a Master Portfolio.
OPERATING POLICIES OF THE S&P 500 INDEX MASTER PORTFOLIO AND INTERNATIONAL
INDEX MASTER PORTFOLIO
The S&P 500 Index Master Portfolio and the International Index Master
Portfolio is subject to the following fundamental investment limitations which
cannot be changed without approval by the holders of a majority (as defined in
the 1940 Act) of the Master Portfolio's outstanding voting securities. To obtain
approval, a majority of the Master Portfolio's outstanding voting securities
means the vote of the lesser of: (1) 67% or more of the voting securities
present, if more than 50% of the outstanding voting securities are present or
represented, or (2) more than 50% of the outstanding voting shares.
Neither of these Master Portfolios may:
1. Invest more than 5% of its assets in the obligations of any
single issuer, except that up to 25% of the value of its
total assets may be invested, and securities issued or
guaranteed by the U.S. government, or its agencies or
instrumentalities may be purchased, without regard to any
such limitation. With respect to the International Index
Master Portfolio, this limitation does not apply to foreign
currency transactions, including, without limitation,
forward currency contracts.
2. Hold more than 10% of the outstanding voting securities of
any single issuer. This investment restriction applies only
with respect to 75% of its total assets.
3. Invest in commodities, except that a Master Portfolio may
purchase and sell (i.e., write) options, forward contracts,
futures contracts, including those relating to indexes, and
options on futures contracts or indexes.
4. Purchase, hold or deal in real estate, or oil, gas or other
mineral leases or exploration or development programs, but a
Master Portfolio may purchase and sell securities that are
secured by real estate or issued by companies that invest or
deal in real estate.
5. Borrow money, except to the extent permitted under the 1940
Act, provided that the Master Portfolio may borrow up to 20%
of the current value of its net assets for temporary
purposes only to meet redemptions, and these borrowings may
be secured by the pledge of up to 20% of the current value
of its net assets (but, with respect to the S&P 500 Index
Master Portfolio, investment may not be purchased while any
such outstanding borrowing in excess of 5% of its net assets
exists). For purposes of this investment restriction, a
Master Portfolio's entry into
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<PAGE>
options, forward contracts, futures contracts, including
those relating to indexes, and options on futures contracts
or indexes shall not constitute borrowing to the extent
certain segregated accounts are established and maintained
by such Master Portfolio.
6. Make loans to others, except through the purchase of debt
obligations and the entry into repurchase agreements.
However, a Master Portfolio may lend its portfolio
securities in an amount not to exceed one-third of the value
of its total assets. Any loans of portfolio securities will
be made according to guidelines established by the
Commission and the Master Fund's Board of Trustees.
7. Act as an underwriter of securities or other issuers, except
to the extent that a Master Portfolio may be deemed an
underwriter under the Securities Act of 1933, as amended, by
virtue of disposing of portfolio securities.
8. Invest 25% of more of its total assets in the securities of
issuers in any particular industry or group of closely
related industries except that there shall be no limitation
with respect to investments in (i) obligations of the U.S.
government, its agencies or instrumentalities; (ii) in the
case of the S&P 500 Index Master Portfolio, any industry in
which the S&P 500 Index becomes concentrated to the same
degree during the same period, the Master Portfolio will be
concentrated as specified above only to the extent the
percentage of its assets invested in those categories of
investments is sufficiently large that 25% or more of its
total assets would be invested in a single industry; or
(iii) in the case of International Index Master Portfolio
any industry in which EAFE Free Index becomes concentrated
to the same degree during the same period, the Master
Portfolio will be concentrated as specified above only to
the extent the percentage of assets invested in those
categories of investments is sufficiently large that 25% or
more of its total assets would be invested in a single
industry.
9. Issue any senior security (as such term is defined in
Section 18(f) of the 1940 Act), except to the extent the
activities permitted in the Master Portfolio's fundamental
policies (3) and (5) may be deemed to give rise to a senior
security.
10. In the case of the S&P 500 Index Master Portfolio, purchase
securities on margin, but the Master Portfolio may make
margin deposits in connection with transactions in options,
forward contracts, futures contracts, including those
related to indexes, and options on futures contracts or
indexes.
The S&P 500 Index Master Portfolio and the International Index Master
Portfolio are subject to the following non-fundamental operation policies which
may be changed by the Board
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<PAGE>
of Trustees of the Master Fund without the approval of the holders of the
Master Portfolio's outstanding securities. The Master Portfolios may:
1. invest in shares of other open-end management investment
companies, subject to the limitations of Section 12(d)(1) of
the 1940 Act. Under the 1940 Act, a Master Portfolio's
investment in such securities currently is limited, subject
to certain exceptions, to (i) 3% of the total voting stock
of any one investment company, (ii) 5% of such Master
Portfolio's net assets with respect to any one investment
company, and (iii) 10% of such Master Portfolio's net assets
in the aggregate. Other investment companies in which a
Master Portfolio invests can be expected to charge fees for
operating expenses, such as investment advisory and
administration fees, that would be in addition to those
charged by the Master Portfolio.
2. not invest more than 15% of its net assets in illiquid
securities. For this purpose, illiquid securities include,
among others, (i) securities that are illiquid by virtue of
the absence of a readily available market or legal or
contractual restrictions on resale, (ii) fixed time deposits
that are subject to withdrawal penalties and that have
maturities of more than seven days, and (iii) repurchase
agreements not terminable within seven days.
3. lend securities from its portfolio to brokers, dealers and
financial institutions, in amounts not to exceed (in the
aggregate) one-third of the Master Portfolio's total assets.
Any such loans of portfolio securities will be fully
collateralized based on values that are marked to market
daily. The Master Portfolio will not enter into any
portfolio security lending arrangement having a duration of
longer than one year.
If a percentage restriction is adhered to at the time of investment, a
later change in percentage resulting from a change in values or assets will not
constitute a violation of such restriction.
OPERATING POLICIES OF THE RUSSELL 2000 MASTER PORTFOLIO
The Russell 2000 Master Portfolio is subject to the following
fundamental investment limitations which cannot be changed without approval by
the holders of a majority (as defined in the 1940 Act) of the Master Portfolio's
outstanding voting securities. To obtain approval, a majority of the Master
Portfolio's outstanding voting securities means the vote of the lesser of: (1)
67% or more of the voting securities present, if more than 50% of the
outstanding voting securities are present or represented, or (2) more than 50%
of the outstanding voting shares.
The Russell 2000 Index Master Portfolio may not:
1. Purchase the securities of issuers conducting their
principal business activity in the same industry if,
immediately after the purchase and as a result thereof, the
value of the Master Portfolio's investments in that
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<PAGE>
industry would equal or exceed 25% of the current value of
the Master Portfolio's total assets, provided that this
restriction does not limit the Master Portfolio's: (i)
investments in securities of other investment companies,
(ii) investments in securities issued or guaranteed by the
U.S. Government, its agencies or instrumentalities, or
(iii) investments in repurchase agreements provided further
that the Master Portfolio reserves the right to concentrate
in the obligations of domestic banks (as such term is
interpreted by the SEC or its staff); and provided further
that the Master Portfolio reserves the right to concentrate
in any industry in which the Russell 2000 Index becomes
concentrated to the same degree during the same period.
2. Purchase securities of any issuer if, as a result, with
respect to 75% of the Master Portfolio's total assets, more
than 5% of the value of its total assets would be invested
in the securities of any one issuer or the Master
Portfolio's ownership would be more than 10% of the
outstanding voting securities of such issuer, provided that
this restriction does not limit the Master Portfolio's
investments in securities issued or guaranteed by the U.S.
Government, its agencies and instrumentalities, or
investments in securities of other investment companies.
3. Borrow money, except to the extent permitted under the 1940
Act, including the rules, regulations and any orders
obtained thereunder.
4. Issue senior securities, except to the extent permitted
under the 1940 Act, including the rules, regulations and any
orders obtained thereunder.
5. Make loans to other parties if, as a result, the aggregate
value of such loans would exceed one-third of the Master
Portfolio's total assets. For the purposes of this
limitation, entering into repurchase agreements, lending
securities and acquiring any debt securities are not deemed
to be the making of loans.
6. Underwrite securities of other issuers, except to the extent
that the purchase of permitted investments directly from the
issuer thereof or from an underwriter for an issuer and the
later disposition of such securities in accordance with a
Master Portfolio's investment program may be deemed to be an
underwriting.
7. Purchase or sell real estate unless acquired as a result of
ownership of securities or other instruments (but this shall
not prevent the Master Portfolio from investing in
securities or other instruments backed by real estate or
securities of companies engaged in the real estate
business).
8. Purchase or sell commodities, provided that (i) currency
will not be deemed to be a commodity for purposes of this
restriction, (ii) this
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<PAGE>
restriction does not limit the purchase or sale of futures
contracts, forward contracts or options, and (iii) this
restriction does not limit the purchase or sale of
securities or other instruments backed by commodities or
the purchase or sale of commodities acquired as a result of
ownership of securities or other instruments.
The Russell 2000 Index Master Portfolio has adopted the following
investment restrictions as non-fundamental policies. These restrictions may be
changed without interestholder approval by voter of a majority of the Trustees
of the Master Fund, at any time. The Master Portfolio is subject to the
following investment restrictions, all of which are non-fundamental policies.
1. The Master Portfolio may invest in shares of other open-end
management investment companies, subject to the limitations
of Section 12(d)(1) of the 1940 Act. Under the 1940 Act, the
Master Portfolio's investment in such securities currently
is limited, subject to certain exceptions, to (i) 3% of the
total voting stock of any one investment company, (ii) 5% of
the Master Portfolio's total assets with respect to any one
investment company, and (iii) 10% of the Master Portfolio's
total assets in the aggregate. Other investment companies in
which the Master Portfolio invests can be expected to charge
fees for operating expenses, such as investment advisory and
administrative fees, that would be in addition to those
charged by the Master Portfolio
2. The Master Portfolio may not invest more than 15% of its net
assets in illiquid securities. For this purpose, illiquid
securities include, among others, (a) securities that are
illiquid by virtue of the absence of a readily available
market or legal or contractual restrictions on resale, (b)
fixed time deposits that are subject to withdrawal penalties
and that have maturities of more than seven days, and (c)
repurchase agreements not terminable within seven days.
3. The Master Portfolio may lend securities from its portfolio
to brokers, dealers and financial institutions, in amounts
not to exceed (in the aggregate) one-third of the Master
Portfolio's total assets. Any such loans of portfolio
securities will be fully collateralized based on values that
are marked to market daily. The Master Portfolio will not
enter into any portfolio security lending arrangement having
a duration of longer than one year.
MORE ABOUT THE EQUITY INDEX FUNDS
MASTER/FEEDER STRUCTURE
The Equity Index Funds seek to achieve their investment objective by
investing all of their assets into Master Portfolios of the Master Fund. The
Equity Index Funds and other entities
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<PAGE>
investing in Master Portfolios are each liable for all obligations of the
Master Portfolio. However, the risk of the Equity Index Funds incurring
financial loss on account of such liability is limited to circumstances in
which both inadequate insurance existed and the Master Fund itself is unable
to meet its obligations. Accordingly, the Trust's Board of Trustees believes
that neither the Equity Index Funds nor their respective shareholders will be
adversely affected by investing assets in the Master Portfolios. However, if
a mutual fund or other investor withdraws its investment from a Master
Portfolio, the economic efficiencies (e.g., spreading fixed expenses among a
larger asset base) that the Trust's Board believes may be available through
investment in a Master Portfolio may not be fully achieved. In addition,
given the relative novelty of the master/feeder structure, accounting or
operational difficulties, although unlikely, could arise.
An Equity Index Fund may withdraw its investment in the Master
Portfolios only if the Trust's Board of Trustees determines that such action is
in the best interests of the Equity Index Fund and its shareholders. Upon any
such withdrawal, the Trust's Board would consider alternative investments,
including investing all of the Fund's assets in another investment company with
the same investment objective as the Fund or hiring an investment adviser to
manage the Fund's assets in accordance with the investment policies described
below with respect to a Master Portfolio.
The investment objective and other fundamental policies of a Master
Portfolio cannot be changed without approval by the holders of a majority (as
defined in the 1940 Act) of the Master Portfolio's outstanding interests.
Whenever an Equity Index Fund, as an interestholder of a Master Portfolio, is
requested to vote on any matter submitted to interestholders of the Master
Portfolio, the Equity Index Fund will either (1) hold a meeting of its
shareholders to consider such matters, and cast its votes in proportion to the
votes received from its shareholders (shares for which the Equity Index Fund
receives no voting instructions will be voted in the same proportion as the
votes received from the other Equity Index Fund shareholders); or (2) cast its
votes, as an interestholder of the Master Portfolio, in proportion to the votes
received by the Master Portfolio from all other interestholders of the Master
Portfolio.
Certain policies of the Master Portfolios which are non-fundamental may
be changed by vote of a majority of the Master Fund's Trustees without
interestholder approval. If the Master Portfolio's investment objective or
fundamental or non-fundamental policies are changed, the Equity Index Fund may
elect to change its objective or policies to correspond to those of the Master
Portfolio. The Equity Index Fund also may elect to redeem its interests in the
Master Portfolio and either seek a new investment company with a matching
objective in which to invest or retain its own investment adviser to manage the
Equity Index Fund's portfolio in accordance with its objective. In the latter
case, the Equity Index Fund's inability to find a substitute investment company
in which to invest or equivalent management services could adversely affect
shareholders' investments in the Equity Index Fund. The Equity Index Fund will
provide shareholders with 30 days' written notice prior to the implementation of
any change in the investment objective of the Equity Index Fund or the Master
Portfolio, to the extent possible.
