Registration No. 02-35570
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
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POST-EFFECTIVE AMENDMENT NO. 46 TO
FORM N-1A
REGISTRATION STATEMENT
under
THE SECURITIES ACT OF 1933
and
REGISTRATION STATEMENT
under
THE INVESTMENT COMPANY ACT OF 1940
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PRINCIPAL VARIABLE CONTRACTS FUND, INC.
(Exact name of Registrant as specified in Charter)
The Principal Financial Group
Des Moines, Iowa 50392
(Address of principal executive offices)
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Telephone Number (515) 248-3842
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MICHAEL D. ROUGHTON Copy to:
The Principal Financial Group JONES & BLOUCH L.L.P.
Des Moines, Iowa 50392 Suite 405 West
1025 Thomas Jefferson Street, N.W.
Washington, DC 20007-0805
(Name and address of agent for service)
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It is proposed that this filing will become effective (check appropriate box)
___ immediately upon filing pursuant to paragraph (b)of Rule 485
___ on (date) pursuant to paragraph (b) of Rule 485
___ 60 days after filing pursuant to paragraph (a)(1) of Rule 485
___ on (date) pursuant to paragraph (a)(1) of Rule 485
X 75 days after filing pursuant to paragraph (a)(2) of Rule 485
___ on (date) pursuant to paragraph (a)(2) of Rule 485
If appropriate, check the following box:
This post-effective amendment designates a new effective date for
a previously filed post-effective amendment.
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<PAGE>
PRINCIPAL VARIABLE CONTRACTS FUND, INC.
ACCOUNTS OF THE FUND
Aggressive Growth Account LargeCap Stock Index Account
Asset Allocation Account MicroCap Account
Balanced Account MidCap Account
Bond Account MidCap Growth Account
Capital Value Account MidCap Growth Equity Account
Government Securities Account Money Market Account
Growth Account Real Estate Account
International Account SmallCap Account
International Emerging Markets Account SmallCap Growth Account
International SmallCap Account SmallCap Value Account
LargeCap Growth Account Utilities Account
LargeCap Growth Equity Account
This Prospectus describes a mutual fund organized by Principal Life Insurance
Company. The Fund provides a choice of investment objectives through the
accounts listed above.
The date of this Prospectus is May 1, 2000 as revised through ________________
Neither the Securities and Exchange Commission nor any State Securities
Commission has approved or disapproved of these securities or determined if this
prospectus is accurate or complete. Any representation to the contrary is a
criminal offense.
TABLE OF CONTENTS
ACCOUNT DESCRIPTIONS ........................................ 4
Aggressive Growth Account................................ 6
Asset Allocation Account................................. 8
Balanced Account......................................... 10
Bond Account............................................. 12
Capital Value Account.................................... 14
Government Securities Account............................ 16
Growth Account........................................... 18
International Account.................................... 20
International Emerging Markets Account................... 21
International SmallCap Account........................... 22
LargeCap Growth Account.................................. 22
LargeCap Growth Equity Account........................... 22
LargeCap Stock Index Account............................. 22
MicroCap Account......................................... 24
MidCap Account........................................... 26
MidCap Growth Account.................................... 28
MidCap Growth Equity Account............................. 28
Money Market Account..................................... 30
Real Estate Account...................................... 32
SmallCap Account......................................... 34
SmallCap Growth Account.................................. 36
SmallCap Value Account................................... 38
Utilities Account........................................ 42
CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS............... 44
PRICING OF ACCOUNT SHARES..................................... 49
DIVIDENDS AND DISTRIBUTIONS................................... 49
MANAGEMENT, ORGANIZATION AND CAPITAL STRUCTURE................ 50
The Manager.............................................. 50
The Sub-Advisors......................................... 50
Duties of the Manager and Sub-Advisor.................... 51
MANAGERS' COMMENTS............................................ 52
GENERAL INFORMATION ABOUT AN ACCOUNT.......................... 65
Eligible Purchasers...................................... 65
Shareholders Rights...................................... 65
Non-Cumulative Voting.................................... 66
Purchase of Account Shares............................... 66
Sale of Account Shares................................... 66
Restricted Transfers..................................... 67
Financial Statements..................................... 67
FINANCIAL HIGHLIGHTS.......................................... 68
Notes to Financial Highlights............................ 76
ACCOUNT DESCRIPTIONS.......
The Principal Variable Contracts Fund (the "Fund") is made up of Accounts. Each
Account has its own investment objective. Principal Management Corporation*, the
Manager of the Fund, has selected a Sub-Advisor for certain Accounts (based on
the Sub-Advisor's experience with the investment strategy for which it was
selected). The Manager seeks to provide a full range of investment approaches
through the Fund.
<TABLE>
<CAPTION>
Sub-Advisor Account
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<S> <C>
Berger LLC ("Berger") SmallCap Growth
Dreyfus Corporation ("Dreyfus") MidCap Growth
Duncan-Hurst Capital Management Inc. ("Duncan-Hurst") LargeCap Growth Equity
Goldman Sachs Asset Management ("Goldman") MicroCap
Invista Capital Management, LLC* ("Invista") Balanced, Capital Value, Government Securities,
Growth, International, International Emerging
Markets, International SmallCap, LargeCap Stock
Index, MidCap, SmallCap and Utilities
Janus Capital Corporation ("Janus") LargeCap Growth
J.P. Morgan Investment Management, Inc. ("Morgan") SmallCap Value
Morgan Stanley Asset Management ("Morgan Stanley") Aggressive Growth and Asset Allocation
Turner Investment Partners, Inc. ("Turner") MidCap Growth Equity
* Principal Management Corporation and Invista are members of the
Principal Financial Group.
</TABLE>
In the description for each Account, you will find important information about
the Account's:
Primary investment strategy
This section summarizes how the Account intends to achieve its investment
objective. It identifies the Account's primary investment strategy (including
the type or types of securities in which the Account primarily invests) and any
policy to concentrate in securities of issuers in a particular industry or group
of industries.
Annual operating expenses
The annual operating expenses for each Account are deducted from Account assets
(stated as a percentage of Account assets) and are shown as of the end of the
most recent fiscal year (estimates of expenses are shown for Accounts which have
not completed a fiscal year of operation). The example is intended to help you
compare the cost of investing in a particular Account with the cost of investing
in other mutual funds. The example assumes you invest $10,000 in an Account for
the time periods indicated. The example also assumes that your investment has a
5% total return each year and that the Account's operating expenses are the same
as the most recent fiscal year expenses (or estimated expenses for the new
Accounts). Although your actual costs may be higher or lower, based on these
assumptions, your costs would be as shown.
Day-to-day Account management
The investment professionals who manage the assets of each Account are listed
with each Account. Backed by their staffs of experienced securities analysts,
they provide the Accounts with professional investment management.
Account Performance
As certain Accounts have been operating for a limited period of time, no
historical information is available for those Accounts. If historical
information is available, the Account's description includes a set of tables and
a bar chart.
The bar chart is included to provide you with an indication of the risks
involved when you invest. The chart shows changes in the Account's performance
from year to year.
One of the tables compares the Account's average annual returns with:
o a broad-based securities market index (An index measures the market price
of a specific group of securities in a particular market of securities in a
market sector. You cannot invest directly in an index. An index does not
have an investment advisor and does not pay any commissions or expenses. If
an index had expenses, its performance would be lower.); and
o an average of mutual funds with a similar investment objective and
management style. The averages used are prepared by independent statistic
services.
The other table provides the highest and lowest quarterly rate of return for the
Account's shares over the same period of time used in the bar chart.
An Account's past performance is not necessarily an indication of how the
Account will perform in the future.
You may call Principal Mutual Funds (1-800-247-4123) to get the current 7-day
yield for the Money Market Account.
NOTE: Investments in these Accounts are not deposits of a bank and are not
insured or guaranteed by the FDIC or any other government agency.
No salesperson, dealer or other person is authorized to give
information or make representations about an Account other than those
contained in this Prospectus. Information or representations from
unauthorized parties may not be relied upon as having been made by an
Account, the Fund, the Manager or any Sub-Advisor.
GROWTH-ORIENTED ACCOUNT
International Emerging Markets Account
The Account seeks to achieve long-term growth of capital by investing primarily
in equity securities of issuers in emerging market countries.
Main Strategies
The Account seeks to achieve its objective by investing in common stocks of
companies in emerging market countries. For this Account, the term "emerging
market country" means any country which is considered to be an emerging country
by the international financial community (including the International Bank for
Reconstruction and Development (also known as the World Bank) and the
International Financial Corporation). These countries generally include every
nation in the world except the United States, Canada, Japan, Australia, New
Zealand and most nations located in Western Europe. Investing in many emerging
market countries is not feasible or may involve unacceptable political risk.
Invista, the Sub-Advisor, focuses on those emerging market countries that it
believes have strongly developing economies and markets which are becoming more
sophisticated.
Under normal conditions, at least 65% of the Account's assets are invested in
emerging market country equity securities. The Account invests in securities of:
o companies with their principal place of business or principal office in
emerging market countries;
o companies for which the principal securities trading market is an emerging
market country; or
o companies, regardless of where its securities are traded, that derive 50%
or more of their total revenue from either goods or services produced in
emerging market countries or sales made in emerging market countries.
Main Risks
Foreign stocks carry risks that are not generally found in stocks of U.S.
companies. These include the risk that a foreign security could lose value as a
result of political, financial and economic events in foreign countries. In
addition, foreign securities may be subject to securities regulators with less
stringent accounting and disclosure standards than are required of U.S.
companies.
Because foreign securities generally are denominated in foreign currencies, the
value of the net assets of the Account as measured in U.S. dollars will be
affected by changes in exchange rates. To protect against future uncertainties
in foreign currency exchange rates, the Account is authorized to enter into
certain foreign currency exchange transactions. In addition, the Account's
foreign investments may be less liquid and their price more volatile than
comparable investments in U.S. securities. Settlement periods may be longer for
foreign securities and portfolio liquidity may be affected.
Investments in emerging market countries involve special risks. Certain emerging
market countries have historically experienced, and may continue to experience,
certain economic problems. These may include: high rates of inflation, high
interest rates, exchange rate fluctuations, large amounts of debt, balance of
payments and trade difficulties, and extreme poverty and unemployment.
Under unusual market or economic conditions, the Account may invest in the same
kinds of securities as the other Growth-Oriented Accounts. These include
securities issued by domestic or foreign corporations, governments or
governmental agencies, instrumentalities or political subdivisions. The
securities may be denominated in U.S. dollars or other currencies.
Because the values of the Account's assets are likely to rise or fall
dramatically, if you sell your shares when their value is less than the price
you paid, you will lose money.
Investor Profile
The Account is generally a suitable investment if you are seeking long-term
growth and want to invest a portion of your assets in securities of companies in
emerging market countries. This Account is not an appropriate investment if you
are seeking either preservation of capital or high current income. You must be
able to assume the increased risks of higher price volatility and currency
fluctuations associated with investments in international stocks which trade in
non-U.S. currencies.
Account Performance Information
As the inception date of the Fund is ____________, historical performance data
is not available. Estimated annual Account operating expenses are as follows:
Account Operating Expenses
Management Fees................ ____%
Other Expenses................. ____
Total Account Operating Expenses____%
Examples
The Examples assume that you invest $10,000 in the Account for the time periods
indicated and then redeem all of your shares at the end of those periods. The
Examples also assume that your investment has a 5% return each year and that the
Account's operating expenses remain the same. Although your actual costs may be
higher or lower, based on these assumptions your cost would be:
1 Year 3 Years 5 Years 10 Years
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$---- $---- $---- $----
Day-to-day Account Management
Since ___________ Kurtis D. Spieler, CFA. Mr. Spieler joined Invista Capital
(Account's inception)Management in 1995. He holds an MBA from Drake University
and a BBA from Iowa State University. He has earned the
right to use the Chartered Financial Analyst designation.
GROWTH-ORIENTED ACCOUNT
LargeCap Growth Equity Account
The Account seeks to achieve long-term growth of capital by investing primarily
in common stocks of larger capitalization domestic companies.
Main Strategies
The Account is a non-diversified Account that invests primarily in equity
securities of companies in the U.S. with comparatively larger market
capitalizations. Market capitalization is defined as total current market value
of a company's outstanding common stock. Under normal market conditions, the
Account invests at least 75% of its total assets in domestic companies with
market capitalizations in excess of $10 billion. In addition, the Account may
invest up to 25% of its assets in securities of foreign issuers.
In selecting securities for investment, the Sub-Advisor, Duncan-Hurst, looks at
stocks it believes have prospects for above average growth over an extended
period of time. Duncan-Hurst seeks to identify companies with accelerating
earnings growth and positive company fundamentals. While economic forecasting
and industry sector analysis play a part in its research effort, Duncan-Hurst's
stock selection process begins with individual company analysis. This is often
referred to as a bottom-up approach to investing. From a group of companies that
meet Duncan-Hurst's standards, it selects the securities of those companies that
it believes will have accelerating earnings growth. In making this
determination, Duncan-Hurst considers certain characteristics of a particular
company including new product development, management change and competitive
market dynamics.
Main Risks
While stocks have historically been a leading choice of long-term investors,
they do fluctuate in price. The value of the stocks owned by the Account changes
on a daily basis. The current price reflects the activities of individual
companies and general market conditions. In the short-term, stock prices
fluctuate dramatically in response to these factors. As a result, the value of
your investment in the Account will go up and down. If you sell your shares when
their value is less than the price you paid, you will lose money. Because
different types of stocks tend to shift in and out of favor depending on market
and economic conditions, the Account's performance may sometimes be lower or
higher than that of other funds.
Foreign stocks carry risks that are not generally found in stocks of U.S.
companies. These include the risk that a foreign security could lose value as a
result of political, financial and economic events in foreign countries. In
addition, foreign securities may be subject to securities regulators with less
stringent accounting and disclosure standards than are required of U.S.
companies.
The Account anticipates that its portfolio turnover rate will typically exceed
150%. Turnover rates in excess of 100% generally result in higher transaction
costs and a possible increase in short-term capital gains (or losses).
The Account is a non-diversified investment company, as defined in the
Investment Company Act of 1940, as amended (the "1940 Act"), which means that a
relatively high percentage of assets of the Account may be invested in the
obligations of a limited number of issuers. The value of the shares of the
Account may be more susceptible to a single economic, political or regulatory
occurrence than the shares of a diversified investment company.
Investor Profile
The Account is generally a suitable investment if you are seeking long-term
growth and are willing to accept the potential for short-term, volatile
fluctuations in the value of your investment. This Account is designed as a
long- term investment with growth potential. It is not appropriate if you are
seeking income or short-term conservation of capital.
Account Performance Information
As the inception date of the Fund is ____________, historical performance data
is not available. Estimated annual Account operating expenses are as follows:
Account Operating Expenses
Management Fees................ ____%
Other Expenses................. ____
Total Account Operating Expenses____%*
* Manager has agreed to reimburse operating expenses so that total
Account operating expenses will not be greater than 1.20% for 2000.
Examples
The Examples assume that you invest $10,000 in the Account for the time periods
indicated and then redeem all of your shares at the end of those periods. The
Examples also assume that your investment has a 5% return each year and that the
Account's operating expenses remain the same. Although your actual costs may be
higher or lower, based on these assumptions your cost would be:
1 Year 3 Years
$---- $----
Day-to-day Account Management
Since _________ David C. Magee. Mr. Magee has been with Duncan-Hurst Capital
(Account's inception)Management since 1992. He holds an MBA in Finance from UCLA
and a BS in Economics and Business Management from the
University of California, Davis.
GROWTH-ORIENTED ACCOUNT
MidCap Growth Equity Account
The Account seeks to achieve long-term growth of capital by investing primarily
in medium capitalization U.S. companies with strong earnings growth potential.
Main Strategies
The Account invests primarily in common stocks and other equity securities of
U.S. companies. Under normal market conditions, the Account invests at least 65%
of its assets in companies with market capitalizations in the $1 billion and $10
billion range.
The Account invests in securities of companies that are diversified across
economic sectors. It attempts to maintain sector concentrations that approximate
those of its current benchmark, the Russell MidCap Index. The Account is not an
index fund and does not limit its investment to the securities of issuers in the
Russell MidCap Index.
The Sub-Advisor, Turner, selects stocks that it believes have strong earnings
growth potential. Turner invests in companies with strong earnings dynamics, and
sells those with deteriorating earnings prospects. Turner believes forecasts for
market timing and sector rotation are unreliable, and introduce an unacceptable
level of risk. As a result, under normal market conditions the Account is fully
invested.
Due to its investment strategy, the Account may buy and sell securities
frequently. This may result in higher transaction costs and additional capital
gains tax.
Main Risks
Because it purchases equity securities, the Account is subject to the risk that
stock prices will fall over short or extended periods of time. Individual
companies may report poor results or be negatively affected by industry and/or
economic trends and developments. The price of securities issued by such
companies may suffer a decline in response. These factors contribute to price
volatility, which is the principal risk of investing in the Account.
In addition, the Account is subject to the risk that its principal market
segment, medium capitalization growth stocks, may underperform compared to other
market segments or to the equity markets as a whole. Because of this volatility,
the value of the Account's equity securities may fluctuate on a daily basis.
These fluctuations may reduce your principal investment and lead to varying
returns. If you sell your shares when their value is less than the price you
paid, you will lose money.
The medium capitalization companies the Account invests in may be more
vulnerable to adverse business or economic events than larger, more established
companies. In particular, these mid-size companies may pose greater risk due to
narrow product lines, limited financial resources, less depth in management or a
limited trading market for their securities.
Investor Profile
The Account is generally a suitable investment if you are seeking long-term
growth of capital and are willing to accept the potential for short-term
fluctuations in the value of your investment. This Account is not designed for
income or conservation of capital.
Account Performance Information
As the inception date of the Fund is ____________, historical performance data
is not available. Estimated annual Account operating expenses are as follows:
Account Operating Expenses
Management Fees................ ____%
Other Expenses................. ____
Total Account Operating Expenses____%*
* Manager has agreed to reimburse operating expenses so that total
Account operating expenses will not be greater than ____% for 2000.
Examples
The Examples assume that you invest $10,000 in the Account for the time periods
indicated and then redeem all of your shares at the end of those periods. The
Examples also assume that your investment has a 5% return each year and that the
Account's operating expenses remain the same. Although your actual costs may be
higher or lower, based on these assumptions your cost would be:
1 Year 3 Years
$---- $----
Day-to-day Account Management
Since __________ Christopher K. McHugh. Mr. McHugh joined Turner Investment
(Account's inception)Partners, Inc. in 1990. He holds a BS in Accounting from
Philadelphia College of Textiles and Science and an MBA in
Finance from St. Joseph's University.
CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS
The Statement of Additional Information (SAI) contains additional information
about investment strategies and their related risks.
Securities and Investment Practices
Equity securities include common stocks, preferred stocks, convertible
securities and warrants. Common stocks, the most familiar type, represent an
equity (ownership) interest in a corporation. Although equity securities have a
history of long term growth in value, their prices fluctuate based on changes in
a company's financial condition and on overall market and economic conditions.
Smaller companies are especially sensitive to these factors.
Accounts that focus their investments in equity securities include: Aggressive
Growth, Capital Value, Growth, International, International Emerging Markets,
International SmallCap, LargeCap Growth, LargeCap Growth Equity, LargeCap Stock
Index, MicroCap, MidCap, MidCap Growth, MidCap Growth Equity, SmallCap, SmallCap
Growth, SmallCap Value and Utilities. The Asset Allocation and Balanced Accounts
invest in a mix of equity and fixed-income securities.
Fixed-income securities include bonds and other debt instruments that are used
by issuers to borrow money from investors. The issuer generally pays the
investor a fixed, variable or floating rate of interest. The amount borrowed
must be repaid at maturity. Some debt securities, such as zero coupon bonds, do
not pay current interest, but are sold at a discount from their face values.
Fixed-income securities are sensitive to changes in interest rates. In general,
bond prices rise when interest rates fall and fall when interest rates rise.
Longer term bonds and zero coupon bonds are generally more sensitive to interest
rate changes.
Bond prices are also affected by the credit quality of the issuer. Investment
grade debt securities are medium and high quality securities. Some bonds, such
as "junk" bonds, may have speculative characteristics and may be particularly
sensitive to economic conditions and the financial condition of the issuers.
Accounts that focus their investments in fixed income securities include the
Bond and Government Securities Accounts.
Repurchase Agreements and Loaned Securities
Each of the Accounts may invest a portion of its assets in repurchase
agreements. Repurchase agreements typically involve the purchase of debt
securities from a financial institution such as a bank, savings and loan
association or broker-dealer. A repurchase agreement provides that the Account
sells back to the seller and that the seller repurchases the underlying
securities at a specified price on a specific date. Repurchase agreements may be
viewed as loans by an Account collateralized by the underlying securities. This
arrangement results in a fixed rate of return that is not subject to market
fluctuation while the Account holds the security. In the event of a default or
bankruptcy by a selling financial institution, the affected Account bears a risk
of loss. To minimize such risks, the Account enters into repurchase agreements
only with large, well-capitalized and well-established financial institutions.
In addition, the value of the collateral underlying the repurchase agreement is
always at least equal to the repurchase price, including accrued interest.
Each of the Accounts may lend its portfolio securities to unaffiliated
broker-dealers and other unaffiliated qualified financial institutions.
Currency Contracts
The Accounts (except Government Securities and Money Market) may each enter into
forward currency contracts, currency futures contracts and options, and options
on currencies for hedging and other non-speculative purposes. A forward currency
contract involves a privately negotiated obligation to purchase or sell a
specific currency at a future date at a price set in the contract. An Account
will not hedge currency exposure to an extent greater than the aggregate market
value of the securities held or to be purchased by the Account (denominated or
generally quoted or currently convertible into the currency).
Hedging is a technique used in an attempt to reduce risk. If an Account's
Manager or Sub-Advisor hedges market conditions incorrectly or employs a
strategy that does not correlate well with the Account's investment, these
techniques could result in a loss, regardless of whether the intent was to
reduce risk or to increase return. These techniques may increase the volatility
of an Account and may involve a small investment of cash relative to the
magnitude of the risk assumed. In addition, these techniques could result in a
loss if the other party to the transaction does not perform as promised.
Additionally, there is the risk of governmental action through exchange controls
that would restrict the ability of the Account to deliver or receive currency.
Forward Commitments
Each of the Accounts may enter into forward commitment agreements. These
agreements call for the Account to purchase or sell a security on a future date
at a fixed price. Each of these Accounts may also enter into contracts to sell
its investments either on demand or at a specific interval.
Warrants
Each of the Accounts (except Government Securities and Money Market) may invest
up to 5% of its total assets in warrants. A warrant is a certificate granting
its owner the right to purchase securities from the issuer at a specified price,
normally higher than the current market price. Up to 2% of an Account's total
assets may be invested in warrants that are not listed on either the New York or
American Stock Exchanges. For the International and International SmallCap
Accounts, the 2% limitation also applies to warrants not listed on the Toronto
Stock Exchange and Chicago Board Options Exchange.
Risks of High Yield Securities
The Asset Allocation, Balanced, and Bond Accounts may, to varying degrees,
invest in debt securities rated lower than BBB by S&P or Baa by Moody's or, if
not rated, determined to be of equivalent quality by the Manager and/or
Sub-Advisor. Such securities are sometimes referred to as high yield or "junk
bonds" and are considered speculative.
Investment in high yield bonds involves special risks in addition to the risks
associated with investment in high rated debt securities. High yield bonds may
be regarded as predominantly speculative with respect to the issuer's continuing
ability to meet principal and interest payments. Moreover, such securities may,
under certain circumstances, be less liquid than higher rated debt securities.
Analysis of the creditworthiness of issuers of high yield securities may be more
complex than for issuers of higher quality debt securities. The ability of an
Account to achieve its investment objective may, to the extent of its investment
in high yield bonds, be more dependent on such creditworthiness analysis than
would be the case if the Account were investing in higher quality bonds.
High yield bonds may be more susceptible to real or perceived adverse economic
and competitive industry conditions than higher-grade bonds. The prices of high
yield bonds have been found to be less sensitive to interest rate changes than
more highly rated investments, but more sensitive to adverse economic downturns
or individual corporate developments. If the issuer of high yield bonds
defaults, an Account may incur additional expenses to seek recovery.
The secondary market on which high yield bonds are traded may be less liquid
than the market for higher-grade bonds. Less liquidity in the secondary trading
market could adversely affect the price at which an Account could sell a high
yield bond and could adversely affect and cause large fluctuations in the daily
price of the Account's shares. Adverse publicity and investor perceptions,
whether or not based on fundamental analysis, may decrease the value and
liquidity of high yield bonds, especially in a thinly traded market.
The use of credit ratings for evaluating high yield bonds also involves certain
risks. For example, credit ratings evaluate the safety of principal and interest
payments, not the market value risk of high yield bonds. Also, credit rating
agencies may fail to change ratings in a timely manner to reflect subsequent
events. If a credit rating agency changes the rating of a portfolio security
held by an Account, the Account may retain the security if the Manager and/or
sub-Advisor thinks it is in the best interest of shareholders.
Options, Futures Contract
Each of the Accounts (except Money Market) may buy and sell certain types of
options. Each type, and their associated risks, is more fully discussed in the
SAI.
Foreign Securities
Each of the following Accounts may invest in foreign securities to the indicated
percentage of its assets (debt securities issued in the United States pursuant
to a registration statement filed with the Securities and Exchange Commission
are not treated as foreign securities for purposes of these limitations.):
o Asset Allocation, International, International Emerging Markets and
International SmallCap Accounts - 100%;
o Aggressive Growth, LargeCap Growth, LargeCap Growth Equity, MicroCap, Real
Estate and SmallCap Growth Accounts - 25%;
o Bond, Capital Value, SmallCap and Utilities Accounts - 20%;
o Balanced, Growth, LargeCap Stock Index, MidCap, MidCap Growth, MidCap
Growth Equity and SmallCap Value Accounts - 10%.
The Money Market Account does not invest in foreign securities other than those
that are U.S. dollar denominated. All principal and interest payments for the
security are payable in U.S. dollars. The interest rate, the principal amount to
be repaid and the timing of payments related to the securities do not vary or
float with the value of a foreign currency, the rate of interest on foreign
currency borrowings or with any other interest rate or index expressed in a
currency other than U.S. dollars.
For purposes of these restrictions, foreign securities include:
o companies organized under the laws of countries outside of the U.S.;
o companies for which the principal securities trading market is outside of
the U.S.; and
o companies, regardless of where its securities are traded, that derive 50%
or more of their total revenue from either goods or services produced
outside the U.S. or sales made outside of the U.S.
Investment in foreign securities presents certain risks including: fluctuations
in currency exchange rates, revaluation of currencies, the imposition of foreign
taxes, future political and economic developments including war, expropriations,
nationalization, the possible imposition of currency exchange controls and other
foreign governmental laws or restrictions. In addition, there may be reduced
availability of public information concerning issuers compared to domestic
issuers. Foreign issuers are not generally subject to uniform accounting,
auditing and financial reporting standards or to other regulatory practices and
requirements that apply to domestic issuers. Transactions in foreign securities
may be subject to higher costs. Each Account's investment in foreign securities
may also result in higher custodial costs and the costs associated with currency
conversions.
Securities of many foreign issuers may be less liquid and their prices more
volatile than those of comparable domestic issuers. Foreign securities markets,
particularly those in emerging market countries, are known to experience long
delays between the trade and settlement dates of securities purchased and sold.
Such delays may result in a lack of liquidity and greater volatility in the
price of securities on those markets. As a result of these factors, the Board of
Directors of the Fund has adopted Daily Pricing and Valuation Procedures for the
Fund. These procedures outline the steps to be followed by the Manager and
Sub-Advisor to establish a reliable market or fair value if a reliable market
value is not available through normal market quotations. The Executive Committee
of the Board of Directors oversees this process.
Securities of Smaller Companies
The Asset Allocation, International Emerging Markets, International SmallCap,
LargeCap Growth Equity, MicroCap, MidCap, MidCap Growth, MidCap Growth Equity,
SmallCap, SmallCap Growth and SmallCap Value Accounts may invest in securities
of companies with small- or mid-sized market capitalizations. Market
capitalization is defined as total current market value of a company's
outstanding common stock. Investments in companies with smaller market
capitalizations may involve greater risks and price volatility (wide, rapid
fluctuations) than investments in larger, more mature companies. Smaller
companies may be less mature than older companies. At this earlier stage of
development, the companies may have limited product lines, reduced market
liquidity for their shares, limited financial resources or less depth in
management than larger or more established companies. Small companies also may
be less significant within their industries and may be at a competitive
disadvantage relative to their larger competitors. While smaller companies may
be subject to these additional risks, they may also realize more substantial
growth than larger or more established companies.
Unseasoned Issuers
The Accounts (except Government Securities) may invest in the securities of
unseasoned issuers. Unseasoned issuers are companies with a record of less than
three years continuous operation, including the operation of predecessors and
parents. Unseasoned issuers by their nature have only a limited operating
history that can be used for evaluating the company's growth prospects. As a
result, investment decisions for these securities may place a greater emphasis
on current or planned product lines and the reputation and experience of the
company's management and less emphasis on fundamental valuation factors than
would be the case for more mature growth companies. In addition, many unseasoned
issuers also may be small companies and involve the risks and price volatility
associated with smaller companies.
Temporary or Defensive Measures
For temporary or defensive purposes in times of unusual or adverse market
conditions, the Accounts may invest without limit in cash and cash equivalents.
For this purpose, cash equivalents include: bank certificates of deposit,
bankers acceptances, repurchase agreements, commercial paper, and commercial
paper master notes which are floating rate debt instruments without a fixed
maturity. In addition, an Account may purchase U.S. Government securities,
preferred stocks and debt securities, whether or not convertible into or
carrying rights for common stock.
Portfolio Turnover
"Portfolio Turnover" is the term used in the industry for measuring the amount
of trading that occurs in an Account's portfolio during the year. For example, a
100% turnover rate means that on average every security in the portfolio has
been replaced once during the year.
Accounts with high turnover rates (more than 100%) often have higher transaction
costs (which are paid by the Account) and may generate short-term capital gains.
No turnover rate is calculated for the Money Market Account because of the short
maturities of the securities in which it invests. No turnover rates are
calculated for the Accounts which have been in existence for less than six
months (Interational Emerging Markets, LargeCap Growth Equity and MidCap Growth
Equity). You can find the turnover rate for each of the other Accounts in the
Account's Financial Highlights table.
Please consider all the factors when you compare the turnover rates of different
funds. A fund with consistently higher total returns and higher turnover rates
than another fund may actually be achieving better performance precisely because
the managers are active traders. You should also be aware that the "total
return" line in the Financial Highlights section already includes portfolio
turnover costs.
PRICING OF ACCOUNT SHARES
Each Account's shares are bought and sold at the current share price. The share
price of each Account is calculated each day the New York Stock Exchange is
open. The share price is determined as of the close of business of the Exchange
(normally at 3:00 p.m. Central Time). When your order to buy or sell shares is
received, the share price used to fill the order is the next price calculated
after the order is placed.
For all Accounts, except the Money Market Account, the share price is calculated
by:
o taking the current market value of the total assets of the Account
o subtracting liabilities of the Account
o dividing the remainder by the total number of shares owned by the Account.
The securities of the Money Market Account are valued at amortized cost. The
calculation procedure is described in the Statement of Additional Information.
The Money Market Account reserves the right to determine a share price more than
once a day.
NOTES:
o If current market values are not readily available for a security, its fair
value is determined using a policy adopted by the Fund's Board of
Directors.
o An Account's securities may be traded on foreign securities markets that
generally complete trading at various times during the day prior to the
close of the New York Stock Exchange. The values of foreign securities used
in computing share price are determined at the time the foreign market
closes. Occasionally, events affecting the value of foreign securities
occur when the foreign market is closed and the New York Stock Exchange is
open. If the Manager and/or Sub-Advisor believes the market value is
materially affected, the share price will be calculated using the policy
adopted by the Fund.
o Foreign securities markets may trade on days when the New York Stock
Exchange is closed (such as customary U.S. holidays) and an Account's share
price is not calculated. As a result, the value of an Account's assets may
be significantly affected by such trading on days when you cannot purchase
or sell shares of the Fund.