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<PAGE>
SELECTION OF INVESTMENTS FOR THE MASTER PORTFOLIO
The manner in which stocks are chosen for each of the Equity Index Fund
differs from the way securities are chosen in most other mutual funds. Unlike
other mutual funds where the portfolio securities are chosen by an investment
adviser based upon the adviser's research and evaluations, stocks are selected
for inclusion in a Master Portfolio's portfolio to have aggregate investment
characteristics (based on market capitalization and industry weightings),
fundamental characteristics (such as return variability, earnings valuation and
yield) and liquidity measures similar to those of the benchmark index taken in
its entirety.
As briefly discussed in the Prospectus, the S&P 500 Index Master
Portfolio generally holds every stock in the S&P 500. However, each of the
Russell 2000 Index Master Portfolio and International Index Master Portfolio
generally do not hold all of the issues that comprise their respective benchmark
index, due in part to the costs involved and, in certain instances, the
potential illiquidity of certain securities. Instead, the Russell 2000 Index
Master Portfolio attempts to hold a representative sample of the securities in
its benchmark index, which are selected by Barclays utilizing quantitative
analytical models in a technique known as "portfolio sampling." Under this
technique, each stock is considered for inclusion in the Master Portfolio based
on its contribution to certain capitalization, industry and fundamental
investment characteristics. The International Index Master Portfolio holds
securities selected by Barclays utilizing a quantitative model known as minimum
variance optimization. Under this technique, stocks are selected for inclusion
if the fundamental investment characteristics of the security reduce the
portfolio's predicted tracking error against the benchmark index. Barclays seeks
to construct the portfolio of each of the Russell 2000 Index Master Portfolio
and International Index Master Portfolio so that, in the aggregate, their
capitalization, industry and fundamental investment characteristics perform like
those of their benchmark index.
Over time, the portfolio composition of each Master Portfolio may be
altered (or "rebalanced") to reflect changes in the characteristics of its
benchmark index or, for the Russell 2000 Index Master Portfolio and the
International Index Master Portfolio, with a view to bringing the performance
and characteristics more in line with that of their benchmark index. Such
rebalancings will require the Master Portfolios to incur transaction costs and
other expenses. Each of the Russell 2000 Index Master Portfolio and
International Index Master Portfolio reserve the right to invest in all of the
securities in their benchmark index.
TRACKING ERROR
Barclays uses the "expected tracking error" of a Master Portfolio as a
way to measure the Master Portfolios' performance relative to the performance of
its benchmark index. An expected tracking error of 5% means that there is a 68%
probability that the net asset value of the Master Portfolio will be between 95%
and 105% of the subject index level after one year, without rebalancing the
portfolio composition. A tracking error of 0% would indicate perfect tracking,
which would be achieved when the net asset value of the Master Portfolio
increases or decreases in exact proportion to changes in its benchmark index.
Factors such as expenses of the Master Portfolio, taxes, the need to comply with
the diversification and other requirements of the Code
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<PAGE>
and other requirements may adversely impact the tracking of the performance
of a Master Portfolio to that of its benchmark index. In the event that
tracking error exceeds 5%, the Board of Trustees of the Trust will consider
what action might be appropriate to reduce the tracking error.
RELATIONSHIP WITH THE INDEX PROVIDERS
STANDARD & POOR'S
The S&P 500 Index Fund and the S&P 500 Index Master Portfolio seek
to match the performance of the Standard & Poor's Index of 500 stocks ("S&P
500"). "Standard & Poor's-Registered Trademark-," "S&P-Registered Trademark-,"
"S&P 500-Registered Trademark-," "Standard and Poor's 500" and "500" are
trademarks of The McGraw-Hill Companies, Inc. and have been licensed for use
by the Trust. Neither the S&P 500 Index Fund nor the S&P 500 Index Master
Portfolio is sponsored, endorsed sold or promoted by Standard & Poor's, a
division of the McGraw-Hill Companies, Inc. ("S&P").
S&P makes no representation or warranty, express or implied, to the
owners of the S&P 500 Index Fund, the S&P 500 Index Master Portfolio or any
member of the public regarding the advisability of investing in securities
generally or in the S&P 500 Index Fund particularly or the ability of the S&P
500 Index to track general stock market performance. S&P's only relationship to
the Trust is the licensing of certain trademarks and trade names of S&P and of
the S&P 500 Index which is determined, composed and calculated by S&P without
regard to the Trust or the S&P 500 Index Fund. S&P has no obligation to take the
needs of the Trust or the owners of the S&P 500 Index Fund into consideration in
determining, composing or calculating the S&P 500 Index. S&P is not responsible
for and has not participated in the determination of the prices and amount of
the S&P 500 Index Fund or the timing of the issuance or sale of the S&P 500
Index Fund or in the determination or calculation of the equation by which the
S&P 500 Index Fund is to be converted into cash. S&P has no obligation or
liability in connection with the administration, marketing or trading of the S&P
500 Index Fund.
S&P DOES NOT GUARANTEE THE ACCURACY AND/OR THE COMPLETENESS OF THE S&P
500 INDEX OR ANY DATA INCLUDED THEREIN AND S&P SHALL HAVE NO LIABILITY FOR ANY
ERRORS, OMISSIONS, OR INTERRUPTIONS THEREIN. S&P MAKES NO WARRANTY, EXPRESS OR
IMPLIED, AS TO RESULTS TO BE OBTAINED BY THE TRUST, OWNERS OF THE FUND, OR ANY
OTHER PERSON OR ENTITY FROM THE USE OF THE S&P 500 INDEX OR ANY DATA INCLUDED
THEREIN. S&P MAKES NO EXPRESS OR IMPLIED WARRANTIES, AND EXPRESSLY DISCLAIMS ALL
WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE WITH
RESPECT TO THE S&P 500 INDEX OR ANY DATA INCLUDED THEREIN. WITHOUT LIMITING ANY
OF THE FOREGOING, IN NO EVENT SHALL S&P HAVE ANY LIABILITY FOR ANY SPECIAL,
PUNITIVE, INDIRECT OR CONSEQUENTIAL DAMAGES (INCLUDING LOST PROFITS), EVEN IF
NOTIFIED OF THE POSSIBILITY OF SUCH DAMAGES.
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<PAGE>
RUSSELL 2000
The Small Cap Index Fund and the Russell 2000 Index Master Portfolio
seek to match the performance of the Russell 2000 Small Stock Index (the
"Russell 2000"). The Russell 2000 tracks the common stock performance of the
2000 smallest U.S. companies in the Russell 3000 Index, representing about 10%
in the aggregate of the capitalization of the Russell 3000 Index. The Russell
2000 and the Russell 3000 are trademarks/service marks, and "Russell" is a
trademark, of Frank Russell Company. Neither the Small Cap Index Fund nor the
Russell 2000 Index Master Portfolio is promoted, sponsored or endorsed by, nor
in any way affiliated with Frank Russell Company. Frank Russell Company is not
responsible for and has not reviewed the Small Cap Index Fund nor any associated
literature or publications and makes no representation or warranty, express or
implied, as to their accuracy or completeness, or otherwise.
Frank Russell Company reserves the right, at any time and without
notice, to alter, amend, terminate or in any way change the Russell 2000. Frank
Russell Company has no obligation to take the needs of any particular fund or
its participants or any other product or person into consideration in
determining, composing or calculating the Russell 2000.
Frank Russell Company's publication of the Russell 2000 in no way
suggests or implies an opinion by Frank Russell Company as to the attractiveness
or appropriateness of investment in any or all securities upon which the index
is based. FRANK RUSSELL COMPANY MAKES NO REPRESENTATION, WARRANTY, OR GUARANTEE
AS TO THE ACCURACY, COMPLETENESS, RELIABILITY, OR OTHERWISE OF THE RUSSELL 2000
OR ANY DATA INCLUDED IN THE RUSSELL 2000. FRANK RUSSELL COMPANY MAKES NO
REPRESENTATION OR WARRANTY REGARDING THE USE, OR THE RESULTS OF USE, OF THE
RUSSELL 2000 OR ANY DATA INCLUDED THEREIN, OR ANY SECURITY (OR COMBINATION
THEREOF) COMPRISING THE RUSSELL 2000. FRANK RUSSELL COMPANY MAKES NO OTHER
EXPRESS OR IMPLIED WARRANTY, AND EXPRESSLY DISCLAIMS ANY WARRANTY, OF ANY KIND,
INCLUDING, WITHOUT MEANS OF LIMITATION, ANY WARRANTY OF MERCHANTABILITY OR
FITNESS FOR A PARTICULAR PURPOSE WITH RESPECT TO THE RUSSELL 2000 OR ANY DATA OR
ANY SECURITY (OR COMBINATION THEREOF) INCLUDED THEREIN.
EAFE INDEX
The International Index Fund and the International Index Master
Portfolio seek to match the performance of the Morgan Stanley Capital
International Europe, Australia, and Far East Free Index ("EAFE Free"). EAFE
Free is the property of Morgan Stanley & Co. Incorporated ("Morgan Stanley").
Morgan Stanley Capital International is a service mark of Morgan Stanley and has
been licensed for use by the Trust. Neither the International Index Fund nor the
International Index Master Portfolio is sponsored, endorsed, sold or promoted by
Morgan Stanley. Morgan Stanley makes no representation or warranty, express or
implied, to the owners of shares of the International Index Fund, the
International Index Master Portfolio or any member of the public regarding the
advisability of investing in securities generally or in the shares of the
International Index Fund or International Index Master Portfolio particularly or
the ability of EAFE Free to track general stock market performance. Morgan
Stanley is the licensor of certain trademarks, service marks and trade names of
Morgan Stanley and of the EAFE Free,
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<PAGE>
which is determined, composed and calculated by Morgan Stanley without regard
to the International Index Fund. Morgan Stanley has no obligation to take the
needs of the International Index Fund or International Index Master Portfolio
or the owners of the International Index Fund into consideration in
determining, composing or calculating the EAFE Free. Morgan Stanley is not
responsible for and has not participated in the determination of the timing
of, prices at, or quantities of the International Index Fund to be issued or
in the determination or calculation of the equation by which the
International Index Fund is redeemable for cash. Morgan Stanley has no
obligation or liability to owners of the International Index Fund in
connection with the administration, marketing or trading of the International
Index Fund.
ALTHOUGH MORGAN STANLEY SHALL OBTAIN INFORMATION FOR INCLUSION IN OR FOR USE IN
THE CALCULATION OF THE INDEX FROM SOURCES WHICH MORGAN STANLEY CONSIDERS
RELIABLE, NEITHER MORGAN STANLEY NOR ANY OTHER PARTY GUARANTEES THE ACCURACY
AND/OR THE COMPLETENESS OF THE EAFE FREE OR ANY DATA INCLUDED THEREIN. NEITHER
MORGAN STANLEY NOR ANY OTHER PARTY MAKES ANY WARRANTY, EXPRESS OR IMPLIED, AS TO
RESULTS TO BE OBTAINED BY THE TRUST, THE TRUST'S CUSTOMERS AND COUNTERPARTIES,
OWNERS OF THE INTERNATIONAL INDEX FUND, OR ANY OTHER PERSON OR ENTITY FROM THE
USE OF THE EAFE FREE OR ANY DATA INCLUDED THEREIN IN CONNECTION WITH THE RIGHTS
LICENSED HEREUNDER OR FOR ANY OTHER USE. NEITHER MORGAN STANLEY NOR ANY OTHER
PARTY MAKES ANY EXPRESS OR IMPLIED WARRANTIES, AND MORGAN STANLEY HEREBY
EXPRESSLY DISCLAIMS ALL WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A
PARTICULAR PURPOSE WITH RESPECT TO THE EAFE FREE OR ANY DATA INCLUDED THEREIN.
WITHOUT LIMITING ANY OF THE FOREGOING, IN NO EVENT SHALL MORGAN STANLEY OR ANY
OTHER PARTY HAVE ANY LIABILITY FOR ANY DIRECT, INDIRECT, SPECIAL PUNITIVE,
CONSEQUENTIAL OR ANY OTHER DAMAGES (INCLUDING LOST PROFITS) EVEN IF NOTIFIED OF
THE POSSIBILITY OF SUCH DAMAGES.
TRUSTEES AND OFFICERS
The Board of Trustees has overall responsibility for the conduct of the Trust's
affairs. It is possible that the interests of the Equity and Bond Fund could
diverge from the interests of one or more of the underlying Funds in which it
invests. If such interests were ever to become divergent, it is possible that a
conflict of interest could arise and affect how the Trustees and officers
fulfill their fiduciary duties to each Fund. The Trustees believe they have
structured each Fund to avoid these concerns. However, conceivably, a situation
could occur where proper action for the Equity and Bond Fund could be adverse to
the interests of an underlying Fund, or the reverse could occur. If such a
possibility arises, the Manager and the Trustees and officers of the Trust will
carefully analyze the situation and take all steps they believe reasonable to
minimize and, where possible, eliminate the potential conflict. Moreover, close
and continuous monitoring will be exercised to avoid, insofar as possible, these
concerns.
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The Trustees and officers of the Trust, their ages at December 1, 2000,
their principal occupations for the last five years and their affiliations, if
any, with the Manager and State Farm VP Management Corp., the Trust's principal
underwriter, are listed below. Unless otherwise noted, the address of each is
One State Farm Plaza, Bloomington, Illinois 61710-0001.
<TABLE>
<CAPTION>
POSITION(S) HELD
NAME, AGE AND ADDRESS WITH THE FUNDS PRINCIPAL OCCUPATION(S) DURING PAST FIVE YEARS
--------------------- -------------- ----------------------------------------------
<S> <C> <C>
Edward B. Rust, Jr.*, Trustee and President CHAIRMAN OF THE BOARD, CEO, AND DIRECTOR - State
Age 50 Farm Mutual Automobile Insurance Company;
PRESIDENT, CEO, AND DIRECTOR - State Farm
Life Insurance Company, State Farm Life and
Accident Assurance Company, State Farm
Annuity and Life Insurance Company, State
Farm General Insurance Company, State Farm
Fire and Casualty Company, State Farm
Investment Management Corp.; TRUSTEE,
CHAIRMAN OF THE BOARD AND PRESIDENT (SINCE
1997) - State Farm Variable Product Trust;
CHAIRMAN OF THE BOARD AND DIRECTOR (since
1999) - State Farm Federal Savings Bank;
PRESIDENT, CEO, AND DIRECTOR (SINCE 1997) -
State Farm VP Management Corp.; PRESIDENT -
State Farm County Mutual Insurance Company of
Texas; DIRECTOR - State Farm Lloyds, Inc.,
State Farm International Services, Inc.;
CHAIRMAN OF THE BOARD, PRESIDENT, AND
TREASURER - State Farm Companies Foundation;
PRESIDENT AND DIRECTOR - State Farm Interim
Fund, Inc., State Farm Municipal Bond Fund,
Inc., State Farm Balanced Fund Inc., State
Farm Growth Fund, Inc.
</TABLE>
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<PAGE>
<TABLE>
<CAPTION>
POSITION(S) HELD
NAME, AGE AND ADDRESS WITH THE FUNDS PRINCIPAL OCCUPATION(S) DURING PAST FIVE YEARS
--------------------- -------------- ----------------------------------------------
<S> <C> <C>
Roger S. Joslin*, Trustee, Senior Vice President VICE CHAIRMAN, CHIEF FINANCIAL OFFICER, SENIOR
Age 64 and Treasurer VICE PRESIDENT, TREASURER, AND DIRECTOR - State
Farm Mutual Automobile Insurance Company;
DIRECTOR - State Farm Life Insurance Company,
State Farm Life and Accident Assurance Company,
State Farm Annuity and Life Insurance Company;
DIRECTOR, SENIOR VICE PRESIDENT, AND TREASURER
- State Farm General Insurance Company, State
Farm Lloyds, Inc., State Farm International
Services, Inc.; SENIOR VICE PRESIDENT AND
TREASURER - State Farm Investment Management
Corp.; TRUSTEE, VICE PRESIDENT AND TREASURER
(SINCE 1997) - State Farm Variable Product
Trust; DIRECTOR, SENIOR VICE PRESIDENT, CHIEF
FINANCIAL OFFICER AND TREASURER (SINCE 1997) -
State Farm VP Management Corp.; DIRECTOR, VICE
PRESIDENT AND TREASURER (since 1999) - State
Farm Federal Savings Bank; CHAIRMAN OF THE
BOARD, TREASURER, AND DIRECTOR - State Farm
Fire and Casualty Company; TREASURER - State
Farm County Mutual Insurance Company of Texas;
ASSISTANT TREASURER - State Farm Companies
Foundation; SENIOR VICE PRESIDENT, TREASURER
AND DIRECTOR - State Farm Interim Fund, Inc.,
State Farm Municipal Bond Fund, Inc., State Farm
Balanced Fund, Inc., State Farm Growth Fund, Inc.
Thomas M. Mengler, Trustee DEAN, UNIVERSITY OF ILLINOIS COLLEGE OF LAW
Age 47 (SINCE 1993); TRUSTEE - State Farm Variable
Swanland Building Product Trust (since 1997); DIRECTOR - State
601 E. John St. Farm Interim Fund, Inc., State Farm Municipal
Champaign, IL 61820 Bond Fund, Inc., State Farm Balanced Fund, Inc.,
State Farm Growth Fund, Inc.
James A. Shirk, Trustee DIRECTOR AND PRESIDENT - Beer Nuts, Inc.;
Age 56 TRUSTEE - State Farm Variable Product Trust
103 North Robinson (since 1997); DIRECTOR - State Farm Interim
Bloomington, IL 61701 Fund, Inc., State Farm Municipal Bond Fund,
Inc., State Farm Balanced Fund, Inc., State Farm
Growth Fund, Inc.
Victor J. Boschini, Trustee PRESIDENT, Illinois State University (since
Age 44 1999); VICE PRESIDENT, Illinois State University
100 Gregory St., (1997 to 1999); ASSOCIATE PROVOST, Butler
Normal, Illinois 61761 University (1990-1997).
</TABLE>
39
<PAGE>
<TABLE>
<CAPTION>
POSITION(S) HELD
NAME, AGE AND ADDRESS WITH THE FUNDS PRINCIPAL OCCUPATION(S) DURING PAST FIVE YEARS
--------------------- -------------- ----------------------------------------------
<S> <C> <C>
David L. Vance Trustee PRESIDENT, Caterpillar University (since 2000);
Age 48 CHIEF ECONOMIST AND MANAGER of the Business Intelligence
100 N.E. Adams St., Group, Caterpillar, Inc. (since 1994).
Peoria, Illinois 61629
Donald A. Altorfer Trustee CHAIRMAN, Altorfer, Inc. (dealer in heavy machinery
Age 57 and equipment, since 1998);
4200 Rodger St. PRESIDENT, Capitol Machine Company (1981-1998).
Springfield, Illinois
62703
Kurt G. Moser, Age 55 Senior Vice President SENIOR VICE PRESIDENT - INVESTMENTS (SINCE 1998)
VICE PRESIDENT - INVESTMENTS - State Farm Mutual
Automobile Insurance Company, State Farm County
Mutual Insurance Company of Texas, State Farm
Lloyds, Inc.; SENIOR VICE PRESIDENT -
INVESTMENTS (SINCE 1998), VICE PRESIDENT -
INVESTMENTS, AND DIRECTOR - State Farm Life
Insurance Company, State Farm Life and Accident
Assurance Company, State Farm Annuity and Life
Insurance Company, State Farm Fire and Casualty
Company, State Farm General Insurance Company;
SENIOR VICE PRESIDENT - INVESTMENTS (SINCE
1998), INVESTMENT OFFICER - State Farm Indemnity
Company; VICE PRESIDENT - INVESTMENTS (since
1998) - State Farm Florida Insurance Company;
VICE PRESIDENT (SINCE 1997), VICE PRESIDENT, AND
DIRECTOR (PRIOR TO 1997) - State Farm Investment
Management Corp.; VICE PRESIDENT (SINCE 1997)
-State Farm Variable Product Trust; DIRECTOR
(SINCE 1997) - State Farm VP Management Corp.;
VICE PRESIDENT - INVESTMENTS - State Farm
International Services, Inc.; UNDERWRITER -
State Farm Lloyds, Inc.; SENIOR VICE PRESIDENT -
State Farm Interim Fund, Inc., State Farm
Municipal Bond Fund, Inc., State Farm Balanced
Fund, Inc., State Farm Growth Fund, Inc.
</TABLE>
40
<PAGE>
<TABLE>
<CAPTION>
POSITION(S) HELD
NAME, AGE AND ADDRESS WITH THE FUNDS PRINCIPAL OCCUPATION(S) DURING PAST FIVE YEARS
--------------------- -------------- ----------------------------------------------
<S> <C> <C>
Paul N. Eckley, Senior Vice President SENIOR VICE PRESIDENT - INVESTMENTS AND
Age 46 ASSISTANT SECRETARY-TREASURER (SINCE 1998),
VICE PRESIDENT - COMMON STOCKS - State Farm
Mutual Automobile Insurance Company, State Farm
Fire and Casualty Company; SENIOR VICE PRESIDENT
- INVESTMENTS AND ASSISTANT SECRETARY-TREASURER
(SINCE 1998) - State Farm General Insurance
Company, State Farm Life Insurance Company, State
Farm Life and Accident Assurance Company, State
Farm Annuity and Life Insurance Company, State Farm
Indemnity Company, State Farm County Mutual Insurance
Company of Texas, State Farm Lloyds, Inc.;
SENIOR VICE PRESIDENT (SINCE 1997), AND
INVESTMENT OFFICER (PRIOR TO 1997) - State Farm
Investment Management Corp.; VICE PRESIDENT
(SINCE 1997) - State Farm Variable Product
Trust; SENIOR VICE PRESIDENT - State Farm
Balanced Fund, Inc., State Farm Growth Fund, Inc.
Susan D. Waring Vice President VICE PRESIDENT (SINCE 2000) - State Farm Mutual
Age 51 Automobile Insurance Company, State Farm
Investment Management Corp., State Farm Variable
Product Trust, State Farm Growth Fund, Inc.,
State Farm Balanced Fund, Inc., State Farm
Interim Fund, Inc., State Farm Municipal Bond
Fund, Inc.; VICE PRESIDENT - AGENCY - (1997-2000)
- State Farm Mutual Automobile Insurance Company;
EXECUTIVE ASSISTANT (1995-1997) - State Farm Mutual
Automobile Insurance Company
</TABLE>
41
<PAGE>
<TABLE>
<CAPTION>
POSITION(S) HELD
NAME, AGE AND ADDRESS WITH THE FUNDS PRINCIPAL OCCUPATION(S) DURING PAST FIVE YEARS
--------------------- -------------- ----------------------------------------------
<S> <C> <C>
Donald E. Heltner, Vice President VICE PRESIDENT (SINCE 1998) - State Farm
Age 53 Variable Product Trust; State Farm Balanced
Fund, Inc. and State Farm Interim Fund, Inc.,
VICE PRESIDENT - FIXED INCOME AND ASSISTANT
SECRETARY-TREASURER (SINCE 1998), State Farm
Life Insurance Company, State Farm Life and
Accident Assurance Company, and State Farm
Annuity and Life Insurance Company (SINCE
1998); VICE PRESIDENT - FIXED INCOME, State
Farm Mutual Automobile Insurance Company, State
Farm Fire and Casualty Company, State Farm
General Insurance Company, State Farm Indemnity
Company, and State Farm Lloyds, Inc. (SINCE
1998); prior to 1998, VICE PRESIDENT, Century
Investment Management Co.
Julian R. Bucher, Vice President VICE PRESIDENT State Farm Municipal Bond
Age 58 Fund, Inc.; VICE PRESIDENT - MUNICIPAL
SECURITIES AND ASSISTANT
SECRETARY-TREASURER (SINCE 1997), State
Farm Mutual Automobile Insurance Company,
State Farm Fire and Casualty Company,
State Farm Life Insurance Company, State
Farm Life and Accident Assurance Company,
and State Farm General Insurance Company ;
VICE PRESIDENT - MUNICIPAL SECURITIES
(SINCE 1997), State Farm Indemnity Company
and State Farm Lloyds, Inc. (SINCE 1997);
prior to 1997, INVESTMENT OFFICER, State
Farm Investment Management Corp.
Duncan Funk Assistant Vice President INVESTMENT OFFICER AND ASSISTANT SECRETARY -
Age 39 TREASURER (SINCE 1997) - State Farm Life
Insurance Company, State Farm Life and Accident
Assurance Company, and State Farm Annuity and
Life Insurance Company; INVESTMENT OFFICER
(SINCE 1997) - State Farm Mutual Automobile
Insurance Company, State Farm Fire and Casualty
Company, State Farm General Insurance Company,
State Farm Indemnity Company, and State Farm
Lloyds, Inc.; PRIOR TO 1997, INVESTMENT
ANALYST; ASSISTANT VICE PRESIDENT - State Farm
Variable Product Trust
</TABLE>
42
<PAGE>
<TABLE>
<CAPTION>
POSITION(S) HELD
NAME, AGE AND ADDRESS WITH THE FUNDS PRINCIPAL OCCUPATION(S) DURING PAST FIVE YEARS
--------------------- -------------- ----------------------------------------------
<S> <C> <C>
David R. Grimes, Assistant Vice President and ASSISTANT VICE PRESIDENT OF ACCOUNTING - State
Age 58 Secretary Farm Mutual Automobile Insurance Company; VICE
PRESIDENT AND SECRETARY - State Farm Investment
Management Corp.; VICE PRESIDENT AND SECRETARY
(SINCE 1997) - State Farm Variable Product
Trust; VICE PRESIDENT AND SECRETARY (SINCE
1997) - State Farm VP Management Corp.; VICE
PRESIDENT AND SECRETARY - State Farm Municipal
Bond Fund, Inc., State Farm Balanced Fund, Inc.,
State Farm Growth Fund, Inc., State Farm Interim
Fund, Inc.
Jerel S. Chevalier, Assistant Secretary - DIRECTOR OF MUTUAL FUNDS - State Farm Mutual
Age 62 Treasurer Automobile Insurance Company; ASSISTANT
SECRETARY - TREASURER - State Farm Investment
Management Corp.; ASSISTANT SECRETARY-TREASURER
(SINCE 1997) - State Farm Variable Product
Trust; ASSISTANT SECRETARY - TREASURER - State
Farm Interim Fund, Inc., State Farm Municipal
Bond Fund, Inc., State Farm Balanced Fund, Inc.,
State Farm Growth Fund, Inc.
Howard A. Thomas, Assistant Secretary-Treasurer DIRECTOR OF MUTUAL FUNDS (SINCE 1998) - State
Age 52 Farm Mutual Automobile Insurance Company;
MANAGER OF ACCOUNTING BENEFITS (1988 - 1998) -
State Farm Mutual Automobile Insurance Company;
ASSISTANT SECRETARY - TREASURER (SINCE 1998) -
State Farm Investment Management Corp., State
Farm Variable Product Trust; ASSISTANT SECRETARY
- TREASURER - State Farm Interim Fund, Inc., State
Farm Municipal Bond Fund, Inc., State Farm
Balanced Fund, Inc., State Farm Growth Fund, Inc.