DIVIDENDS AND DISTRIBUTIONS
The issuer of an equity security held by an Account may make a dividend payment.
When an Account receives a dividend, it increases the net asset value of a share
of the Account.
An Account accrues interest daily on its fixed income securities in anticipation
of an interest payment from the issuer of the security. This accrual increases
the net asset value of an Account.
The Money Market Account (or any other Account holding commercial paper)
amortizes the discount on commercial paper it owns on a daily basis. This
increases the net asset value of the Account.
NOTE: As the net asset value of a share of an Account increases, the unit
value of the corresponding division also reflects an increase. The
number of units you own in the Account are not increased.
MANAGEMENT, ORGANIZATION AND CAPITAL STRUCTURE
The Manager
Principal Management Corporation (the "Manager") serves as the manager for the
Principal Variable Contracts Fund, Inc. In its handling of the business affairs
of the Fund, the Manager provides clerical, recordkeeping and bookkeeping
services, and keeps the financial and accounting records required for the
Accounts.
The Manager is a subsidiary of Princor Financial Services Corporation and an
affiliate of Principal Life Insurance Company. It has managed mutual funds since
1969. As of December 31, 1999, the Funds it managed had assets of approximately
$6.42 billion. The Manager's address is Principal Financial Group, Des Moines,
Iowa 50392-0200.
The Sub-Advisors
The Manager has signed contracts with various Sub-Advisors. Under the
Sub-Advisory agreements, the Sub-Advisor agrees to assume the obligations of the
Manager to provide investment advisory services for a specific Account. For
these services, each Sub-Advisor is paid a fee by the Manager.
Accounts: Aggressive Growth and Asset Allocation
Sub-Advisor: Morgan Stanley Asset Management ("Morgan Stanley"), with
principal offices at 1221 Avenue of the Americas, New York, NY 10020,
provides a broad range of portfolio management services to customers in the
U.S. and abroad. As of December 31, 1999, Morgan Stanley, together with its
affiliated institutional asset management companies, managed investments
totaling approximately $184.9 billion as named fiduciary or fiduciary
adviser. On December 1, 1998 Morgan Stanley Asset Management Inc. changed
its name to Morgan Stanley Dean Witter Investment Management Inc. but
continues to do business in certain instances using the name Morgan Stanley
Asset Management.
Accounts: Balanced, Capital Value, Government Securities, Growth,
International, International Emerging Markets, International SmallCap,
LargeCap Stock Index, MidCap, SmallCap, and Utilities
Sub-Advisor: Invista Capital Management, LLC ("Invista"), an indirectly
wholly-owned subsidiary of Principal Life Insurance Company and an
affiliate of the Manager, was founded in 1985. It manages investments for
institutional investors, including Principal Life. Assets under management
as of December 31, 1999 were approximately $35.3 billion. Invista's address
is 1800 Hub Tower, 699 Walnut, Des Moines, Iowa 50309.
Account: LargeCap Growth
Sub-Advisor: Janus Capital Corporation ("Janus"), 100 Fillmore Street,
Denver CO 80206-4928, was formed in 1969. Kansas City Southern Industries,
Inc. ("KCSI") owns approximately 82% of the outstanding voting stock of
Janus, indirectly through its subsidiary Stillwell Financial Inc., most of
which it acquired in 1984. KCSI has announced its intention to spin-off its
financial services subsidiaries, which it expects to complete in the first
half of 2000. As of January 31, 2000, Janus managed or administered over
$256 billion in assets.
Account: LargeCap Growth Equity
Sub-Advisor: Duncan-Hurst was founded in 1990. Its address is 4365
Executive Drive, Suite 1520, San Diego, CA 92121. As of December 31, 1999,
Duncan-Hurst managed assets of approximately $5.9 billion for institutional
and individual investors.
Account: MicroCap
Sub-Advisor: Goldman Sachs Assets Management ("GSAM"), 32 Old Slip, 17th
Floor, New York, NY 10005. As of September 1, 1999, the Investment Division
("IMD") was established as a new operating division of Goldman, Sachs & Co.
("Goldman Sachs"). This newly created entity includes GSAM. GSAM provides a
wide range of discretionary investment advisory services, quantitatively
driven and actively managed to U.S. and international equity portfolios,
U.S. and global fixed-income portfolios, commodity and currency products
and money market accounts. As of December 31, 1999, GSAM, along with other
units of IMD, had assets under management of $258.5 billion.
Account: MidCap Growth
Sub-Advisor: The Dreyfus Corporation ("Dreyfus"), 200 Park Avenue, New
York, NY 10166, was formed in 1947. Dreyfus is a wholly owned subsidiary of
Mellon Bank, N.A., which is a wholly owned subsidiary of Mellon Bank
Corporation ("Mellon"). As of December 31, 1999, Dreyfus managed or
administered approximately $119.6 billion in assets for approximately 1.7
million investor accounts nationwide.
Account: MidCap Growth Equity
Sub-Advisor: Turner was founded in 1990. Its address is 1235 Westlake
Drive, Suite 350, Berwyn, PA 1931. As of December 31, 1999, Turner had
discretionary management authority with respect to approximately $5.7
billion in assets.
Account: SmallCap Growth
Sub-Advisor: Berger LLC ("Berger"), 210 University Boulevard, Suite 900,
Denver, CO 80206. It serves as investment advisor, sub-advisor,
administrator or sub-administrator to mutual funds and institutional
investors. Berger is a wholly owned subsidiary of Kansas City Southern
Industries, Inc. ("KCSI"). KCSI is a publicly traded holding company with
principal operations in rail transportation, through its subsidiary the
Kansas City Southern Railway Company, and financial asset management
businesses. Assets under management for Berger as of December 31, 1999 were
approximately $7.1 billion.
Account: SmallCap Value
Sub-Advisor: J.P. Morgan Investment Management, Inc. ("Morgan"), 522 Fifth
Avenue, New York, NY 10036 is a wholly-owned subsidiary of J.P. Morgan &
Co. Incorporated ("J.P. Morgan") a bank holding company. J.P. Morgan,
through Morgan and its other subsidiaries, offers a wide range of services
to governmental, institutional, corporate and individual customers and acts
as investment advisor to individual and institutional clients. As of
December 31, 1999, J.P. Morgan and its subsidiaries had total combined
assets under management of approximately $349 billion.
Duties of the Manager and Sub-Advisor
The Manager or the Sub-Advisor provides the Board of Directors of the Fund a
recommended investment program. Each program must be consistent with the
Account's investment objective and policies. Within the scope of the approved
investment program, the Manager or the Sub-Advisor advises each Account on its
investment policies and determines which securities are bought and sold, and in
what amounts.
The Manager is paid a fee by each Account for its services, which includes any
fee paid to the Sub-Advisor. The fee paid by each Account (as a percentage of
the average daily net assets) for the fiscal year ended December 31, 1999 was:
Management Other Total Operating
Account Fees Expenses Expenses
Aggressive Growth 0.75% 0.02% 0.77%
Asset Allocation 0.80 0.05 0.85
Balanced 0.57 0.01 0.58
Bond 0.49 0.01 0.50
Capital Value 0.43 0.00 0.43
Government Securities 0.49 0.01 0.50
Growth 0.45 0.00 0.45
International 0.73 0.05 0.78
International SmallCap 1.20 0.12 1.32
LargeCap Growth 1.10 0.13 1.23*
LargeCap Stock Index 0.35 0.14 0.49*
MicroCap 1.00 0.28 1.28*
MidCap 0.61 0.00 0.61
MidCap Growth 0.90 0.19 1.09*
Money Market 0.50 0.02 0.52
Real Estate 0.90 0.09 0.99
SmallCap 0.85 0.06 0.91
SmallCap Growth 1.00 0.07 1.07*
SmallCap Value 1.10 0.34 1.44*
Utilities 0.60 0.04 0.64
* Before waiver
The Fund and the Manager, under an order received from the SEC, may enter into
and materially amend agreements with Sub-Advisors without obtaining shareholder
approval. For any Accounts as to which the Fund is relying on the order, the
Manager may:
o hire one or more Sub-Advisors;
o change Sub-Advisors; and
o reallocate management fees between itself and Sub-Advisors.
The Manager will continue to have the ultimate responsibility for the investment
performance of these Accounts due to its responsibility to oversee Sub-Advisors
and recommend their hiring, termination and replacement. The Fund will not rely
on the order as to any Account until it receives approval from:
o contract owners who have assets in the Account, or
o in the case of a new Account, the Account's sole initial shareholder before
the Account is available to contract owners, and
the Fund states in its prospectus that it intends to rely on the order with
respect to the Account. The Manager will not enter into an agreement with an
affiliated Sub-Advisor without that agreement, including the compensation to be
paid under it, being similarly approved. The Fund has received the necessary
shareholder approval and intends to rely on the order with respect to the
Aggressive Growth, Asset Allocation, LargeCap Growth, LargeCap Growth Equity,
MicroCap, MidCap Growth, MidCap Growth Equity, MidCap Value, SmallCap Growth and
SmallCap Value Accounts (not all of these Accounts are available through this
contract).
MANAGERS' COMMENTS
Principal Management Corporation and its Sub-Advisors are staffed with
investment professionals who manage each individual Account. Comments by these
individuals in the following paragraphs summarize in capsule form the general
strategy and results of each Account for 1999. The accompanying graphs display
results for the past 10 years or the life of the Account, whichever is shorter.
Average annual total return figures provided for each Account in the graphs
reflect all expenses of the Account and assume all distributions are reinvested
at net asset value. The figures do not reflect expenses of the variable life
insurance contracts or variable annuity contracts that purchase Account shares;
performance figures for the divisions of the contracts would be lower than
performance figures for the Accounts due to the additional contract expenses.
Past performance is not predictive of future performance. Returns and net asset
values fluctuate. Shares are redeemable at current net asset value, which may be
more or less than original cost.
The various indices included in the following graphs are unmanaged and do not
reflect any commissions or fees which would be incurred by an investor
purchasing the securities included in the index. Investors cannot invest
directly into these or any indices.
Growth-Oriented Accounts
Aggressive Growth Account
(William Auslander and Philip Friedman)
The Aggressive Growth Account seeks to provide long-term capital appreciation by
investing primarily in growth-oriented common stocks of large capitalization
U.S. corporations and, to a limited extent, foreign corporations. The portfolio
of this Account generated excellent returns in 1999. The portfolio appreciated
40.2% versus 21.0% for the S&P 500 and 34.8% for the Lipper Large-Cap Growth
Index. Fourth quarter performance was solid as well with the portfolio
appreciating 22.0% versus 14.9% for the S&P 500 and 25.5% for the Lipper
Large-Cap Growth Index. The Account maintained and benefited from its philosophy
of opportunistic concentration driven by bottom-up fundamental company analysis
and an emphasis on gaining an "information edge" in the sectors and companies in
which the Account invests. At year-end, the Account's top 10 holdings accounted
for about 36% of total assets and the portfolio held positions in 80 stocks
U.S. equity markets again set records in 1999, led by large capitalization
growth stocks in general and a white-hot technology sector in particular. The
S&P 500's 21.0% increase left the index at an all-time high and 1999 marked the
10th consecutive up year for this index. The compounded return for the past five
years is a stunning 250%. With the exception of a brief period in the spring,
growth outperformed value throughout the year. Investors continue to believe and
invest in the sustainability of the growth of the largest companies, and for the
most part, these companies continue to deliver stellar results.
In the Aggressive Growth Account long-term capital appreciation is sought by
investing in growth-oriented equity securities of large capitalization,
predominantly U.S. corporations. The Account continues to reflect a mix of
classic growth stocks such as Microsoft, Cisco Systems, General Electric, Home
Depot and less well known growth names such as Tyco International, Clear Channel
Communications, and United Technologies. Managers were pleased with the
Account's broad-based performance, particularly in the context of a market that
continued to be dominated by a small number of large capitalization stocks. No
single stock accounted for more than 10% of the Account's absolute performance.
In addition, about 70% of the Account's relative outperformance was driven by
stock picking versus sector allocation.
Technology dominated the headlines and the sector performance charts in 1999.
Given the tremendous outperformance of the group, technology stocks now account
for 30% of the S&P 500's total market capitalization, up from 19% at the end of
1998 and 10% five years ago. Given technology's extremely strong performance,
one might find two things surprising. First, only about 27% of the Account's
1999 outperformance relative to the S&P 500 was attributable to technology
holdings. Second, about 86% of that relative outperformance was attributable to
successful stock picking within the group as the Account maintained a relatively
neutral posture toward technology versus the index weight throughout most of the
year. Account Managers feel this reflects well on the bottom-up, research
intensive approach used in stock picking.
Avoiding prominent underperformers remains important to the Account's success.
In a bull market, it is very easy to focus excessive attention on picking
winning stocks. Simple math reinforces the view that equal effort should be
spent attempting to avoid those companies with potential disappointing
fundamental changes, particularly in a current environment that has little
tolerance for "negative newsflow." In fact, much of the Account's outperformance
in 1999 was attributable to avoiding companies with deteriorating fundamentals.
Comparison of Change in Value of $10,000 Investment in the Aggressive Growth
Account, Lipper Large-Cap Growth Fund Average and S&P 500 Stock Index.
Total Returns*
as of December 31, 1999
1 Year 5 Year 10 Year
------------------------
39.50% 32.01% 28.82%**
** Since inception 6/1/94
S&P 500
PAG Broad Lipper Large-Cap
Total Based Growth
Return Index Average
10,000 10,000 10,000
1994 10,259 10,230 10,055
1995 14,793 14,069 13,151
1996 18,942 17,297 15,681
1997 24,788 23,066 19,649
1998 29,486 29,657 24,140
1999 41,130 35,896 33,335
Note: Past performance is not predictive of future performance.
Asset Allocation Account
(Francine Bovich)
Global equity markets finished 1999 with strong gains, as the global economy
began to heal after the Asian and Russian economic crises experienced in 1997
and 1998. The S&P 500 delivered its fifth year of double-digit returns rising
21.0% in calendar year 1999. Morgan Stanley Capital International EAFE (Europe,
Australia and Far East) Index returned 27.0%, beating the S&P 500 for the first
time in five years, despite weak currencies in Europe. The most disappointing
asset class was fixed-income. As global growth stabilized and resumed,
inflationary fears mounted driving bond yields higher in the U.S. and Europe.
The Lehman Aggregate Index returned -0.8% during a volatile year.
Although the U.S. bull market in the first half showed signs of broadening,
market leadership narrowed dramatically in the second half. Value stocks, which
began to outperform growth in February and March, stagnated later in the year,
as inflation fears moderated and economic growth surprised on the upside. The
year ended with growth stocks again dominating value stocks by a wide margin.
Although rising interest rates and inflation expectations are usually bad for
stocks, markets have shrugged off rising rates as growth surprises outpaced
inflation surprises throughout 1999. This growth environment was also reflected
in the bond market. As investor confidence improved, risk tolerance rose to more
normal levels, benefiting spread products, which had suffered large losses in
the flight to quality at the end of 1998. Fixed-income spreads narrowed, and
investment grade governments and corporates underperformed mortgages, high yield
debt, and emerging market debt.
Non-U.S. stock market performance was strong, despite being held back by weaker
European currencies. The strongest performing regions were those which had
suffered the most over the past three years of currency crises and debt
deflation. Japan led the developed markets, rising 61.5% in 1999, as the
Japanese economy bottomed and began to recover. The combination of low
valuations, low interest rates, and a better earnings outlook was a powerful
contributor to the rise in the Japanese market and a strengthening of the Yen.
Pacific region stock performance was also strong, but was highly differentiated,
as the countries hardest hit by the emerging market debt crisis, Hong Kong and
Singapore, outperformed the more stable economies of Australia and New Zealand.
Asian economies bottomed in the early part of the year, and began a steep
trajectory of recovery. The depegging of Asian currencies from the U.S. Dollar
enabled many countries to exercise more flexibility in economic management, and
to some extent, decreased their vulnerability to rising U.S. interest rates.
European stock performance was mixed during the year. In the first half,
Eurozone economic performance disappointed on the downside, as Germany continued
to lag contributing to poor equity performance and a weaker currency. Although
European economic performance was more robust in the second half, the Euro
continued to weaken, closing the year 15% below its January 1 level. Europe
returned 15.9% in 1999.
The Account appreciated 19.5% for the year, outperforming the Lipper Flexible
Portfolio Fund average gain of 12.6%. The outperformance of the Account was due
to allocation decisions and strong security selection within certain of the
underlying implementation strategies. Allocation decisions that contributed
positively to results included overweighting equities relative to fixed-income
throughout the year, as equities significantly outperformed fixed-income, and an
emphasis on growth. Security selection within the U.S. growth strategies (Large
Cap and Emerging Growth) was the largest contributor to outperformance.
Throughout the year, the Account maintained a diversified investment strategy.
The Account's allocation to non-U.S. stocks also added value, as non-U.S. stocks
outperformed the S&P during this period. Account allocations to value-based
equity strategies and fixed-income detracted from results, but were more than
offset by other favorable portfolio decisions.
Comparison of Change in Value of $10,000 Investment in the Asset Allocation
Account, Lipper Flexible Portfolio Fund Average and S&P 500 Stock Index.
Total Returns*
as of December 31, 1999
1 Year 5 Year 10 Year
-----------------------
19.49% 16.01% 14.32%**
** Since inception 6/1/94
PAA Lipper
Total Flexible Portfolio
Return S&P 500 Index
10,000 10,000 10,000
1994 10,052 10,230 10,008
1995 12,128 14,069 12,518
1996 13,696 17,297 14,220
1997 16,187 23,066 16,878
1998 17,673 29,657 19,268
1999 21,117 35,897 21,686
Note: Past performance is not predictive of future performance.
Balanced Account
(Martin Schafer, Mary Sunderland and Judith Vogel)
In the stock market, technology was THE place to be for performance. Nothing
else came close. Early in the year it was the largest and most liquid technology
stocks that garnered investors' attention. By the fourth quarter, Y2K liquidity
and unprecedented money flows into speculative technology and Internet sector
funds sent already strong technology stocks through the roof. Valuation was
seemingly given no consideration as aggressive growth and momentum strategies
won over value, hands down.
The macro-economic picture was constructive for the broad market (especially
cheaper stocks) with strong real GDP growth, improving corporate profits, and
interest rates moving up. Typically value stocks outperform under these
conditions. Yet it was the most richly priced companies that performed the best
in 1999 and it was these stocks that boosted index returns for the year. The
narrow bull market in technology continues to hide a broader bear market
underway in the U.S. as evidenced by the fact that 70% of the universe of 6,000
common stocks are actually down in price since April of 1998.
With ten-year Treasury yields up 1.75% over the year, fixed-income markets
stalled in 1999. Bonds produced negative returns as too-strong economic growth
in the U.S., improving global demand, and resulting fears of inflation spooked
fixed-income investors. Negative bond returns couldn't compete with
off-the-chart equity returns, which contributed to extreme negative sentiment
toward fixed-income investments, especially toward the end of the year.
The Balanced Account was underweighted in technology throughout the year, based
on high valuations of most tech stocks. While the prices of leading technology
stocks appeared to fully discount very optimistic growth expectations, the
stocks of many financial, energy, healthcare, and consumer staples companies
were cheap. Despite huge valuation disparities, the market continued to bid
already expensive tech stocks higher. Not having enough technology exposure was
the single largest detriment to the Account's total performance, which landed in
the low single digits for the year.
There is no independent market index against which to measure returns of
balanced portfolios, however, we show the S&P 500 Stock Index and the Lehman
Government/Corporate Bond Index for your information.
Comparison of Change in Value of $10,000 Investment in the Balanced Account,
Lipper Balanced Fund Average, Lehman Brothers Government/Corporate Bond Index
and S&P 500 Stock Index.
Total Returns*
as of December 31, 1999
1 Year 5 Year 10 Year
-----------------------
2.40% 13.75% 11.38%
Lipper Lehman
Balanced S&P 500 Balanced Govt Corp
Account Index Fund Avg Bond Index
10,000 10,000 10,000 10,000
1990 9,357 9,689 9,945 10,828
1991 12,572 12,642 12,607 12,575
1992 14,181 13,605 13,495 13,528
1993 15,750 14,974 14,943 15,020
1994 15,420 15,171 14,566 14,493
1995 19,212 20,865 18,231 17,281
1996 21,734 25,652 20,740 17,782
1997 25,630 34,207 24,680 19,518
1998 28,684 43,982 28,007 21,366
1999 29,371 53,236 30,441 20,907
Note: Past performance is not predictive of future performance.
Capital Value Account
(Catherine Zaharis)
The market divergence has been the most dramatic in performance since the late
1960's. It has been a very simple process to determine which stocks will
outperform. On average, stocks with earnings underperformed the market. Stocks
with high P/E ratios tended to outperform the market. For the Capital Value
Account, this means the history of the account and its philosophy and process
fly in the face of what has worked the past year on Wall Street.
The Account Managers prefer to invest in companies that have earnings, but
prefer not to pay a premium for those earnings. In 1999 this led the Account
into consumer staples, financials and health care. The only problem was that
while technology was the favored sector, these three sectors were closer to the
bottom of relative returns.
Account Managers have struggled with this year and how to deal with markets that
do not favor value investors, and in fact punish them severely. Account Managers
have reviewed their process in a detailed manner and added some flexibility
without compromising philosophy. Valuations are now analyzed by sector versus
the overall market. For example comparing paper company stocks to technology
stocks, technology will nearly always look expensive. But, when looking at
technology as its own universe, many attractive opportunities appear. This
approach will work better in an environment where there is minimal change in
portfolio emphasis.
Comparison of Change in Value of $10,000 Investment in the Capital Value
Account, Lipper Large-Cap Value Fund Average, S&P 500 Stock Index and S&P 500
Barra Value Index
Total Returns*
as of December 31, 1999
1 Year 5 Year 10 Year
-----------------------
-4.29% 17.88% 12.94%
Capital S&P 500 S&P 500 Lipper
Value Stock Barra Value Large-Cap Value
Account Index Index Fund Average
10,000 10,000 10,000 10,000
1990 9,014 9,689 9,315 9,555
1991 12,499 12,642 11,416 12,334
1992 13,690 13,605 12,617 13,442
1993 14,746 14,974 14,965 14,995
1994 14,818 15,171 14,869 14,854
1995 19,547 20,865 20,369 19,432
1996 24,139 25,652 24,850 23,470
1997 31,027 34,207 32,300 29,840
1998 35,240 43,982 37,038 34,498
1999 33,730 53,236 41,479 38,372
Note: Past performance is not predictive of future performance.
Growth Account
(Mary Sunderland)
Technology stocks drove the market in 1999. The technology sector of the S&P 500
returned 74% for the year. Coming out of 1998, technology stocks had been down
on concerns of a global economic slowdown. The slowdown did not occur and, in
fact, accelerated as world economic growth picked up. Technology is very
sensitive to global growth since 50% of the S&P 500 technology companies
earnings come from outside the U.S. The other major driver of technology stocks
was the realization that the Internet is for real and that it requires
technology spending to support its growth. The Growth Account trailed the S&P
500 by 4.60% in 1999. Returns were hampered by healthcare overweighting
throughout the year and a technology underweighting over the first nine months
of the year. Healthcare stocks were hurt by fears of further governmental
involvement, patent expirations and moderating earnings growth.
At the beginning of this year, management of the Growth Account was assumed by a
new large cap growth team based in New York City. During the transition, the
Account's exposure to technology and financials was increased and exposure to
healthcare and consumer staples was decreased.
Going forward, the technology sector continues to be seen as the highest growth
area of the economy and Account Managers expect to remain overweighted in
technology. The Internet is still in the early stages of its development.
Companies representing both the "old" and "new" economy must continue their
aggressive spending on infrastructure, irrespective of economic conditions, in
order to remain competitive. This sector is expected to continue to benefit from
increased usage of the World Wide Web for a wide range of purposes including
business-to-business e-commerce, communication, and entertainment.
Account Managers are currently looking to increase exposure to the health care
area. They feel current political concerns are overblown and issues related to
product pipelines are manageable. This sector exhibits superior growth at a
reasonable value.
Account Managers plan to remain neutral-weighted in the financial sector. This
sector offers solid potential based on very favorable demographics; an aging
worldwide population will fuel demand for retirement savings products. There is
a trend globally for increased demand for financial services. Although the
current interest rate environment augurs a short-term period of uncertainty,
Account Managers believe that interest rates are near their top and they are
bullish longer term on the direction of rates.
Consumer cyclical and retail stores focused on the baby boomer offer very good
growth potential. Management plans to be over-weighted in this sector, with
positive contributions to performance likely over the next 6-12 months.
Comparison of Change in Value of $10,000 Investment in the Growth Account,
Lipper Large-Cap Growth Fund Average and S&P 500 Stock Index
Total Returns*
as of December 31, 1999
1 Year 5 Year 10 Year
-----------------------
16.44% 20.45% 18.94%**
** Since inception 5/2/94
Lipper
Growth S&P 500 Large-Cap Growth
Account Index Fund Avg.
10,000 10,000 10,000
1994 10,542 10,131 10,090
1995 13,243 13,934 13,197
1996 14,899 17,131 15,736
1997 18,916 22,844 19,717
1998 22,956 29,372 24,224
1999 26,729 35,552 33,451
Note: Past performance is not predictive of future performance.
International Account
(Kurtis Spieler and Scott Opsal)
The International Account's return of 25.93% in 1999 was slightly below the
Morgan Stanley Capital International EAFE (Europe, Australia and Far East) Index
return of 26.96%. Throughout 1999 the world economy continued to strengthen.
Leading economic indicators in Europe, Japan and the emerging markets were all
positive. Recovery of the emerging markets and Japan, as well as an attractively
valued European currency, resulted in an export-led recovery in Europe.
During 1999 merger and acquisition (M&A) activity in Europe doubled, setting a
record, and positively impacting several companies in the Account's portfolio.
Emerging markets exposure added marginally to performance, mainly in the fourth
quarter, as changes made in the emerging holdings in the beginning of the year
performed strongly. The largest move made in the Account during 1999 was the
entry into Japanese equities. As the Japanese market underperformed other
developed markets year after year, the forward-looking return spread relative to
equities in the rest of the world narrowed. As Account Managers monitored
valuation levels, investments were made in companies that were trading at
attractive levels. The Account also benefited from increased exposure to the
"new economy", including telecommunications, technology and media.
The Account continues to invest in companies that have sustainable competitive
advantages that will allow continued growth in earnings and cash flow sufficient
to justify their current trading price. This strategy is consistently applied to
build a diversified portfolio with exposure to both "new" and "old" economy
companies - all with positive forward-looking return profiles. Changes are being
made to the portfolio in media, energy and financials. Media stocks are highly
valued along with other technology and telecom stocks, but possess lower growth
rates, causing a lightening of the Account's weighting in select holdings.
Account Managers have become slightly more positive on the energy sector due to
the disconnect between oil prices and the valuation levels of the energy
companies and have added to the energy weighting. Within the financial sector
the Managers are lightening some banks and adding to diversified financials.
Companies that have ability to gather assets, benefiting from the long-term
savings trends throughout Europe are preferred. The Account has invested in some
brokerage firms in Japan which are expected to benefit from outflows out of the
postal savings system into the equity market.
Comparison of Change in Value of $10,000 Investment in the International
Account, Lipper International Fund Average and MSCI EAFE Index
Total Returns*
as of December 31, 1999
1 Year 5 Year 10 Year
-----------------------
25.93% 17.29% 14.41%**
** Since inception date 5/2/94
Morgan Stanley Lipper
Intern'l EAFE International
Account Index Index
10,000 10,000 10,000
1994 9,663 9,990 9,758
1995 11,032 11,110 10,676
1996 13,800 11,781 11,934
1997 15,488 11,991 12,583
1998 17,034 14,389 14,221
1999 21,451 18,268 20,023
Note: Past performance is not predictive of future performance.
International SmallCap Account
(Dan Sherman and Darren Sleister)
The international small cap arena saw returns that were unprecedented previous
to 1999. The median international small cap fund's return according to Lipper
was 75.41% for the year. The International SmallCapAccount's return exceeded the
Lipper International Small-Cap Fund Average by 18.4% on a 1-year basis. Earlier
this year Japan was a significant outperformer in the small cap world and the
Account's holdings outpaced the index, returning on average, some 60%. The
Account went from a zero weighting in Japan to one that more closely matched the
benchmark mid-year, to lightening, fourth quarter, as Managers felt much of the
Japanese market had simply run out of steam. Fourth quarter saw investors taking
gains in the Japanese small caps as the economy once again came into question of
what could be delivered and how much restructuring was actually occurring.
1999 was a year for European start-up companies, many of which were
technology-oriented that soon turned into mid-caps due to massive price
appreciation in a short time span. A fundamental change was seen in the
liquidity flows as capital began to pour into the European markets in the fourth
quarter. The top performing sectors included media, telecommunications and
technology as those companies that had exposure in these areas saw strong price
appreciation in the fourth quarter as investors scrambled to gain exposure to
these industries.
Account Managers continue to look for market leaders in their respective fields
with good growth characteristics, a solid business strategy and strong barriers
to entry. 1999 was a year of stellar performance for technology companies as the
Internet and e-commerce began to demonstrate that they would revolutionize the
business world. Account Managers found some strong companies that were global
leaders and would benefit from the explosion of growth in e-commerce. We have
rotated out of many of the stronger performers and continue to look for new
opportunities where growth opportunities are undervalued relative to stock
price.
The International SmallCap Account continues to benefit from themes such as
outsourcing of electronic components, increasing advertising expenditures,
market research companies and indirect e-commerce solutions. At the current
time, growth companies offer the most attractive investments from a risk/return
trade-off compared to the more traditional value stocks. Managers continue to
look for companies that are at attractive valuations and also offer long-term
earnings growth potential.
Comparison of Change in Value of $10,000 Investment in the International
SmallCap Account, Lipper International Small-Cap Fund Average and MSCI EAFE
Index
Total Returns*
as of December 31, 1999
1 Year 5 Year 10 Year
-----------------------
93.81% 39.24%** --
** Since inception date 5/1/98
Morgan Stanley Lipper International
Capital International International SmallCap SmallCap
EAFE Index Fund Average Account*
--------------------- ---------------------- -------------
10,000 10,000 10,000
"1998" 10,379 9,320 8,963
"1999" 13,177 16,348 17,371
Note: Past performance is not predictive of future performance.
LargeCap Growth Account
(E. Marc Pinto)
The LargeCap Growth Account returned 32.47% between its inception on April 15,
1999 and December 31, 1999. This was significantly better than the 10.99% earned
by its benchmark, the S&P 500 Index, over the same period. The Account's success
is owed to the efforts of its research staff, who spent the Account's first year
of operations scouring the market for individual companies believed capable of
performing well in any market.
Fears that economic growth in the U.S. would force the Federal Reserve to
aggressively increase interest rates in a bid to forestall inflation pressured
fast-growing stocks during May. Although the Account held its own during this
difficult period, interest rate uneasiness and a brief rotation into
economically sensitive sectors of the market kept a lid on performance
throughout the spring and into early summer. Growth shares staged a dramatic
mid-summer comeback, however, and eventually finished the year far ahead of
their value-oriented peers.
Despite the market's mixed signals, Account Managers held firm to their belief
that companies are ultimately rewarded for sustainable earnings growth. More
importantly, the Managers successfully anticipated the staying power of the
market's return to growth-oriented stocks and substantially increased the
Account's growth profile during the third quarter. This strategy paid off
handsomely and was largely responsible for the strong performance in 1999.
Looking ahead, interest rate uncertainty seems likely to persist in 2000 and
could keep markets volatile for the foreseeable future. In addition, investors
may begin to question the extremely high valuations placed on several of the
technology sector's most visible companies. However, by focusing on
fast-growing, well-managed and fundamentally sound companies, the Account
Managers believe they have assembled a portfolio capable of performing well
across a range of economic scenarios.
The Managers believe they have developed an information edge that enables them
to invest with confidence by getting to know the details that drive each
individual holding in the portfolio - a process that begins with the development
of extensive, proprietary financial models and often involves meeting a
company's customers, competitors and suppliers. For that reason, many of the
same themes that contributed to performance in 1999 will continue to play a
central role in 2000. These include wireless, telecommunications, media,
semiconductors, and selected technology companies. At the same time, a
deliberate attempt has been made to balance the portfolio between fast-growing
companies and more traditional growth franchises - a strategy that allows
participation in the unbounded upside associated with a number of the New
Economy's most compelling opportunities while simultaneously providing a measure
of downside protection.
Comparison of Change in Value of $10,000 Investment in the LargeCap Growth
Account, Lipper Large-Cap Growth Fund Average and Russell 1000 Growth Index.
Total Returns*
as of December 31, 1999
1 Year 5 Year 10 Year
32.47%** -- --
** Since inception date 5/3/99
Russell Lipper
1000 Growth Large-Cap Growth LargeCap Growth
Index Fund Average Account*
---------- ---------------- ---------------
10,000 10,000 10,000
"1999" 12,504 14,359 13,247
Note: Past performance is not predictive of future performance.
MicroCap Account
(Eileen Aptman, Paul Farrell and Eileen Rominger)
1999 ended on a positive note, as interest rate concerns dissipated, Y2K-related
liquidity fears proved unsubstantiated and the marketplace evaded any actual
trading volume declines or grand-scale increases in cash levels. During the
year, restrained inflation, solid growth in corporate profits and gains by a few
lead sectors drove U.S. indexes to record levels; the S&P 500 Index, Russell
Midcap Index and Russell 2000 Index ("Index") gained 21.0%, 18.2% and 21.3%,
respectively.
The Account's performance lagged the Index, as the small cap market was led by
an extremely narrow band of companies in a select few industries. The top 10
performers in the Index logged an extraordinary gain of 719% (weighted average
return of top 10 performers); nine of these ten stocks were in technology or
telecommunications. In fact, technology and media/telecom industries accounted
for more than 100% of the gain for the Index in 1999. These industries -
wireless, semiconductors, media, computer software and hardware, electronic
equipment and information services - together contributed 24 percentage points
of positive performance, compared to the index total return of 21%. The
Account's underweight in several of these industries hurt performance for the
year.
In an extraordinary period for the overall economy, many companies have posted
solid operating results. Lacking the badges of a) high-visibility growth or b)
an obvious role in the "New Economy," however, these same solid operators have
lagged in the stock market. Investors' gravitation to a very few leaders has
driven remarkable stock price performance commensurate with remarkably high
growth expectations. Since the year end, though, the rising interest rate
environment has bred increased investor impatience toward those stocks which
have not yet delivered earnings results to match their valuations. This
impatience has translated into tremendous volatility among expensively priced
stocks and some solid returns among those stocks which had gone unrecognized
even as their underlying businesses performed well. The Microcap Account has
benefited by owning well-positioned businesses selling at conservative
valuations.
Even though there has been a broadening of the market since the end of 1999,
Account Managers feel there is no simple answer when asked about the "New
Economy" vs. the "Old Economy." The New Economy (i.e., companies and industries
which offer new technological tools and platforms) has indeed changed the way to
conduct - and for analysts, the way to evaluate - a business. We acknowledge the
vast potential for new technologies' ability to enhance productivity, provide
new delivery and access mechanisms for both hard goods and entertainment
content, and shorten cycle times. Many holdings in the Account have benefited
already from their exposure to the New Economy, and Account Managers feel any
company's ability to utilize new technologies - whether the company is in the
technology or transportation sector - will likely be critical to its long-term
success. By owning some of the companies which are in the business of these new
technologies, and many companies which are their direct beneficiaries, Account
Managers believe the Account offers substantial upside to the long-term
investor.
Although the Account has experienced strong gains since the end of 1999, the
narrow leadership of the market by technology, internet and telecom stocks over
the last two years has left many excellent, highly profitable, well-managed
companies behind in terms of performance, even as these companies have posted
solid operating results. Our research-based investments offer substantial upside
potential, as they represent quality businesses selling at conservative
valuations.
Comparison of Change in Value of $10,000 Investment in the MicroCap Account,
Lipper Small-Cap Core Fund Average and Russell 2000 Index
Total Returns*
as of December 31, 1999
1 Year 5 Year 10 Year
-----------------------
-1.07% -12.05%** --
** Since inception date 5/1/98
Lipper
Russell Small-Cap Core MicroCap
2000 Index Fund Average Account*
---------- -------------- --------
10,000 10,000 10,000
"1998" 8,806 8,468 8,158
"1999" 10,678 10,875 8,071
Note: Past performance is not predictive of future performance.
MidCap Account
(William Nolin)
In 1999, the MidCap Account trailed the S&P 400 Index slightly, despite rallying
strongly in the fourth quarter. Technology was the story for the market as a
whole. It was a strange year, with technology up strongly and almost everything
else unchanged. The divergence between the Account and the Index was mainly due
to several technology stocks in the Index performing well which were not in the
Account. One of these companies is no longer in the Index and the others
continue to be overvalued.
The Account changed portfolio managers in the fourth quarter of 1999. The
underlying philosophy of investing and the fundamental analysis process will not
change.
Going forward the Account is positioned to take advantage of the growth in
technology and communications. Technology will continue to benefit from the
substitution of capital for labor, the growth of the Internet, and the
acceleration of global economic growth. The cost of labor is going up 3% per
year, while the cost of capital equipment is falling 4% per year. This
divergence is causing companies either to provide their workers with better
tools or replace those workers with machines. This process is being accelerated
by the low availability of workers in this country. Communications benefit from
many of the same trends as technology. Valuations remain high in these sectors,
but Account Managers believe the strong business fundamentals justify the
valuations.
Comparison of Change in Value of $10,000 Investment in the MidCap Account,
Lipper Mid-Cap Core Fund Average, S&P 500 Stock Index and S&P 400 MidCap Index
Total Returns*
as of December 31, 1999
1 Year 5 Year 10 Year
-----------------------
13.04% 17.59% 15.35%
S&P 400 Lipper
MidCap S&P 500 MidCap Mid-Cap Core
Account Index Index Index
10,000 10,000 10,000 10,000
1990 8,750 9,689 9,488 9,644
1991 13,431 12,642 14,239 14,586
1992 15,437 13,605 15,933 15,915
1993 18,414 14,974 18,152 18,255
1994 18,558 15,171 17,500 17,881
1995 23,942 20,865 22,911 23,633
1996 28,996 25,652 27,305 27,868
1997 35,594 34,207 36,111 33,338
1998 36,906 43,982 43,012 37,392
1999 41,719 53,236 49,343 51,702
Note: Past performance is not predictive of future performance.
MidCap Growth Account
(John O'Toole)
For the calendar year 1999, the portfolio return was below the performance
benchmark, and obviously disappointing. The primary causes of the
underperformance relative to the benchmark were individual stock selection along
with a portfolio beta (price volatility) that was modestly below that of the
benchmark.
The quantitative process used in managing this Account performed below its
historical trend in 1999, which implies that individual stock selection had the
greatest negative impact on return. The Account Manager's approach to equity
management continues to focus on determining what types of valuation
characteristics are preferred by the market, and then to select stocks that
exhibit those preferred traits. Though this valuation system uses a number of
fundamental characteristics that are earnings (growth) driven, some factors that
are price (value) sensitive are also included. An economic sector neutral
approach to portfolio construction has also been maintained. During most of 1999
the Account operated in a market environment where investors also had total
focus on growth type valuation factors, and paid little attention to traditional
price sensitive measures of value.
Companies with the highest price multiples and in many cases very modest real
earnings provided the most attractive returns during 1999. Account Managers use
long-term trends to guide stock selection, and thus continue to operate with
some sensitivity to issues such as actual earnings and measures of value. A
review of 1999 seems to indicate that any valuation process that exhibited even
a modest focus on "value" type inputs, was penalized by the strong emphasis on
growth type factors by investors. The Account's management process did not
preclude the portfolio from owning any of these types of issues, and in fact a
number of holdings in a variety of industries owned by the Account had total
returns during the year of over 50%. These issues include Young & Rubicam,
Biogen, Lexmark International, and Kansas City Southern Industries. As for
issues that had a negative impact upon the annual return, Quintiles
Transnational and TJX Companies would be included.
Another factor that had a negative impact upon return was a modestly below
benchmark beta. The beta of the portfolio was within the historical range
(benchmark beta +/- 0.05), but given the positive equity market returns during
1999, this was a negative factor. 1999 was a year during which investors
rewarded volatility, and the portfolio was modestly less volatile than the
general middle capitalization equity market.
Finally, 1999 was also an equity market environment where the Account saw a
concentration of performance in certain sectors (technology). Thus, the
valuation process and the broadly diversified sector neutral portfolio
construction techniques used by Account Managers tended to result, at least in
the period of this report, in a portfolio whose structure did not generate
optimum results.
Comparison of Change in Value of $10,000 Investment in the MidCap Growth
Account, Lipper Mid-Cap Core Fund Average, Lipper Mid-Cap Growth Fund Average
and S&P 400 MidCap Index
Total Returns*
as of December 31, 1999
1 Year 5 Year 10 Year
-----------------------
10.67% 4.09%** --
** Since inception date 5/1/98
Lipper Lipper
S&P Mid-Cap Core Mid-Cap Growth
MidCap Growth 400 Fund Fund
Account MidCap Index Avg. Avg.
10,000 10,000 10,000 10,000
1998 9,660 10,538 9,814 9,814
1999 10,691 12,089 13,570 16,964
Note: Past performance is not predictive of future performance.
Real Estate Account
(Kelly Rush)
Signs that earnings growth was peaking in 1998 started a slide in real estate
stock prices that year which continued in 1999. Earnings growth of over 13% in
1998 fell to 10% in 1999. This pattern of decelerating earnings caused real
estate stocks to lose favor in a market focused on the extraordinary growth of
high technology companies. The result has been a price decline of over 30% in
the past two years.
The Real Estate Account performed in line with its benchmark index for the
twelve months ended December 31, 1999 and fell short of its peer group average.
Poor relative performance was concentrated in the first quarter where the
Account underperformed its peers by 1.90%.
The primary reason for underperformance versus peers was the Account's
underweighting in office property owners early in the year. Several office
companies delivered positive returns throughout the year and many peers elected
to overweight these companies. The Account lost ground in the first quarter
while it was underweighted in office owners. This exposure was later increased
and this shift helped contribute to the recovery in the Account's relative
performance.
The Account's exposure to industrial property owners also hampered performance.
The decision to overweight industrial owners proved right as this group
outperformed. However, security selection was poor causing a drag on returns.
Favorably impacting the Account's relative returns was the decision to
underweight owners of hotels and net leased properties. Account Managers
generally avoided hotel owners as lodging fundamentals declined and avoided net
lease property owners as they correctly anticipated rising interest rates would
hurt prices.
In 2000 Account Managers will continue to follow the relative valuation approach
used successfully in the past. Simply, the objective is to buy good companies at
attractive prices and sell them when more attractive opportunities are
uncovered. It is a fairly simple concept Account Managers diligently and
consistently seek to execute.
Comparison of Change in Value of $10,000 Investment in the Real Estate Account,
Lipper Real Estate Fund Average and Morgan Stanley REIT Index
Total Returns*
as of December 31, 1999
1 Year 5 Year 10 Year
-----------------------
-4.48% -6.58%** --
** Since inception date 5/1/98
Lipper
Morgan Stanley Real Estate Real Estate
REIT Index Fund Average Account*
10,000 10,000 10,000
-------------- ------------ -----------
"1998" 8,677 8,250 9,344
"1999" 8,282 7,991 8,925
Note: Past performance is not predictive of future performance.
SmallCap Account
( John McClain and Mark Williams)
The Account's yearly return figure of 43.6% compared favorably to the S&P 600
Index return of 12.4%. The growth segments of the Account and the benchmark
handily beat their value counterparts. The decision by Account Managers to
allocate more of the assets to the growth segment continues to pay dividends.
Because the Account was overweighted in the better performing growth sector, it
realized a positive asset allocation return.
The return and weighting components of certain sectors contributed to the
Account's outperformance relative to its benchmark. The technology sector return
of 68.1% led all sectors in the benchmark. The Account's technology sector
return was an incredible 208.5%. The Account's second best performing sector for
the year was consumer cyclicals. Teen retailing is the main contributor to this
return. Communication services sector's return was substantially higher than
that of the benchmark 179.6% versus 25.9%. The Account's sector weighting of
5.4% was approximately 11 times the benchmark sector weighting of 0.5%.
Comparison of Change in Value of $10,000 Investment in the SmallCap Account,
Lipper Small-Cap Core Fund Average and S&P 600 Index
Total Returns*
as of December 31, 1999
1 Year 5 Year 10 Year
-----------------------
43.58% 8.24%** --
** Since inception date 5/1/98
Lipper
S&P 600 Small-Cap Core SmallCap
Index Fund Average Account*
10,000 10,000 10,000
"1998" 8,835 8,873 7,949
"1999" 9,931 11,396 11,413
Note: Past performance is not predictive of future performance.
SmallCap Growth Account
(Amy Selner)
For the year, the SmallCap Growth Account rose 95.69 % versus the 43.09% rise of
the Russell 2000 Growth Index. The Account outperformed the Russell Growth Index
by 52.60 percentage points.
Small cap stocks began 1999 very weak, as seen in the 10.4% underperformance of
the Russell 2000 versus the S&P500 in the first quarter of 1999. During this
quarter, which signaled the end of the interest rate easing by the Federal
Reserve Bank, the market was fraught with volatility in illiquid stocks. The
second quarter of 1999 marked the best quarterly outperformance for small caps
since the fourth quarter of 1992, as small caps outperformed large caps by
7.93%. Small caps were much cheaper on a valuation basis, after their first
quarter drubbing, and bounced nicely in the second quarter. Also in June, small
cap funds had positive inflows of $1.3 billion, after experiencing large cash
outflows in the first five months of 1999. The general market quickly discounted
the Federal Reserve's .25% rise in interest rates during the second quarter and
continued to rise modestly.
The second half of 1999 was a roller coaster. During the third quarter, both
small and large cap stocks fell close to 6% as interest rate fears crept back
into the marketplace. This volatility was exaggerated by the slowdown in
news-flow over the summer period. The fourth quarter roared as the Russell 2000
rose over 18% and the Russell 2000 Growth rose over 33%. All in all, the Russell
2000 and the S&P 500 ended 1999 up over 21% and 19% respectively, marking a
solid year of gains.
Throughout the year, the U.S. economy has remained undeniably robust while
international economies were picking up. The deflationary boom continued as
labor markets remained tight and inflation remained relatively benign. Operating
profits were quite strong.
Despite this up and down year for small cap stocks, the Account was able to
considerably outperform its benchmarks mainly due to stock selection.
The Account remained heavily weighted in industries where growth prospects are
the most visible and consistent. Technology, the Account's largest sector,
continues to have the greatest long-term growth fundamentals. Account Managers
believe that the growth prospects are explosive for the Internet infrastructure
in particular. Therefore, a focus continues on telecommunication and broadband
companies, which provide the plumbing that enables broad acceptance of Internet
applications and services. Similarly, companies such as Proxim, which
manufactures wireless local-area networking products, contributed to
performance.
The Account lowered its exposure to the healthcare group over this fiscal year.
Uncertainty surrounding prescription drug benefits and the government's impact
on drug pricing kept a lid on these stocks. One bright spot in the sector was
biotechnology stocks. Account Managers believe the biotech industry continues to
acquire critical mass as genomics and combinatorial chemistry lead to an
explosion in new drug targets. Emerging biotechnology companies such as Biocryst
Pharmaceutical and Cephalon boosted Account performance.
An energy weighting contributed to the Account's outperformance in 1999.
Although there are worries that OPEC will irrationally increase oil production,
the Account remains positive on the long-term supply/demand fundamentals within
the sector.
Within the consumer group, radio stocks were solid performers. The environment
for radio advertising was robust in 1999, and we expect this group's strong
fundamentals to carry into next year. Over the short term these stocks may be
prone to profit taking as their valuations are high, but long term the
management team remains comfortable.
The Account Managers remain cautiously optimistic about the market entering
2000. The U.S. economy remains robust and international economies are picking
up. Productivity is expected to continue to grow and to fuel low inflationary
growth into 2000.
Moving through 2000, Account Managers are cautious as to the potential for
profit taking in the technology sector due to tremendous performance in the
fourth quarter of 1999. If economic metrics continue to show an overheating
economy, interest rates will continue to creep up and the market may become
volatile and move sideways as the slower summer period is entered. It is
estimated that a potential correction in technology stocks which, while
uncomfortable, will be healthy for the market over the long-term and may present
an excellent buying opportunity in the strongest growth stocks.
Comparison of Change in Value of $10,000 Investment in the SmallCap Growth
Account, Lipper Small-Cap Growth Fund Average and Russell 2000 Growth Index
Total Returns*
as of December 31, 1999
1 Year 5 Year 10 Year
-----------------------
95.69% 52.17%** --
** Since inception date 5/1/98
Lipper
Russell 2000 Small-Cap Growth SmallCap Growth
Growth Index Fund Average Account*
------------ ---------------- ---------------
10,000 10,000 10,000
"1998" 10,123 8,873 10,296
"1999" 14,485 14,430 20,148
Note: Past performance is not predictive of future performance.
SmallCap Value Account
(Marian Pardo and Leon Roisenberg)
The much anticipated Y2K rollover was the focus of attention for investors
throughout 1999. Expectations of a smooth transition were realized at year-end
with very little disruption. The Federal Reserve delayed raising interest rates
in December, despite a very strong economy, in order to prevent a Y2K market
correction. The resulting surge in the money supply contributed to a very strong
stock market. The S&P 500 ended the year up 21.04% but was surpassed by the
Russell 2000 Index (+21.26%) for the first time in six years.
As in the large cap market, technology stocks dominated the performance of the
small cap market. The growth in technology spending caused by the explosion of
the Internet has caused a frenzy among investors and many of the companies in
this sector traded at record high valuations. A number of newly public Internet
infrastructure, communications and software companies were top performers for
the year. The Initial Public Offering market flourished and merger and
acquisition activity continued at a record pace despite Y2K and interest rate
fears.
The strong performance by technology and Internet related shares perpetuated the
division between growth and value companies. The Russell 2000 Value Index
finished the year in negative territory -1.49% and significantly underperformed
the Russell 2000 Growth Index, which rose +43.09%.
The Account was up 21.5% for the year, versus the Russell 2000 Value Index,
which returned -1.5% for the 12-month period ending December 31, 1999.
The portfolio's top performing sectors were technology hardware +409.3%, drugs
+277.0% and technology software +80.8%. The weakest sector was retail, which
returned -44.4%. Other sectors that detracted from performance included health
services -24.5% and miscellaneous finance -24.4%. Stock selection had a
significant positive impact on performance.
Comparison of Change in Value of $10,000 Investment in the SmallCapValue
Account, Lipper Small-Cap Value Fund Average and Russell 2000 Value Index
Total Returns*
as of December 31, 1999
1 Year 5 Year 10 Year
-----------------------
21.45% 1.88%** --
** Since inception date 5/1/98
Lipper
Russell 2000 Small-Cap Value SmallCap Value
Value Index Fund Average Account*
------------ --------------- --------------
10,000 10,000 10,000
"1998" 8,592 8,873 8,494
"1999" 8,464 9,435 10,316
Note: Past performance is not predictive of future performance.
Stock Index 500 Account
(Robert Baur and Rhonda VanderBeek)
The Stock Index 500 Account seeks investment results that correspond with the
total return performance of the Standard & Poor's 500 Index. The percentage of
total assets of the Account allocated to each of the 500 stocks closely follows
the weighting of each of the stocks in the S&P 500 Index.
The Stock Index 500 Account began May 3, 1999. The total return from inception
through year-end 1999 was 8.93%; during the same period, the total return of the
S&P 500 Index was 11.00%. The difference was attributable to start-up costs and
other variables intrinsic to the creation of a new account.
The performance of the stock market since inception date of the Account was
strong, but there were some rough periods. During the third quarter, investors
had some fears about inflation, disappointing profits and the potential for the
Federal Reserve to raise interest rates. The broad market declined about 12% in
response. Those fears dissipated during the fourth quarter as business profits
perked up, the economy accelerated, and inflation stayed under control. As a
result, the return from the bottom of the correction was spectacular with the
S&P 500 Index up 17.5%.
Comparison of Change in Value of $10,000 Investment in the Stock Index 500
Account, Lipper S&P 500 Fund Average and S&P 500 Stock Index
Total Returns*
as of December 31, 1999
1 Year 5 Year 10 Year
-----------------------
8.93%** -- --
** Since inception date 5/3/99
Standard & Poor's Lipper Stock Index
500 Stock S&P 500 500
Index Fund Average Account*
----------------- ------------ ------------
10,000 10,000 10,000
"1999" 11,100 11,615 10,893
Note: Past performance is not predictive of future performance.
Utilities Account
(Catherine Zaharis)
The Utilities Account had a stronger return than its index, and was ahead of
many diversified managers even though it lagged behind the average utility fund.
The reason for the dichotomy of performance was quite evident. The Account's
performance relative to the benchmark was due to a focus on telecommunications
that is no longer represented in the index. The telecommunications portion of
the utility universe had stronger relative returns, as the core growth prospects
of these companies are stronger than the electric and gas companies. The
telecommunications sector is one where growth has come from a variety of new
sources, particularly the new need for data transmission.
Many members of the peer group had investments in companies outside of the U.S.
These companies, both in telecommunications and electricity, performed better
than their U.S. counterparts. That was the primary source of underperformance,
in addition to energy-related holdings that were not included in the portfolio
in 1999.
Going forward, Account Managers continue to focus on growth opportunities within
all industries of this sector. The telecommunications industry has many new
entrants who are not only establishing a piece of market share, but are also
creating new ways of delivering service.
On the electric and gas side, mergers and maximizing opportunities in all areas
of providing energy to customers are key to long-term success. Companies are
looking at the optimal ways to provide the energy needs for their clients,
whether it is through traditional services or a variety of new and exciting
options. Account Managers are continually monitoring these companies for the
most promising opportunities within these fields.
Comparison of Change in Value of $10,000 Investment in the Utilities Account,
Lipper Utilities Fund Average, Dow Jones Utilities Index with Income Fund
Average and S&P 500 Stock Index
Total Returns*
as of December 31, 1999
1 Year 5 Year 10 Year
-----------------------
2.29% 10.43%** --
** Since inception date 5/1/98
Standard & Poor's Dow Jones Lipper
500 Stock Utilities Index with Utilities Utilities
Index Income Fund Average Fund Average Account*
10,000 10,000 10,000 10,000
"1998" 11,172 10,250 10,957 11,536
"1999" 13,523 9,663 12,690 11,800
Note: Past performance is not predictive of future performance.
Important Notes of the Growth-Oriented Accounts:
The values of these indexes will vary according to the aggregzte value of the
common equity of each of the securities included. The indexes represented asset
types which are subject to risk, including possible loss of principal. You
cannot invest directly in an index. An index does not have an investment adviser
and does not pay any commissions or expenses. If an index had expenses, its
performance would be lower.
Dow Jones Utility Index with Income: This average is a price-weighted average of
15 utility companies that are listed on the New York Stock Exchange and are
involved in the production of electrical energy.
Lehman Brothers Government/Corporate Bond Index: This index consists of publicly
issued securities from the Government Index and the Corporate Index. The
Government Index includes U.S. Treasuries and Agencies. The Corporate Index
includes U.S. Corporate and Yankee debentures and secured notes from the
Industrial, Utility, Finance, and Yankee categories.
Lipper Balanced Fund Average: this average consists of mutual funds which
attempt to conserve principal by maintaining at all times a balanced portfolio
of both stocks and bonds. Typically, the stock/bond ratio ranges around 60%/40%.
The one year average currently contains 449 mutual funds.
Lipper Flexible Portfolio Fund Average: This average consists of funds which
allocate their investments across various asset classes, including domestic
common stocks, bonds and money market instruments, with a focus on total return.
The one-year average currently contains 223 funds.
Lipper International Fund Average: This average consists of funds which invest
in securities primarily traded in markets outside of the United States. The
one-year average currently contains 618 funds.
Lipper International Small-Cap Funds Average: This average consists of funds
which invest at least 65% of their assets in equity securities of non-United
States companies with market capitalizations less than U.S. $1 billion at the
time of purchase. The one-year average currently contains 70 funds.
Lipper Large-Cap Growth Fund Average: This average consists of funds which
invest at least 75% of their equity assets in companies with market
capitalizations of greater than 300% of the dollar-weighted median market
capitalization of the S&P Mid-Cap 400 Index. These funds normally invest in
companies with long-term earnings expected to grow significantly faster than the
earnings of the stocks represented in a major unmanaged stock index. The
one-year average currently contains 364 funds.
Lipper Large-CapValue Fund Average: This average consists of funds which invest
at least 75% of their equity assets in companies with market capitalizations of
greater than 300% of the dollar-weighted median market capitalization of the S&P
Mid-Cap 400 Index. These funds seek long-term growth of capital by investing in
companies that are considered to be undervalued relative to a major unmanaged
stock index based on price-to-current earnings, book value, asset value, or
other factors. The one-year average currently contains 279 funds.
Lipper Mid-Cap Core Fund Average: This average consists of funds that invest at
least 75% of their equity assets in companies with market capitalizations of
less than 300% of the dollar weighted median market capitalization of the S&P
Mid-Cap 400 Index. These funds have wide latitude in the companies in which they
invest. The one-year average currently contains 144 funds.
Lipper Mid-Cap Growth Fund Average: This average consists of funds that invest
at least 75% of their equity assets in companies with market capitalizations of
less than 300% of the dollar weighted median market capitalization of the S&P
Mid-Cap 400 Index. These funds normally invest in companies with long-term
earnings expected to grow significantly faster than the earnings of the stocks
represented in a major unmanaged stock index. The one-year average currently
contains 230 funds.
Lipper Real Estate Fund Average: This average consists of funds which invest 65%
of their equity portfolio in equity securities of domestic and foreign companies
engaged in the real estate industry. The one-year average currently contains 132
funds.
Lipper S&P 500 Fund Average: This average consists of funds that are passively
managed, have limited expenses (advisor fee no higher than 0.50%), and are
designed to replicate the performance of the Standard & Poor's 500 Index on a
reinvested basis. The one-year average currently contains 107 funds.
Lipper Small-Cap Core Fund Average: This average consists of funds that invest
at least 75% of their equity assets in companies with market capitalizations of
less than 250% of the dollar weighted median market capitalization of the S&P
Small-Cap 600 Index. These funds have wide latitude in the companies in which
they invest. The one-year average currently contains 188 funds.
Lipper Small-Cap Growth Fund Average: This average consists of funds that invest
at least 75% of their equity assets in companies with market capitalizations of
less than 250% of the dollar weighted median market capitalization of the S&P
Small-Cap 600 Index. These funds normally invest in companies with long-term
earnings expected to grow significantly faster than the earnings of the stocks
represented in a major unmanaged stock index. The one-year average currently
contains 263 funds.
Lipper Small-Cap Value Fund Average: This average consists of funds that invest
at least 75% of their equity assets in companies with market capitalizations of
less than 250% of the dollar weighted median market capitalization of the S&P
Small-Cap 600 Index. These funds seek long-term growth of capital by investing
in companies that are considered to be undervalued relative to a major unmanaged
stock index based on price-to-current earnings, book value, asset value, or
other factors. The one-year average currently contains 263 funds.
Lipper Utilities Fund Average: This average consists of funds which invest 65%
of their equity portfolio in utility shares. The one-year average currently
contains 100 funds.
Morgan Stanley EAFE (Europe, Australia and Far East) Index: This average
reflects an arithmetic, market value weighted average of performance of more
than 900 securities which are listed on the stock exchanges of the following
countries: Australia, Austria, Belgium, Denmark, Netherlands, New Zealand,
Norway, Singapore/Malaysia, Spain, Sweden, Switzerland, and the United Kingdom.
Morgan Stanley REIT Index: This is a capitalization-weighted index of the most
actively traded real estate investment trusts, and is designed to be a measure
of real estate equity performance.
Russell 2000 Growth Index: This index measures the performance of those Russell
2000 companies with higher price-to-book ratios and lower forecasted growth
values.
Russell 2000 Value Index measures the performance of those Russell 2000
companies with lower price-to-book ratios and lower forecasted growth values.
Standard & Poor's 500 Barra Value Index: This is a market
capitalization-weighted index of the stocks in the Standard & Poor's 500 Index
having the highest book to price ratios. The index consists of approximately
half of the S&P 500 on a market capitalization basis.
Standard & Poor's 500 Stock Index: This is an unmanaged index of 500 widely held
common stocks representing industrial, financial, utility and transportation
companies listed on the New York Stock Exchange, American Stock Exchange and the
Over-the-Counter market.
Standard & Poor's 600 Index: This is a market-value weighted index consisting of
600 domestic stocks chosen for market size, liquidity and industry group
representation.
Standard & Poor's MidCap 400 Index: This index measures the performance of the
mid-size company segment of the U.S. Market.
Income-Oriented Accounts:
Bond Account
(Scott Bennett)
Interest rates moved significantly higher last year as the world economy
rebounded from the emerging market crisis of 1998 and investors became less
interested in holding super-safe U.S. Treasury obligations. The increase in
rates pushed most fixed-income product returns negative for the year, including
the Bond Account.
Corporate bonds performed relatively well in this environment, significantly
outperforming Treasuries, as investors put additional money into higher yielding
assets. The fundamentals continued to be very positive for U.S. corporations
with strong U.S. and world economies producing strong earnings growth with
little inflation. The Account was positioned to take advantage of this rebound
through an increase in holdings of higher yielding securities.
The performance of the Account was below expectations in 1999 due to
underperformance of several holdings. The corporate bond market has become more
equity like in its increasing hostility towards companies reporting below
expected earnings or any whiff of other problems. Given the expectation of
further downside risk, several of the Account's holdings were sold after
year-end 1999, including J.C. Penney and Rite Aid Corporation.
Account Managers expect underlying economic fundamentals to remain strong which
is positive for corporate securities. Corporate yield premiums to Treasuries
remain high and should produce long-term performance relative to Treasuries.
Comparison of Change in Value of $10,000 Investment in the Bond Account, Lipper
Corporate Debt BBB Rated Fund Average and Lehman Brothers BAA Corporate Index
Total Returns*
as of December 31, 1999
1 Year 5 Year 10 Year
-----------------------
-2.59% 7.73% 7.77%
Lehman Lipper
Bond BAA BBB
Account Index Avg
10,000 10,000 10,000
1990 10,522 10,528 10,573
1991 12,281 12,561 12,455
1992 13,432 13,742 13,481
1993 14,999 15,518 15,142
1994 14,565 15,022 14,467
1995 17,793 18,435 17,370
1996 18,214 19,176 17,924
1997 20,144 21,304 19,731
1998 21,693 21,577 20,964
1999 21,131 21,400 20,612
Note: Past performance is not predictive of future performance.
Government Securities Account
(Martin Schafer)
This Account underperformed for the period ended December 31, 1999. A slightly
longer duration and the performance of the noncallable Private Export Funding
Corporation and Student Loan Marketing Association bonds versus mortgage-backed
securities (MBS), led to a modest underperformance for the period ended December
31, 1999.
Over the last year the Federal Reserve has cut interest rates to stabilize the
global financial turmoil, only to reverse course and start raising rates as
markets stabilized and global growth resumed. Account Managers view the Federal
Reserve actions as the equivalent of a doctor prescribing aspirin to treat the
economic patient. These are mild treatments, needed to keep inflation low and
growth reasonable.
On an absolute basis, the return for the Government Securities Account for the
year was poor. Fixed-income securities had no momentum, especially with the
Federal Reserve raising interest rates. This was especially true during December
as investors poured money into "Go-Go" name stocks and away from fixed-income
securities. Their attitude seems to be, "Why buy bonds when a stock will give
you one year's worth of returns in one day!"
Account Managers continue to believe that mortgage-backed securities (MBS) will
do well into the future. The quality, liquidity, lack of credit volatility and
agency participation are cited as the key drivers. The agency participation is a
"Huge" factor. Federal National Mortgage Association (FNMA) and Federal Home
Loan Mortgage Corporation (FHLMC) are stock companies driven by stockholders. In
order to grow earnings in the face of declining new issue MBS (rates have
risen), they are arbitraging more of the outstanding MBS. These agencies issue
debt and buy MBS to earn the "spread" for their stockholders. FNMA and FHLMC
should buy 60% of net MBS issuance in 2000 - keeping spreads very tight!