</TABLE>
43
<PAGE>
<TABLE>
<CAPTION>
POSITION(S) HELD
NAME, AGE AND ADDRESS WITH THE FUNDS PRINCIPAL OCCUPATION(S) DURING PAST FIVE YEARS
--------------------- -------------- ----------------------------------------------
<S> <C> <C>
Donald O. Jaynes, Assistant Secretary ASSOCIATE GENERAL COUNSEL - State Farm Mutual
Age 52 Automobile Insurance Company; ASSISTANT
SECRETARY (SINCE 1998) - State Farm Investment
Management Corp., State Farm Variable Product
Trust; ASSISTANT SECRETARY - State Farm Interim
Fund, Inc., State Farm Municipal Bond Fund,
Inc., State Farm Balanced Fund, Inc., State Farm
Growth Fund, Inc.
Stephen L. Horton, Assistant Secretary COUNSEL - State Farm Mutual Automobile Insurance
Age 43 Company; COUNSEL AND ASSISTANT SECRETARY (SINCE
1999) - State Farm VP Management Corp; ASSISTANT
SECRETARY (SINCE 2000) - State Farm Interim
Fund, Inc., Municipal Bond Fund, Inc., State
Farm Balanced Fund, Inc., State Farm Growth
Fund, Inc., State Farm Variable Product Trust
and State Farm Investment Management Corp.
David M. Moore, Assistant Secretary COUNSEL (SINCE 1997), ASSISTANT TAX COUNSEL
Age 38 (1995-1997) - State Farm Mutual Automobile
Insurance Company; ASSISTANT SECRETARY (SINCE
2000)- State Farm Investment Management Corp.,
State Farm Interim Fund, Inc., Municipal Bond
Fund, Inc., State Farm Balanced Fund, Inc.,
State Farm Growth Fund, Inc., State Farm
Variable Product Trust
Michael L. Tipsord, Assistant Secretary VICE PRESIDENT AND ASSISTANT TREASURER (SINCE
Age 42 1998), EXECUTIVE ASSISTANT - OPERATIONS (SINCE
1997), ASSISTANT CONTROLLER (1996-1997),
DIRECTOR OF ACCOUNTING (1995-1996) - State Farm
Mutual Automobile Insurance Company; ASSISTANT
SECRETARY - State Farm Investment Management
Corp., ASSISTANT SECRETARY (SINCE 1997) - State
Farm Variable Product Trust; TREASURER (SINCE
1996) - Insurance Placement Services, Inc.;
ASSISTANT SECRETARY - State Farm Municipal Bond
Fund, Inc., State Farm Balanced Fund, Inc.,
State Farm Growth Fund, Inc., State Farm Interim
Fund, Inc.
*Trustee who is an "interested person" of the Trust or of the Manager, as defined in the 1940 Act.
</TABLE>
44
<PAGE>
Trustees or officers who are interested persons do not receive any
compensation from any Fund for their services to the Fund. The Trustees who
are not interested persons of any Fund will receive a monthly retainer equal
to $1,750, and a fee for each board meeting attended at a rate of $750.00
per meeting. These fees are paid to the Trustees on behalf of the Trust and
on behalf of ten other mutual funds advised by the Manager. Each fund managed
by the Manager shares in the expenses pro-rata based upon the relative net
assets of each Fund as of the end of the most recently completed calendar
quarter. In addition, Trustees who are not interested persons of the Funds
will be reimbursed for any out-of-pocket expenses incurred in connection with
the affairs of the Trust.
Trustees and officers of the Trust do not receive any benefits from the
Trust upon retirement nor does the Trust accrue any expenses for pension or
retirement benefits. Officers of the Trust and Trustees who are interested
persons of the Trust are also employees of the State Farm Insurance Companies.
As such, these persons may purchase Class A shares of the Funds without paying
an initial sales charge. The purpose of this program is to encourage these
persons to purchase Fund shares.
<TABLE>
<CAPTION>
AGGREGATE TOTAL COMPENSATION
COMPENSATION FROM THE TRUST AND OTHER
NAME FROM THE TRUST (1) STATE FARM MUTUAL FUNDS (1)(2)
---- ------------------ ------------------------------
<S> <C> <C>
Edward B. Rust, Jr. None (3) None (3)
Roger S. Joslin None (3) None (3)
Thomas M. Mengler $5,500 $16,350
James A. Shirk $5,500 $19,950
Donald Altorfer $2,400 $2,400
Victor Boschini $2,400 $2,400
David L. Vance $2,400 $2,400
</TABLE>
(1) For the fiscal year ended December 31, 2000.
(2) The "other State Farm Mutual Funds" are State Farm Growth Fund, Inc., State
Farm Balanced Fund, Inc., State Farm Interim Fund, Inc., State Farm
Municipal Bond Fund, Inc. and State Farm Variable Product Trust
(3) Non-compensated interested trustee.
INVESTMENT ADVISORY AGREEMENTS
BETWEEN THE TRUST AND THE MANAGER
The Manager is a wholly-owned subsidiary of State Farm Mutual
Automobile Insurance Company ("Auto Company"). The duties and responsibilities
of the Manager are specified in the
45
<PAGE>
Investment Advisory and Management Services Agreement between the Trust and
the Manager and the separate Service Agreement among the Trust, the Manager
and Auto Company (collectively, the "Management Agreements"). The Management
Agreements were approved for each Fund by the Board of Trustees of the Trust
(including a majority of Trustees who are not parties to the Management
Agreements or interested persons, as defined by the 1940 Act, of any such
party) at a meeting held for that purpose on October 30, 2000 and
subsequently were approved by the sole shareholder of each Fund. The
Management Agreements are not assignable and each may be terminated without
penalty upon 60 days written notice at the option of the Trust, the Manager
or Auto Company, as appropriate, or by a vote of shareholders. Each
Management Agreement provides that it shall continue in effect for two years
and can thereafter be continued for each applicable Fund from year to year so
long as such continuance is specifically approved annually (a) by the Board
of Trustees of the Trust or by a majority of the outstanding voting shares of
the Fund and (b) by a majority vote of the Trustees who are not parties to
the Agreement, or interested persons of any such party, cast in person at a
meeting held for that purpose.
The Manager (under the supervision of the Board of Trustees)
continuously furnishes an investment program for the Funds (other than the Small
Cap Equity Fund and International Equity Fund and the Equity Index Funds), is
responsible for monitoring the performance of the Equity Index Funds, is
responsible for managing the investments of such Funds, and has responsibility
for making decisions governing whether to buy, sell or hold any particular
security. In carrying out its obligations to manage the investment and
reinvestment of the assets of these Funds, the Manager performs research and
obtains and evaluates pertinent economic, statistical and financial data
relevant to the investment policies of these Funds.
The Trust pays the Manager monthly compensation in the form of an
investment advisory and management services fee. The fee is based upon average
daily net assets and is accrued daily and paid to the Manager quarterly at the
following annual rates for each of the Funds:
<TABLE>
<S> <C>
Equity Fund 0.60% of net assets
Small Cap Equity Fund 0.80% of net assets
International Equity Fund 0.80% of net assets
S&P 500 Index Fund 0.15% of net assets
Small Cap Index Fund 0.25% of net assets
International Index Fund 0.25% of net assets
Equity and Bond Fund 0.40% of net assets
Bond Fund 0.10% of net assets
Tax Advantaged Bond Fund 0.10% of net assets
Money Market Fund 0.10% of net assets
</TABLE>
The Manager has agreed not to be paid an investment advisory fee for
performing its services for the Equity and Bond Fund. The investment advisory
and management services fee for the Equity and Bond Fund is based on the fees
that the Equity Fund and Bond Fund pay to the Manager, which has agreed to
reimburse the Equity and Bond Fund for all other expenses
46
<PAGE>
incurred. The Manager will reimburse each Fund, if and to the extent, the
Fund's total annual operating expenses exceed the following percentages of
the Fund's average net assets.
<TABLE>
<S> <C>
Equity Fund 0.70%
Small Cap Equity Fund 0.90%
International Equity Fund 1.00%
S&P 500 Index Fund 0.30%
Small Cap Index Fund 0.45%
International Index Fund 0.65%
Equity and Bond Fund None
Bond Fund 0.20%
Tax Advantaged Bond Fund 0.20%
Money Market Fund 0.20%
</TABLE>
The reimbursement arrangement set forth above and the reimbursement
arrangement for the Equity and Bond Fund are voluntary and may be eliminated by
the Manager at any time.
As described below, the Manager has engaged Capital Guardian as the
investment sub-adviser for the Small Cap Equity Fund and International Equity
Fund.
The Manager is responsible for payment of all expenses it may incur in
performing the services described. These expenses include costs incurred in
providing investment advisory services, compensating and furnishing office space
for officers and employees of the Manager connected with investment and economic
research, trading and investment management of the Trust and the payment of any
fees to interested Trustees of the Trust. The Manager provides all executive,
administrative, clerical and other personnel necessary to operate the Trust and
pays the salaries and other employment related costs of employing those persons.
The Manager furnishes the Trust with office space, facilities and equipment and
pays the day-to-day expenses related to the operation and maintenance of such
office space facilities and equipment. All other expenses incurred in the
organization of the Trust or of new Funds of the Trust, including legal and
accounting expenses and costs of the initial registration of securities of the
Trust under federal and state securities laws, are also paid by the Manager.
Pursuant to the Service Agreement, Auto Company provides the Manager
with certain personnel, services and facilities to enable the Manager to perform
its obligations to the Trust. The Manager reimburses Auto Company for such
costs, direct and indirect, as are fairly attributable to the services performed
and the facilities provided by Auto Company under the separate service
agreement. Accordingly, the Trust makes no payment to Auto Company under the
Service Agreement.
The Trust is responsible for payment of all expenses it may incur in
its operation and all of its general administrative expenses except those
expressly assumed by the Manager as described in the preceding paragraphs. These
include (by way of description and not of limitation), any share redemption
expenses, expenses of portfolio transactions, shareholder
47
<PAGE>
servicing costs, pricing costs (including the daily calculation of net asset
value), interest on borrowings by the Trust, charges of the custodian and
transfer agent, cost of auditing services, non-interested Trustees' fees,
legal expenses, all taxes and fees, investment advisory fees, certain
insurance premiums, cost of maintenance of corporate existence, investor
services (including allocable personnel and telephone expenses), costs of
printing and mailing updated Trust prospectuses to shareholders, costs of
preparing, printing, and mailing proxy statements and shareholder reports to
shareholders, the cost of paying dividends, capital gains distribution, costs
of Trustee and shareholder meetings, dues to trade organizations, and any
extraordinary expenses, including litigation costs in legal actions involving
the Trust, or costs related to indemnification of Trustees, officers and
employees of the Trust.
The Board of Trustees of the Trust determines the manner in which
expenses are allocated among the Funds of the Trust. The Board allocates those
expenses associated to a specific Fund to that Fund. Those expenses which are
paid for the benefit of all the Funds are allocated by the Board pro-rata based
upon each Fund's net assets.
The Management Agreements also provide that the Manager shall not be
liable to the Trust or to any shareholder or contract owner for any error of
judgment or mistake of law or for any loss suffered by the Trust or by any
shareholder in connection with matters to which the such Agreements relate,
except for a breach of fiduciary duty or a loss resulting from willful
misfeasance, bad faith, gross negligence, or reckless disregard on the part of
the Manager in the performance of its duties thereunder.
BETWEEN BARCLAYS AND THE MASTER PORTFOLIOS
Barclays is investment adviser to the Master Portfolios. Barclays is an
indirect subsidiary of Barclays Bank PLC. Pursuant to Investment Advisory
Contracts ("Master Portfolio Advisory Contracts") with the Master Fund, Barclays
provides investment guidance and policy direction in connection with the
management of the Master Portfolios' assets. Pursuant to the Master Portfolio
Advisory Contracts, Barclays furnishes to the Master Fund's Boards of Trustees
periodic reports on the investment strategy and performance of the Master
Portfolios. The Master Portfolio Advisory Contracts are required to be approved
annually (i) by the holders of a majority of the Master Fund's outstanding
voting securities or by the Master Fund's Boards of Trustees and (ii) by a
majority of the Trustees of the Master Fund who are not parties to the Master
Portfolio Advisory Contract or "interested persons" (as defined in the 1940 Act)
of any such party. The Master Portfolio Advisory Contracts may be terminated on
60 days' written notice by either party and will terminate automatically if
assigned.
Barclays is entitled to receive monthly fees as compensation for its
advisory services to each Master Portfolio as described below:
<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------------
FUND ANNUAL MANAGEMENT FEE
---------------------------------------------------------------------------------------------------------------------
<S> <C>
S&P 500 Index Master Portfolio 0.05% of average daily net assets
---------------------------------------------------------------------------------------------------------------------
Russell 2000 Index Master Portfolio 0.10% of average daily net assets, which includes a
---------------------------------------------------------------------------------------------------------------------
</TABLE>
48
<PAGE>
<TABLE>
<S> <C>
---------------------------------------------------------------------------------------------------------------------
0.02% administrative fee
---------------------------------------------------------------------------------------------------------------------
International Index Master Portfolio 0.25% of the average daily net assets up to $1 billion, which
includes a 0.10% administrative fee, and 0.17% of the average daily
net assets thereafter, which includes a 0.07% administrative fee
---------------------------------------------------------------------------------------------------------------------
</TABLE>
The Master Portfolio Advisory Contracts provide that the advisory fee is accrued
daily and paid monthly. This advisory fee is an expense of the Master Portfolios
borne proportionately by its interestholders, such as the Equity Index Funds.
The administration fee is designed to compensate Barclays for custody costs and
administration expenses.
Barclays has agreed to provide to the Master Portfolios, among other
things, money market security and fixed-income research, analysis and
statistical and economic data and information concerning interest rate and
security market trends, portfolio composition, credit conditions and average
maturities of the Master Portfolio's investment portfolio.