The Account continues to hold more discount MBS securities than the Lehman MBS
index (this leads to a bias of longer duration) as the Managers believe the
homeowner's propensity to refinance and the mortgage banker's technology driven
inducement to refinance loans puts great risk on securities priced above par.
This is especially true in a market when overall volume is declining as higher
interest rates impact both new and existing home markets.
Account Managers expect to stay close to the duration benchmarks. Currently the
Account is a little long but the Managers expect to be duration neutral soon,
and patiently wait for the opportunity to strategically lengthen.
As we look forward to 2000 keep in mind that a diamond is a lump of coal that
made good under severe pressure.
Comparison of Change in Value of $10,000 Investment in the Government Securities
Account, Lipper U.S. Mortgage Fund Average and Lehman Brothers Mortgage Index
Total Returns*
as of December 31, 1999
1 Year 5 Year 10 Year
-----------------------
-0.29% 7.96% 7.75%
Government Lehman Lipper
Securities Mortgage U.S. Mortgage
Account Index Index
10,000 10,000 10,000
1990 10,955 11,072 10,938
1991 12,812 12,813 12,556
1992 13,688 13,706 13,323
1993 15,066 14,643 14,316
1994 14,384 14,407 13,719
1995 17,127 16,827 15,946
1996 17,700 17,727 16,563
1997 19,538 19,409 17,984
1998 21,154 20,760 19,077
1999 21,094 21,146 19,201
Note: Past performance is not predictive of future performance.
Important Notes of the Income-Oriented Accounts:
The values of these indexes will vary according to the aggregzte value of the
common equity of each of the securities included. The indexes represented asset
types which are subject to risk, including possible loss of principal. You
cannot invest directly in an index. An index does not have an investment adviser
and does not pay any commissions or expenses. If an index had expenses, its
performance would be lower.
Lehman Brothers, BAA Corporate Index: This is an unmanaged index of all publicly
issued fixed rate nonconvertible, dollar-denominated, SEC-registered corporate
debt rated Baa or BBB by Moody's or S&P.
Lehman Brothers Mortgage Index: This is an unmanaged index of 15- and 30-year
fixed rate securities backed by mortgage pools of the Government National
Mortgage Association (GNMA), Federal Home Loan Mortgage Corporation (FHLMC), and
Federal National Mortgage Association (FNMA).
Lipper Corporate Debt BBB Rated Funds Average: This average consists of mutual
funds investing at least 65% of their assets in corporate and government debt
issues rated by S&P or Moody's in the top four grades. The one year average
currently contains 132 mutual funds.
Lipper U.S. Mortgage Fund Average: This average consists of mutual funds
investing at least 65% of their assets in mortgages/securities issued or
guaranteed as to principal and interest by the U.S. Government and certain
federal agencies. The one year average currently contains 62 mutual funds.
Note: Mutual fund data from Lipper Inc.
Important Notes of the Income-Oriented Accounts:
Lehman Brothers, BAA Corporate Index: This is an unmanaged index of all publicly
issued fixed rate nonconvertible, dollar-denominated, SEC-registered corporate
debt rated Baa or BBB by Moody's or S&P.
Lehman Brothers Mortgage Index: This is an unmanaged index of 15- and 30-year
fixed rate securities backed by mortgage pools of the Government National
Mortgage Association (GNMA), Federal Home Loan Mortgage Corporation (FHLMC), and
Federal National Mortgage Association (FNMA).
Lipper Corporate Debt BBB Rated Funds Average: this average consists of mutual
funds investing at least 65% of their assets in corporate and government debt
issues rated by S&P or Moody's in the top four grades. The one year average
currently contains 132 mutual funds.
Lipper U.S. Mortgage Fund Average: this average consists of mutual funds
investing at least 65% of their assets in mortgages/securities issued or
guaranteed as to principal and interest by the U.S. Government and certain
federal agencies. The one year average currently contains 62 mutual funds.
Note: Mutual fund data from Lipper Inc.
GENERAL INFORMATION ABOUT AN ACCOUNT
Eligible Purchasers
Only certain eligible purchasers may buy shares of the Accounts. Eligible
purchasers are limited to 1) separate accounts of Principal Life Insurance
Company or of other insurance companies, 2) Principal Life Insurance Company or
any of its subsidiaries or affiliates, 3) trustees of other managers of any
qualified profit sharing, incentive or bonus plan established by Principal Life
Insurance Company or any of its subsidiaries or affiliates for employees of such
company, subsidiary or affiliate. Such trustees or managers may buy Account
shares only in their capacities as trustees or managers and not for their
personal accounts. The Board of Directors of the Fund reserves the right to
broaden or limit the designation of eligible purchaser.
Each Account serves as the underlying investment vehicle for variable annuity
contracts and variable life insurance policies that are funded through separate
accounts established by Principal Life. It is possible that in the future, it
may not be advantageous for variable life insurance separate accounts and
variable annuity separate accounts to invest in the Accounts at the same time.
Although neither Principal Life nor the Fund currently foresees any such
disadvantage, the Fund's Board of Directors monitors events in order to identify
any material conflicts between such policy owners and contract holders. Material
conflict could result from, for example 1) changes in state insurance laws, 2)
changes in Federal income tax law, 3) changes in the investment management of an
Account, or 4) differences in voting instructions between those given by policy
owners and those given by contract holders. Should it be necessary, the Board
would determine what action, if any, should be taken. Such action could include
the sale of Account shares by one or more of the separate accounts which could
have adverse consequences.
Shareholder Rights
The following information applies to each Account of the Principal Variable
Contracts Fund, Inc. Each Account share is eligible to vote, either in person or
by proxy, at all shareholder meetings for that Account. This includes the right
to vote on the election of directors, selection of independent auditors and
other matters submitted to meetings of shareholders of the Account. Each share
has equal rights with every other share of the Account as to dividends,
earnings, voting, assets and redemption. Shares are fully paid, non-assessable
and have no preemptive or conversion rights. Shares of an Account are issued as
full or fractional shares. Each fractional share has proportionately the same
rights including voting as are provided for a full share. Shareholders of the
Fund may remove any director with or without cause by the vote of a majority of
the votes entitled to be case at a meeting of all Account shareholders.
The bylaws of the Fund provide that the Board of Directors of the Fund may
increase or decrease the aggregate number of shares which the Fund has the
authority to issue, without a shareholder vote.
The bylaws of the Fund also provide that the Fund does not need to hold an
annual meeting of shareholders unless one of the following is required to be
acted upon by shareholders under the Investment Company Act of 1940: election of
directors, approval of an investment advisory agreement, ratification of the
selection of independent auditors, and approval of the distribution agreement.
The Fund intends to hold shareholder meetings only when required by law and at
such other times when the Board of Directors deems it to be appropriate.
Shareholder inquiries should be directed to: Principal Variable Contracts Fund,
Inc., Principal Financial Group, Des Moines, Iowa 50392-0200.
Non-Cumulative Voting
The Fund's shares have non-cumulative voting rights. This means that the holders
of more than 50% if the shares voting for the election of directors of the Fund
can elect 100% of the directors if they choose to do so. In such event, the
holders of the remaining shares voting for the election of directors will not be
able to elect any directors.
Principal Life votes each Account's shares allocated to each of its separate
accounts registered under the Investment Company Act of 1940 and attributable to
variable annuity contracts or variable life insurance policies participating in
the separate accounts. The shares are voted in accordance with instructions
received from contract holders, policy owners, participants and annuitants.
Other shares of each Account held by each separate account, including shares for
which no timely voting instructions are received, are voted in proportion to the
instructions that are received with respect to contracts or policies
participating that separate account. Shares of each of the Accounts held in the
general account of Principal Life or in the unregistered separate accounts are
voted in proportion to the instructions that are received with respect to
contracts and policies participating in its registered and unregistered separate
accounts. If Principal Life determines, under applicable law, that an Account's
shares held in one or more separate accounts or in its general account need not
be voted according to the instructions that are received, it may vote those
Account shares in its own right.
Purchase of Account Shares
Shares are purchased from Princor Financial Services Corporation, the Fund's
principal underwriter. There are no sales charges on shares of the Accounts.
There are not restrictions on amounts to be invested in shares of the Accounts.
Shareholder accounts for each Account are maintained under an open account
system. Under this system, an account is opened and maintained for each
investor. Each investment is confirmed by sending the investor a statement of
account showing the current purchase and the total number of shares owned. The
statement of account is treated by each Account as evidence of ownership of
Account shares. Share certificates are not issued.
Sale of Account Shares
This section applies to eligible purchasers other than the separate accounts of
Principal Life and its subsidiaries.
Each Account sells its shares upon request. There is no charge for the sale. A
shareholder sends a written request to the Account requesting the sale of any
part or all of the shares. The letter must be signed exactly as the account is
registered. If payment is to be made to the registered shareholder or joint
shareholder, the Account does not require a signature guarantee. If payment is
to be made to another party, the shareholder's signature(s) must be guaranteed
by a commercial bank, trust company, credit union, savings and loan association,
national securities exchange member or brokerage firm. Shares are redeemed at
the net asset value per share next computed after the request is received by the
Account in proper and complete form.
Sales proceeds are generally sent within three business days after the request
is received in proper form. However, the right to sell shares may be suspended
during any period when 1) trading on the New York Stock Exchange is restricted
as determined by the SEC or when the Exchange is closed for other than weekends
and holidays, or 2) an emergency exists, as determined by the SEC, as a result
of which i) disposal by a fund of securities owned by it is not reasonably
practicable, ii) it is not reasonably practicable for a fund to fairly determine
the value of its net assets; or iii) the SEC permits suspension for the
protection of security holders.
If payments are delayed and the instruction is not canceled by the shareholder's
written instruction, the amount of the transaction is determined as of the first
valuation date following the expiration of the permitted delay. The transaction
occurs within five days thereafter.
In addition, payments on surrenders attributable to a premium payment made by
check may be delayed up to 15 days. This permits payment to be collected on the
check.
Restricted Transfers
Shares of each of the Accounts may be transferred to an eligible purchaser.
However, if an Account is requested to transfer shares to other than an eligible
purchaser, the Account has the right, at its election, to purchase the shares at
the net asset value next calculated after the receipt of the transfer request.
However, the Account must give written notification to the transferee(s) of the
shares of the election to buy the shares within seven days of the request.
Settlement for the shares shall be made within the seven day period.
Financial Statements
You will receive an annual financial statement for the Fund, examined by the
Fund's independent auditors, Ernst & Young LLP. That report is a part of this
prospectus. You will also receive a semiannual financial statement that is
unaudited. The following financial highlights are derived from financial
statements that were audited by Ernst & Young LLP.
FINANCIAL HIGHLIGHTS
PRINCIPAL VARIABLE CONTRACTS FUND, INC.
WILL BE FILED BY AMENDMENT
Additional information about the Fund is available in the Statement of
Additional Information dated May 1, 2000 and which is part of this prospectus.
Information about the Fund's investments is also available in the Fund's annual
and semi-annual reports to shareholders. In the Fund's annual report, you will
find a discussion of the market conditions and investment strategies that
significantly affected the Fund's performance during its last fiscal year. The
Statement of Additional Information and annual and semi-annual reports can be
obtained free of charge by writing or telephoning Princor Financial Services
Corporation, P.O. Box 10423, Des Moines, IA 50306. Telephone 1-800-451-5447.
Information about the Fund can be reviewed and copied at the Securities and
Exchange Commission's Public Reference Room in Washington, D.C. Information on
the operation of the public reference room may be obtained by calling the
Commission at 800-SEC-0330. Reports and other information about the Fund are
available on the Commission's internet site at http://www.sec.gov. Copies of
this information may be obtained, upon payment of a duplicating fee, by writing
the Public Reference Section of the Commission, Washington, D.C. 20549-6009.
The U.S. Government does not insure or guarantee an investment in the Fund.
Shares of the Fund are not deposits or obligations of, or guaranteed or endorsed
by, any financial institution, nor are shares of the Fund federally insured by
the Federal Deposit Insurance Corporation, the Federal Reserve Board, or any
other agency.
Principal Variable Contracts Fund, Inc. SEC File 811-01944
Part B
PRINCIPAL VARIABLE CONTRACTS FUND, INC.
STATEMENT OF ADDITIONAL INFORMATION
dated May 1, 2000
as revised through __________________
This Statement of Additional Information is not a prospectus, but contains
additional information which should be read in conjunction with the prospectus
dated May 1, 2000, as revised through _______________, for the Fund listed
above, as supplemented from time to time. Additionally, this Statement of
Additional Information incorporates by reference the financial statements
included in the shareholder report relating to the Fund dated December 31, 1999.
The prospectus and the financial statements, including the independent
accountants' report thereon, are available, without charge, upon request from:
Principal Variable Contracts Fund, Inc.
Principal Financial Group
Des Moines, Iowa 50392-0200
Telephone: 1-800-247-4123
TABLE OF CONTENTS
Investment Policies and Restrictions of the Accounts..................
Growth-Oriented Accounts..........................................
Income-Oriented Accounts..........................................
Money Market Account..............................................
Accounts' Investments.................................................
Management of the Fund................................................
Manager and Sub-Advisors..............................................
Cost of Manager's Services............................................
Brokerage on Purchases and Sales of Securities........................
Determination of Net Asset Value of Account Shares....................
Performance Calculation...............................................
Tax Status............................................................
General Information and History.......................................
Financial Statements..................................................
Appendix A............................................................
INVESTMENT POLICIES AND RESTRICTIONS OF THE ACCOUNTS
The following information is about the Principal Variable Contracts Fund, Inc.
which is an incorporated, open-end management investment company, commonly
called a mutual fund. It supplements the information provided in the Prospectus
under the caption CERTAIN INVESTMENT STRATEGIES AND RELATED RISKS. The Fund
offers multiple Accounts.
There are three categories of Accounts: Growth-Oriented Accounts, which include
Accounts seeking:
o primarily capital appreciation through investments in equity securities
(Aggressive Growth, Blue Chip, Capital Value, Growth, LargeCap Growth,
LargeCap Growth Equity, MicroCap, MidCap, MidCap Growth, MidCap Growth
Equity, MidCap Value, SmallCap, SmallCap Growth and SmallCap Value);
o total investment return including both capital appreciation and income
through investments in equity and debt securities (Asset Allocation and
Balanced);
o long-term growth of capital primarily through investments in equity
securities of corporations located outside of the U.S. (International,
International Emerging Markets and International SmallCap);
o long-term growth of income and capital through investment in equity
securities of real estate companies (Real Estate);
o to approximate the performance of the Standard & Poor's 500 Composite Stock
Price Index (LargeCap Stock Index (formerly known as "Stock Index 500"));
and
o current income and long-term growth of income and capital through
investment in equity and fixed-income securities of public utilities
companies (Utilities).
Income-Oriented Accounts, which include Accounts seeking primarily a high level
of income through investments in debt securities (Bond, Government Securities
and High Yield).
Money Market Account, which seeks primarily a high level of income through
investments in short-term debt securities.
In seeking to achieve its investment objective, each Account has adopted as
matters of fundamental policy certain investment restrictions which cannot be
changed without approval by the holders of the lesser of:
o 67% of the Account's shares present or represented at a shareholders'
meeting at which the holders of more than 50% of such shares are present or
represented by proxy; or
o more than 50% of the outstanding shares of the Account.
Similar shareholder approval is required to change the investment objective of
each of the Accounts. The following discussion provides for each Account:
o a statement of its investment objective;
o a description of its investment restrictions that are matters of
fundamental policy; and
o a description of any investment restrictions it may have adopted that are
not matters of fundamental policy and may be changed without shareholder
approval.
For purposes of the investment restrictions, all percentage and rating
limitations apply at the time of acquisition of a security. Any subsequent
change in any applicable percentage resulting from market fluctuations or in a
rating by a rating service does not require elimination of any security from the
portfolio. Unless specifically identified as a matter of fundamental policy,
each investment policy discussed in the Prospectus or the Statement of
Additional Information is not fundamental and may be changed by the Fund's Board
of Directors.
GROWTH-ORIENTED ACCOUNTS
Investment Objectives
o Aggressive Growth Account seeks to achieve long-term capital appreciation
by investing primarily in growth oriented common stocks of medium and large
capitalization U.S. companies and, to a limited extent, foreign companies.
o Asset Allocation Account seeks to generate a total investment return
consistent with the preservation of capital.
o Balanced Account seeks to generate a total investment return consisting of
current income and capital appreciation while assuming reasonable risks in
furtherance of the investment objective.
o Blue Chip Account seeks to achieve growth of capital and income. The
Account attempts to achieve its objective by investing primarily in common
stocks of well capitalized, established companies.
o Capital Value Account seeks to achieve primarily long-term capital
appreciation and secondarily growth of investment income through the
purchase primarily of common stocks, but the Account may invest in other
securities.
o Growth Account seeks growth of capital through the purchase primarily of
common stocks, but the Account may invest in other securities.
o International Account seeks to achieve long-term growth of capital by
investing in a portfolio of equity securities of companies domiciled in any
of the nations of the world.
o International Emerging Markets Account seeks to achieve long-term growth of
capital by investing primarily in equity securities of issuers in emerging
market countries.
o International SmallCap Account seeks to achieve long-term growth of
capital. The Account will attempt to achieve its objective by investing
primarily in equity securities of non-United States companies with
comparatively smaller market capitalizations.
o LargeCap Growth Account seeks to achieve long-term growth of capital. The
Account attempts to achieve its objective by investing primarily in growth
stocks of companies with market capitalizations over $10 billion measured
at the time of investment.
o LargeCap Growth Equity Account seeks to achieve long-term growth of capital
by investing primarily in common stocks of larger capitalization domestic
companies.
o LargeCap Stock Index Account seeks to achieve long-term growth of capital.
The Account attempts to mirror the investment results of the Standard &
Poor's 500 Stock Index.
o MicroCap Account seeks to achieve long-term growth of capital. The Account
will attempt to achieve its objective by investing primarily in value and
growth oriented companies with small market capitalizations, generally less
than $700 million.
o MidCap Account seeks to achieve capital appreciation by investing primarily
in securities of emerging and other growth-oriented companies.
o MidCap Growth Account seeks to achieve long-term growth of capital. The
Account will attempt to achieve its objective by investing primarily in
growth stocks of companies with market capitalizations in the $1 billion to
$10 billion range.
o MidCap Growth Equity Account seeks to achieve long-term growth of capital
by investing primarily in medium capitalization U.S. companies with strong
earnings growth potential.
o MidCap Value Account seeks to achieve long-term growth of capital. The
Account attempts to achieve its objective by investing primarily in equity
securities of companies with value characteristics and market
capitalizations in the $1 billion to $10 billion range.
o Real Estate Account seeks to generate a high total return The Account will
attempt to achieve its objective by investing primarily in equity
securities of companies principally engaged in the real estate industry.
o SmallCap Account seeks to achieve long-term growth of capital. The Account
will attempt to achieve its objective by investing primarily in equity
securities of both growth and value oriented companies with comparatively
smaller market capitalizations.
o SmallCap Growth Account seeks long-term growth of capital. The Account will
attempt to achieve its objective by investing primarily in equity
securities of small growth companies with market capitalization of less
than $1 billion at the time of initial purchase.
o SmallCap Value Account seeks to achieve long-term growth of capital. The
Account will attempt to achieve its objective by investing primarily in
equity securities of small companies with value characteristics and market
capitalizations of less than $1 billion.
o Utilities Account seeks to achieve current income and long-term growth of
income and capital. The Account will attempt to achieve its objective by
investing primarily in equity and fixed-income securities of companies in
the public utilities industry.
Investment Restrictions
Aggressive Growth Account, Asset Allocation Account, Balanced Account, Growth
Account, International Account and
MidCap Account.
Each of the following numbered restrictions is a matter of fundamental policy
and may not be changed without shareholder approval. The Aggressive Growth,
Asset Allocation, Balanced, Growth, International and MidCap Accounts each may
not:
(1) Issue any senior securities as defined in the Investment Company
Act of 1940. Purchasing and selling securities and futures
contracts and options thereon and borrowing money in accordance
with restrictions described below do not involve the issuance of
a senior security.
(2) Purchase or retain in its portfolio securities of any issuer if
those officers or directors of the Account or the Manager owning
beneficially more than one-half of 1% (0.5%) of the securities of
the issuer together own beneficially more than 5% of such
securities.
(3) Invest in commodities or commodity contracts, but it may purchase
and sell financial futures contracts and options on such
contracts.
(4) Invest in real estate, although it may invest in securities that
are secured by real estate and securities of issuers that invest
or deal in real estate.
(5) Borrow money, except for temporary or emergency purposes, in an
amount not to exceed 5% of the value of the Account's total
assets at the time of the borrowing. The Balanced Account may
borrow only from banks.
(6) Make loans, except that the Account may (i) purchase and hold
debt obligations in accordance with its investment objective and
policies, (ii) enter into repurchase agreements, and (iii) lend
its portfolio securities without limitation against collateral
(consisting of cash or securities issued or guaranteed by the
United States Government or its agencies or instrumentalities)
equal at all times to not less than 100% of the value of the
securities loaned.
(7) Invest more than 5% of its total assets in the securities of any
one issuer (other than obligations issued or guaranteed by the
United States Government or its agencies or instrumentalities)
except that this limitation shall apply only with respect to 75%
of the total assets of each Account; or purchase more than 10% of
the outstanding voting securities of any one issuer.
(8) Act as an underwriter of securities, except to the extent the
Account may be deemed to be an underwriter in connection with the
sale of securities held in its portfolio.
(9) Concentrate its investments in any particular industry or
industries, except that the Account may invest not more than 25%
of the value of its total assets in a single industry.
(10) Sell securities short (except where the Account holds or has the
right to obtain at no added cost a long position in the
securities sold that equals or exceeds the securities sold short)
or purchase any securities on margin, except it may obtain such
short-term credits as are necessary for the clearance of
transactions. The deposit or payment of margin in connection with
transactions in options and financial futures contracts is not
considered the purchase of securities on margin.
(11) Invest in interests in oil, gas or other mineral exploration or
development programs, although the Account may invest in
securities of issuers that invest in or sponsor such programs.
Each of these Accounts has also adopted the following restrictions that are not
fundamental policies and may be changed without shareholder approval. It is
contrary to each Account's present policy to:
(1) Invest more than 15% of its total assets in securities not
readily marketable and in repurchase agreements maturing in more
than seven days. The value of any options purchased in the
Over-the-Counter market, including all covered spread options
and the assets used as cover for any options written in the
Over-the-Counter market are included as part of this 15%
limitation.
(2) Purchase warrants in excess of 5% of its total assets, of which
2% may be invested in warrants that are not listed on the New
York or American Stock Exchange. The 2% limitation for the
International Account does not apply to warrants listed on the
Toronto Stock Exchange or the Chicago Board Options Exchange.
(3) Purchase securities of any issuer having less than three years'
continuous operation (including operations of any predecessors)
if such purchase would cause the value of the Account's
investments in all such issuers to exceed 5% of the value of its
total assets.
(4) Pledge, mortgage or hypothecate its assets, except to secure
permitted borrowings. The deposit of underlying securities and
other assets in escrow and other collateral arrangements in
connection with transactions in put and call options, futures
contracts and options on futures contracts are not deemed to be
pledges or other encumbrances.
(5) Invest in companies for the purpose of exercising control or
management.
(6) Invest more than 10% (25% for the Aggressive Growth Account) of
its total assets in securities of foreign issuers. This
restriction does not pertain to the International Account or the
Asset Allocation Account.
(7) Invest more than 5% of its total assets in the purchase of
covered spread options and the purchase of put and call options
on securities, securities indices and financial futures
contracts. Options on financial futures contracts and options on
securities indices will be used solely for hedging purposes, not
for speculation.
(8) Invest more than 5% of its assets in initial margin and premiums
on financial futures contracts and options on such contracts.
(9) Invest in arbitrage transactions.
(10) Invest in real estate limited partnership interests.
(11) Acquire securities of other investment companies, except as
permitted by the Investment Company Act of 1940, as amended, or
any rule, order or interpretation thereunder, or in connection
with a merger, consolation, reorganization, acquisition of
assets or an offer of exchange. The Account may purchase
securities of closed-end investment companies in the open market
where no underwriter or dealer's commission or profit, other
than a customary broker's commission, is involved.
Capital Value Account
Each of the following numbered restrictions is a matter of fundamental policy
and may not be changed without shareholder approval. The Capital Value Account
may not:
(1) Concentrate its investments in any one industry. No more than
25% of the value of its total assets will be invested in any one
industry.
(2) Invest more than 5% of its total assets in the securities of any
one issuer (other than obligations issued or guaranteed by the
United States Government or its agencies or instrumentalities)
or purchase more than 10% of the outstanding voting securities
of any one issuer, except that these limitations shall apply
only with respect to 75% of the Account's total assets.
(3) Underwrite securities of other issuers, except that the Account
may acquire portfolio securities under circumstances where if
sold the Account might be deemed an underwriter for purposes of
the Securities Act of 1933.
(4) Purchase securities of any company with a record of less than
three years' continuous operation (including that of
predecessors) if the purchase would cause the value of the
Account's aggregate investments in all such companies to exceed
5% of the Account's total assets.
(5) Engage in the purchase and sale of illiquid interests in real
estate. For this purpose, readily marketable interests in real
estate investment trusts are not interests in real estate.
(6) Invest in commodities or commodity contracts, but it may
purchase and sell financial futures contracts and options on
such contracts.
(7) Purchase or retain in its portfolio securities of any issuer if
those officers and directors of the Fund or the Manager owning
beneficially more than one-half of one percent (0.5%) of the
securities of the issuer together own beneficially more than 5%
of such securities.
(8) Purchase securities on margin, except it may obtain such
short-term credits as are necessary for the clearance of
transactions. The deposit or payment of margin in connection
with transactions in options and financial futures contracts is
not considered the purchase of securities on margin.
(9) Invest in companies for the purpose of exercising control or
management.
(10) Invest more than 5% of its assets at the time of purchase in
rights and warrants (other than those that have been acquired in
units or attached to other securities).
(11) Invest more than 20% of its total assets in securities of
foreign issuers.
(12) Sell securities short (except where the Account holds or has
the right to obtain at no added cost a long position in the
securities sold that equals or exceeds the securities sold
short).
In addition:
(13) The Account may not make loans, except that the Account may (i)
purchase and hold debt obligations in accordance with its
investment objective and policies, (ii) enter into repurchase
agreements, and (iii) lend its portfolio securities without
limitation against collateral (consisting of cash or securities
issued or guaranteed by the United States Government or its
agencies or instrumentalities) equal at all times to not less
than 100% of the value of the securities loaned.
(14) The Account does not propose to borrow money except for temporary
or emergency purposes from banks in an amount not to exceed the
lesser of (i) 5% of the value of the Account's assets, less
liabilities other than such borrowings, or (ii) 10% of the
Account's assets taken at cost at the time such borrowing is
made. The Account may not pledge, mortgage, or hypothecate its
assets (at value) to an extent greater than 15% of the gross
assets taken at cost. The deposit of underlying securities and
other assets in escrow and other collateral arrangements in
connection with transactions in put and call options, futures
contracts and options on futures contracts are not deemed to be
pledges or other encumbrances.
(15) It is contrary to the Account's present policy to purchase
warrants in excess of 5% of its total assets of which 2% may be
invested in warrants that are not listed on the New York or
American Stock Exchange.
The Account has also adopted the following restrictions that are not fundamental
policies and may be changed without shareholder approval. It is contrary to the
Account's present policy to:
(1) Invest its assets in the securities of any investment company
except that the Account may invest not more than 10% of its
assets in securities of other investment companies, invest not
more than 5% of its total assets in the securities of any one
investment company, or acquire not more than 3% of the
outstanding voting securities of any one investment company
except in connection with a merger, consolidation, or plan of
reorganization, and the Account may purchase securities of
closed-end companies in the open market where no underwriter or
dealer's commission or profit, other than a customary broker's
commission, is involved.
(2) Invest more than 15% of its total assets in securities not
readily marketable and in repurchase agreement maturing in more
than seven days.
(3) Invest more than 5% of its total assets in the purchase of
covered spread options and the purchase of put and call options
on securities, securities indices and financial futures
contracts. Options on financial futures contracts and options on
securities indices will be used solely for hedging purposes, not
for speculation.
(4) Invest more than 5% of its assets in initial margin and premiums
on financial futures contracts and options on such contracts.
Investment Restrictions
International SmallCap Account, MicroCap Account, MidCap Growth Account, Real
Estate Account, SmallCap Account,
SmallCap Growth Account, SmallCap Value Account and Utilities Account.
Each of the following numbered restrictions is a matter of fundamental policy
and may not be changed without shareholder approval. The International SmallCap,
MicroCap, MidCap Growth, Real Estate, SmallCap, SmallCap Growth, SmallCap Value
and Utilities Accounts each may not:
(1) Issue any senior securities as defined in the Investment Company
Act of 1940, as amended. Purchasing and selling securities and
futures contracts and options thereon and borrowing money in
accordance with restrictions described below do not involve the
issuance of a senior security.
(2) Invest in physical commodities or commodity contracts (other than
foreign currencies), but it may purchase and sell financial
futures contracts and options on such contracts.
(3) Invest in real estate, although it may invest in securities that
are secured by real estate and securities of issuers that invest
or deal in real estate.
(4) Borrow money, except it may (a) borrow from banks (as defined in
the Investment Company Act of 1940, as amended) or other
financial institutions or through reverse repurchase agreements
in amounts up to 331/3% of its total assets (including the amount
borrowed); (b) to the extent permitted by applicable law, borrow
up to an additional 5% of its total assets for temporary
purposes; (c) obtain such short-term credits as may be necessary
for the clearance of purchases and sales of portfolio securities,
and (d) purchase securities on margin to the extent permitted by
applicable law. In addition, the MicroCap Account may engage in
transactions in mortgage dollar rolls which are accounted for as
financings.
(5) Make loans, except that the Account may (i) purchase and hold
debt obligations in accordance with its investment objective and
policies, (ii) enter into repurchase agreements, and (iii) lend
its portfolio securities without limitation against collateral
(consisting of cash or securities issued or guaranteed by the
United States Government or its agencies or instrumentalities)
equal at all times to not less than 100% of the value of the
securities loaned.
(6) Invest more than 5% of its total assets in the securities of any
one issuer (other than obligations issued or guaranteed by the
United States Government or its agencies or instrumentalities) or
purchase more than 10% of the outstanding voting securities of
any one issuer, except that this limitation shall apply only with
respect to 75% of the total assets of each Account.
(7) Act as an underwriter of securities, except to the extent the
Account may be deemed to be an underwriter in connection with the
sale of securities held in its portfolio.
(8) Concentrate its investments in any particular industry, except
that the Account may invest not more than 25% of the value of its
total assets in a single industry.
However, the Real Estate Account may not invest less than 25% of
its total assets in securities of companies in the real estate
industry, and the Utilities Account may not invest less than 25%
of its total assets in securities of companies in the public
utilities industry except that each may, for temporary defensive
purposes, place all of its assets in cash, cash equivalents, bank
certificates of deposit, bankers acceptances, repurchase
agreements, commercial paper, commercial paper master notes,
United States government securities, and preferred stocks and
debt securities, whether or not convertible into or carrying
rights for common stock.
(9) Sell securities short (except where the Account holds or has the
right to obtain at no added cost a long position in the
securities sold that equals or exceeds the securities sold short)
or purchase any securities on margin, except to the extent
permitted by applicable law and except that the Account may
obtain such short-term credits as are necessary for the clearance
of transactions. The deposit or payment of margin in connection
with transactions in options and financial futures contracts is
not considered the purchase of securities on margin.
Each of these Accounts has also adopted the following restrictions that are not
fundamental policies and may be changed without shareholder approval. It is
contrary to each Account's present policy to:
(1) Invest more than 15% of its total assets in illiquid securities
and in repurchase agreements maturing in more than seven days.