BETWEEN THE MANAGER AND CAPITAL GUARDIAN
Pursuant to the separate sub-advisory agreement described below, the
Manager has engaged Capital Guardian as the investment sub-adviser to provide
day-to-day portfolio management for the Small Cap Equity Fund and the
International Equity Fund. Capital Guardian manages the investments of the Small
Cap Equity Fund and the International Equity Fund, determining which securities
or other investments to buy and sell for each, selecting the brokers and dealers
to effect the transactions, and negotiating commissions. In placing orders for
securities transactions, Capital Guardian follows the Manager's policy of
seeking to obtain the most favorable price and efficient execution available.
For its services, the Manager pays Capital Guardian an investment
sub-advisory fee equal to a percentage of the average daily net assets of each
of Small Cap Equity Fund and International Equity Fund at the rates set forth
below. The fee is accrued daily and paid to Capital Guardian quarterly. The
rates upon which the fee is based are as follows:
<TABLE>
<CAPTION>
---------------------------------------------------------------------------------------------------------------------
ANNUAL MANAGEMENT FEE, BASED ON AVERAGE
FUND DAILY NET ASSETS
---------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Small Cap Equity Fund On the first $25 million - 0.75%
$25 million to $50 million - 0.60%
$50 million to $100 million - 0.425%
Over $100 million - 0.375%
---------------------------------------------------------------------------------------------------------------------
International Equity Fund On the first $25 million - 0.75%
$25 million to $50 million - 0.60%
$50 million to $250 million - 0.425%
Over $250 million - 0.375%
---------------------------------------------------------------------------------------------------------------------
</TABLE>
49
<PAGE>
The sub-advisory agreement was approved for each of Small Cap Equity
Fund and International Equity Fund by the Board of Trustees of the Trust
(including a majority of Trustees who are not parties to such agreements or
interested persons, as defined by the 1940 Act, of any such party) at a meeting
held for that purpose on October 30, 2000 and subsequently was approved by the
sole shareholder of each of those Funds. The sub-advisory agreement is not
assignable and may be terminated without penalty upon 60 days written notice at
the option of the Manager or Capital Guardian, or by the Board of Trustees of
the Trust or by a vote of a majority of the outstanding shares of the class of
stock representing an interest in the appropriate Fund. The sub-advisory
agreement provides that it shall continue in effect for two years and can
thereafter be continued for each Fund from year to year so long as such
continuance is specifically approved annually (a) by the Board of Trustees of
the Trust or by a majority of the outstanding shares of the Fund and (b) by a
majority vote of the Trustees who are not parties to the agreement, or
interested persons of any such party, cast in person at a meeting held for that
purpose.
SECURITIES ACTIVITIES OF THE MANAGER, CAPITAL GUARDIAN AND BARCLAYS
Securities held by the Trust may also be held by separate accounts or
mutual funds for which the Manager, Barclays or Capital Guardian acts as an
adviser, some of which may be affiliated with them. Because of different
investment objectives, cash flows or other factors, a particular security may be
bought by the Manager, Barclays or Capital Guardian for one or more of its
clients, when one or more other clients are selling the same security. Pursuant
to procedures adopted by the Board of Trustees, the Manager, Barclays or Capital
Guardian may cause a Fund to buy or sell a security from another Fund or another
account. Any such transaction would be executed at a price determined in
accordance with those procedures and without sales commissions. Transactions
executed pursuant to such procedures are reviewed by the Board of Trustees
quarterly.
If purchases or sales of securities for a Fund or other client of the
Manager, Barclays or Capital Guardian arise for consideration at or about the
same time, transactions in such securities will be allocated as to amount and
price, insofar as feasible, for the Fund and other clients in a manner deemed
equitable to all. To the extent that transactions on behalf of more than one
client of the Manager, Barclays or Capital Guardian during the same period may
increase the demand for securities being purchased or the supply of securities
being sold, there may be an adverse effect on price. It is the opinion of the
Board of Trustees of the Trust, however, that the benefits available to the
Trust outweigh any possible disadvantages that may arise from such concurrent
transactions.
On occasions when the Manager, Barclays or Capital Guardian (under the
supervision of the Board of Trustees) deem the purchase or sale of a security to
be in the best interests of the Trust as well as other accounts or companies, it
may, to the extent permitted by applicable laws and regulations, but will not be
obligated to, aggregate the securities to be sold or purchased for
50
<PAGE>
the Trust with those to be sold or purchased for other accounts or companies
in order to obtain favorable execution and low brokerage commissions. In that
event, allocation of the securities purchased or sold, as well as the
expenses incurred in the transaction, will be made by the Manager, Barclays
or Capital Guardian in the manner each considers to be most equitable and
consistent with its fiduciary obligations to the Trust and to such other
accounts or companies. In some cases this procedure may adversely affect the
size of the position obtainable for a Fund.
PORTFOLIO TRANSACTIONS AND BROKERAGE
THE EQUITY FUND, EQUITY AND BOND FUND, BOND FUND, TAX ADVANTAGED BOND FUND AND
MONEY MARKET FUND.
As described above, the Manager determines which securities to buy and
sell for these Funds, selects brokers and dealers to effect the transactions,
and negotiates commissions. Transactions in equity securities will usually be
executed through brokers who will receive a commission paid by the Fund. Fixed
income securities are generally traded with dealers acting as principals for
their own accounts without a stated commission. The dealer's margin is reflected
in the price of the security. Money market obligations may be traded directly
with the issuer. Underwritten offerings of stock may be purchased at a fixed
price including an amount of compensation to the underwriter. Upon commencement
of operations, the Trust will disclose brokerage commissions paid.
In placing orders for securities transactions, the Manager's policy is
to attempt to obtain the most favorable price and efficient execution available.
These entities, subject to the review of the Trust's Board of Trustees, may pay
higher than the lowest possible commission on agency trades, not principal
trades, to obtain better than average execution of transactions and/or valuable
investment research information described below, if, in their opinion, improved
execution and investment research information will benefit the performance of
each of the Funds.
When selecting broker-dealers to execute portfolio transactions, the
Manger considers factors including the rate of commission or size of the
broker-dealer's "spread", the size and difficulty of the order, the nature of
the market for the security, the willingness of the broker-dealer to position,
the reliability, financial condition and general execution and operational
capabilities of the broker-dealer, and the research, statistical and economic
data furnished by the broker-dealer to the Manager. In some cases, the Manager
may use such information to advise other investment accounts that it advises.
Brokers or dealers which supply research may be selected for execution of
transactions for such other accounts, while the data may be used by the Manager
in providing investment advisory services to the Fund. In addition, the Manager
may select broker-dealers to execute portfolio transactions who are affiliated
with the Fund or the Manager. However, all such directed brokerage will be
subject to the Manager's policy to attempt to obtain the most favorable price
and efficient execution possible.
EQUITY INDEX FUNDS
Barclays assumes general supervision over placing orders on behalf of
each Master Portfolio for the purchase or sale of portfolio securities.
Allocation of brokerage transactions,
51
<PAGE>
including their frequency, is made in the best judgment of Barclays and in a
manner deemed fair and reasonable to shareholders. In executing portfolio
transactions and selecting brokers or dealers, Barclays seeks to obtain the
best overall terms available for each Master Portfolio. In assessing the best
overall terms available for any transaction, Barclays considers factors
deemed relevant, including the breadth of the market in the security, the
price of the security, the financial condition and execution capability of
the broker or dealer, and the reasonableness of the commission, if any, both
for the specific transaction and on a continuing basis. The primary
consideration is prompt execution of orders at the most favorable net price.
Certain of the brokers or dealers with whom the Master Portfolios may
transact business offer commission rebates to the Master Portfolios. Barclays
considers such rebates in assessing the best overall terms available for any
transaction. The overall reasonableness of brokerage commissions paid is
evaluated by Barclays based upon its knowledge of available information as to
the general level of commissions paid by other institutional investors for
comparable services.
S&P 500 INDEX MASTER PORTFOLIO. Brokers also are selected because of
their ability to handle special executions such as are involved in large block
trades or broad distributions, provided the primary consideration is met.
Portfolio turnover my vary from year to year, as well as within a year. High
turnover rates over 100% are likely to result in comparatively greater brokerage
expenses.
SMALL CAP EQUITY FUND AND INTERNATIONAL EQUITY FUND
Capital Guardian strives to obtain the best available prices in its
portfolio transactions taking into account the costs and quality of executions.
When, in the opinion of Capital Guardian, two or more brokers (either directly
or through their correspondent clearing agents) are in a position to obtain the
best price and execution, preference may be given to brokers who have provided
investment research, statistical, or other related services to Capital Guardian.
This research may be used for other Capital Guardian clients in addition to the
Funds. The Funds do not consider that they have an obligation to obtain the
lowest available commission rate to the exclusion of price, service and
qualitative considerations.
PORTFOLIO TURNOVER
Because of the Equity Fund's, Small Cap Equity Fund's and International Equity
Fund's flexibility of investment and emphasis on growth of capital, these Funds
may have greater portfolio turnover than that of mutual funds that have primary
objectives of income or maintenance of a balanced investment position. The
Equity and Bond Fund's portfolio turnover is expected to be low. The Equity and
Bond Fund will purchase or sell securities to: (i) accommodate purchases and
sales of its shares; (ii) change the percentages of its assets invested in each
of the underlying Funds in response to market conditions; and (iii) maintain or
modify the allocation of its assets among the underlying Funds within the
percentage limits described in the Prospectus.
Consistent with the Equity Index Funds' investment objectives, each
will attempt to minimize portfolio turnover. There are no fixed limitations
regarding the portfolio turnover rate
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for the Bond Fund, and securities initially satisfying the objectives and
policies of this Fund may be disposed of when they are no longer deemed
suitable.
In periods of relatively stable interest rate levels, Tax Advantaged
Bond Fund does not expect its annual portfolio turnover rate to exceed 50% for
issues with maturities longer than one year at the time of purchase. In years of
sharp fluctuations in interest rates, however, the annual portfolio turnover
rate may exceed 50%. Most of the sales in the Fund's portfolio will occur when
the proportion of securities owned with longer term maturities is reduced in
anticipation of a bond market decline (rise in interest rates), or increased in
anticipation of a bond market rise (decline in interest rates). The rate of
portfolio turnover will not be a limiting factor and, accordingly, will always
be incidental to transactions undertaken with the view of achieving the Fund's
investment objective.
Since short term instruments are excluded from the calculation of a
portfolio turnover rate, no meaningful portfolio turnover rate can be estimated
or calculated for the Money Market Fund. Turnover rates may vary greatly from
year to year as well as within a particular year and may also be affected by
cash requirements for redemptions of a Fund's shares and by requirements, the
satisfaction of which enable the Trust to receive certain favorable tax
treatment.
DETERMINATION OF NET ASSET VALUE
The Net Asset Value (NAV) for each Fund is determined as of the time of
the close of regular session trading on the New York Stock Exchange ("NYSE")
(currently at 4:00 p.m., Eastern Time), on each day when the NYSE is open for
business. Shares of the Funds will not be priced on days when the NYSE is
closed.
ALL FUNDS EXCEPT MONEY MARKET FUND
Equity securities (including common stocks, preferred stocks,
convertible securities and warrants) and call options written on all portfolio
securities, listed or traded on a national exchange are valued at their last
sale price on that exchange prior to the time when assets are valued. In the
absence of any exchange sales on that day, such securities are valued at the
last sale price on the exchange on which it is traded. Securities traded only on
over-the-counter markets generally are valued at the closing bid price.
Debt securities traded on a national exchange are valued at their last
sale price on that exchange prior to the time when assets are valued, or,
lacking any sales, at the last reported bid price. Debt securities other than
money market instruments traded in the over-the-counter market are valued at the
last reported bid price or at yield equivalent as obtained from one or more
dealers that make markets in the securities. If the market quotations described
above are not available, debt securities, other than short-term debt securities,
may be valued at a fair value as determined by one or more independent pricing
services (each, a "Service"). The Service may use available market quotations
and employ electronic data processing techniques and/or a matrix system to
determine valuations. Each Service's procedures are reviewed by the officers
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of the Trust under the general supervision of the Boards of Trustees of the
Trust and the Master Fund.
Money market instruments held with a remaining maturity of 60 days or
less (other than U.S. Treasury bills) are generally valued on an amortized cost
basis. Under the amortized cost basis method of valuation, the security is
initially valued at its purchase price (or in the case of securities purchased
with more than 60 days remaining to maturity, the market value on the 61st day
prior to maturity), and thereafter by amortizing any premium or discount
uniformly to maturity. If for any reason the amortized cost method of valuation
does not appear to fairly reflect the fair value of any security, a fair value
will be determined in good faith by or under the direction of the Boards of
Trustees of the Trust or the Master Fund, as the case may be, as in the case of
securities having a maturity of more than 60 days.
Securities that are primarily traded on foreign securities exchanges
are generally valued at the last sale price on the exchange where they are
primarily traded. All foreign securities traded on the over-the-counter market
are valued at the last sale quote, if market quotes are available, or the last
reported bid price if there is no active trading in a particular security on a
given day. Quotations of foreign securities in foreign currencies are converted,
at current exchange rates, to their U.S. dollar equivalents in order to
determine their current value. Forward currency contracts are valued at the
current cost of offsetting the contract. Because foreign securities (other than
American Depositary Receipts) are valued as of the close of trading on various
exchanges and over-the-counter markets throughout the world, the net asset value
of Funds investing in foreign securities generally includes values of foreign
securities held by those Funds that were effectively determined several hours or
more before the time NAV is calculated. In addition, foreign securities held by
Funds may be traded actively in securities markets which are open for trading on
days when the Funds do not calculate their net asset value. Accordingly, there
may be occasions when a Fund holding foreign securities does not calculate its
net asset value but when the value of such Fund's portfolio securities is
affected by such trading activity.
Exchange listed options that are written or purchased by a Fund are
valued on the primary exchange on which they are traded. Over-the-counter
options written or purchased by a Fund are valued based upon prices provided by
market-makers in such securities. Exchange-traded financial futures contracts
are valued at their settlement price established each day by the board of trade
or exchange on which they are traded.