(2) Pledge, mortgage or hypothecate its assets, except to secure
permitted borrowings. The deposit of underlying securities and
other assets in escrow and other collateral arrangements in
connection with transactions in put and call options, futures
contracts and options on futures contracts are not deemed to be
pledges or other encumbrances.
(3) Invest in companies for the purpose of exercising control or
management.
(4) Invest more than 25% (20% for each of the SmallCap and Utilities
Accounts, 10% for each of the MidCap Growth and SmallCap Value
Accounts) of its total assets in securities of foreign issuers.
This restriction does not apply to the International SmallCap
Account.
(5) Invest more than 5% of its assets in initial margin and premiums
on financial futures contracts and options on such contracts.
(6) Invest in real estate limited partnership interests or real
estate investment trusts except that this restriction shall not
apply to either the MicroCap or Real Estate Accounts.
(7) Acquire securities of other investment companies, except as
permitted by the Investment Company Act of 1940, as amended or
any rule, order or interpretation thereunder, or in connection
with a merger, consolidation, reorganization, acquisition of
assets or an offer of exchange. The Account may purchase
securities of closed-end investment companies in the open market
where no underwriter or dealer's commission or profit, other
than a customary broker's commission, is involved.
Blue Chip Account, International Emerging Markets Account, LargeCap Growth
Account, LargeCap Growth Equity Account, LargeCap Stock Index Account, MidCap
Growth Equity Account and MidCap Value Account
Each of the following numbered restrictions is a matter of fundamental policy
and may not be changed without shareholder approval. The Blue Chip,
International Emerging Markets, LargeCap Growth, LargeCap Growth Equity,
LargeCap Stock Index, MidCap Growth Equity and MidCap Value Accounts each may
not:
(1) Issue any senior securities as defined in the Investment Company
Act of 1940, as amended. Purchasing and selling securities and
futures contracts and options thereon and borrowing money in
accordance with restrictions described below do not involve the
issuance of a senior security.
(2) Invest in physical commodities or commodity contracts (other
than foreign currencies), but it may purchase and sell financial
futures contracts and options on such contracts, swaps and
securities backed by physical commodities.
(3) Invest in real estate, although it may invest in securities that
are secured by real estate and securities of issuers that invest
or deal in real estate.
(4) Borrow money, except it may (a) borrow from banks (as defined in
the Investment Company Act of 1940, as amended) or other
financial institutions or through reverse repurchase agreements
in amounts up to 331/3% of its total assets (including the
amount borrowed); (b) to the extent permitted by applicable law,
borrow up to an additional 5% of its total assets for temporary
purposes; (c) obtain such short-term credits as may be necessary
for the clearance of purchases and sales of portfolio
securities, and (d) purchase securities on margin to the extent
permitted by applicable law.
(5) Make loans, except that the Account may (i) purchase and hold
debt obligations in accordance with its investment objective and
policies, (ii) enter into repurchase agreements, and (iii) lend
its portfolio securities without limitation against collateral
(consisting of cash or securities issued or guaranteed by the
United States Government or its agencies or instrumentalities)
equal at all times to not less than 100% of the value of the
securities loaned. This limit does not apply to purchases of
debt securities or commercial paper.
(6) Invest more than 5% of its total assets in the securities of any
one issuer (other than obligations issued or guaranteed by the
United States Government or its agencies or instrumentalities)
or purchase more than 10% of the outstanding voting securities
of any one issuer, except that this limitation shall apply only
with respect to 75% of the total assets of each Account. This
restriction does not apply to the LargeCap Growth Equity Account
as this Account is not intended to qualify as a diversified
management investment company as defined by the Investment
Company Act of 1940.
(7) Act as an underwriter of securities, except to the extent the
Account may be deemed to be an underwriter in connection with
the sale of securities held in its portfolio.
(8) Concentrate its investments in any particular industry, except
that the Account may invest not more than 25% of the value of
its total assets in a single industry, provided that, when the
Account has adopted a temporary defensive posture, there shall
be no limitation on the purchase of obligations issued or
guaranteed by the U.S. Government, its agencies or
instrumentalities. This restriction applies to the LargeCap
Stock Index Account except to the extent that the Standard &
Poor's 500 Stock Index also is so concentrated.
(9) Sell securities short (except where the Account holds or has the
right to obtain at no added cost a long position in the
securities sold that equals or exceeds the securities sold
short) or purchase any securities on margin, except to the
extent permitted by applicable law and except that the Account
may obtain such short-term credits as are necessary for the
clearance of transactions. The deposit or payment of margin in
connection with transactions in options and financial futures
contracts is not considered the purchase of securities on
margin.
Each of these Accounts has also adopted the following restrictions that are not
fundamental policies and may be changed without shareholder approval. It is
contrary to each Account's present policy to:
(1) Invest more than 15% of its total assets in illiquid securities
and in repurchase agreements maturing in more than seven days.
(2) Pledge, mortgage or hypothecate its assets, except to secure
permitted borrowings. The deposit of underlying securities and
other assets in escrow and other collateral arrangements in
connection with transactions in put and call options, futures
contracts and options on futures contracts are not deemed to be
pledges or other encumbrances.
(3) Invest in companies for the purpose of exercising control or
management.
(4) Invest more than 25% (20% for the Blue Chip Account, 10% for the
LargeCap Stock Index and MidCap Growth Equity Accounts) of its
total assets in securities of foreign issuers. This restriction
does not apply to the International Emerging Markets Account.
(5) Enter into (i) any futures contracts and related options for
purposes other than bona fide hedging transactions within the
meaning of Commodity Futures Trading Commission ("CFTC")
regulations if the aggregate initial margin and premiums
required to establish positions in futures contracts and related
options that do not fall within the definition of bona fide
hedging transactions will exceed 5% of the fair market value of
an Account's net assets, after taking into account unrealized
profits and unrealized losses on any such contracts it has
entered into; and (ii) any futures contracts if the aggregate
amount of such Account's commitments under outstanding futures
contracts positions would exceed the market value of its total
assets.
(6) Invest in real estate limited partnership interests or real
estate investment trusts except that this restriction shall not
apply to the LargeCap Growth or MidCap Growth Equity Accounts.
(7) Acquire securities of other investment companies, except as
permitted by the Investment Company Act of 1940, as amended or
any rule, order or interpretation thereunder, or in connection
with a merger, consolidation, reorganization, acquisition of
assets or an offer of exchange. The Account may purchase
securities of closed-end investment companies in the open market
where no underwriter or dealer's commission or profit, other
than a customary broker's commission, is involved.
INCOME-ORIENTED ACCOUNTS
Investment Objectives
o Bond Account seeks to provide as high a level of income as is consistent
with preservation of capital and prudent investment risk.
o Government Securities Account seeks a high level of current income,
liquidity and safety of principal by purchasing obligations issued or
guaranteed by the United States Government or its agencies, with emphasis
on Government National Mortgage Association Certificates ("GNMA
Certificates"). The guarantee by the United States Government extends only
to principal and interest; Account shares are not guaranteed by the United
States Government. There are certain risks unique to GNMA Certificates.
o High Yield Account seeks high current income primarily by purchasing high
yielding, lower or non-rated fixed income securities which are believed to
not involve undue risk to income or principal. Capital growth is a
secondary objective when consistent with the objective of high current
income.
Investment Restrictions
Bond Account and High Yield Account
Each of the following numbered restrictions is a matter of fundamental policy
and may not be changed without shareholder approval. The Bond Account and High
Yield Account each may not:
(1) Issue any senior securities as defined in the Investment Company
Act of 1940. Purchasing and selling securities and futures
contracts and options thereon and borrowing money in accordance
with restrictions described below do not involve the issuance of
a senior security.
(2) Purchase or retain in its portfolio securities of any issuer if
those officers or directors of the Account or the Manager owning
beneficially more than one-half of 1% (0.5%) of the securities
of the issuer together own beneficially more than 5% of such
securities.
(3) Invest in commodities or commodity contracts, but it may
purchase and sell financial futures contracts and options on
such contracts.
(4) Invest in real estate, although it may invest in securities
which are secured by real estate and securities of issuers which
invest or deal in real estate.
(5) Borrow money, except for temporary or emergency purposes, in an
amount not to exceed 5% of the value of the Account's total
assets at the time of the borrowing. The Bond Account and High
Yield Account may borrow only from banks.
(6) Make loans, except that the Account may (i) purchase and hold
debt obligations in accordance with its investment objective and
policies, (ii) enter into repurchase agreements, and (iii) lend
its portfolio securities without limitation against collateral
(consisting of cash or securities issued or guaranteed by the
United States Government or its agencies or instrumentalities)
equal at all times to not less than 100% of the value of the
securities loaned.
(7) Invest more than 5% of its total assets in the securities of any
one issuer (other than obligations issued or guaranteed by the
United States Government or its agencies or instrumentalities)
or purchase more than 10% of the outstanding voting securities
of any one issuer, except that these limitations shall apply
only with respect to 75% of the total assets of each Account.
(8) Act as an underwriter of securities, except to the extent the
Account may be deemed to be an underwriter in connection with
the sale of securities held in its portfolio.
(9) Concentrate its investments in any particular industry or
industries, except that the Bond Account and High Yield Account
each may invest not more than 25% of the value of its total
assets in a single industry.
(10) Sell securities short (except where the Account holds or has the
right to obtain at no added cost a long position in the
securities sold that equals or exceeds the securities sold
short) or purchase any securities on margin, except it may
obtain such short-term credits as are necessary for the
clearance of transactions. The deposit or payment of margin in
connection with transactions in options and financial futures
contracts is not considered the purchase of securities on
margin.
(11) Invest in interests in oil, gas or other mineral exploration or
development programs, although the Account may invest in
securities of issuers which invest in or sponsor such programs.
Each of these Accounts has also adopted the following restrictions that are not
fundamental policies and may be changed without shareholder approval. It is
contrary to each Account's present policy to:
(1) Invest more than 15% of its total assets in securities not
readily marketable and in repurchase agreements maturing in more
than seven days. The value of any options purchased in the
Over-the-Counter market, including all covered spread options
and the assets used as cover for any options written in the
Over-the-Counter market are included as part of this 15%
limitation.
(2) Purchase warrants in excess of 5% of its total assets, of which
2% may be invested in warrants that are not listed on the New
York or American Stock Exchange.
(3) Purchase securities of any issuer having less than three years'
continuous operation (including operations of any predecessors)
if such purchase would cause the value of the Account's
investments in all such issuers to exceed 5% of the value of its
total assets.
(4) Purchase securities of other investment companies except in
connection with a merger, consolidation, or plan of
reorganization or by purchase in the open market of securities
of closed-end companies where no underwriter or dealer's
commission or profit, other than a customary broker's
commission, is involved, and if immediately thereafter not more
than 10% of the value of the Account's total assets would be
invested in such securities.
(5) Pledge, mortgage or hypothecate its assets, except to secure
permitted borrowings. The deposit of underlying securities and
other assets in escrow and other collateral arrangements in
connection with transactions in put and call options, futures
contracts and options on futures contracts are not deemed to be
pledges or other encumbrances.
(6) Invest in companies for the purpose of exercising control or
management.
(7) Invest more than 20% of its total assets in securities of
foreign issuers.
(8) Invest more than 5% of its total assets in the purchase of
covered spread options and the purchase of put and call options
on securities, securities indices and financial futures
contracts. Options on financial futures contracts and options on
securities indices will be used solely for hedging purposes; not
for speculation.
(9) Invest more than 5% of its assets in initial margin and premiums
on financial futures contracts and options on such contracts.
(10) Invest in arbitrage transactions.
(11) Invest in real estate limited partnership interests.
Government Securities Account
Each of the following numbered restrictions is a matter of fundamental policy
and may not be changed without shareholder approval. The Government Securities
Account may not:
(1) Issue any senior securities as defined in the Act except insofar
as the Account may be deemed to have issued a senior security by
reason of (a) purchasing any securities on a standby,
when-issued or delayed delivery basis; or (b) borrowing money in
accordance with restrictions described below.
(2) Purchase any securities other than obligations issued or
guaranteed by the U.S. Government or its agencies or
instrumentalities, except that the Account may maintain
reasonable amounts in cash or commercial paper or purchase
short-term debt securities not issued or guaranteed by the U.S.
Government or its agencies or instrumentalities for daily cash
management purposes or pending selection of particular long-term
investments.
(3) Act as an underwriter of securities, except to the extent the
Account may be deemed to be an underwriter in connection with
the sale of GNMA certificates held in its portfolio.
(4) Engage in the purchase and sale of interests in real estate,
including interests in real estate investment trusts (although
it will invest in securities secured by real estate or interests
therein, such as mortgage-backed securities) or invest in
commodities or commodity contracts, oil and gas interests, or
mineral exploration or development programs.
(5) Purchase or retain in its portfolio securities of any issuer if
those officers and directors of the Fund or the Manager owning
beneficially more than one-half of 1% (0.5%) of the securities
of the issuer together own beneficially more than 5% of such
securities.
(6) Sell securities short or purchase any securities on margin,
except it may obtain such short-term credits as are necessary
for the clearance of transactions. The deposit or payment of
margin in connection with transactions in options and financial
futures contracts is not considered the purchase of securities
on margin.
(7) Invest in companies for the purpose of exercising control or
management.
(8) Make loans, except that the Account may purchase or hold debt
obligations in accordance with the investment restrictions set
forth in paragraph (2) and may enter into repurchase agreements
for such securities, and may lend its portfolio securities
without limitation against collateral consisting of cash, or
securities issued or guaranteed by the United States Government
or its agencies or instrumentalities, which is equal at all
times to 100% of the value of the securities loaned.
(9) Borrow money, except for temporary or emergency purposes, in an
amount not to exceed 5% of the value of the Account's total
assets at the time of the borrowing.
(10) Enter into repurchase agreements maturing in more than seven
days if, as a result thereof, more than 10% of the value of the
Account's total assets would be invested in such repurchase
agreements and other assets without readily available market
quotations.
(11) Invest more than 5% of its total assets in the purchase of
covered spread options and the purchase of put and call options
on securities, securities indices and financial futures
contracts.
(12) Invest more than 5% of its assets in initial margin and premiums
on financial futures contracts and options on such contracts.
The Government Securities Account has also adopted the following restrictions
that are not a fundamental policy and may be changed without shareholder
approval. It is contrary to the Government Securities Account's present policy
to:
(1) Pledge, mortgage or hypothecate its assets, except to secure
permitted borrowings. The deposit of underlying securities and
other assets in escrow and other collateral arrangements in
connection with transactions in put and call options, futures
contracts and options on future contracts are not deemed to be
pledges or other encumbrances.
(2) Invest its assets in the securities of any investment company
except that the Account may invest not more than 10% of its
assets in securities of other investment companies, invest not
more than 5% of its total assets in the securities of any one
investment company, or acquire not more than 3% of the
outstanding voting securities of any one investment company
except in connection with a merger, consolidation, or plan of
reorganization, and the Account may purchase securities of
closed-end companies in the open market where no underwriter or
dealer's commission or profit, other than a customary broker's
commission, is involved.
MONEY MARKET ACCOUNT
Investment Objective
o Money Market Account seeks as high a level of income available from
short-term securities as is considered consistent with preservation of
principal and maintenance of liquidity by investing in a portfolio of money
market instruments.
Investment Restrictions
Money Market Account
Each of the following numbered restrictions is a matter of fundamental policy
and may not be changed without shareholder approval. The Money Market Account
may not:
(1) Concentrate its investments in any one industry. No more than 25%
of the value of its total assets will be invested in securities
of issuers having their principal activities in any one industry,
other than securities issued or guaranteed by the U.S. Government
or its agencies or instrumentalities, or obligations of domestic
branches of U.S. banks and savings institutions. (See "Bank
Obligations").
(2) Purchase the securities of any issuer if the purchase will cause
more than 25% of the value of its total assets to be invested in
the securities of any one issuer (except securities issued or
guaranteed by the U.S. Government, its agencies or
instrumentalities).
(3) Purchase the securities of any issuer if the purchase will cause
more than 10% of the outstanding voting securities of the issuer
to be held by the Account (other than securities issued or
guaranteed by the U.S. Government, its agencies or
instrumentalities).
(4) Invest a greater percentage of its total assets in securities not
readily marketable than is allowed by federal securities rules or
interpretations.
(5) Act as an underwriter except to the extent that, in connection
with the disposition of portfolio securities, it may be deemed to
be an underwriter under the federal securities laws.
(6) Purchase securities of any company with a record of less than 3
years continuous operation (including that of predecessors) if
the purchase would cause the value of the Account's aggregate
investments in all such companies to exceed 5% of the value of
the Account's total assets.
(7) Engage in the purchase and sale of illiquid interests in real
estate, including interests in real estate investment trusts
(although it may invest in securities secured by real estate or
interests therein) or invest in commodities or commodity
contracts, oil and gas interests, or mineral exploration or
development programs.
(8) Purchase or retain in its portfolio securities of any issuer if
those officers and directors of the Fund or the Manager owning
beneficially more than one-half of 1% (0.5%) of the securities of
the issuer together own beneficially more than 5% of such
securities.
(9) Purchase securities on margin, except it may obtain such
short-term credits as are necessary for the clearance of
transactions. The Account will not issue or acquire put and call
options, straddles or spreads or any combination thereof.
(10) Invest in companies for the purpose of exercising control or
management.
(11) Make loans, except that the Account may (i) purchase and hold
debt obligations in accordance with its investment objective and
policies, (ii) enter into repurchase agreements, and (iii) lend
its portfolio securities without limitation against collateral
(consisting of cash or securities issued or guaranteed by the
United States Government or its agencies or instrumentalities)
equal at all times to not less than 100% of the value of the
securities loaned.
(12) Borrow money, except from banks for temporary or emergency
purposes, including the meeting of redemption requests which
might otherwise require the untimely disposition of securities,
in an amount not to exceed the lesser of (i) 5% of the value of
the Account's assets, or (ii) 10% of the value of the Account's
net assets taken at cost at the time such borrowing is made. The
Account will not issue senior securities except in connection
with such borrowings. The Account may not pledge, mortgage, or
hypothecate its assets (at value) to an extent greater than 10%
of the net assets.
(13) Invest in uncertificated time deposits maturing in more than
seven days; uncertificated time deposits maturing from two
business days through seven calendar days may not exceed 10% of
the value of the Account's total assets.
(14) Enter into repurchase agreements maturing in more than seven days
if, as a result thereof, more than 10% of the value of the
Account's total assets would be invested in such repurchase
agreements and other assets (excluding time deposits) without
readily available market quotations.
The Money Market Account has also adopted the following restriction that is not
a fundamental policy and may be changed without shareholder approval. It is
contrary to the Money Market Account's present policy to: invest its assets in
the securities of any investment company except that the Account may invest not
more than 10% of its assets in securities of other investment companies, invest
not more than 5% of its total assets in the securities of any one investment
company, or acquire not more than 3% of the outstanding voting securities of any
one investment company except in connection with a merger, consolidation, or
plan of reorganization, and the Account may purchase securities of closed-end
companies in the open market where no underwriter or dealer's commission or
profit, other than a customary broker's commission, is involved.
ACCOUNTS' INVESTMENTS
The following information supplements the discussion of the Accounts investment
objectives and policies in the Prospectus under the caption "CERTAIN INVESTMENT
STRATEGIES AND RELATED RISKS."
Fundamental Analysis
Equity securities are selected for the Accounts by the Sub-Advisor, if any, or
the Manager.
Invista Capital Management, LLC ("Invista"), the Sub-Advisor for the Balanced,
Blue Chip, Capital Value, Growth, International, International Emerging Markets,
International SmallCap, MidCap, SmallCap and Utilities Accounts and the Manager,
in selecting securities for the Real Estate Account, use an approach described
broadly as that of fundamental analysis. Three basic steps are involved in this
analysis.
o First is the continuing study of basic economic factors in an effort to
conclude what the future general economic climate is likely to be over the
next one to two years.
o Second, given some conviction as to the likely economic climate, the
Manager or Sub-Advisor attempts to identify the prospects for the major
industrial, commercial and financial segments of the economy. By looking at
such factors as demand for products, capacity to produce, operating costs,
pricing structure, marketing techniques, adequacy of raw materials and
components, domestic and foreign competition, and research productivity,
the Manager or Sub-Advisor evaluates the prospects for each industry for
the near and intermediate term.
o Finally, determinations are made regarding earnings prospects for
individual companies within each industry by considering the same types of
factors described above. These earnings prospects are evaluated in relation
to the current price of the securities of each company.
Berger LLC ("Berger"), the Sub-Advisor for the SmallCap Growth Account, selects
equity securities using the same three basic steps but in the reverse order.
This process is often referred to as "bottom-up" fundamental analysis. Neuberger
Berman Management Inc. ("Neuberger Berman"), Sub-Advisor for the MidCap Value
Account primarily uses a bottom-up approach although a limited top-down analysis
will be used as well.
Janus Capital Corporation ("Janus"), the Sub-Advisor for the LargeCap Growth
Account, uses a bottom-up approach in building its portfolio that seeks to
identify individual companies with earnings growth potential that may not be
recognized by the market at large. Although themes may emerge in the Account,
securities are generally selected without regard to any defined industry sector
or other similarly defined selection procedure.
Morgan Stanley Asset Management ("Morgan Stanley"), the Sub-Advisor for the
Aggressive Growth and Asset Allocation Accounts, and Duncan-Hurst Capital
Management Inc ("Duncan-Hurst"), the Sub-Advisor for the LargeCap Growth Equity
Account, follow a flexible investment program in looking for companies with
above average capital appreciation potential. The Sub-Advisor focuses on
companies with consistent or rising earnings growth records and compelling
business strategies. The Sub-Advisor continually and rigorously studies company
developments, including business strategy, management focus and financial
results, to identify companies with earnings growth and business momentum. In
addition, the Sub-Advisor closely monitors analysts' expectations to identify
issuers that have the potential for positive earnings surprises versus consensus
expectations. In its selection of securities for the Aggressive Growth and Asset
Allocation Accounts, Morgan Stanley considers valuation to be of secondary
importance and viewed in the context of prospects for sustainable earnings
growth.
Turner Investment Partners, Inc. ("Turner"), the Sub-Advisor for the MidCap
Growth Equity Account, selects securities that it believes to have strong
earnings growth potential. Turner seeks to purchase securities that are well
diversified across economic sectors and to maintain sector concentrations that
approximate the economic sector weightings comprising the Russell Midcap Growth
Index (or such other appropriate index as selected by Turner). Any remaining
assets may be invested in securities issued by smaller capitalization companies
and larger capitalization companies, warrants and rights to purchase common
stocks, and may invest up to 10% of Account assets in ADRs. Turner will only
purchase securities that are traded on registered exchanges or the
over-the-counter market in the U.S.
Invista, the Sub-Advisor for the LargeCap Stock Index Account, allocates Account
assets in approximately the same weightings as the S&P 500. Invista may omit or
remove any S&P 500 stocks from the Account if it determines that the stock is
not sufficiently liquid. In addition, Invista may exclude or remove a stock from
the Account if extraordinary events or financial conditions lead it to believe
that such stock should not be part of the Account' s assets. Account assets may
be invested in futures and options.
J.P. Morgan Investment Management, Inc. ("Morgan"), the Sub-Advisor for the
SmallCap Value Account, uses fundamental research, systematic stock valuation
and a disciplined portfolio construction process. Morgan seeks to enhance
returns and reduce the volatility in the value of the Account relative to that
of the U.S. small company value universe. Morgan continuously screens the small
company universe to identify for further analysis those companies that exhibit
favorable characteristics. Such characteristics include significant and
predictable cash flow and high quality management. Based on fundamental research
and using a dividend discount model. Morgan ranks these companies within
economic sectors according to their relative values. Morgan then selects for
purchase the companies it feels to be most attractive within each economic
sector.
Dreyfus Corporation ("Dreyfus"), the Sub-Advisor for the MidCap Growth Account,
uses valuations models designed to identify common stocks of companies that have
demonstrated consistent earnings momentum and delivered superior results
relative to market analyst expectations. Other considerations include profit
margins, growth in cash flow and other standard balance sheet measures. The
securities held are generally characterized by strong earnings growth momentum
measures and higher expected earnings per share growth. Once such common stocks
are identified, Dreyfus, constructs a portfolio that in the aggregate breakdown
and risk profile resembles the Standard and Poor's MidCap 400 Index, but is
weighted toward the most attractive stocks. The valuation model incorporates
information about the relevant criteria as of the most recent period for which
data are available. Once ranked, the securities are categorized under the
headings "buy", "sell" or "hold." The decision to buy, sell or hold is made by
Dreyfus based primarily on output of the valuation model. However, that decision
may be modified due to subsequently available or other specific relevant
information about the security.
Goldman Sachs Asset Management ("Goldman"), the Sub-Advisor for the MicroCap
Account, selects securities that it believes are well-managed niche businesses
that have the potential to achieve high or improving returns on capital and/or
above-average sustainable growth. Goldman invests in companies that have value
characteristics as well as those with growth characteristics with no consistent
preference between the two categories.
Restricted Securities
Each of the Accounts (except Government Securities and Money Market) has adopted
investment restrictions that limit its investments in illiquid securities to 15%
of its net assets. The Board of Directors has adopted procedures for the Manager
or Sub-Advisor to determine the liquidity of Rule 4(2) short-term paper and of
restricted securities under Rule 144A. Securities determined to be liquid under
these procedures are excluded from this limit when applying the preceding
investment restrictions.
Generally, restricted securities are not readily marketable because they are
subject to legal or contractual restrictions upon resale. They are sold only in
a public offering with an effective registration statement or in a transaction
that is exempt from the registration requirements of the Securities Act of 1933.
When registration is required, an Account may be obligated to pay all or part of
the registration expenses and a considerable period may elapse between the time
of the decision to sell and the time the Account may be permitted to sell a
security. If, during such a period, adverse market conditions were to develop,
the Account might obtain a less favorable price than existed when it decided to
sell. Restricted securities and other securities not readily marketable are
priced at fair value as determined in good faith by or under the direction of
the Board of Directors.
Foreign Securities
Each of the following Accounts may invest in foreign securities to the indicated
percentage of its assets (debt securities issued in the United States pursuant
to a registration statement filed with the Securities and Exchange Commission
are not treated as foreign securities for purposes of these limitations.):
o Asset Allocation, International, International Emerging Markets and
International SmallCap Accounts - 100%;
o Aggressive Growth, LargeCap Growth, LargeCap Growth Equity, MicroCap, Real
Estate and SmallCap Growth Accounts - 25%;
o Bond, Capital Value, High Yield, SmallCap and Utilities Accounts - 20%.
o Balanced, Growth, LargeCap Stock Index, MidCap, MidCap Growth, MidCap
Growth Equity, MidCap Value, SmallCap Value Accounts - 10%.
The Money Market Account does not invest in foreign securities other than those
that are United States dollar denominated. All principal and interest payments
for the security are payable in U.S. dollars. The interest rate, the principal
amount to be repaid and the timing of payments related to the securities do not
vary or float with the value of a foreign currency, the rate of interest on
foreign currency borrowings or with any other interest rate or index expressed
in a currency other than U.S. dollars.
For purposes of these restrictions, foreign securities include:
o companies organized under the laws of countries outside of the U.S.;
o companies for which the principal securities trading market is outside of
the U.S.; and
o companies, regardless of where its securities are traded, that derive 50%
or more of their total revenue from either goods or services produced
outside the U.S. or sales made outside of the U.S.
Investment in foreign securities presents certain risks including: fluctuations
in currency exchange rates, revaluation of currencies, the imposition of foreign
taxes, future political and economic developments including war, expropriations,
nationalization, the possible imposition of currency exchange controls and other
foreign governmental laws or restrictions. In addition, there may be reduced
availability of public information concerning issuers compared to domestic
issuers. Foreign issuers are not generally subject to uniform accounting,
auditing and financial reporting standards or to other regulatory practices and
requirements that apply to domestic issuers. Transactions in foreign securities
may be subject to higher costs. Each Account's investment in foreign securities
may also result in higher custodial costs and the costs associated with currency
conversions.
Securities of many foreign issuers may be less liquid and their prices more
volatile than those of comparable domestic issuers. Foreign securities markets,
particularly those in emerging market countries, are known to experience long
delays between the trade and settlement dates of securities purchased and sold.
Such delays may result in a lack of liquidity and greater volatility in the
price of securities on those markets. As a result of these factors, the Board of
Directors of the Fund has adopted Daily Pricing and Valuation Procedures for the
Accounts that set forth the steps to be followed by the Manager and/or
Sub-Advisor to establish a reliable market or fair value if a reliable market
value is not available through normal market quotations. Oversight of this
process is provided by the Executive Committee of the Board of Directors.
Securities of Smaller Companies
The Accounts may invest in securities of companies with small- or mid-sized
market capitalizations. Market capitalization is defined as total current market
value of a company's outstanding common stock. Investments in companies with
smaller market capitalizations may involve greater risks and price volatility
(wide, rapid fluctuations) than investments in larger, more mature companies.
Smaller companies may be less mature than older companies. At this earlier stage
of development, the companies may have limited product lines, reduced market
liquidity for their shares, limited financial resources or less depth in
management than larger or more established companies. Small companies also may
be less significant factors within their industries and may be at a competitive
disadvantage relative to their larger competitors. While smaller companies may
be subject to these additional risks, they may also realize more substantial
growth than larger or more established companies.
Unseasoned Issuers
Each of the Accounts (except Government Securities Account) may invest in the
securities of unseasoned issuers. Unseasoned issuers are companies with a record
of less than three years continuous operation, including the operation of
predecessors and parents. Unseasoned issuers by their nature have only a limited
operating history that can be used for evaluating the company's growth
prospects. As a result, investment decisions for these securities may place a
greater emphasis on current or planned product lines and the reputation and
experience of the company's management and less emphasis on fundamental
valuation factors than would be the case for more mature growth companies. In
addition, many unseasoned issuers also may be small companies and involve the
risks and price volatility associated with smaller companies.
Spread Transactions, Options on Securities and Securities Indices, and Futures
Contracts and Options on Futures Contracts
Each of the Accounts may engage in the practices described under this heading.
In the following discussion, the terms "the Account," "each Account" or "the
Accounts" refer to each of the Accounts that may engage in these transactions.
Spread Transactions
Each Account may purchase covered spread options. Such covered spread options
are not presently exchange listed or traded. The purchase of a spread option
gives the Account the right to put, or sell, a security that it owns at a fixed
dollar spread or fixed yield spread in relation to another security that the
Account does not own, but which is used as a benchmark. The risk to the Account
in purchasing covered spread options is the cost of the premium paid for the
spread option and any transaction costs. In addition, there is no assurance that
closing transactions will be available. The purchase of spread options can be
used to protect each Account against adverse changes in prevailing credit
quality spreads, i.e., the yield spread between high quality and lower quality
securities. The security covering the spread option is maintained in a
segregated account by each Account's custodian. The Accounts do not consider a
security covered by a spread option to be "pledged" as that term is used in the
Accounts' policy limiting the pledging or mortgaging of assets.
Options on Securities and Securities Indices
Each Account may write (sell) and purchase call and put options on securities in
which it invests and on securities indices based on securities in which the
Account invests. The Accounts may write call and put options to generate
additional revenue, and may write and purchase call and put options in seeking
to hedge against a decline in the value of securities owned or an increase in
the price of securities which the Account plans to purchase.
Writing Covered Call and Put Options
When an Account writes a call option, it gives the purchaser of the option the
right to buy a specific security at a specified price at any time before the
option expires. When an Account writes a put option, it gives the purchaser of
the option the right to sell to the Account a specific security at a specified
price at any time before the option expires. In both situations, the Account
receives a premium from the purchaser of the option.
The premium received by an Account reflects, among other factors, the current
market price of the underlying security, the relationship of the exercise price
to the market price, the time period until the expiration of the option and
interest rates. The premium generates additional income for the Account if the
option expires unexercised or is closed out at a profit. By writing a call, an
Account limits its opportunity to profit from any increase in the market value
of the underlying security above the exercise price of the option, but it
retains the risk of loss if the price of the security should decline. By writing
a put, an Account assumes the risk that it may have to purchase the underlying
security at a price that may be higher than its market value at time of
exercise.