Securities for which market quotations are not readily available, or
for which the procedures described above do not produce a fair value, are valued
at a fair value as determined in good faith in accordance with procedures
approved by the Boards of Trustees of the Trust or the Master Fund, as the case
may be. The effect of this will be that NAV will not be based on the last quoted
price on the security, but on a price with the Board of Trustees or its delegate
believes reflects the current and true price of the security.
MONEY MARKET FUND
All of the assets of the Money Market Fund are valued on the basis of
amortized cost in an effort to maintain a constant net asset value of $1.00 per
share. The Board of Trustees of the
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Trust has determined this to be in the best interests of the Money Market
Fund and its shareholders. Under the amortized cost method of valuation,
securities are valued at cost on the date of their acquisition, and
thereafter as adjusted for amortization of premium or accretion of discount,
regardless of the impact of fluctuating interest rates on the market value of
the security. While this method provides certainty in valuation, it may
result in periods in which value as determined by amortized cost is higher or
lower than the price the Fund would receive if it sold the security. During
such periods, the quoted yield to investors may differ somewhat from that
obtained by a similar fund or portfolio which uses available market
quotations to value all of its portfolio securities.
The Board has established procedures reasonably designed, taking into
account current market conditions and the Money Market Fund's investment
objectives, to stabilize the net asset value per share for purposes of sales and
redemptions at $1.00. These procedures include review by the Board, at such
intervals as it deems appropriate, to determine the extent, if any, to which the
net asset value per share calculated by using available market quotations
deviates from $1.00 per share. In the event such deviation should exceed one
half of one percent, the Board will promptly consider initiating corrective
action. If the Board believes that the extent of any deviation from a $1.00
amortized cost price per share may result in material dilution or other unfair
results to new or existing shareholders, it will take such steps as it considers
appropriate to eliminate or reduce these consequences to the extent reasonably
practicable. Such steps may include: selling portfolio securities prior to
maturity; shortening the average maturity of the portfolio; withholding or
reducing dividends; or utilizing a net asset value per share determined from
available market quotations. Even if these steps were taken, the Money Market
Fund's net asset value might still decline.
GENERAL
Computation of NAV (and the sale and redemption of fund shares) may be
suspended or postponed during any period when (a) trading on the NYSE is
restricted, as determined by the Commission, or the NYSE is closed for other
than customary weekend and holiday closings, (b) the Commission has by order
permitted such suspension, or (c) an emergency, as determined by the Commission,
exists making disposal of portfolio securities or valuation of the net assets of
the funds not reasonably practicable.
PERFORMANCE INFORMATION
The Trust may from time to time quote or otherwise use average annual
total return information for the Funds in advertisements, shareholder reports or
sales literature. Average annual total return values are computed pursuant to
equations specified by the Commission as follows:
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Average Annual Total Return will be computed as follows:
ERV = P(1+T) to the power of n
Where: P = the amount of an assumed initial investment in Fund shares
T = average annual total return
n = number of years from initial investment to the end of the
period
ERV = ending redeemable value of shares held at the end of the
period
Average annual total return for a specified period is derived by
calculating the actual dollar amount of the investment return on a $1,000
investment in a Fund made at the beginning of the period, and then calculating
the annual compounded rate of return which would produce that amount, assuming a
redemption at the end of the period. This calculation assumes a complete
redemption of the investment. It also assumes that all dividends and
distributions are reinvested at net asset value on the reinvestment dates during
the period. The Trust also may from time to time quote or otherwise use
year-by-year total return, cumulative total return and yield information for the
Funds in advertisements, shareholder reports or sales literature. Year-by-year
total return and cumulative total return for a specified period are each derived
by calculating the percentage rate required to make a $1,000 investment in a
Fund (assuming that all distributions are reinvested) at the beginning of such
period equal to the actual total value of such investment at the end of such
period.
Yield is computed by dividing net investment income earned during a
recent 30 day period by the product of the average daily number of shares
outstanding and entitled to receive dividends during the period and the price
per share on the last day of the relevant period. The results are compounded on
a bond equivalent (semi-annual) basis and then annualized. Net investment income
is equal to the dividends and interest earned during the period, reduced by
accrued expenses for the period. The calculation of net investment income for
these purposes may differ from the net investment income determined for
accounting purposes. The SEC's yield formula is as follows:
The Yield formula is as follows:
6
YIELD = 2[((a-b/cd)+1) to the power of 6 -1].
Where: a = dividends and interest earned during the period.
(For this purpose, a Fund will recalculate the yield to
maturity based on market value of each portfolio
security on each business day on which net asset value
is calculated.)
b = expenses accrued for the period (net of reimbursements).
c = the average daily number of shares outstanding
during the period that were entitled to receive
dividends.
d = the ending net asset value of a Fund for the period.
The Money Market Fund may also quote its current yield and effective
yield. Current yield is an annualized yield based on the actual total return for
a seven-day period. Effective yield is an annualized yield based on a daily
compounding of the current yield.
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Any performance data quoted for a Fund will represent historical
performance and the investment return and principal value of an investment will
fluctuate so that shares, when redeemed, may be worth more or less than original
cost.
From time to time the Trust may publish an indication of the Funds'
past performance as measured by independent sources such as (but not limited to)
Lipper, Inc., Weisenberger Investment Companies Service, Donoghue's Money Fund
Report, Barron's, Business Week, Changing Times, Financial World, Forbes,
Fortune, Money, Personal Investor, Sylvia Porter's Personal Finance and The Wall
Street Journal. The Trust may also advertise information which has been provided
to the NASD for publication in regional and local newspapers. In addition, the
Trust may from time to time advertise its performance relative to certain
indices and benchmark investments, including (a) the Lipper, Inc. Mutual Fund
Performance Analysis, Fixed-Income Analysis and Mutual Fund Indices (which
measure total return and average current yield for the mutual fund industry and
rank mutual fund performance); (b) the CDA Mutual Fund Report published by CDA
Investment Technologies, Inc. (which analyzes price, risk and various measures
of return for the mutual fund industry); (c) the Consumer Price Index published
by the U.S. Bureau of Labor Statistics (which measures changes in the price of
goods and services); (d) Stocks, Bonds, Bills and Inflation published by
Ibbotson Associates (which provides historical performance figures for stocks,
government securities and inflation); (e) the Hambrecht & Quist Growth Stock
Index; (f) the NASDAQ OTC Composite Prime Return; (g) the Russell Midcap Index;
(h) the Russell 2000 Index-Total Return; (i) the ValueLine Composite-Price
Return; (j) the Wilshire 4600 Index; (k) the Salomon Brothers' World Bond Index
(which measures the total return in U.S. dollar terms of government bonds,
Eurobonds and foreign bonds of ten countries, with all such bonds having a
minimum maturity of five years); (l) the Shearson Lehman Brothers Aggregate Bond
Index or its component indices (the Aggregate Bond Index measures the
performance of Treasury, U.S. Government agencies, mortgage and Yankee bonds);
(m) the S&P Bond indices (which measure yield and price of corporate, municipal
and U.S. Government bonds); (n) the J.P. Morgan Global Government Bond Index;
(o) Donoghue's Money Market Fund Report (which provides industry averages of
7-day annualized and compounded yields of taxable, tax-free and U.S. Government
money market funds); (p) other taxable investments including certificates of
deposit, money market deposit accounts, checking accounts, savings accounts,
money market mutual funds and repurchase agreements; (q) historical investment
data supplied by the research departments of Goldman Sachs, Lehman Brothers,
First Boston Corporation, Morgan Stanley (including EAFE "Free"), Salomon
Brothers, Merrill Lynch, Donaldson Lufkin and Jenrette or other providers of
such data; (r) the FT-Actuaries Europe and Pacific Index; (s) mutual fund
performance indices published by Variable Annuity Research & Data Service; and
(t) mutual fund performance indices published by Morningstar, Inc. The
composition of the investments in such indices and the characteristics of such
benchmark investments are not identical to, and in some cases are very different
from, those of a Fund's portfolio. These indices and averages are generally
unmanaged and the items included in the calculations of such indices and
averages may be different from those of the equations used by the Trust to
calculate a Fund's performance figures.
The Trust may from time to time summarize the substance of discussions
contained in shareholder reports in advertisements and publish the views as to
markets of the Manager,
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Barclays or Capital Guardian, the rationale for a Fund's investments and
discussions of the Fund's current asset allocation.
From time to time, advertisements or information may include a
discussion of certain attributes or benefits to be derived by an investment in a
particular Fund. Such advertisements or information may include symbols,
headlines or other material which highlight or summarize the information
discussed in more detail in the communication.
Such performance data will be based on historical results and will not
be intended to indicate future performance. The total return or yield of a Fund
will vary based on market conditions, portfolio expenses, portfolio investments
and other factors. The value of a Fund's shares will fluctuate and your shares
may be worth more or less than their original cost upon redemption.
PURCHASE AND REDEMPTION OF FUND SHARES
Purchases of Fund shares are discussed fully in the Prospectus under
the heading "Shareholder Information - How to Buy and Sell Shares."
Each Fund reserves the right, in its sole discretion, to reject
purchases when, in the judgment of the Manager, the purchase would not be in the
best interest of the Fund.
SPECIAL REDEMPTIONS. Although it would not normally do so, each Fund
has the right to pay the redemption price of shares of the Fund in whole or in
part in portfolio securities as prescribed by the Board of Trustees of the
Trust. When the shareholder sells portfolio securities received in this fashion,
he would incur a brokerage charge. Any such securities would be valued for the
purposes of making such payment at the same value as used in determining net
asset value. The Funds have elected to be governed by Rule 18f-1 under the 1940
Act, pursuant to which each Fund is obligated to redeem shares solely in cash up
to $500,000 of the applicable Fund during any 90 day period for any one account.
SUSPENSION OF REDEMPTIONS. A Fund may not suspend a shareholder's right
of redemption, or postpone payment for a redemption for more than seven days,
unless the NYSE is closed for other than customary weekends or holidays, or
trading on the NYSE is restricted, or for any period during which an emergency
exists as a result of which (1) disposal by a Fund of securities owned by it is
not reasonably practicable, or (2) it is not reasonably practicable for a Fund
to fairly determine the value of its assets, or for such other periods as the
Commission may permit for the protection of investors.
DISTRIBUTION EXPENSES
State Farm VP Management Corp. ("Management Corp.") serves as the
principal underwriter for the Trust pursuant to an Underwriting Agreement
initially approved by the Board of Trustees of the Trust. Management Corp. is a
registered broker-dealer and a member of the National Association of Securities
Dealers, Inc. ("NASD"). Shares of each Fund will be continuously offered and
will be sold by registered representatives of Management Corp. which
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receives sales charges and distribution plan fees from each Fund under the
Underwriting Agreement.
Management Corp. bears all the expenses of providing services pursuant
to the Underwriting Agreement, including the payment of the expenses relating to
the distribution of Prospectuses for sales purposes as well as any advertising
or sales literature. The Trust bears the expenses of registering its shares with
the Commission and paying the fees required to be paid by state regulatory
authorities. The Underwriting Agreement continues in effect for two years from
initial approval and for successive one-year periods thereafter, provided that
each such continuance is specifically approved (i) by vote of a majority of the
Board of Trustees of the Trust, including a majority of the Trustees who are not
parties to the Underwriting Agreement or interested persons of any such party,
(as the term interested person is defined in the 1940 Act); or (ii) by the vote
of a majority of the outstanding voting securities of a Fund. Management Corp.
is not obligated to sell any specific amount of shares of any Fund.
Management Corp.'s business and mailing address is One State Farm
Plaza, Bloomington, Illinois 61710. Management Corp. was organized as a Delaware
corporation in November 1996 and is a wholly-owned subsidiary of Auto Company.
OTHER SERVICE PROVIDERS
CUSTODIANS
Chase Manhattan Trust Company of Illinois, c/o Chase Manhattan Bank,
North American Insurance Securities Services, 3 Chase MetroTech Center, 6th
Floor, Brooklyn, New York 11245 ("Chase Manhattan"), acts as custodian of the
assets of each Fund, except the Equity Index Funds and the International Equity
Fund. Investors Bank and Trust Company, 200 Clarendon Street, Boston,
Massachusetts 02116 ("IBT"), is the Trust's custodian for the Equity Index Funds
and the International Equity Fund.
Chase Manhattan and IBT (the "custodians") may hold securities of the
Funds in amounts sufficient to cover put and call options written on futures
contracts in a segregated account by transferring (upon the Trust's
instructions) assets from a Fund's general (regular) custody account. The
custodians also will hold certain assets of certain of the Funds or Master
Portfolios constituting margin deposits with respect to financial futures
contracts at the disposal of FCMs through which such transactions are effected.
The Manager performs fund accounting services, including the valuation of
portfolio securities and the calculation of net asset value, for each Fund other
than the International Equity Fund and the International Index Fund. IBT
performs fund accounting services for these Funds.
TRANSFER AGENT
The Transfer Agent Agreements between the Trust and the Manager
appoints the Manager as the Funds' transfer agent and dividend disbursing agent.
Under the terms of the agreement, the Manager: (1) prepares and mails
transaction confirmations, annual records of investments and tax information
statements; (2) effects transfers of Fund shares; (3) prepares
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annual shareowner meeting lists; (4) prepares, mails and tabulates proxies;
(5) mails shareowner reports; and (6) disburses dividend and capital gains
distributions. These services are performed by the Manager at a fee
determined by the Board of Trustees to be reasonable in relation to the
services provided and no less favorable to the Funds than would have been
available from a third party.
IBT acts as transfer agent and dividend disbursing agent for the Master
Portfolios.
INDEPENDENT AUDITORS
The Funds' independent auditors are Ernst & Young LLP, 233 South Wacker
Drive, Chicago, Illinois 60606. The firm audits each Fund's annual financial
statements, reviews certain regulatory reports and each Fund's federal income
tax returns, and performs other professional accounting, auditing, tax and
advisory services when engaged to do so by the Funds.
TAXES
GENERAL TAX INFORMATION
The Trust intends for each Fund to qualify as a regulated investment
company under the Subchapter M of the Code. If a Fund qualifies as a regulated
investment company and distributes substantially all of its net income and gains
to its shareholders (which the Funds intend to do), then under the provisions of
Subchapter M, that Fund should have little or no income taxable to it under the
Code.
Each Fund must meet several requirements to maintain its status as a
regulated investment company. These requirements include the following: (1) at
least 90% of the Fund's gross income must be derived from dividends, interest,
payments with respect to securities loans and gains from the sale or disposition
of securities of foreign currencies; and (2) at the close of each quarter of the
Fund taxable year, (a) at least 50% of the value of the Fund's total assets must
consist of cash, U.S. Government securities and other securities, such that no
more than 5% of the value of the Fund consists of such other securities of any
one issuer and the Fund must not hold more than 10% of the outstanding voting
stock of any such issuer, and (b) the Fund must not invest more than 25% of the
value of its total assets in the securities of any one issuer (other than U.S.
Government securities) or two or more issuers which the Fund controls and which
are engaged in the same, similar or related trades or businesses.
In order to maintain the qualification of a Fund's status as a
regulated investment company, the Trust may, in its business judgment, restrict
a Fund's ability to invest in certain financial instruments. For the same
reason, the Trust may, in its business judgment, require a Fund to maintain or
dispose of an investment in certain types of financial instruments beyond the
time when it might otherwise be advantageous to do so.
Each Fund will be subject to a 4% non-deductible federal excise tax on
certain amounts not distributed (and not treated as having been distributed) on
a timely basis in accordance with
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annual minimum distribution requirement. The Funds intend under normal
circumstances to avoid liability for such tax by satisfying such distribution
requirements.
If a Fund acquires stock in certain non-U.S. corporations that receive
at least 75% of their annual gross income from passive sources (such as
interest, dividends, rents, royalties or capital gain) or hold at least 50% of
their assets in investments producing such passive income ("passive foreign
investment companies"), that Fund could be subject to federal income tax and
additional interest charges on "excess distributions" received from such
companies or gain from the sale of stock in such companies, even if all income
or gain actually received by the Fund is timely distributed to its shareholders.
The Fund would not be able to pass through to its shareholders any credit or
deduction for such a tax. Certain elections may, if available, ameliorate these
adverse tax consequences, but any such election would require the applicable
Fund to recognize taxable income or gain without the concurrent receipt of cash.
Any Fund that is permitted to acquire stock in foreign corporations may limit
and/or manage its holdings in passive foreign investment companies to minimize
its tax liability or maximize its return from these investments.
Foreign exchange gains and losses realized by a Fund in connection with
certain transactions involving foreign currency-denominated debt securities,
certain foreign currency futures and options, foreign currency forward
contracts, foreign currencies, or payables or receivables denominated in a
foreign currency are subject to Section 988 of the Code, which generally causes
such gains and losses to be treated as ordinary income and losses and may affect
the amount, timing and character of distributions to shareholders. Any such
transactions that are not directly related to a Fund's investment in stock or
securities, possibly including speculative currency positions or currency
derivatives not used for hedging purposes, could under future Treasury
regulations produce income not among the types of "qualifying income" from which
the Fund must derive at least 90% of its annual gross income.
Some Funds may be subject to withholding and other taxes imposed by
foreign countries with respect to their investments in foreign securities. Tax
conventions between certain countries and the U.S. may reduce or eliminate such
taxes. For the International Equity Fund and International Index Fund, if more
than 50% of the Fund's assets at year-end consists of the debt and equity
securities of foreign corporations, the Fund may elect to permit shareholders to
claim a credit or deduction on their income tax returns for their pro rata
portion of qualified taxes paid by the Fund to foreign countries. In such a
case, shareholders will include in gross income from foreign sources their pro
rata shares of such taxes. A shareholder's ability to claim a foreign tax credit
or deduction in respect of foreign taxes paid by the Fund may be subject to
certain limitations imposed by the Code, as a result of which a shareholder may
not receive a full credit or deduction for the amount of such taxes.
Shareholders who do not itemize on their federal income tax returns may claim a
credit (but no deduction) for such foreign taxes. The Funds, other than the
International Equity Fund and the International Index Fund, anticipate that they
generally will not qualify to pass such foreign taxes and any associated tax
deductions or credits through to their shareholders, who therefore generally
will not report such amounts on their tax returns.
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For Federal income tax purposes, each Fund is permitted to carry
forward a net capital loss in any year to offset its own capital gains, if any,
during the eight years following the year of the loss. To the extent subsequent
capital gains are offset by such losses, they would not result in federal income
tax liability to the applicable Fund and would not be distributed as such to
shareholders.
Investment in debt obligations that are at risk or in default presents
special tax issues for any Fund that may hold such obligations. Tax rules are
not entirely clear about issues such as when the Fund may cease to accrue
interest, original issue discount, or market discount, when and to what extent
deductions may be taken for bad debts or worthless securities, how payments
received on obligations in default should be allocated between principal and
income, and whether exchanges of debt obligations in a workout context are
taxable. These and other issues will be addressed by any Fund that may hold such
obligations in order to reduce the risk of distributing insufficient income to
preserve its status as a regulated investment company and avoid becoming subject
to federal income or excise tax.
Limitations imposed by the Code on regulated investment companies like
the Funds may restrict a Fund's ability to enter into futures, options, and
forward transactions.
Certain options, futures and forward foreign currency transactions
undertaken by a Fund may cause the Fund to recognize gains or losses from
marking to market even though its positions have not been sold or terminated and
affect the character as long-term or short-term (or, in the case of certain
currency forwards, options and futures, as ordinary income or loss) and timing
of some capital gains and losses realized by the Fund. Also, certain of a Fund's
losses on its transactions involving options, futures or forward contracts
and/or offsetting portfolio positions may be deferred rather than being taken
into account currently in calculating the Fund's taxable income. Certain of the
applicable tax rules may be modified if a Fund is eligible and chooses to make
one or more of certain tax elections that may be available. These transactions
may therefore affect the amount, timing and character of a Fund's distributions
to shareholders. The Funds will take into account the special tax rules
(including consideration of available elections) applicable to options, futures
or forward contracts in order to minimize any potential adverse tax
consequences.
Distributions from a Fund's current or accumulated earnings and profits
("E&P"), as computed for federal income tax purposes, will be taxable as
described in the Fund's prospectus whether taken in shares or in cash.
Distributions, if any, in excess of E&P will constitute a return of capital,
which will first reduce an investor's tax basis in a Fund's shares and
thereafter (after such basis is reduced to zero) will generally give rise to
capital gains. Shareholders electing to receive distributions in the form of
additional shares will have a cost basis for federal income tax purposes in each
share so received equal to the amount of cash they would have received had they
elected to receive the distributions in cash, divided by the number of shares
received.
At the time of an investor's purchase of shares of a Fund, a portion of
the purchase price is often attributable to realized or unrealized appreciation
in the Fund's portfolio or undistributed taxable income of the Fund.
Consequently, subsequent distributions from such appreciation or
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income may be taxable to such investor even if the net asset value of the
investor's shares is, as a result of the distributions, reduced below the
investor's cost for such shares, and the distributions in reality represent a
return of a portion of the purchase price.
Upon a redemption of shares of a Fund (including by exercise of the
exchange privilege), a shareholder may realize a taxable gain or loss depending
upon his basis in his shares. Such gain or loss will be treated as capital gain
or loss if the shares are capital assets in the shareholder's hands and will be
long-term or short-term, depending upon that shareholder's tax holding period
for the shares. A sales charge paid in purchasing shares of a Fund cannot be
taken into account for purposes of determining gain or loss on the redemption or
exchange of such shares within 90 days after their purchase to the extent shares
of the Fund are subsequently acquired without payment of a sales charge pursuant
to the increase in the shareholder's tax basis in the shares subsequently
acquired. Also, any loss realized on a redemption or exchange will be disallowed
to the extent the shares disposed of are replaced with shares of the same Fund
within a period of 61 days beginning 30 days before and ending 30 days after the
shares are disposed of, such as pursuant to an election to reinvest dividends of
capital gain distributions automatically. In such a case, the basis of the
shares acquired will be adjusted to reflect the disallowed loss. Any loss
realized upon redemption of shares with a tax holding period of six months or
less will be treated as a long-term capital loss to the extent of any amounts
treated as distributions of long-term capital gain with respect to such shares.
For purposes of the dividends received deduction available to
corporations, dividends received by a Fund, if any, from U.S. domestic
corporations in respect of the stock of such corporations held by the Fund, for
federal income tax purposes, for at least 46 days (91 days in the case of
certain preferred stock) and distributed and designated by the Fund may be
treated as qualifying dividends. Corporate shareholders must meet the minimum
holding period requirement stated above (46 or 91 days) with respect to their
shares of the applicable Fund in order to qualify for the deduction and, if they
borrow to acquire such shares, may be denied a portion of the dividends received
deduction. The entire qualifying dividend, including the otherwise deductible
amount, will be included in determining the excess (if any) of a corporate
shareholder's adjusted current earnings over its alternative minimum taxable
income, which may increase its alternative minimum tax liability. Additionally,
any corporate shareholder should consult its tax adviser regarding the
possibility that its basis in its shares may be reduced, for federal income tax
purposes, by reason of "extraordinary dividends" received with respect to the
shares, for the purpose of computing its gain or loss on redemption or other
disposition of the shares.
Different tax treatment, including penalties on certain excess
contributions and deferrals, certain pre-retirement and post-retirement
distributions and certain prohibited transactions, is accorded to shareholder
accounts maintained as qualified retirement plans. Shareholders should consult
their tax advisers for more information.
The foregoing discussion relates solely to U.S. Federal income tax law
as applicable to U.S. persons (i.e., U.S. citizens or residents and U.S.
domestic corporations, partnerships, trusts or estates) subject to tax under
such law. The discussion does not address special tax rules
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applicable to certain classes of investors, such as tax-exempt entities,
insurance companies, and financial institutions. Dividends, capital gain
distributions, and ownership of or gains realized on the redemption
(including an exchange) of the shares of a Fund may also be subject to state
and local taxes. Shareholders should consult their own tax advisers as to the
federal, state or local tax consequences of ownership of shares of, and
receipt of distributions from, the Funds in their particular circumstances.
Non-U.S. investors not engaged in a U.S. trade or business with which
their investment in a Fund is effectively connected will be subject to U.S.
Federal income tax treatment that is different from that described above. These
investors may be subject to non-resident alien withholding tax at the rate of
30% (or a lower rate under an applicable tax treaty) on amounts treated as
ordinary dividends from a Fund and, unless an effective IRS Form W-8 (or
equivalent form) or authorized substitute is on file, to 31% backup withholding
on certain other payments from the Fund. Non-U.S. investors should consult their
tax advisers regarding such treatment and the application of foreign taxes to an
investment in any Fund. The Funds do not generally accept investments by
non-U.S. investors.
TAX ADVANTAGED BOND FUND. The Tax Advantaged Bond Fund will be
qualified to pay exempt-interest dividends to its shareholders only if, at the
close of each quarter of the Fund's taxable year, at least 50% of the total
value of the Fund's assets consists of obligations the interest on which is
exempt from federal income tax. Distributions that the Fund properly designates
as exempt-interest dividends are treated by shareholders as interest excludable
from their gross income for federal income tax purposes but may be taxable for
federal alternative minimum tax purposes and for state and local purposes.
Because the Fund intends to be qualified to pay exempt-interest dividends, the
Fund may be limited in its ability to enter into taxable transactions involving
forward commitments, repurchase agreements, financial futures, and options
contracts on financial futures, tax-exempt bond indices, and other assets.
The Fund uses the "average annual" method to determine the designated
percentage of dividends that qualifies as tax-exempt income. This designation is
made annually in January. The percentage of a particular dividend that is
designated as tax-exempt income may be substantially different from the
percentage of the Fund's income that was tax-exempt during the period from which
the distribution was made.
Exempt-interest dividends are exempt from regular federal income tax,
but they may affect the tax liabilities of taxpayers who are subject to the AMT.
Exempt-interest dividends are also includible in the modified income of
shareholders who receive Social Security benefits for purposes of determining
the extent to which such benefits may be taxable.
Part or all of the interest on indebtedness, if any, incurred or
continued by a shareholder to purchase or carry shares of the Tax Advantaged
Bond Fund is not deductible. The portion of interest that is not deductible is
equal to the total interest paid or accrued on the indebtedness, multiplied by
the percentage of the Fund's total distributions (not including distributions
from net long-term capital gains) paid to the shareholder that are
exempt-interest dividends. Under rules used by the Internal Revenue Service for
determining when borrowed funds are considered
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used for the purpose of purchasing or carrying particular assets, the
purchase of shares may be considered to have been made with borrowed funds
even though such funds are not directly traceable to the purchase of the
shares.
In general, exempt-interest dividends, if any, attributable to interest
received on certain private activity obligations and certain industrial
development bonds will not be tax-exempt to any shareholders who are
"substantial users" of the facilities financed by such obligations or bonds or
who are "related persons" of such substantial users.
If a shareholder sells shares at a loss within six months of purchase,
any loss will be disallowed for Federal income tax purposes to the extent of any
exempt-interest dividends received on such shares.
STATE AND LOCAL. Each Fund may be subject to state or local taxes in
jurisdictions in which such Fund may be deemed to be doing business. In
addition, in those states or localities which have income tax laws, the
treatment of such Fund and its shareholders under such laws may differ from
their treatment under federal income tax laws, and investment in such Fund may
have different tax consequences for shareholders than would direct investment in
such Fund's portfolio securities. Shareholders should consult their own tax
advisers concerning these matters.