The Accounts write only covered options and comply with applicable regulatory
and exchange cover requirements. The Accounts usually own the underlying
security covered by any outstanding call option. With respect to an outstanding
put option, each Account deposits and maintains with its custodian cash, U.S.
Government securities or other liquid assets with a value at least equal to the
exercise price of the option.
Once an Account has written an option, it may terminate its obligation, before
the option is exercised. The Account executes a closing transaction by
purchasing an option of the same series as the option previously written. The
Account has a gain or loss depending on whether the premium received when the
option was written exceeds the closing purchase price plus related transaction
costs.
Purchasing Call and Put Options
When an Account purchases a call option, it receives, in return for the premium
it pays, the right to buy from the writer of the option the underlying security
at a specified price at any time before the option expires. An Account purchases
call options in anticipation of an increase in the market value of securities
that it ultimately intends to buy. During the life of the call option, the
Account is able to buy the underlying security at the exercise price regardless
of any increase in the market price of the underlying security. In order for a
call option to result in a gain, the market price of the underlying security
must exceed the sum of the exercise price, the premium paid and transaction
costs.
When an Account purchases a put option, it receives, in return for the premium
it pays, the right to sell to the writer of the option the underlying security
at a specified price at any time before the option expires. An Account purchases
put options in anticipation of a decline in the market value of the underlying
security. During the life of the put option, the Account is able to sell the
underlying security at the exercise price regardless of any decline in the
market price of the underlying security. In order for a put option to result in
a gain, the market price of the underlying security must decline, during the
option period, below the exercise price enough to cover the premium and
transaction costs.
Once an Account purchases an option, it may close out its position by selling an
option of the same series as the option previously purchased. The Account has a
gain or loss depending on whether the closing sale price exceeds the initial
purchase price plus related transaction costs.
Options on Securities Indices
Each Account may purchase and sell put and call options on any securities index
based on securities in which the Account may invest. Securities index options
are designed to reflect price fluctuations in a group of securities or segment
of the securities market rather than price fluctuations in a single security.
Options on securities indices are similar to options on securities, except that
the exercise of securities index options requires cash payments and does not
involve the actual purchase or sale of securities. The Accounts engage in
transactions in put and call options on securities indices for the same purposes
as they engage in transactions in options on securities. When an Account writes
call options on securities indices, it holds in its portfolio underlying
securities which, in the judgment of the Manager or the Sub-Advisor, correlate
closely with the securities index and which have a value at least equal to the
aggregate amount of the securities index options.
Risks Associated with Options Transactions
An options position may be closed out only on an exchange that provides a
secondary market for an option of the same series. The Accounts generally
purchase or write only those options for which there appears to be an active
secondary market. However, there is no assurance that a liquid secondary market
on an exchange exists for any particular option, or at any particular time. If
an Account is unable to effect closing sale transactions in options it has
purchased, it has to exercise its options in order to realize any profit and may
incur transaction costs upon the purchase or sale of underlying securities. If
an Account is unable to effect a closing purchase transaction for a covered
option that it has written, it is not able to sell the underlying securities, or
dispose of the assets held in a segregated account, until the option expires or
is exercised. An Account's ability to terminate option positions established in
the over-the-counter market may be more limited than for exchange-traded options
and may also involve the risk that broker-dealers participating in such
transactions might fail to meet their obligations.
Futures Contracts and Options on Futures
Each Account may purchase and sell financial futures contracts and options on
those contracts. Financial futures contracts are commodities contracts based on
financial instruments such as U.S. Treasury bonds or bills or on securities
indices such as the S&P 500 Index. Futures contracts, options on futures
contracts and the commodity exchanges on which they are traded are regulated by
the Commodity Futures Trading Commission ("CFTC"). Through the purchase and sale
of futures contracts and related options, an Account seeks to hedge against a
decline in securities owned by the Account or an increase in the price of
securities that the Account plans to purchase. An Account may also purchase and
sell futures contracts and related options to maintain cash reserves while
stimulating full investment in equity securities and to keep substantially all
of its assets exposed to the market.
Futures Contracts
When an Account sells a futures contract based on a financial instrument, the
Account is obligated to deliver that kind of instrument at a specified future
time for a specified price. When an Account purchases that kind of contract, it
is obligated to take delivery of the instrument at a specified time and to pay
the specified price. In most instances, these contracts are closed out by
entering into an offsetting transaction before the settlement date. The Account
realizes a gain or loss depending on whether the price of an offsetting purchase
plus transaction costs are less or more than the price of the initial sale or on
whether the price of an offsetting sale is more or less than the price of the
initial purchase plus transaction costs. Although the Accounts usually liquidate
futures contracts on financial instruments in this manner, they may make or take
delivery of the underlying securities when it appears economically advantageous
to do so.
A futures contract based on a securities index provides for the purchase or sale
of a group of securities at a specified future time for a specified price. These
contracts do not require actual delivery of securities but result in a cash
settlement. The amount of the settlement is based on the difference in value of
the index between the time the contract was entered into and the time it is
liquidated (at its expiration or earlier if it is closed out by entering into an
offsetting transaction).
When a futures contract is purchased or sold, a brokerage commission is paid.
Unlike the purchase or sale of a security or option, no price or premium is paid
or received. Instead, an amount of cash or other liquid assets (generally about
5% of the contract amount) is deposited by the Account with its custodian for
the benefit of the futures commission merchant through which the Account engages
in the transaction. This amount is known as "initial margin." It does not
involve the borrowing of funds by the Account to finance the transaction. It
instead represents a "good faith" deposit assuring the performance of both the
purchaser and the seller under the futures contract. It is returned to the
Account upon termination of the futures contract if all the Account's
contractual obligations have been satisfied.
Subsequent payments to and from the broker, known as "variation margin," are
required to be made on a daily basis as the price of the futures contract
fluctuates, a process known as "marking to market." The fluctuations make the
long or short positions in the futures contract more or less valuable. If the
position is closed out by taking an opposite position prior to the settlement
date of the futures contract, a final determination of variation margin is made.
Any additional cash is required to be paid to or released by the broker and the
Account realizes a loss or gain.
In using futures contracts, the Account seeks to establish more accurately than
would otherwise be possible the effective price of or rate of return on
portfolio securities or securities that the Account proposes to acquire. An
Account, for example, sells futures contracts in anticipation of a rise in
interest rates that would cause a decline in the value of its debt investments.
When this kind of hedging is successful, the futures contract increases in value
when the Account's debt securities decline in value and thereby keep the
Account's net asset value from declining as much as it otherwise would. An
Account also sells futures contracts on securities indices in anticipation of or
during a stock market decline in an endeavor to offset a decrease in the market
value of its equity investments. When an Account is not fully invested and
anticipates an increase in the cost of securities it intends to purchase, it may
purchase financial futures contracts. When increases in the prices of equities
are expected, an Account purchases futures contracts on securities indices in
order to gain rapid market exposure that may partially or entirely offset
increases in the cost of the equity securities it intends to purchase.
Options on Futures.
The Accounts may also purchase and write call and put options on futures
contracts. A call option on a futures contract gives the purchaser the right, in
return for the premium paid, 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, 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.
Upon the exercise of a call, the writer of the option is obligated to sell the
futures contract (to deliver a long position to the option holder) at the option
exercise price, which will presumably be lower than the current market price of
the contract in the futures market. Upon exercise of a put, the writer of the
option is obligated to purchase the futures contract (deliver a short position
to the option holder) at the option exercise price, which will presumably be
higher than the current market price of the contract in the futures market.
However, as with the trading of futures, most options are closed out prior to
their expiration by the purchase or sale of an offsetting option at a market
price that reflects an increase or a decrease from the premium originally paid.
Options on futures can be used to hedge substantially the same risks addressed
by the direct purchase or sale of the underlying futures contracts. For example,
if an Account anticipates a rise in interest rates and a decline in the market
value of the debt securities in its portfolio, it might purchase put options or
write call options on futures contracts instead of selling futures contracts.
If an Account purchases an option on a futures contract, it may obtain benefits
similar to those that would result if it held the futures position itself. But
in contrast to a futures transaction, the purchase of an option involves the
payment of a premium in addition to transaction costs. In the event of an
adverse market movement, however, the Account is not subject to a risk of loss
on the option transaction beyond the price of the premium it paid plus its
transaction costs.
When an Account writes an option on a futures contract, the premium paid by the
purchaser is deposited with the Account's custodian. The Account must maintain
with its custodian all or a portion of the initial margin requirement on the
underlying futures contract. It assumes a risk of adverse movement in the price
of the underlying futures contract comparable to that involved in holding a
futures position. Subsequent payments to and from the broker, similar to
variation margin payments, are made as the premium and the initial margin
requirement are marked to market daily. The premium may partially offset an
unfavorable change in the value of portfolio securities, if the option is not
exercised, or it may reduce the amount of any loss incurred by the Account if
the option is exercised.
Risks Associated with Futures Transactions.
There are a number of risks associated with transactions in futures contracts
and related options. An Account's successful use of futures contracts is subject
to the Manager and Sub-Advisor's ability to predict correctly the factors
affecting the market values of the Account's portfolio securities. For example,
if an Account is hedged against the possibility of an increase in interest rates
that would adversely affect debt securities held by the Account and the prices
of those debt securities instead increases, the Account loses part or all of the
benefit of the increased value of its securities it hedged because it has
offsetting losses in its futures positions. Other risks include imperfect
correlation between price movements in the financial instrument or securities
index underlying the futures contract, on the one hand, and the price movements
of either the futures contract itself or the securities held by the Account, on
the other hand. If the prices do not move in the same direction or to the same
extent, the transaction may result in trading losses.
Prior to exercise or expiration, a position in futures may be terminated only by
entering into a closing purchase or sale transaction. This requires a secondary
market on the relevant contract market. The Account enters into a futures
contract or related option only if there appears to be a liquid secondary
market. There can be no assurance, however, that such a liquid secondary market
exists for any particular futures contract or related option at any specific
time. Thus, it may not be possible to close out a futures position once it has
been established. Under such circumstances, the Account continues to be required
to make daily cash payments of variation margin in the event of adverse price
movements. In such situations, if the Account has insufficient cash, it may be
required to sell portfolio securities to meet daily variation margin
requirements at a time when it may be disadvantageous to do so. In addition, the
Account may be required to perform under the terms of the futures contracts it
holds. The inability to close out futures positions also could have an adverse
impact on the Account's ability effectively to hedge its portfolio.
Most United States futures exchanges limit the amount of fluctuation permitted
in futures contract prices during a single trading day. This daily limit
establishes the maximum amount that the price of a futures contract may vary
either up or down from the previous day's settlement price at the end of a
trading session. Once the daily limit has been reached in a particular type of
contract, no more trades may be made on that day at a price beyond that limit.
The daily limit governs only price movements during a particular trading day and
therefore does not limit potential losses because the limit may prevent the
liquidation of unfavorable positions. Futures contract prices have occasionally
moved to the daily limit for several consecutive trading days with little or no
trading, thereby preventing prompt liquidation of futures positions and
subjecting some futures traders to substantial losses.
Limitations on the Use of Futures and Options on Futures.
Each Account intends to come within an exclusion from the definition of
"commodity pool operator" provided by CFTC regulations by complying with certain
limitations on the use of futures and related options prescribed by those
regulations.
The Accounts are required to operate within certain guidelines and restrictions
with respect to their use of futures and options thereon which have been
established by the CFTC. In particular, an Account is excluded from registration
as a "commodity pool operator" if it complies with Rule 4.5 adopted by the CFTC.
This Rule does not limit the percentage of an Account's assets that may be used
for futures margin and related options premiums for a bona fide hedging
position. However, under the Rule each Account must limit its aggregate initial
futures margin and related option premiums to no more than 5% of the Account's
net assets for strategies that are not considered bona fide hedging strategies
under the Rule.
The Accounts may enter into futures contracts and related options transactions
only for bona fide hedging purposes as permitted by the CFTC. Each Account
determines that the price fluctuations in the futures contracts and options on
futures used for hedging or risk management purposes are substantially related
to price fluctuations in securities held by the Account or which it expects to
purchase. In pursuing traditional hedging activities, each Account may sell
futures contracts or acquire puts to protect against a decline in the price of
securities that the Account owns. Each Account may purchase futures contracts or
calls on futures contracts to protect the Account against an increase in the
price of securities the Account intends to purchase before it is in a position
to do so.
When an Account purchases a futures contract, or purchases a call option on a
futures contract, it places any asset, including equity securities and
non-investment grade debt, in a segregated account, so long as the asset is
liquid and marked to the market daily. The amount so segregated plus the amount
of initial margin held for the account of its broker equals the market value of
the futures contract.
Forward Foreign Currency Exchange Contracts
The Accounts (except the Government Securities and Money Market Accounts) may,
but are not obligated to, enter into forward foreign currency exchange contracts
with securities dealers, financial institutions or other parties deemed credit
worthy by the Account's Sub-Advisor to hedge the value of portfolio securities
denominated in or exposed to foreign currencies. The MidCap Value Account can
also engage in foreign currency exchange transactions on a spot basis. Currency
transactions include forward currency contracts, exchange listed currency
futures contracts and options thereon, and exchange listed or over-the-counter
options on currencies. A forward currency contract involves a privately
negotiated obligation to purchase or sell (with delivery generally required) a
specific currency at a specified future date at a price set at the time of the
contract.
The Accounts enter into forward foreign currency exchange contracts only for the
purpose of "hedging," that is limiting the risks associated with changes in the
relative rates of exchange between the U.S. dollar and foreign currencies in
which securities owned by an Account are denominated or exposed. It should be
noted that the use of forward foreign currency exchange contracts does not
eliminate fluctuations in the underlying prices of the securities. It simply
establishes a rate of exchange between the currencies that can be achieved at
some future point in time. Additionally, although such contracts tend to
minimize the risk of loss due to a decline in the value of the hedged currency,
they also tend to limit any potential gain that might result if the value of the
currency increases.
Currency hedging involves some of the same risks and considerations as other
transactions with similar instruments. Currency transactions can result in
losses to an Account if the currency being hedged fluctuates in value to a
degree or in a direction that is not anticipated. Further, the risk exists that
the perceived linkage between various currencies may not be present or may not
be present during the particular time that an Account is engaging in proxy
hedging. Currency transactions are also subject to risks different from those of
other portfolio transactions. Because currency control is of great importance to
the issuing governments and influences economic planning and policy, purchases
and sales of currency and related instruments can be adversely affected by
government exchange controls, limitations or restrictions on repatriation of
currency, and manipulations or exchange restrictions imposed by governments.
These forms of governmental actions can result in losses to an Account if it is
unable to deliver or receive currency or monies in settlement of obligations.
They could also cause hedges the Account has entered into to be rendered
useless, resulting in full currency exposure as well as incurring transaction
costs. Currency exchange rates may also fluctuate based on factors extrinsic to
a country's economy. Buyers and sellers of currency futures contracts are
subject to the same risks that apply to the use of futures contracts generally.
Further, settlement of a currency futures contract for the purchase of most
currencies must occur at a bank based in the issuing nation. Trading options on
currency futures contracts is relative new, and the ability to establish and
close out positions on these options is subject to the maintenance of a liquid
market that may not always be available.
Repurchase Agreements
All of the Accounts may invest in repurchase agreements. None of the Accounts
may enter into repurchase agreements that do not mature within seven days if any
such investment, together with other illiquid securities held by the Account,
amount to more than 15% of its net assets. The MicroCap Account (together with
other registered investment companies having management agreements with Goldman
or its affiliates) may transfer uninvested cash balances into a single joint
account, the daily aggregate balance of which will be invested in one or more
repurchase agreements. The LargeCap Growth Account (together with other
registered investment companies having management agreements with Janus or its
affiliates) may transfer uninvested cash balances into a single joint account,
the daily aggregate balance of which will be invested in one or more repurchase
agreements. Repurchase agreements typically involve the acquisition by the
Account of debt securities from a selling financial institution such as a bank,
savings and loan association or broker-dealer. A repurchase agreement provides
that the Account sells back to the seller and that the seller repurchases the
underlying securities at a specified price and at a fixed time in the future.
Repurchase agreements may be viewed as loans by an Account collateralized by the
underlying securities. This arrangement results in a fixed rate of return that
is not subject to market fluctuation during the Account's holding period.
Although repurchase agreements involve certain risks not associated with direct
investments in debt securities, each of the Accounts follows procedures
established by the Board of Directors that are designed to minimize such risks.
These procedures include entering into repurchase agreements only with large,
well-capitalized and well-established financial institutions that the Account's
Manager or Sub-Advisor believes present minimum credit risks. In addition, the
value of the collateral underlying the repurchase agreement is always at least
equal to the repurchase price, including accrued interest. In the event of a
default or bankruptcy by a selling financial institution, the affected Account
bears a risk of loss. In seeking to liquidate the collateral, an Account may be
delayed in or prevented from exercising its rights and may incur certain costs.
Further, to the extent that proceeds from any sale upon default of the
obligation to repurchase are less than the repurchase price, the Account could
suffer a loss.
Lending of Portfolio Securities
All of the Accounts may lend their portfolio securities. None of the Accounts
will lend its portfolio securities if, as a result, the aggregate of such loans
made by the Account would exceed the limits established by the Investment
Company Act. Portfolio securities may be lent to unaffiliated broker-dealers and
other unaffiliated qualified financial institutions provided that such loans are
callable at any time on not more than five business days' notice and that cash
or other liquid assets equal to at least 100% of the market value of the
securities loaned, determined daily, is deposited by the borrower with the
Account and is maintained each business day. While such securities are on loan,
the borrower pays the Account any income accruing thereon. The Account may
invest any cash collateral, thereby earning additional income, or may receive an
agreed-upon fee from the borrower. Borrowed securities must be returned when the
loan terminates. Any gain or loss in the market value of the borrowed securities
that occurs during the term of the loan belongs to the Account and its
shareholders. An Account pays reasonable administrative, custodial and other
fees in connection with such loans and may pay a negotiated portion of the
interest earned on the cash or liquid assets pledged as collateral to the
borrower or placing broker. An Account does not normally retain voting rights
attendant to securities it has lent, but it will call a loan of securities in
anticipation of an important vote.
When-Issued and Delayed Delivery Securities
Each of the Accounts may from time to time purchase securities on a when-issued
basis and may purchase or sell securities on a delayed delivery basis. The price
of such a transaction is fixed at the time of the commitment, but delivery and
payment take place on a later settlement date, which may be a month or more
after the date of the commitment. No interest accrues to the purchaser during
this period. The securities are subject to market fluctuations that involve the
risk for the purchaser that yields available in the market at the time of
delivery are higher than those obtained in the transaction. Each Account only
purchases securities on a when-issued or delayed delivery basis with the
intention of acquiring the securities. However, an Account may sell the
securities before the settlement date, if such action is deemed advisable. At
the time an Account commits to purchase securities on a when-issued or delayed
delivery basis, it records the transaction and reflects the value of the
securities in determining its net asset value. Each Account also establishes a
segregated account with its custodian bank in which it maintains cash or liquid
assets equal in value to the Account's commitments for when-issued or delayed
delivery securities. The availability of liquid assets for this purpose and the
effect of asset segregation on an Account's ability to meet its current
obligations, to honor requests for redemption and to have its investment
portfolio managed properly limit the extent to which the Account may engage in
forward commitment agreements. Except as may be imposed by these factors, there
is no limit on the percent of an Account's total assets that may be committed to
transactions in such agreements.
Industry Concentrations
Each of the Accounts, except the Real Estate and Utilities Accounts, may not
concentrate its investments in any particular industry. The LargeCap Stock Index
Account may concentrate its investments in a particular industry only to the
extent that the S&P 500 Stock Index is concentrated. For purposes of applying
the LargeCap Growth Equity and SmallCap Growth Accounts' industry concentration
restrictions, the Accounts use the industry groups used in the Data Monitor
Portfolio Monitoring System of William O'Neill & Co., Incorporated. The LargeCap
Growth Account uses Bloomberg L.P. industry classifications. The MidCap Growth
Equity Account uses the classification system of ________________. The other
Accounts use industry classifications based on the "Directory of Companies
Filing Annual Reports with the Securities and Exchange Commission."
Money Market Instruments
The Money Market Account invests all of its available assets in money market
instruments maturing in 397 days or less.
The types of money market instruments that the Accounts may purchase are
described below.
(1) U.S. Government Securities -- Securities issued or guaranteed by the U.S.
Government, including treasury bills, notes and bonds.
(2) U.S. Government Agency Securities -- Obligations issued or guaranteed by
agencies or instrumentalities of the U.S. Government.
o U.S. agency obligations include, but are not limited to, the Bank for
co-operatives, Federal Home Loan Banks, Federal Intermediate Credit
Banks, and the Federal National Mortgage Association.
o U.S. instrumentality obligations include, but are not limited to, the
Export-Import Bank and Farmers Home Administration.
Some obligations issued or guaranteed by U.S. Government agencies and
instrumentalities are supported by the full faith and credit of the U.S.
Treasury. Others, such as those issued by the Federal National Mortgage
Association, are supported by discretionary authority of the U.S.
Government to purchase certain obligations of the agency or
instrumentality. Still others, such as those issued by the Student Loan
Marketing Association, are supported only by the credit of the agency or
instrumentality.
(3) Bank Obligations -- Certificates of deposit, time deposits and bankers'
acceptances of U.S. commercial banks having total assets of at least one
billion dollars and overseas branches of U.S. commercial banks and foreign
banks, which in the Manager's opinion, are of comparable quality. However,
each such bank with its branches has total assets of at least five billion
dollars, and certificates, including time deposits of domestic savings and
loan associations having at least one billion dollars in assets that are
insured by the Federal Savings and Loan Insurance Corporation. The Account
may acquire obligations of U.S. banks that are not members of the Federal
Reserve System or of the Federal Deposit Insurance Corporation.
Any obligations of foreign banks must be denominated in U.S. dollars.
Obligations of foreign banks and obligations of overseas branches of U.S.
banks are subject to somewhat different regulations and risks than those of
U.S. domestic banks. For example, an issuing bank may be able to maintain
that the liability for an investment is solely that of the overseas branch
which could expose the Account to a greater risk of loss. In addition,
obligations of foreign banks or of overseas branches of U.S. banks may be
affected by governmental action in the country of domicile of the branch or
parent bank. Examples of adverse foreign governmental actions include the
imposition of currency controls, the imposition of withholding taxes on
interest income payable on such obligations, interest limitations, seizure
or nationalization of assets, or the declaration of a moratorium. Deposits
in foreign banks or foreign branches of U.S. banks are not covered by the
Federal Deposit Insurance Corporation. The Account only buys short-term
instruments where the risks of adverse governmental action are believed by
the Manager to be minimal. The Account considers these factors along with
other appropriate factors in making an investment decision to acquire such
obligations. It only acquires those which, in the opinion of management,
are of an investment quality comparable to other debt securities bought by
the Account. The Account invests in certificates of deposit of selected
banks having less than one billion dollars of assets providing the
certificates do not exceed the level of insurance (currently $100,000)
provided by the applicable government agency.
A certificate of deposit is issued against funds deposited in a bank or
savings and loan association for a definite period of time, at a specified
rate of return. Normally they are negotiable. However, the Account
occasionally invests in certificates of deposit that are not negotiable.
Such certificates may provide for interest penalties in the event of
withdrawal prior to their maturity. A bankers' acceptance is a short-term
credit instrument issued by corporations to finance the import, export,
transfer or storage of goods. They are termed "accepted" when a bank
guarantees their payment at maturity and reflect the obligation of both the
bank and drawer to pay the face amount of the instrument at maturity.
(4) Commercial Paper -- Short-term promissory notes issued by U.S. or foreign
corporations.
(5) Short-term Corporate Debt -- Corporate notes, bonds and debentures that at
the time of purchase have 397 days or less remaining to maturity.
(6) Repurchase Agreements -- Instruments under which securities are purchased
from a bank or securities dealer with an agreement by the seller to
repurchase the securities at the same price plus interest at a specified
rate. (See "ACCOUNTS' INVESTMENTS - Repurchase Agreements.")
The ratings of nationally recognized statistical rating organization (NRSRO),
such as Moody's Investor Services, Inc. ("Moody's") and Standard and Poor's
("S&P"), which are described in Appendix A, represent their opinions as to the
quality of the money market instruments which they undertake to rate. It should
be emphasized, however, that ratings are general and are not absolute standards
of quality. These ratings, including ratings of NRSROs other than Moody's and
S&P, are the initial criteria for selection of portfolio investments, but the
Manager further evaluates these securities.
Portfolio Turnover
Portfolio turnover normally differs for each Account, varies from year to year
(as well as within a year) and is affected by portfolio security sales necessary
to meet cash requirements for redemptions of Account shares. This need to redeem
may in some cases limit the ability of an Account to effect certain portfolio
transactions. The portfolio turnover rate for an Account is calculated by
dividing the lesser of purchases or sales of its portfolio securities during the
fiscal year by the monthly average of the value of its portfolio securities
(excluding from the computation all securities, including options, with
maturities at the time of acquisition of one year or less). A high rate of
portfolio turnover generally involves correspondingly greater brokerage
commission expenses that are paid by the Account.
No portfolio turnover rate can be calculated for the Money Market Account
because of the short maturities of the securities in which it invests. No
turnover rates are calculated for the International Emerging Markets, LargeCap
Growth Equity or MidCap Growth Equity Accounts as they have been in existence
for less than six months. The portfolio turnover rates for each of the other
Accounts for its most recent and immediately preceding fiscal periods were as
follows (annualized when reporting period is less than one year):
1999 1998
Aggressive Growth 89.6% 155.6%
Asset Allocation 86.7% 162.7%
Balanced 21.7% 24.2%
Blue Chip 16.2% N/A
Bond 40.1% 26.7%
Capital Value 43.4% 22.0%
Government Securities 19.7% 11.0%
Growth 65.7% 9.0%
High Yield 93.8% 87.8%
International 65.5% 33.9%
International SmallCap 241.2% 60.3%
LargeCap Growth 39.6% N/A
LargeCap Stock Index 3.8% N/A
MicroCap 88.9% 55.3%
MidCap 79.6% 26.9%
MidCap Growth 74.1% 91.9%
MidCap Value 154.0% N/A
Real Estate 101.9% 5.6%
SmallCap 111.1% 45.2%
SmallCap Growth 98.0% 166.5%
SmallCap Value 89.7% 53.4%
Utilities 23.0% 9.5%
Fund History
Organization and Share Ownership: Effective January 1, 1998, certain Funds
sponsored by Principal Life Insurance Company were reorganized into a series of
the Principal Variable Contracts Fund, Inc., a corporation incorporated in the
State of Maryland on May 27, 1997. Each of the Accounts of the new series
adopted the assets and liabilities of the corresponding Fund. Those Funds were
incorporated in the state of Maryland on the following dates: Aggressive Growth
Fund - August 20, 1993; Asset Allocation Fund - August 20, 1993; Balanced Fund -
November 26, 1986; Bond Fund - November 26, 1986; Capital Accumulation Fund -
May 26, 1989 (effective November 1, 1989 succeeded to the business of a
predecessor Fund that had been incorporated in Delaware on February 6, 1969);
Emerging Growth Fund - February 20, 1987; Government Securities Fund - June 7,
1985; Growth Fund - August 20, 1993; Money Market Fund - June 10, 1982; and
World Fund - August 20, 1993. The Articles of Incorporation for the Principal
Variable Contracts Fund, Inc. were amended on February 13, 1998 to reflect the
addition of the following new Accounts: International SmallCap; MicroCap; MidCap
Growth; Real Estate; SmallCap; SmallCap Growth; SmallCap Value; and Utilities.
The Articles of Incorporation were also amended on February 1, 1999 to reflect
the addition of the Blue Chip, LargeCap Growth, MidCap Value and Stock Index 500
Accounts. The Articles of Incorporation were amended on ___________ to reflect
the addition of the International Emerging Markets, LargeCap Growth Equity and
MidCap Growth Equity Accounts. Principal Life Insurance Company owns 100% of
each Account's outstanding shares.
MANAGEMENT OF THE FUND
Under Maryland law, a Board of Directors oversees the Fund. The Directors have
financial or other relevant experience and meet several times during the year to
review contracts, Fund activities and the quality of services provided to the
Fund. Other than serving as Directors, most of the Board members have no
affiliation with the Fund or service providers.
The current Directors and Officers are shown below. Each person (except
Aschenbrenner, Gilbert and Kimball who do not serve as directors of Principal
Special Markets Fund, Inc.) also has the same position with other mutual funds
that are also sponsored by Principal Life Insurance Company. Unless an address
is shown, the mailing address for the Directors and Officers is Principal
Financial Group, Des Moines, Iowa 50392.
* John E. Aschenbrenner, 50, Director. Executive Vice President, Principal
Life Insurance Company since 2000; Senior Vice President, 1996-2000; Vice
President - Individual Markets 1990-1996. Director, Principal Management
Corporation and Princor Financial Services Corporation.
@ James D. Davis, 66, Director. 4940 Center Court, Bettendorf, Iowa.
Attorney. Vice President, Deere and Company, Retired.
*# Ralph C. Eucher, 47, Director and President. Vice President, Principal Life
Insurance Company since 1999. Director and Executive Vice President,
Princor Financial Services Corporation and Director and President,
Principal Management Corporation.
@ Pamela A. Ferguson, 56, Director. 4112 River Oaks Drive, Des Moines, Iowa.
Professor of Mathematics, Grinnell College since 1998. Prior thereto,
President, Grinnell College.
Richard W. Gilbert, 59, Director. Gilbert Communications, 5040 Arbor Lane,
#302, Northfield, Illinois 60093. President, Gilbert Communications, Inc.
since 1993. Prior thereto, President and Publisher, Pioneer Press.
*# J. Barry Griswell, 51, Director and Chairman of the Board. Chief Executive
Officer & President, Principal Life Insurance Company since 2000;
President, 1998-2000. Executive Vice President, 1996-1998; Senior Vice
President, 1991-1996. Director and Chairman of the Board, Principal
Management Corporation and Princor Financial Services Corporation.
@ William C. Kimball, 52, Director. 4700 Westown Parkway, Suite 300, West Des
Moines, Iowa 50266-6730. Chairman and CEO, Medicap Pharmacies, Inc. since
1998. Prior thereto, President and CEO.
# Barbara A. Lukavsky, 59, Director. 13731 Bay Hill Court, Clive, Iowa.
President and CEO, Barbican Enterprises, Inc. since 1997. President and
CEO, Lu San ELITE USA, L.C. 1985-1998.
* Craig L. Bassett, 48, Treasurer. Second Vice President and Treasurer,
Principal Life Insurance Company since 1998. Director - Treasury 1996-1998.
Prior thereto, Associate Treasurer.
* Ron L. Danilson, 49, Executive Vice President. Executive Vice President and
Chief Operating Officer, Princor Financial Services Corporation, since
2000. Vice President, Principal Life Insurance Company since 2000.
President and Chief Executive Officer, Delaware Chartger Guarantee and
Trust Company, 1996-2000. Prior thereto, Chief Operating Officer.
* Arthur S. Filean, 61, Senior Vice President and Secretary. Senior Vice
President, Princor Financial Services Corporation and Principal Management
Corporation, since 2000. Vice President, Princor Financial Services
Corporation, 1990-2000. Vice President, Principal Management Corporation,
1996-2000.
* Ernest H. Gillum, 44, Vice President and Assistant Secretary. Vice
President - Product Development, Princor Financial Services Corporation and
Principal Management Corporation, since 2000. Vice President - Compliance
and Product Development, Princor Financial Services Corporation and
Principal Management Corporation, 1998-2000. Prior thereto, Assistant Vice
President, Registered Products, 1995-1998. Prior thereto, Product
Development and Compliance Officer.
* Jane E. Karli, 43, Assistant Treasurer. Assistant Treasurer, Principal Life
Insurance Company since 1998; Senior Accounting and Custody Administrator
1994-1998; Prior thereto, Senior Investment Cost Accountant.
* Layne A. Rasmussen, 41, Controller. Controller - Mutual Funds, Princor
Financial Services Corporation since 1995.
* Michael D. Roughton, 48, Counsel. Vice President and Senior Securities
Counsel, Principal Life Insurance Company since 1999. Counsel 1994-1999.