CODES OF ETHICS
The Manager intends that: all of its activities function exclusively
for the benefit of the owners or beneficiaries of the assets it manages; assets
under management or knowledge as to current or prospective transactions in
managed assets are not utilized for personal advantage or for the advantage of
anyone other than the owners or beneficiaries of those assets; persons
associated with the Manager and the Trust avoid situations involving actual or
potential conflicts of interest with the owners or beneficiaries of managed
assets; and situations appearing to involve actual or potential conflicts of
interest or impairment of objectivity are avoided whenever doing so does not run
counter to the interests of the owners or beneficiaries of the managed assets.
The Board of Trustees of the Trust has adopted a Code of Ethics which imposes
certain prohibitions, restrictions, preclearance requirements and reporting
rules on the personal securities transactions of subscribers to the Code, who
include the Trust's officers and Trustees and the employees of the Manager.
Barclays and Capital Guardian have adopted similar Codes of Ethics relating to
their employees, and the Board of Trustees of the Trust has adopted Barclays and
Capital Guardian's Code of Ethics insofar as it relates to their respective
employees' activities in connection with the Trust. The Board of Trustees
believes that the provisions of its Code of Ethics and Barclays' and Capital
Guardian's Code of Ethics are reasonably designed to prevent subscribers from
engaging in conduct that violates these principles.
SHARES
The Trust was organized as a business trust pursuant to the laws of the
State of Delaware on June 8, 2000. The Trust is authorized to issue an unlimited
number of shares of beneficial interest in the Trust, all without par value.
Shares are divided into and may be issued in a
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designated series representing beneficial interests in one of the Trust's
Funds. There are currently ten series of shares.
Each share of a series issued and outstanding is entitled to
participate equally in dividends and distributions declared by such series and,
upon liquidation or dissolution, in net assets allocated to such series
remaining after satisfaction of outstanding liabilities. The shares of each
series, when issued, will be fully paid and non-assessable and have no
preemptive or conversion rights.
Auto Company provided the initial capital for the Trust by purchasing
$100,000 of Class A shares of the Bond Fund. Such shares were acquired for
investment.
As of the date of this Statement of Additional Information, Auto
Company owned 100% of each Fund's outstanding shares.
The Master Portfolios are series of the Master Fund, an open-end,
series management investment company organized as Delaware business trust. The
Master Fund was organized October 21, 1993. The Master Fund currently consists
of twelve series, including the Master Portfolios.
VOTING RIGHTS
Each share (including fractional shares) is entitled to one vote for
each dollar of net asset value represented by that share on all matters to which
the holder of that share is entitled to vote. Only shares representing interests
in a particular Fund will be entitled to vote on matters affecting only that
Fund. The shares do not have cumulative voting rights. Accordingly, owners
having shares representing more than 50% of the assets of the Trust voting for
the election of Trustees could elect all of the Trustees of the Trust if they
choose to do so, and in such event, shareowners having voting interests in the
remaining shares would not be able to elect any Trustees.
Matters requiring separate shareholder voting by Fund shall have been
effectively acted upon with respect to any Fund if a majority of the outstanding
voting interests of that Fund vote for approval of the matter, notwithstanding
that: (1) the matter has not been approved by a majority of the outstanding
voting interests of any other Fund; or (2) the matter has not been approved by a
majority of the outstanding voting interests of the Trust.
In a situation where an Equity Index Fund does not receive instruction
from certain of its shareholders on how to vote the corresponding shares of a
Master Portfolio, such Equity Index Fund will vote such shares in the same
proportion as the shares of which the Equity Index Fund does receive voting
instructions.
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FINANCIAL STATEMENTS
REPORT OF INDEPENDENT AUDITORS
The Board of Trustees and Shareholder
State Farm Mutual Fund Trust--Bond Fund
We have audited the accompanying statement of net assets of State Farm Mutual
Fund Trust--Bond Fund as of October 30, 2000. The statement of net assets is
the responsibility of the Trust's management. Our responsibility is to
expresss an opionion on the statement of net assets based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards in the United States. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the statement
of net assets is free of material misstatement. An audit includes examining,
on a test basis, evidence supporting the amounts and disclosures in the
statement of net assets. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluationg the overall financial statement presentation. We believe that our
audit provides a reasonable basis for our opinion.
In our opinion, the statement of net assets referred to above presents
fairly, in all material respects, the financial position of State Farm Mutual
Fund Trust--Bond Fund at October 30, 2000, in conformity with generally
accepted accounting principles in the United States.
ERNST & YOUNG LLP
Chicago, Illinois
October 30, 2000
STATE FARM MUTUAL FUND TRUST - BOND FUND
STATEMENT OF NET ASSETS, OCTOBER 30, 2000
<TABLE>
<S> <C>
ASSETS
Cash $100,000
LIABILITIES
None $---
NET ASSETS
Net assets, applicable to $10,000 Class A shares
of beneficial interest outstanding, equivalent to $100,000
$10.00 per share (unlimited number of shares
authorized, no par value)
PRICING OF SHARES
Net asset value and redemption price per share $10.00
($100,000/10,000 Class A shares outstanding)
Maximum offering price per share (net asset value $10.31
Plus 3.09% of net asset value)
</TABLE>
State Farm Mutual Fund Trust
Notes to the Financial Statement
As of October 30, 2000
Note 1 - Organization and Registration
State Farm Mutual Fund Trust (the "Trust") was established on June 8, 2000 as
a Delaware business trust and is registered under the Investment Company Act
of 1940 as an open-ended management investment company. The Bond Fund (the
"Fund") is a separate investment portfolio of the Trust. The Fund has had no
operations other than those relating to organizational matters, including the
sale of 10,000 Class A shares of beneficial interest to capitalize the Fund
which were sold to State Farm Mutual Automobile Insurance Company on October
30, 2000 for cash in the amount of $100,000.
Note 2 - Significant Accounting Policies
The following is a summary of significant accounting policies consistently
followed by the Fund in the preparation of its financial statements. The
policies are in conformity with generally accepted accounting principles.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and
liabilities at the date of the financial statements and the reported
changes in net assets during the reporting period. Actual results
could differ from those estimates.
Organizational and Registration Expenses
State Farm Investment Management Corp., the Fund's investment
advisor, has incurred and paid expenses in connection with the
organization of the Trust. The Trust has not incurred any expenses.
Federal Income Taxes
The Fund intends to qualify annually for treatment as a regulated
investment company under Subchapter M of the Internal Revenue Code
and, if so qualified, will not be liable for federal income taxes to
the extent earnings are distributed to shareholders on a timely
basis.
Note 3 - Investment Advisory and Other Agreements
As compensation for its services to the Fund, the Advisor will receive an
investment advisory fee at an annual rate of 0.10% of the average daily net
assets of the Fund, which is accrued daily and paid quarterly. The Advisor
has also agreed to reimburse the Fund for expenses on Class A shares that
exceed 0.70% of average daily net assets. This expense reimbursement
arrangement is voluntary and may be discontinued by the Advisor at any time.
The Trust has entered into a shareholder services agreement with State Farm
Investment Management Corp. providing a fee at the annual rate of 0.25% of
the average net assets for Class A and B shares.
The Trust has entered into a distribution agreement with State Farm VP
Management Corp. Under terms of the agreement, State Farm VP Management Corp.
shall offer shares of the Fund on a continuous basis and may engage in sales
and promotional activities in connection therewith.
The Trust has also established a plan for the payment of distribution expense
pursuant to Rule 12b-1 under the Investment Company Act of 1940. Under the
12b-1 Plan for Class A shares, the Fund pays an amount up to 0.25% of its
average daily net assets on an annual basis to State Farm VP Management Corp.
as compensation for distribution expenses incurred by State Farm VP
Management Corp.
Note 4 - Capital Stock
The Fund is authorized to issue an unlimited number of shares with no par
value. The Fund has three separate classes: Class A, Class B, and
Institutional Shares. Each class of shares has a different combination of
sales charges, fees, and eligibility requirements. As of October 30, 2000,
Class A shares are the only class of shares outstanding.
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APPENDIX A
DESCRIPTION OF BOND RATINGS
A rating of a rating service represents the service's opinion as to the
credit quality of the security being rated. However, the ratings are general and
are not absolute standards of quality or guarantees as to the creditworthiness
of an issuer. Consequently, the Manager and Capital Guardian believe that the
quality of debt securities in which a Fund invests should be continuously
reviewed and that individual analysts give different weightings to the various
factors involved in credit analysis. A rating is not a recommendation to
purchase, sell or hold a security, because it does not take into account market
value or suitability for a particular investor. When a security has received a
rating from more than one service, each rating should be evaluated
independently. Ratings are based on current information furnished by the issuer
or obtained by the ratings services from other sources which they consider
reliable. Ratings may be changed, suspended or withdrawn as a result of changes
in or unavailability of such information, or for other reasons.
The following is a description of the characteristics of ratings used
by Moody's Investors Service, Inc. ("Moody's") and Standard & Poor's Corporation
("S&P").
RATINGS BY MOODY'S
Aaa--Bonds rated Aaa are judged to be 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. Although the various protective elements are likely to
change, such changes are not likely to impair the fundamentally strong position
of such bonds.
Aa--Bonds rated Aa are judged to be 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 bonds or fluctuation of protective elements may be
of greater amplitude or there may be other elements present which make the long
term risk appear somewhat larger than in Aaa bonds.
A--Bonds rated A possess many favorable investment attributes and are
to be considered as upper medium grade obligations. Factors giving security to
principal and interest are considered adequate but elements may be present which
suggest a susceptibility to impairment sometime in the future.
Baa--Bonds 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.
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Ba--Bonds 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 rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
Caa--Bonds rated Caa are of poor standing. Such bonds may be in default
or there may be present elements of danger with respect to principal or
interest.
Ca--Bonds rated Ca represent obligations which are speculative in a
high degree. Such bonds are often in default or have other marked shortcomings.
C--Bonds 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.
Conditional Ratings. The designation "Con." followed by a rating
indicated bonds for which the security depends upon the completion of some act
or the fulfillment of some condition. These are bonds secured by (a) earnings of
projects under construction, (b) earnings of projects unseasoned in operating
experience, (c) rentals which begin when facilities are completed, or (d)
payments to which some other limiting condition attaches. Parenthetical rating
denotes probable credit stature upon completion of construction or elimination
of basis of condition.
Note: Those bonds in the Aa, A, Baa, Ba and B groups which Moody's
believes possess the strongest investment attributes are designated by the
symbols Aa 1, A 1, Baa 1, Ba 1, and B 1.
MUNICIPAL NOTES:
MIG 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. This designation denotes high quality. Margins of protection are
ample although not so large as in the preceding group.
MIG 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 established.
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COMMERCIAL PAPER:
Moody's employs the following three designations, all judged to be
investment grade, to indicate the relative repayment capacity of rated issuers:
Prime-1 Highest Quality
Prime 2 Higher Quality
Prime-3 High Quality
If an issuer represents to Moody's that its commercial paper
obligations are supported by the credit of another entity or entities, Moody's,
in assigning ratings to such issuers, evaluates the financial strength of the
indicated affiliated corporations, commercial banks, insurance companies,
foreign governments, or other entities, but only as one factor in the total
rating assessment.
S&P RATINGS
AAA--Bonds rated AAA have the highest rating. Capacity to pay principal
and interest is extremely strong.
AA--Bonds rated AA have a very strong capacity to pay principal and
interest and differ from AAA bonds only in small degree.
A--Bonds rated A have a strong capacity to pay principal and interest,
although they are somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions than bonds in higher rated categories.
BBB--Bonds rated BBB are regarded as having an adequate capacity to pay
principal and interest. Whereas they normally exhibit protection parameters,
adverse economic conditions or changing circumstances are more likely to lead to
a weakened capacity to pay principal and interest for bonds in this capacity
than for bonds in higher rated categories.
BB--B--CCC--CC--Bonds rated BB, B, CCC and CC are regarded, on balance,
as predominantly speculative with respect to the issuer's capacity to pay
interest and repay principal in accordance with the terms of the obligation. BB
indicates the lowest degree of speculation among such bonds and CC the highest
degree of speculation. Although such bonds will likely have some quality and
protective characteristics, these are outweighed by large uncertainties or major
risk exposures to adverse conditions.
C--The rating C is reserved for income bonds on which no interest is
being paid.
In order to provide more detailed indications of credit quality, S&P's
bond letter ratings described above (except for AAA category) may be modified by
the addition of a plus or a minus sign to show relative standing within the
rating category.
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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, although addressing
credit quality subsequent to completion of the project, makes no comment on the
likelihood of, or the risk of default upon the failure of, such completion. The
investor should exercise his own judgment with respect to such likelihood and
risk.
MUNICIPAL NOTES:
SP-1. Notes rated SP-1 have very strong capacity to pay principal and
interest. Those issues determined to possess overwhelming safety characteristics
are designated SP-1+.
SP-2. Notes rated SP-2 have satisfactory capacity to pay principal and
interest.
Notes due in three years or less normally receive a note rating. Notes
maturing beyond three years normally receive a bond rating, although the
following criteria are used in making that assessment:
- Amortization schedule (the larger the final maturity relative to
other maturities, the more likely the issue will be rated as a
note).
- Source of payment (the more dependent the issue is on the market
for its refinancing, the more likely it will be rated as a note).
COMMERCIAL PAPER:
A. Issues assigned this highest rating are regarded as having the
greatest capacity for timely payment. Issues in this category are further
refined with the designations 1, 2 and 3 to indicate the relative degree of
safety.
A-1. This designation indicates that the degree of safety regarding
timely payment is either overwhelming or very strong. Those issues determined to
possess overwhelming safety characteristics are designated A-1+.
4