Counsel, Invista Capital Management, Inc., Princor Financial Services
Corporation, Principal Investors Corporation and Principal Management
Corporation.
* Jean B. Schustek, 48, Assistant Vice President and Assistant Secretary.
Assistant Vice President - Registered Products, Princor Financial Services
Corporation since 2000. Prior thereto, Compliance Officer - Registered
Products.
* Kirk L. Tibbetts, 45, Senior Vice President and Chief Financial Officer.
Senior Vice President and Chief Financial Officer, Princor Financial
Services Corporation, since 2000. Second Vice President, Principal Life
Insurance Company since 2000. Prior thereto, Partner with KPMG LLP.
* Traci L. Weldon, 34, Assistant Counsel. Counsel, Principal Life Insurance
Company since 1999. Assistant Counsel 1998-1999. Assistant State Attorney
General, Iowa Attorney General's Office, 1994-1998. Prior thereto,
Investment Banker, Kirkpatrick Pettis.
* Considered to be "Interested Persons" as defined in the Investment Company
Act of 1940, as amended, because of current or former affiliation with the
Manager or Principal Life.
@ Member of Audit and Nominating Committee
# Member of Executive Committee (which is selected by the Board and which may
exercise all the powers of the Board, with certain exceptions, when the
Board is not in session. The Committee must report its actions to the
Board.) COMPENSATION TABLE fiscal year ended December 31, 1999
Compensation from Compensation from
Director the Fund Fund Complex*
James D. Davis $28,050 $55,050
Pamela A. Ferguson $24,600 $50,850
Richard W. Gilbert $28,050 $50,100
William C. Kimball** $3,450 $19,500
Barbara A. Lukavsky $26,250 $50,250
The Fund did not provide retirement benefits for any of the directors.
* Total compensation from the 20 investment companies included in the fund
complex for the fiscal year ended December 31, 1999.
**Elected to the Board on November 2, 1999.
MANAGER AND SUB-ADVISORS
The Manager of each of the Accounts is Principal Management Corporation (the
"Manager"), a wholly-owned subsidiary of Princor Financial Services Corporation
which is a wholly-owned subsidiary of Principal Financial Services, Inc. The
Manager is an affiliate of Principal Life Insurance Company, a mutual life
insurance company organized in 1879 under the laws of the state of Iowa. The
address of the Manager is The Principal Financial Group, Des Moines, Iowa 50392.
The Manager was organized on January 10, 1969 and since that time has managed
various mutual funds sponsored by Principal Life Insurance Company.
The Manager has executed agreements with various Sub-Advisors. Under those
Sub-Advisory agreements, the Sub-Advisor agrees to assume the obligations of the
Manager to provide investment advisory services for a specific Account. For
these services, each Sub-Advisor is paid a fee by the Manager.
Accounts: Balanced, Blue Chip, Capital Value, Government Securities, Growth,
International, International Emerging Markets, International SmallCap,
LargeCap Stock Index, MidCap, SmallCap and Utilities
Sub-Advisor: Invista Capital Management, LLC ("Invista"). Invista, an indirectly
wholly-owned subsidiary of Principal Life Insurance Company and an
affiliate of the Manager, was founded in 1985. It manages investments for
institutional investors, including Principal Life Insurance Company. Assets
under management as of December 31, 1999 were approximately $35.3 billion.
Invista's address is 1800 Hub Tower, 699 Walnut, Des Moines, Iowa 50309.
Accounts: Aggressive Growth and Asset Allocation
Sub-Advisor: Morgan Stanley Asset Management Inc. ("Morgan Stanley"). Morgan
Stanley, with principal offices at 1221 Avenue of the Americas, New York,
NY 10020, provides a broad range of portfolio management services to
customers in the U.S. and abroad. As of December 31, 1999, Morgan Stanley,
together with its affiliated institutional asset management companies,
managed investments totaling approximately $184.9 billion as named
fiduciary or fiduciary adviser. On December 1, 1998 Morgan Stanley Asset
Management Inc. changed its name to Morgan Stanley Dean Witter Investment
Management Inc. but continues to do business in certain instances using the
name Morgan Stanley Asset Management.
Account: LargeCap Growth
Sub-Advisor: Janus Capital Corporation ("Janus"), 100 Fillmore Street, Denver CO
80206-4928, was formed in 1969. Kansas City Southern Industries, Inc.
("KCSI") owns approximately 82% of the outstanding voting stock of Janus,
indirectly through its subsidiary Stillwell Financial Inc., most of which
it acquired in 1984. KCSI has announced its intention to spin-off its
financial services subsidiaries, which it expects to complete in the first
half of 2000. As of January 31, 2000, Janus managed or administered over
$256 billion in assets.
Account: LargeCap Growth Equity
Sub-Advisor: Duncan-Hurst was founded in 1990. Its address is 4365 Executive
Drive, Suite 1520, San Diego CA 92121. As of December 31, 1999,
Duncan-Hurst managed assets of approximately $5.9 billion for institutional
and individual investors.
Account: MicroCap
Sub-Advisor: Goldman Sachs Assets Management ("GSAM"), 32 Old Slip, 17th Floor,
New York, NY 10005. As of September 1, 1999, the Investment Division
("IMD") was established as a new operating division of Goldman, Sachs & Co.
("Goldman Sachs"). This newly created entity includes GSAM. GSAM provides a
wide range of discretionary investment advisory services, quantitatively
driven and actively managed to U.S. and international equity portfolios,
U.S. and global fixed-income portfolios, commodity and currency products
and money market accounts. As of December 31, 1999, GSAM, along with other
units of IMD, had assets under management of $258.5 billion.
Account: MidCap Growth
Sub-Advisor: The Dreyfus Corporation ("Dreyfus"), located at 200 Park Avenue,
New York, New York 10166, was formed in 1947. The Dreyfus Corporation is a
wholly-owned subsidiary of Mellon Bank, N.A., which is a wholly-owned
subsidiary of Mellon Bank Corporation ("Mellon"). As of December 31, 1999,
The Dreyfus Corporation managed or administered approximately $119.6
billion in assets for approximately 1.7 million investor accounts
nationwide.
Account: MidCap Growth Equity
Sub-Advisor: Turner was founded in 1990. Its address is 1235 Westlake Drive,
Suite 350, Berwyn PA 19312. As of December 31, 1999, Turner had
discretionary management authority with respect to approximately $5.7
billion in assets.
Account: MidCap Value
Sub-Advisor: Neuberger Berman Management, Inc. ("Neuberger Berman") is an
affiliate of Neuberger Berman LLC. Neuberger Berman is located at 605 Third
Avenue, 2nd Floor, New York, NY 10158-0180. Together with Neuberger Berman,
the firms manage more than $54 billion in total assets (as of December 31,
1999) and continue an asset management history that began in 1939.
Account: SmallCap Growth
Sub-Advisor: Berger LLC ("Berger"). Berger's address is 210 University
Boulevard, Suite 900, Denver, CO 80206. It serves as investment advisor,
sub-advisor, administrator or sub-administrator to mutual funds and
institutional investors. Berger is a wholly-owned subsidiary of Berger
Associates, Inc. which is a wholly-owned subsidiary of Kansas City Southern
Industries, Inc. ("KCSI"). KCSI is a publicly traded holding company with
principal operations in rail transportation, through its subsidiary The
Kansas City Southern Railway Company, and financial asset management
businesses. Assets under management for Berger as of December 31, 1999 were
approximately $7.1 billion.
Account: SmallCap Value
Sub-Advisor: J.P. Morgan Investment Management, Inc. ("J.P. Morgan Investment").
J.P. Morgan Investment, with principal offices at 522 Fifth Avenue, New
York, NY 10036 is a wholly-owned subsidiary of J.P. Morgan & Co.
Incorporated ("J.P. Morgan") a bank holding company. J.P. Morgan, through
J.P. Morgan Investment and other subsidiaries, offers a wide range of
services to governmental, institutional, corporate and individual customers
and acts as investment adviser to individual and institutional clients. As
of December 31, 1999, J.P. Morgan and its subsidiaries had total combined
assets under management of approximately $349 billion.
Each of the persons affiliated with the Fund who is also an affiliated person of
the Manager or a Sub-Advisor is named below, together with the capacities in
which such person is affiliated:
<TABLE>
<CAPTION>
Office Held With Office Held With
Name The Fund The Manager/Invista
<S> <C> <C> >
John E. Aschenbrenner Director Director (Manager)
Craig Bassett Treasurer Treasurer (Manager)
Ronald L. Danilson Executive Vice President Executive Vice President
Ralph C. Eucher Director and Director and President
President (Manager)
Arthur S. Filean Senior Vice President and Secretary Senior Vice President (Manager)
Ernest H. Gillum Vice President and Vice President - Product
Assistant Secretary Development (Manager)
J. Barry Griswell Director and Chairman Director and Chairman of
of the Board the Board (Manager)
Layne A. Rasmussen Controller Controller - Mutual Funds (Manager)
Michael D. Roughton Counsel Counsel (Manager; Invista)
Jean B. Schustek Assistant Vice President and Assistant Vice President (Manager)
Assistant Secretary
Kirk L. Tibbetts Senior Vice President and Senior Vice President and
Chief Financial Officer Chief Financial Officer
</TABLE>
COST OF MANAGER'S SERVICES
For providing the investment advisory services, and specified other services,
the Manager, under the terms of the Management Agreement for the Fund, is
entitled to receive a fee computed and accrued daily and payable monthly, at the
following annual rates:
<TABLE>
<CAPTION>
Net Asset Value of Account
First Next Next Next
Account $250 million $250 million $250 million $250 million Thereafter
<S> <C> <C> <C> <C> <C>
Blue Chip, Capital Value and Growth 0.60% 0.55% 0.50% 0.45% 0.40%
International 0.85 0.80 0.75 0.70 0.65
International Emerging Markets -- -- -- -- --
LargeCap Growth 1.10 1.05 1.00 0.95 0.90
MidCap Value 1.05 1.00 0.95 0.90 0.85
</TABLE>
Overall Fee
LargeCap Growth Equity --
LargeCap Stock Index 0.35%
MidCap Growth Equity --
<TABLE>
<CAPTION>
First Next Next Next Over
Account $100 million $100 million $100 million $100 million $400 million
<S> <C> <C> <C> <C> <C>
Aggressive Growth and Asset Allocation 0.80% 0.75% 0.70% 0.65% 0.60%
Balanced, High Yield and Utilities 0.60 0.55 0.50 0.45 0.40
International SmallCap 1.20 1.15 1.10 1.05 1.00
MicroCap and SmallCap Growth 1.00 0.95 0.90 0.85 0.80
MidCap 0.65 0.60 0.55 0.50 0.45
MidCap Growth and Real Estate 0.90 0.85 0.80 0.75 0.70
Small Cap 0.85 0.80 0.75 0.70 0.65
Small Cap Value 1.10 1.05 1.00 0.95 0.90
All Other 0.50 0.45 0.40 0.35 0.30
</TABLE>
Management Fee
Net Assets as of For Year Ended
Account December 31, 1999 December 31, 1999
Aggressive Growth $379,062,318 0.75%
Asset Allocation 89,710,561 0.80
Balanced 209,747,312 0.57
Blue Chip 6,453,467 0.60
Bond 125,066,660 0.49
Capital Value 367,926,766 0.43
Government Securities 137,787,470 0.49
Growth 345,881,593 0.45
High Yield 13,677,725 0.60
International 197,235,476 0.73
International SmallCap 40,039,774 1.20
LargeCap Growth 7,044,631 1.10
MicroCap 6,417,668 1.00
MidCap 262,349,825 0.61
MidCap Growth 14,264,295 0.90
MidCap Value 5,755,642 1.05
Money Market 120,923,710 0.50
Real Estate 10,560,284 0.90
SmallCap 26,109,643 0.85
SmallCap Growth 39,675,181 1.00
SmallCap Value 11,080,457 1.10
Stock Index 500 46,088,322 0.35
Utilities 30,684,146 0.60
Under a Sub-Advisory Agreement between Invista and the Manager, Invista performs
all the investment advisory responsibilities of the Manager under the Management
Agreement for the Balanced, Blue Chip, Capital Value, Government Securities,
Growth, International, International Emerging Markets, International SmallCap,
LargeCap Stock Index, MidCap, SmallCap and Utilities Accounts. The Manager
compensates Invista for its sub-advisory services as provided in the
Sub-Advisory Agreement. The Manager may periodically reallocate management fees
between itself and Invista.
Under a Sub-Advisory Agreement between Morgan Stanley and the Manager, Morgan
Stanley performs all the investment advisory responsibilities of the Manager
under the Management Agreement for the Aggressive Growth and Asset Allocation
Accounts. The Manager pays Morgan Stanley a fee that is accrued daily and
payable monthly. The fee is based on the net asset value of each Account as
follows: first $40 million of net assets - the fee is 0.45%; next $160 million -
0.30%; next $100 million - 0.25%; and net assets over $300 million - 0.20%.
Under a Sub-Advisory Agreement between Berger and the Manager, Berger performs
all the investment advisory responsibilities of the Manager under the Management
Agreement for the SmallCap Growth Account. The Manager pays Berger a fee that is
accrued daily and payable monthly. The fee is based on the net asset value of
the Account as follows: first $100 million of net assets - the fee is 0.50%;
next $200 million - 0.45%; and net assets over $300 million - 0.40%.
Under a Sub-Advisory Agreement between Dreyfus and the Manager, Dreyfus performs
all the investment advisory responsibilities of the Manager under the Management
Agreement for the MidCap Growth Account. The Manager pays Dreyfus a fee that is
accrued daily and payable monthly. The fee is based on the net asset value of
the Account as follows: first $50 million of net assets - the fee is 0.40%; and
net assets over $50 million - 0.35%.
Under a Sub-Advisory Agreement between Duncan-Hurst and the Manager,
Duncan-Hurst performs all the investment advisory responsibilities of the
Manager under the Management Agreement for the LargeCap Growth Equity Account.
The Manager pays Duncan-Hurst a fee that is accrued daily and payable monthly.
The fee is based on the net asset value of the Account as follows:
------------------------------------------------
Under a Sub-Advisory Agreement between Goldman and the Manager, Goldman performs
all the investment advisory responsibilities of the Manager under the Management
Agreement for the MicroCap Account. The Manager pays Goldman a fee that is
accrued daily and payable monthly. The fee is based on the net asset value of
the Account as follows: first $50 million of net assets - the fee is 0.50%; next
$150 million - 0.45%; and net assets over $200 million - 0.40%.
Under a Sub-Advisory Agreement between Janus and the Manager, Janus performs all
the investment advisory responsibilities of the Manager under the Management
Agreement for the LargeCap Growth Account. The Manager pays Janus a fee that is
accrued daily and payable monthly. The fee is based on the net asset value of
the Account as follows: first $100 million of net assets - the fee is 0.55%;
next $400 million - 0.50%; and net assets over $500 million - 0.45%.
Under a Sub-Advisory Agreement between J.P. Morgan Investment and the Manager,
J.P. Morgan Investment performs all the investment advisory responsibilities of
the Manager under the Management Agreement for the SmallCap Value Account. The
Manager pays J.P. Morgan Investment a fee that is accrued daily and payable
monthly. The fee is based on the net asset value of the Account as follows:
first $50 million of net assets - the fee is 0.60%; next $250 million - 0.55%;
and net assets over $300 million - 0.50%.
Under a Sub-Advisory Agreement between Neuberger Berman and the Manager,
Neuberger Berman performs all the investment advisory responsibilities of the
Manager under the Management Agreement for the MidCap Value Account. The Manager
pays Neuberger Berman a fee that is accrued daily and payable monthly. The fee
is based on the net asset value of the Account as follows: first $100 million of
net assets - the fee is 0.50%; next $150 million - 0.475%; next $250 million -
0.450%; next $250 million - 0.425%; and net assets over $750 million - 0.400%.
Under a Sub-Advisory Agreement between Turner and the Manager, Turner performs
all the investment advisory responsibilities of the Manager under the Management
Agreement for the MidCap Growth Equity Account. The Manager pays Turner a fee
that is accrued daily and payable monthly. The fee is based on the net asset
value of the Account as follows:________________________________________________
Except for certain Fund expenses set out below, the Manager is responsible for
expenses, administrative duties and services including the following: expenses
incurred in connection with the registration of the Fund and Fund shares with
the Securities and Exchange Commission; office space, facilities and costs of
keeping the books of the Fund; compensation of personnel and officers and any
directors who are also affiliated with the Manager; fees for auditors and legal
counsel; preparing and printing Fund prospectuses; administration of shareholder
accounts, including issuance, maintenance of open account system, dividend
disbursement, reports to shareholders, and redemption. However, some or all of
these expenses may be assumed by Principal Life Insurance Company and some or
all of the administrative duties and services may be delegated by the Manager to
Principal Life Insurance Company or affiliate thereof.
Each Account pays for certain corporate expenses incurred in its operation.
Among such expenses, the Account pays brokerage commissions on portfolio
transactions, transfer taxes and other charges and fees attributable to
investment transactions, any other local, state or federal taxes, fees and
expenses of all directors of the Fund who are not persons affiliated with the
Manager, interest, fees for Custodian of the Account, and the cost of meetings
of shareholders.
Fees paid for investment management services during the periods indicated were
as follows:
<TABLE>
<CAPTION>
Management Fees For Years Ended December 31,
1999 1998 1997
<S> <C> <C> <C>
Aggressive Growth $2,148,624 $1,436,590 $907,800
Asset Allocation 688,699 650,963 566,727
Balanced 1,218,845 958,526 665,902
Blue Chip 24,000
Bond 619,181 488,898 358,818
Capital Value 1,708,021 1,480,275 1,124,855
Government Securities 692,022 576,926 426,977
Growth 1,366,818 989,512 650,659
High Yield 84,208 87,806 87,845
International 1,225,255 1,045,627 768,332
International SmallCap 250,499 94,388
LargeCap Growth 43,238*
LargeCap Stock Index 61,479*
MicroCap 59,482* 36,591
MidCap 1,522,214 1,504,567 1,145,372
MidCap Growth 95,048* 36,858
MidCap Value 37,469*
Money Market 440,147 306,233 224,424
Real Estate 99,831 64,493
SmallCap 149,481 60,975
SmallCap Growth 153,958* 42,319
SmallCap Value 94,464* 42,234
Utilities 150,219 56,185
* before waiver
</TABLE>
The Management Fees shown above include the fee paid to the Account's
Sub-Advisor, if any. Fees paid to each Sub-Advisor for the most recent and
immediately preceding fiscal periods were as follows:
<TABLE>
<CAPTION>
Sub-Advisor Fees For Years Ended December 31,
1999 1998 1997
<S> <C> <C> <C>
Aggressive Growth $865,212 $534,127 $403,710
Asset Allocation 289,465 375,391 272,596
Balanced 317,009 154,678 65,013
Blue Chip 2,581
Bond 156,996
Capital Value 300,404 189,590 138,908
Government Securities 85,485 30,334 23,421
Growth 228,539 111,780 84,191
High Yield 48,910
International 163,906 68,263 91,476
International SmallCap 98,129 21,431
LargeCap Growth 21,715
LargeCap Stock Index 8,861
MicroCap 29,765 18,365
MidCap 186,260 134,225 112,374
MidCap Growth 42,338 16,479
MidCap Value 17,849
Money Market 43,383
Real Estate 55,330
SmallCap 64,460 16,533
SmallCap Growth 77,425 21,273
SmallCap Value 51,599 23,146
Utilities 26,410 7,405
</TABLE>
For the period ended December 31, 1999, the Manager waived a portion of its fee
as follows:
LargeCap Growth $ 2,452 MidCap Value $ 2,400
LargeCap Stock Index 15,995 SmallCap Growth 3,049
MicroCap 13,239 SmallCap Value 23,900
MidCap Growth 14,359
The Manager intends to continue the waivers and, if necessary, pay expenses
normally payable by the Accounts through December 31, 2000 in an amount that
will maintain total operating expenses as follows:
International Emerging Markets _____ MidCap Growth 0.96%
LargeCap Growth 1.20% MidCap Growth Equity _____
LargeCap Growth Equity _____ MidCap Value 1.20%
LargeCap Stock Index 0.40% SmallCap Growth 1.06%
MicroCap 1.06% SmallCap Value 1.16%
The Management Agreement and Investment Service Agreement under which Principal
Capital Management, a subsidiary of Principal Life Insurance Company, has agreed
to furnish certain personnel, services and facilities required by the Manager to
enable it to fulfill its responsibilities for the Accounts were last approved by
the Fund's Board of Directors on September 13, 1999. The Management Agreement
was last approved by shareholders on November 2, 1999. The Sub-Advisory
Agreements between the Manager and Berger, the Manager and Dreyfus, the Manager
and Goldman, the Manager and Janus, the Manager and J.P. Morgan Investment, the
Manager and Morgan Stanley, and the Manager and Neuberger Berman were also
approved by the Fund's Board of Directors on September 13, 1999. The
Sub-Advisory Agreements between the Manager and Duncan-Hurst, the Manager and
Invista and the Manager and Turner were approved by the Fund's Board of
Directors on _______________.
Each of these agreements provides for continuation in effect from year to year
only so long as such continuation is specifically approved at least annually
either by the Board of Directors of the Fund or by vote of a majority of the
outstanding voting securities of an Account of the Fund. In either event
continuation shall be approved by vote of a majority of the Directors who are
not "interested persons" (as defined in the Investment Company Act of 1940) of
the Manager, Principal Life Insurance Company or its subsidiaries, the Fund and
1) in the case of the Sub-Advisory Agreement for each of the Balanced,
Blue Chip, Capital Value, Government Securities, Growth,
International, International Emerging Markets, International
SmallCap, LargeCap Stock Index, MidCap, SmallCap and Utilities
Accounts, Invista;
2) in the case of the Sub-Advisory Agreement for each of the Aggressive
Growth and Asset Allocation Accounts, Morgan Stanley;
3) for the Sub-Advisory Agreement for the LargeCap Growth Account, Janus;
4) for the Sub-Advisory Agreement for the MicroCap Account, Goldman;
5) for the Sub-Advisory Agreement for the MidCap Growth Account, Dreyfus;
6) for the Sub-Advisory Agreement for the MidCap Value Account, Neuberger
Berman;
7) for the Sub-Advisory Agreement for the SmallCap Growth Account, Berger;
8) for the Sub-Advisory Agreement for the SmallCap Value Account, J.P.
Morgan Investment;
9) for the Sub-Advisory Agreement for the LargeCap Growth Equity Account,
Duncan-Hurst; and
10) for the Sub-Adivsory Agreement for the MidCap Equity Account, Turner.
The Agreements may be terminated at any time on 60 days written notice to the
applicable Sub-Advisor either by vote of the Board of Directors of the Fund or
by a vote of a majority of the outstanding securities of the applicable Account
and by the Manager, Berger, Dreyfus, Duncan-Hurst, Goldman, Invista, J.P. Morgan
Investment, Janus, Morgan Stanley, Neuberger Berman, Principal Life Insurance
Company or Turner, as the case may be, on 60 days written notice to the Fund
and/or applicable Sub-Advisor. The Agreements will automatically terminate in
the event of their assignment.
BROKERAGE ON PURCHASES AND SALES OF SECURITIES
In distributing brokerage business arising out of the placement of orders for
the purchase and sale of securities for any Account, the objective of the
Accounts' Manager or Sub-Advisor is to obtain the best overall terms. In
pursuing this objective, the Manager, or Sub-Advisor, considers all matters it
deems relevant, including the breadth of the market in the security, the price
of the security, the financial condition and executing capability of the broker
or dealer and the reasonableness of the commission, if any (for the specific
transaction and on a continuing basis). This may mean in some instances that the
Manager, or Sub-Advisor, will pay a broker commissions that are in excess of the
amount of commission another broker might have charged for executing the same
transaction when the Manager, or Sub-Advisor, believes that such commissions are
reasonable in light of (a) the size and difficulty of transactions (b) the
quality of the execution provided and (c) the level of commissions paid relative
to commissions paid by other institutional investors. (Such factors are viewed
both in terms of that particular transaction and in terms of all transactions
that broker executes for accounts over which the Manager, or Sub-Advisor,
exercises investment discretion. The Manager, or Sub-Advisor, may purchase
securities in the over-the-counter market, utilizing the services of principal
market matters, unless better terms can be obtained by purchases through brokers
or dealers, and may purchase securities listed on the New York Stock Exchange
from non-Exchange members in transactions off the Exchange.) The Manager, or
Sub-Advisor, may give consideration in the allocation of business to services
performed by a broker (e.g. the furnishing of statistical data and research
generally consisting of information of the following types: analyses and reports
concerning issuers, industries, economic factors and trends, portfolio strategy
and performance of client accounts). If any such allocation is made, the primary
criteria used will be to obtain the best overall terms for such transactions.
The Manager, or Sub-Advisor, may also pay additional commission amounts for
research services but generally does not do so. Such statistical data and
research information received from brokers or dealers as described above may be
useful in varying degrees and the Manager, or Sub-Advisor, may use it in
servicing some or all of the accounts it manages. Some statistical data and
research information may not be useful to the Manager, or Sub-Advisor, in
managing the client account that generated the brokerage which resulted in the
Manager's, or Sub-Advisor's, receipt of the statistical data and research
information. However, in the Manager's, or Sub-Advisor's, opinion, the value
thereof is not determinable and it is not expected that the Manager's, or
Sub-Advisor's, expenses will be significantly reduced since the receipt of such
statistical data and research information is only supplementary to the
Manager's, or Sub-Advisor's, own research efforts. The Manager, or Sub-Advisor,
of certain accounts allocated portfolio transactions to certain brokers during
the fiscal year ended December 31, 1999 due to research services provided by
such brokers. These portfolio transactions resulted in commissions paid as
follows:
Amount Paid for
Account Research Services
Aggressive Growth $36,363
Asset Allocation 1,923
Balanced 22,617
Capital Value 7,570
Growth 89,872
International SmallCap 538
International 43,263
LargeCap Growth 462
MidCap Growth 2,555
MicroCap 1,756
MidCap 72,499
SmallCap Growth 3,500
Utilities 1,140
Subject to the rules promulgated by the SEC, as well as other regulatory
requirements, a Sub-Advisor also may allocate orders on behalf of an Account to
broker-dealers affiliated with the Sub-Advisor. The Sub-Advisor shall determine
the amounts and proportions of orders allocated to the Sub-Advisor or affiliate.
The Board of Directors of the Fund will receive quarterly reports on these
transactions.
Purchases and sales of debt securities and money market instruments usually will
be principal transactions; portfolio securities will normally be purchased
directly from the issuer or from an underwriter or marketmaker for the
securities. Such transactions are usually conducted on a net basis with the
Account paying no brokerage commissions. Purchases from underwriters will
include a commission or concession paid by the issuer to the underwriter, and
the purchases from dealers serving as marketmakers will include the spread
between the bid and asked prices.
The following table shows the brokerage commissions paid during the periods
indicated. In each year, 100% of the commissions paid by each Account went to
broker-dealers that provided research, statistical or other factual information.
<TABLE>
<CAPTION>
Total Brokerage Commissions Paid
Fiscal Year Ended December 31,
Account 1999 1998 1997
<S> <C> <C> <C>
Aggressive Growth $383,741 $606,022 $418,468
Asset Allocation 82,189 214,204 164,992
Balanced 72,544 80,504 58,053
Blue Chip 7,147
Capital Value 386,580 237,630 135,417
Growth 351,610 101,607 33,836
International 582,113 303,293 230,351
International SmallCap 286,006 52,240
LargeCap Growth 5,446
LargeCap Stock Index 20,618
MicroCap 28,837 21,437
MidCap 348,022 137,283 54,019
MidCap Growth 18,685 12,242
MidCap Value 19,510
Real Estate 51,993 24,283
SmallCap 48,350 33,400
SmallCap Growth 15,710 8,899
SmallCap Value 13,044 8,292
Utilities 27,922 23,668
</TABLE>
Brokerage commissions paid to affiliates during the periods indicated were as
follows:
<TABLE>
<CAPTION>
Commissions Paid to Goldman Sachs
Total Dollar As Percent of As Percent of Dollar Amount
Account Year Amount Total Commissions of Commissionable Transactions
<S> <C> <C> <C> <C>
Aggressive Growth 1999 $21,137 5.51% 5.17%
1998 30,744 5.07 4.97
Asset Allocation 1999 2,759 3.36 3.41
1998 11,868 5.54 4.62
Balanced 1999 2,110 2.91 1.44
1998 3,630 4.51 1.72
Blue Chip 1999 10 0.14 0.30
Capital Value 1999 42,634 11.03 8.40
Growth 1999 8,500 2.42 2.80
1998 4,620 4.55 5.03
International 1999 30,962 5.32 4.69
1998 25,436 8.39 14.38
International SmallCap 1999 20,328 7.11 7.41
1998 1,424 2.73 3.32
LargeCap Growth 1999 299 5.49 3.60
MicroCap 1999 1,813 6.29 6.05
1998 2,737 12.77 17.07
MidCap 1999 8,258 2.37 1.74
1998 640 0.47 0.59
MidCap Growth 1999 401 2.15 1.36
1998 3,853 31.47 36.02
MidCap Value 1999 145 0.74 1.16
Real Estate 1999 895 1.72 1.92
SmallCap 1999 990 2.05 3.06
1998 300 0.90 1.44
SmallCap Growth 1999 120 0.76 1.78
1998 325 3.65 5.03
SmallCap Value 1999 771 5.91 3.53
Utilities 1999 1,345 4.82 3.38
</TABLE>
<TABLE>
<CAPTION>
Commissions Paid to J. P. Morgan Securities
Total Dollar As Percent of As Percent of Dollar Amount
Account Year Amount Total Commissions of Commissionable Transactions
<S> <C> <C> <C> <C>
Aggressive Growth 1999 $15,755 4.11% 3.78%
1998 34,133 5.63 6.32
Asset Allocation 1999 1,551 1.89 1.65
1998 10,678 4.98 5.47
Balanced 1999 11,821 16.29 18.28
1998 1,330 1.65 2.41
Blue Chip 1999 4,845 67.79 70.20
Capital Value 1999 11,210 2.90 3.77
1998 4,375 1.84 1.95
Growth 1999 15,652 4.45 4.88
1998 3,496 3.44 2.41
International 1999 12,629 2.17 2.17
1998 1,261 0.42 0.73
International SmallCap 1999 478 0.17 0.19
LargeCap Growth 1999 127 2.33 1.15
MicroCap 1999 785 2.72 1.69
1998 827 3.86 2.29
MidCap 1999 11,203 3.22 3.17
1998 1,040 0.76 0.62
MidCap Growth 1999 264 1.41 0.85
1998 78 0.64 0.31
MidCap Value 1999 22 0.11 0.12
Real Estate 1999 6,400 12.31 11.93
1998 2,355 9.70 8.86
SmallCap 1999 2,055 4.25 5.29
1998 120 0.36 0.91
SmallCap Growth 1999 420 2.67 3.39
Utilities 1999 1,290 4.62 5.23
</TABLE>
<TABLE>
<CAPTION>
Commissions Paid to Morgan Stanley and Co.
Total Dollar As Percent of As Percent of Dollar Amount
Account Year Amount Total Commissions of Commissionable Transactions
<S> <C> <C> <C> <C>
Aggressive Growth 1999 $41,604 10.84% 12.29%
Asset Allocation 1999 11,734 14.28 18.67
1998 751 0.35 0.27
1997 2,974 1.80 1.29
Balanced 1999 3,890 5.36 5.21
1998 3,155 3.92 2.11
1996 1,300 2.80 1.82
Blue Chip 1999 155 2.17 2.40
Capital Value 1999 8,075 2.09 2.81
1998 4,620 1.94 1.77
1997 7,155 5.28 6.12
1996 3,650 1.99 1.48
Growth 1999 16,129 4.59 3.43
1998 6,598 6.49 5.30
1997 1,250 3.69 3.83
International 1999 51,822 8.90 9.14
1998 25,872 8.53 8.46
1997 10,411 4.37 4.20
1996 3,176 2.02 1.78
International SmallCap 1999 17,293 6.05 7.44
1998 5,697 10.91 15.49
Large Cap Growth 1999 276 5.07 2.43
LargeCap Stock Index 1999 23 0.11 1.41
MicroCap 1999 800 2.77 3.10
1998 30 0.14 0.14
MidCap 1999 17,020 4.89 4.21
1998 2,248 1.64 2.19
1997 2,250 4.17 2.54
MidCap Growth 1999 2,067 11.06 12.50
1998 210 1.72 1.15
MidCap Value 1999 185 0.95 1.25
Real Estate 1999 1,945 3.74 3.68
1998 4,600 18.94 15.04
SmallCap 1999 385 0.80 1.32
1998 220 0.66 0.86
SmallCap Growth 1999 162 1.03 1.33
SmallCap Value 1999 535 4.10 3.47
1998 158 1.90 0.75
Utilities 1999 500 1.79 1.61
</TABLE>
<TABLE>
<CAPTION>
Commissions Paid to Neuberger Berman
Total Dollar As Percent of As Percent of Dollar Amount
Account Year Amount Total Commissions of Commissionable Transactions
<S> <C> <C> <C> <C>
Aggressive Growth 1999 $1,040 0.27% 0.28%
Asset Allocation 1999 116 0.14 0.15
MicroCap 1999 83 0.29 0.50
MidCap Value 1999 12,220 62.63 64.65
</TABLE>
Goldman Sachs Asset Management, a separate operating division of Goldman Sachs &
Co., acts as sub-advisor for an account of Principal Variable Contracts Fund,
Inc. J.P. Morgan Investment Management Inc., an affiliate of J.P. Morgan
Securities, acts as a sub-advisor of an account of Principal Variable Contracts
Fund, Inc. In addition, Neuberger Berman Management, Inc., an affiliate of
Neuberger Berman LLC, acts as a sub-advisor of an account of Principal Variable
Contracts Fund, Inc.
Morgan Stanley and Co. is affiliated with Morgan Stanley Asset Management, which
acts as sub-advisor to two accounts of the Principal Variable Contracts Fund and
one fund included in the Fund Complex. On December 1, 1998 Morgan Stanley Asset
Management Inc. changed its name to Morgan Stanley Dean Witter Investment
Management, Inc. but continues to do business in certain instances using the
name Morgan Stanley Asset Management.
The Manager acts as investment advisor for each of the funds sponsored by
Principal Life Insurance Company and places orders to trade portfolio securities
for the funds and the Bond, High Yield, Money Market and Real Estate Accounts.
Orders to trade portfolio securities for the other Accounts are placed by the
sub-advisor for the specific Account. If, in carrying out the investment
objectives of the Accounts, occasions arise when purchases or sales of the same
equity securities are to be made for two or more of the Accounts or Funds at the
same time (or, in the case of Accounts managed by Invista, for two or more Funds
and any other accounts managed by Invista), the Manager or Invista may submit
the orders to purchase or, whenever possible, to sell, to a broker/dealer for
execution on an aggregate or "bunched" basis. The Manager (or, in the case of
Accounts managed by Invista, Invista) may create several aggregate or "bunched"
orders relating to a single security at different times during the same day. On
such occasion, the Manager (or, in the case of Accounts managed by Invista,
Invista) will employ a computer program to randomly order the Accounts whose
individual orders for purchase or sale make up each aggregate or "bunched"
order. Securities purchased or proceeds of sales received on each trading day
with respect to each such aggregate or "bunched" orders shall be allocated to
the various Accounts (or, in the case of Invista, the various Accounts or Funds
and other client accounts) whose individual orders for purchase or sale make up
the aggregate or "bunched" order by filling each Account's or Fund's (or, in the
case of Invista, each Account's or Fund's or other client account's) order, in
the sequence arrived at by the random ordering. Securities purchased for funds
(or, in the case of Invista, Accounts, Funds and other clients accounts)
participating in an aggregate or "bunched" order are placed into those Accounts
and, where applicable, other client accounts at a price equal to the average of
the prices achieved in the course of filling that aggregate or "bunched" order.
If purchases or sales of the same debt securities are to be made for two or more
of the Accounts or Funds at the same time, the securities are purchased or sold
proportionately in accordance with the amount of such security sought to be
purchased or sold at that time for each Account or Fund. If the purchase or sale
of securities consistent with the investment objectives of the Accounts or one
or more of the other clients for which Berger, Dreyfus, Goldman, J.P. Morgan
Investment, Janus or Neuberger Berman acts as investment sub-advisor or advisor
is to be made at the same time, the securities are purchased or sold
proportionately in accordance with the amount of such security sought to be
purchased or sold at that time for each Account or client.
The following describes the allocation process utilized by the Sub-Advisor for
the Aggressive Growth and Asset Allocation Accounts:
Transactions for each portfolio account advised by Morgan Stanley generally are
completed independently. Morgan Stanley, however, may purchase or sell the same
securities or instruments for a number of portfolio accounts, including
portfolios of its affiliates, simultaneously. These accounts will include pooled
vehicles, including partnerships and investment companies for which Morgan
Stanley and related persons of Morgan Stanley act as investment manager and
administrator, and in which Morgan Stanley, its officers, employees and its
related persons have a financial interest, and accounts of pension plans
covering employees of Morgan Stanley and its affiliates ("Proprietary
Accounts"). When possible, orders for the same security are combined or
"batched" to facilitate test execution and to reduce brokerage commissions or
other costs. Morgan Stanley effects batched transactions in a manner designed to
ensure that no participating portfolio, including any Proprietary Account, is
favored over any other portfolio. Specifically, each portfolio (including the
Aggressive Growth and Asset Allocation Accounts) that participates in a batched
transaction will participate at the average share price for all of Morgan
Stanley's transactions in that security on that business day, with respect to
that batched order. Securities purchased or sold in a batched transaction are
allocated pro-rata, when possible, to the participating portfolio accounts in
proportion to the size of the order placed for each account. Morgan Stanley may,
however, increase or decrease the amount of securities allocated to each account
if necessary to avoid holding odd-lot or small numbers of shares for particular
portfolios. Additionally, if Morgan Stanley is unable to fully execute a batched
transaction and Morgan Stanley determines that it would be impractical to
allocate a small number of securities among the accounts participating in the
transaction on a pro-rata basis, Morgan Stanley may allocate such securities in
a manner determined in good faith to be a fair allocation.
The following describes the allocation process utilized by the Sub-Advisor for
the LargeCap Growth Equity Account:
Where Duncan-Hurst buys or sells the same security for two or more clients, it
may place concurrent orders with a single broker, to be executed together as a
single "block" in order to facilitate orderly and efficient execution. Whenever
Duncan-Hurst does so, each account on whose behalf an order was placed will
receive the average price and will bear a proportionate share of all transaction
costs, based on the size of that account's order. Clients receiving such
concurrent treatment may include investment limited partnerships of which
Duncan-Hurst is a general partner and accounts as to which Duncan-Hurst may
receive performance-based fees. In some cases, they may also include affiliates
of Duncan-Hurst.
The following describes the allocation process utilized by the Sub-Advisor for
the MidCap Growth Equity Account:
Turner has developed an allocation system for limited opportunities: block
orders that cannot be filled in one day and IPOs. Allocation of all partially
filled trades will be done pro-rata, unless the small size would cause excessive
ticket charges. In that case, allocation will begin with the next account on the
rotational account listing. Any directed brokerage arrangement will result in
the inability of Turner to, in all cases, include trades for that particular
client in block orders if the block transaction is executed through a broker
other than the one that has been directed. The benefits of that kind of
transaction, a sharing of reduced cost and possible more attractive prices, will
not extend to the directed client. Allocations exceptions may be made if
documented and approved timely by the firm's compliance officer. Turner's
proprietary accounts may trade in the same block with client accounts, if it is
determined to be advantageous to the client to do so.
DETERMINATION OF NET ASSET VALUE OF ACCOUNT SHARES
Growth-Oriented and Income-Oriented Accounts
The net asset values of the shares of each of the Growth-Oriented and
Income-Oriented Accounts are determined daily, Monday through Friday, as of the
close of trading on the New York Stock Exchange, except on days on which changes
in the value of an Account's portfolio securities do not materially affect the
current net asset value of that Account's redeemable securities, on days during
which an Account receives no order for the purchase or sale of its redeemable
securities and no tender of such a security for redemption, and on customary
national business holidays. The Accounts treat as customary national business
holidays those days on which the New York Stock Exchange is closed for New
Year's Day, Martin Luther King, Jr. Day, Presidents' Day, Good Friday, Memorial
Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day. The net
asset value per share for each Account is determined by dividing the value of
securities in the Account's investment portfolio plus all other assets, less all
liabilities, by the number of Account shares outstanding. Securities for which
market quotations are readily available, including options and futures traded on
an exchange, are valued at market value, which is currently determined using the
last reported sale price or, if no sales are reported, as is regularly the case
for some securities traded over-the-counter, the last reported bid price. When
reliable market quotations are not considered to be readily available, which may
be the case, for example, with respect to certain debt securities, preferred
stocks, foreign securities and over-the-counter options, the investments are
valued by using market quotations considered reliable, prices provided by market
makers, that may include dealers with which the Account has executed
transactions, or estimates of market values obtained from yield data and other
factors relating to instruments or securities with similar characteristics in
accordance with procedures established in good faith by the Board of Directors.
Securities with remaining maturities of 60 days or less are valued at amortized
cost. Other assets are valued at fair value as determined in good faith by the
Board of Directors.
Generally, trading in foreign securities is substantially completed each day at
various times prior to the close of the New York Stock Exchange. The values of
such securities used in computing net asset value per share are usually
determined as of such times. Occasionally, events which affect the values of
such securities and foreign currency exchange rates may occur between the times
at which they are generally determined and the close of the New York Stock
Exchange and would therefore not be reflected in the computation of the
Account's net asset value. If events materially affecting the value of such
securities occur during such period, then these securities will be valued at
their fair value as determined in good faith by the Manager under procedures
established and regularly reviewed by the Board of Directors. To the extent the
Account invests in foreign securities listed on foreign exchanges that trade on
days on which the Account does not determine its net asset value, for example
Saturdays and other customary national U.S. holidays, the Account's net asset
value could be significantly affected on days when shareholders have no access
to the Account.
Certain securities issued by companies in emerging market countries may have
more than one quoted valuation at any given point in time, sometimes referred to
as a "local" price and a "premium" price. The premium price is often a
negotiated price that may not consistently represent a price at which a specific
transaction can be effected. It is the policy of International Accounts to value
such securities at prices at which it is expected those shares may be sold, and
the Manager or any Sub-Advisor, is authorized to make such determinations
subject to such oversight by the Fund's Board of Directors as may from time to
time be necessary.
Money Market Account
The net asset value of shares of the Money Market Account is determined at the
same time and on the same days as each of the Growth-Oriented Accounts and
Income-Oriented Accounts as described above. The net asset value per share for
the Account is computed by dividing the total value of the Account's securities
and other assets, less liabilities, by the number of Account shares outstanding.
All securities held by the Money Market Account are valued on an amortized cost
basis. Under this method of valuation, a security is initially valued at cost;
thereafter, the Account assumes a constant proportionate amortization in value
until maturity of any discount or premium, 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 during which
value, as determined by amortized cost, is higher or lower than the price that
would be received upon sale of the security. Use of the amortized cost valuation
method by the Money Market Account requires the Account to maintain a dollar
weighted average maturity of 90 days or less and to purchase only obligations
that have remaining maturities of 397 days or less or have a variable or
floating rate of interest. In addition, the Account can invest only in "Eligible
Securities" as that term is defined in Regulations issued under the Investment
Company Act of 1940 (see the Fund's Prospectus for a more complete description)
determined by the Board of Directors to present minimal credit risks.
The Board of Directors has established procedures designed to stabilize, to the
extent reasonably possible, the Account's price per share as computed for the
purpose of sales and redemptions at $1.00. Such procedures include a directive
to the Manager to test price the portfolio or specific securities thereof upon
certain changes in the Treasury Bill auction interest rate for the purpose of
identifying possible deviations in the net asset value per share calculated by
using available market quotations or equivalents from $1.00 per share. If such
deviation exceeds 1/2 of 1%, the Board of Directors will promptly consider what
action, if any, will be initiated. In the event the Board of Directors
determines that a deviation exists which may result in material dilution or
other unfair results to shareholders, the Board will take such corrective action
as it regards as appropriate, including: the sale of portfolio instruments prior
to maturity; the withholding of dividends; redemptions of shares in kind; the
establishment of a net asset value per share based upon available market
quotations; or splitting, combining or otherwise recapitalizing outstanding
shares. The Account may also reduce the number of shares outstanding by
redeeming proportionately from shareholders, without the payment of any monetary
compensation, such value at $1.00 per share.
PERFORMANCE CALCULATION
Each of the Accounts may from time to time advertise its performance in terms of
total return. The figures used for total return and yield are based on the
historical performance of an Account, or its corresponding, predecessor mutual
fund, show the performance of a hypothetical investment and are not intended to
indicate future performance. Total return and yield will vary from time to time
depending upon market conditions, the composition of an Account's portfolio and
operating expenses. These factors and possible differences in the methods used
in calculating performance figures should be considered when comparing an
Account's performance to the performance of some other kind of investment. The
calculations of total return and yield for the Accounts do not include the fees
and charges of the separate accounts that invest in the Accounts and, therefore,
do not reflect the investment performance of those separate accounts.
Each Account may also include in its advertisements performance rankings and
other performance-related information published by independent statistical
services or publishers, such as Lipper Analytical Services, Weisenberger
Investment Companies Services, Money Magazine, Forbes, The Wall Street Journal,
Barron's and Changing Times, and comparisons of the performance of an Account to
that of various market indices, such as the S&P 500 Index, Lehman Brothers GNMA
Index, Dow Jones Industrials Index, and the Salomon Brothers Investment Grade
Bond Index.
Total Return
When advertising total return figures, each of the Growth-Oriented Accounts and
Income-Oriented Accounts will include its average annual total return for each
of the one, five and ten year periods (or if shorter, the period during which
its corresponding predecessor fund's registration statement has been in effect)
that end on the last day of the most recent calendar quarter. Average annual
total return is computed by calculating the average annual compounded rate of
return over the stated period that would equate an initial $1,000 investment to
the ending redeemable value assuming the reinvestment of all dividends and
capital gains distributions at net asset value. In its advertising, an Account
may also include average annual total return for some other period or cumulative
total return for a specified period. Cumulative total return is computed by
dividing the ending redeemable value (assuming the reinvestment of all dividends
and capital gains distributions at net asset value) by the initial investment.
The following table shows as of December 31, 1999 average annual total return
for each of the Accounts for the periods indicated:
Account 1-Year 5-Year 10-Year
Aggressive Growth 39.50% 32.01% 28.82%(1)
Asset Allocation 19.49% 16.01% 14.32%(1)
Balanced 2.40% 13.75% 11.38%
Blue Chip 1.15%(2)
Bond -2.59% 7.73% 7.77%
Capital Value -4.29% 17.88% 12.94%
Government Securities -0.29% 7.96% 7.75%
Growth 16.44% 20.45% 18.94%(3)
High Yield 1.76% 8.03% 8.39%
International 25.93% 17.29% 14.41%(3)
International SmallCap 93.81% 39.24%(4)
LargeCap Growth 32.47%(2)
LargeCap Stock Index 8.93%(2)
MicroCap -1.07% -12.05%(4)
MidCap 13.04% 17.59% 15.35%
MidCap Growth 10.67% 4.09%(4)
MidCap Value 10.24%(2)
Real Estate -4.48% -6.58%(4)
SmallCap 43.58% 8.24%(4)
SmallCap Growth 95.69% 52.17%(4)
SmallCap Value 21.45% 1.88%(4)
Utilities 2.29% 10.43%(4)
(1) Period beginning June 1, 1994 and ending December 31, 1999.
(2) Period beginning May 1, 1999 and ending December 31, 1999.
(3) Period beginning May 1, 1994 and ending December 31, 1999.
(4) Period beginning May 1, 1998 and ending December 31, 1999.
Yield
Money Market Account
The Money Market Account may advertise its yield and its effective yield.
Yield is computed by determining the net change, exclusive of capital changes,
in the value of a hypothetical pre-existing account having a balance of one
share at the beginning of the period, subtracting a hypothetical charge
reflecting deductions from shareholder accounts, and dividing the difference by
the value of the account at the beginning of the base period to obtain the base
period return, and then multiplying the base period return by (365/7) with the
resulting yield figure carried to at least the nearest hundredth of one percent.
As of December 31, 1999, the Money Market Account's yield was 5.47%. Because
realized capital gains or losses in an Account's portfolio are not included in
the calculation, the Account's net investment income per share for yield
purposes may be different from the net investment income per share for dividend
purposes, that includes net short-term realized gains or losses on the Account's
portfolio.
Effective yield is computed by determining the net change, exclusive of capital
changes, in the value of a hypothetical pre-existing account having a balance of
one share at the beginning of the period, subtracting a hypothetical charge
reflecting deductions from shareholder accounts, and dividing the difference by
the value of the account at the beginning of the base period to obtain the base
period return, and then compounding the base period return by adding 1, raising
the sum to a power equal to 365 divided by 7, and subtracting 1 from the result.
The resulting effective yield figure is carried to at least the nearest
hundredth of one percent. As of December 31, 1999, the Money Market Account's
effective yield was 5.62%.
The yield quoted at any time for the Money Market Account represents the amount
that was earned during a specific, recent seven-day period and is a function of
the quality, types and length of maturity of instruments in the Account's
portfolio and the Account's operating expenses. The length of maturity for the
portfolio is the average dollar weighted maturity of the portfolio. This means
that the portfolio has an average maturity of a stated number of days for its
issues. The calculation is weighted by the relative value of each investment.
The yield for the Money Market Account fluctuates daily as the income earned on
the investments of the Account fluctuates. Accordingly, there is no assurance
that the yield quoted on any given occasion will remain in effect for any period
of time. There is no guarantee that the net asset value or any stated rate of
return will remain constant. A shareholder's investment in the Account is not
insured. Investors comparing results of the Money Market Account with investment
results and yields from other sources such as banks or savings and loan
associations should understand these distinctions. Historical and comparative
yield information may, from time to time, be presented by the Account.
TAX STATUS
It is the policy of each Account to distribute substantially all net investment
income and net realized gains. Through such distributions, and by satisfying
certain other requirements, the Fund intends to qualify for the tax treatment
accorded to regulated investment companies under the applicable provisions of
the Internal Revenue Code. This means that in each year in which the Fund so
qualifies, it is exempt from federal income tax upon the amount so distributed
to investors.
For federal income tax purposes, capital gains and losses on futures contracts
or options thereon, index options or options traded on qualified exchanges are
generally treated at 60% long-term and 40% short-term. In addition, an Account
must recognize any unrealized gains and losses on such positions held at the end
of the fiscal year. An Account may elect out of such tax treatment, however, for
a futures or options position that is part of an "identified mixed straddle"
such as a put option purchased by the Account with respect to a portfolio
security. Gains and losses on figures and options included in an identified
mixed straddle will be considered 100% short-term and unrealized gain or loss on
such positions will not be realized at year end. The straddle provisions of the
Code may require the deferral of realized losses to the extent that the Account
has unrealized gains in certain offsetting positions at the end of the fiscal
year, and may also require recharacterization of all or a part of losses on
certain offsetting positions from short-term to long-term, as well as adjustment
of the holding periods of straddle positions.
The 1986 Tax Reform Act imposes an excise tax on mutual funds that fail to
distribute net investment income and capital gains by the end of the calendar
year in accordance with the provisions of the Act. The Fund intends to comply
with the Act's requirements and to avoid this excise tax.
GENERAL INFORMATION AND HISTORY
On December 31, 1997, certain Funds sponsored by Principal Life Insurance
Company were reorganized into Accounts of the Principal Variable Contracts Fund,
Inc., a corporation incorporated in the State of Maryland. The new series
adopted the assets and liabilities of the corresponding Fund. The old Fund names
and the corresponding Account are shown below:
Fund Account
Principal Aggressive Growth Fund, Inc. Aggressive Growth Account
Principal Asset Allocation Fund, Inc. Asset Allocation Account
Principal Balanced Fund, Inc. Balanced Account
Principal Bond Fund, Inc. Bond Account
Principal Capital Accumulation Fund, Inc. Capital Value Account
Principal Emerging Growth Fund, Inc. MidCap Account
Principal Government Securities Fund, Inc. Government Securities Account
Principal Growth Fund, Inc. Growth Account
Principal High Yield Fund, Inc. High Yield Account
Principal Money Market Fund, Inc. Money Market Account
Principal World Fund, Inc. International Account
The Articles of Incorporation for the Principal Variable Contracts Fund, Inc.
were amended on February 13, 1998 to reflect the addition of the following new
Accounts:
International SmallCap Account SmallCap Account
MicroCap Account SmallCap Growth Account
MidCap Growth Account SmallCap Value Account
Real Estate Account Utilities Account
The Articles of Incorporation for the Principal Variable Contracts Fund, Inc.
were amended on February 1, 1999 to reflect the addition of the following new
Accounts:
Blue Chip Account MidCap Value Account
LargeCap Growth Account Stock Index 500 Account
The Articles of Incorporation for the Principal Variable Contracts Fund, Inc.
were amended on _____________, 2000 to reflect the addition of the new
International Emerging Markets, LargeCap Growth Equity and MidCap Growth Equity
Accounts and the name change of the LargeCap Stock Index Account from the Stock
Index 500 Account.
FINANCIAL STATEMENTS
The financial statements for the Accounts for the fiscal period ended December
31, 1999 appearing in the Annual Report to Shareholders and the report thereon
of Ernst and Young LLP, independent auditors, 801 Grand Avenue, Des Moines, Iowa
50309, appearing therein are incorporated by reference in this Statement of
Additional Information. The Annual Report will be furnished, without charge, to
investors who request copies of the Statement of Additional Information.
APPENDIX A
Description of Bond Ratings:
Moody's Investors Service, Inc. Bond Ratings
Aaa: Bonds that are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally
referred to as "gilt edge." Interest payments are protected by a
large or by an exceptionally stable margin and principal is
secure. While the various protective elements are likely to
change, such changes as can be visualized are most unlikely to
impair the fundamentally strong position of such issues.
Aa: Bonds that are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are
generally known as high grade bonds. They are rated lower than the
best bonds because margins of protection may not be as large as in
Aaa securities or fluctuation of protective elements may be of
greater amplitude or there may be other elements present that make
the long-term risks appear somewhat larger than in Aaa securities.
A: Bonds that are rated A possess many favorable investment
attributes and are to be considered 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 that are rated Baa are considered as medium grade obligations,
i.e., they are neither highly protected nor poorly secured.
Interest payments and principal security appear adequate for the
present but certain protective elements may be lacking or may be
characteristically unreliable over any great length of time. Such
bonds lack outstanding investment characteristics and in fact have
speculative characteristics as well.
Ba: Bonds that are rated Ba are judged to have speculative elements;
their future cannot be considered as well-assured. Often the
protection of interest and principal payments may be very moderate
and thereby not well safeguarded during both good and bad times
over the future. Uncertainty of position characterizes bonds in
this class.
B: Bonds that are rated B generally lack characteristics of the
desirable investment. Assurance of interest and principal
payments or of maintenance of other terms of the contract over any
long period of time may be small.
Caa: Bonds that are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to
principal or interest.
Ca: Bonds that are rated Ca represent obligations that are speculative
in a high degree. Such issues are often in default or have other
marked shortcomings.
C: Bonds that are rated C are the lowest rated class of bonds and
issues so rated can be regarded as having extremely poor prospects
of ever attaining any real investment standing.
CONDITIONAL RATING: Bonds for which the security depends upon the completion of
some act or the fulfillment of some condition are rated conditionally. These
bonds secured by (a) earnings of projects under construction, (b) earnings of
projects unseasoned in operation 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.
RATING REFINEMENTS: Moody's may apply numerical modifiers, 1, 2 and 3 in each
generic rating classification from Aa through B in its bond rating system. The
modifier 1 indicates that the security ranks in the higher end of its generic
rating category; the modifier 2 indicates a mid-range ranking; and a modifier 3
indicates that the issue ranks in the lower end of its generic rating category.
SHORT-TERM NOTES: The four ratings of Moody's for short-term notes are MIG 1,
MIG 2, MIG 3 and MIG 4; MIG 1 denotes "best quality, enjoying strong protection
from established cash flows"; MIG 2 denotes "high quality" with "ample margins
of protection"; MIG 3 notes are of "favorable quality...but lacking the
undeniable strength of the preceding grades"; MIG 4 notes are of "adequate
quality, carrying specific risk for having protection...and not distinctly or
predominantly speculative."
Description of Moody's Commercial Paper Ratings
Moody's Commercial Paper ratings are opinions of the ability to repay punctually
promissory obligations not having an original maturity in excess of nine months.
Moody's employs the following three designations, all judged to be investment
grade, to indicate the relative repayment capacity of rated issuers:
Issuers rated Prime-1 (or related supporting institutions) have a superior
capacity for repayment of short-term promissory obligations.
Issuers rated Prime-2 (or related supporting institutions) have a strong
capacity for repayment of short-term promissory obligations.
Issuers rated Prime-3 (or related supporting institutions) have an acceptable
capacity for repayment of short-term promissory obligations.
Issuers rated Not Prime do not fall within any of the Prime rating categories.
Description of Standard & Poor's Corporation's Debt Ratings
A Standard & Poor's debt rating is a current assessment of the creditworthiness
of an obligor with respect to a specific obligation. This assessment may take
into consideration obligors such as guarantors, insurers, or lessees.
The debt rating is not a recommendation to purchase, sell or hold a security,
inasmuch as it does not comment as to market price or suitability for a
particular investor.
The ratings are based on current information furnished by the issuer or obtained
by Standard & Poor's from other sources Standard & Poor's considers reliable.
Standard & Poor's does not perform an audit in connection with any rating and
may, on occasion, rely on unaudited financial information. The ratings may be
changed, suspended or withdrawn as a result of changes in, or unavailability of,
such information, or for other circumstances.
The ratings are based, in varying degrees, on the following considerations:
I. Likelihood of default-- capacity and willingness of the obligor as to
the timely payment of interest and repayment of principal in accordance
with the terms of the obligation;
II. Nature of and provisions of the obligation;
III.Protection afforded by, and relative position of, the obligation in the
event of bankruptcy, reorganization or other arrangement under the laws
of bankruptcy and other laws affecting creditor's rights.
AAA:
Debt rated "AAA" has the highest rating assigned by Standard & Poor's.
Capacity to pay interest and repay principal is extremely strong.
AA:
Debt rated "AA" has a very strong capacity to pay interest and repay
principal and differs from the highest-rated issues only in small
degree.
A:
Debt rated "A" has a strong capacity to pay interest and repay
principal although they are somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than debt
in higher-rated categories.
BBB:
Debt rated "BBB" is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate
protection parameters, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity to pay
interest and repay principal for debt in this category than for debt
in higher-rated categories.
BB, B, CCC, CC:
Debt rated "BB", "B", "CCC" and "CC" is regarded, on balance, as
predominantly speculative with respect to capacity to pay interest and
repay principal in accordance with the terms of the obligation. "BB"
indicates the lowest degree of speculation and "CC" the highest degree
of speculation. While such debt 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.
D:
Debt rated "D" is in default, and payment of interest and/or repayment
of principal is in arrears.
Plus (+) or Minus (-): The ratings from "AA" to "B" may be modified by
the addition of a plus or minus sign to show relative standing within
the major rating categories.
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 bonds being rated and indicates that
payment of debt service requirements is largely or entirely dependent
upon the successful and timely completion of the project. This rating,
however, while addressing credit quality subsequent to completion of
the project, makes no comment on the likelihood of, or the risk of
default upon failure of, such completion. The investor should exercise
his own judgment with respect to such likelihood and risk.
NR:
Indicates that no rating has been requested, that there is
insufficient information on which to base a rating or that Standard &
Poor's does not rate a particular type of obligation as a matter of
policy.
Standard & Poor's, Commercial Paper Ratings
A Standard & Poor's Commercial Paper Rating is a current assessment of the
likelihood of timely payment of debt having an original maturity of no more than
365 days. Ratings are graded into four categories, ranging from "A" for the
highest quality obligations to "D" for the lowest. Ratings are applicable to
both taxable and tax-exempt commercial paper. The four categories are as
follows:
A: Issues assigned the highest rating are regarded as having the greatest
capacity for timely payment. Issues in this category are delineated
with the numbers 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. Issues that possess overwhelming safety
characteristics will be given a "+" designation.
A-2 Capacity for timely payment on issues with this designation
is strong. However, the relative degree of safety is not as
high as for issues designated "A-1".
A-3 Issues carrying this designation have a satisfactory
capacity for timely payment. They are, however, somewhat
more vulnerable to the adverse effects of changes in
circumstances than obligations carrying the highest
designations.
B: Issues rated "B" are regarded as having only an adequate capacity for
timely payment. However, such capacity may be damaged by changing
conditions or short-term adversities.
C: This rating is assigned to short-term debt obligations with a doubtful
capacity for payment.
D: This rating indicates that the issue is either in default or is
expected to be in default upon maturity.
The Commercial Paper Rating is not a recommendation to purchase or sell a
security. The ratings are based on current information furnished to Standard &
Poor's by the issuer and obtained by Standard & Poor's from other sources it
considers reliable. The ratings may be changed, suspended, or withdrawn as a
result of changes in or unavailability of, such information.
Standard & Poor's rates notes with a maturity of less than three years as
follows:
SP-1A very strong, or strong, capacity to pay principal and interest.
Issues that possess overwhelming safety characteristics will be
given a "+" designation.
SP-2A satisfactory capacity to pay principal and interest.
SP-3A speculative capacity to pay principal and interest.
<PAGE>
PART C. OTHER INFORMATION
Item 23. Exhibits.
-------- ---------
(a) Amendment and Restatement of the Articles
of Incorporation**
(b) By-laws*
(c) Specimen Share Certificate N/A
(d) (1) Management Agreement (filed 10/23/97)
(2) First Amendment to Management Agreement (filed 2/12/98)
(3) Investment Service Agreement (filed 10/23/97)
(4) Sub-Advisory Agreement - Invista (filed 10/23/97)
(5) First Amendment to Sub-Advisory Agrmt. (filed 2/12/98)
(6) Sub-Advisory Agreement - Morgan Stanley Asset Mgmt.
(filed 10/23/97)
(7) Sub-Advisory Agreement - Berger Assoc. (filed 4/13/98)
(8) Sub-Advisory Agreement - Dreyfus Corp. (filed 4/13/98)
(9) Sub-Advisory Agreement - Goldman Sachs (filed 4/13/98)
(10) Sub-Advisory Agreement - JP Morgan (filed 4/13/98)
(11) Sub-Adv. Agreement - Neuberger Berman (filed 4/21/99)
(12) Sub-Advisory Agreement - Janus Capital (filed 4/21/99)
(e) Distribution Agreement**
(f) N/A
(g) Custodian Agreement
(1) Domestic Custody Agreement (filed 10/23/97)
(2) Global Custody Agreement (filed 10/23/97)
(h) Agreement and Plan of Reorganization and Liquidation
(filed 10/23/97)
(i) Legal Opinion**
(j) Consent of Independent Auditors**
(k) Financial Statements included in this Registration
Statement:
(1) Part A:
None
(2) Part B:
None
(3) Annual Report to Shareholders filed under Rule
N-30D-1 on February 28, 2000**
(m) Rule 12b-1 Plan N/A
(n) Financial Data Schedule**
(o) Rule 18f-3 Plan N/A
(p) Code of Ethics
(1) PMC Code of Ethics (filed April, 2000)
(2) Invista Code of Ethics (filed April, 2000)
(3) Dreyfus Code of Ethics (filed April, 2000)
(4) Goldman Code of Ethics (filed April, 2000)
(5) JP Morgan Code of Ethics (filed April, 2000)
(6) Janus Code of Ethics (filed April, 2000)
(7) MSDW Code of Ethics (filed April, 2000)
(8) Neuberger Berman Code of Ethics (filed April, 2000)
(9) Berger Code of Ethics (filed April, 2000)
* Filed herein.
** To be filed by amendment.
*** Incorporated herein by reference.
Item 24. Persons Controlled by or Under Common Control with Registrant
Principal Financial Services, Inc. (an Iowa corporation) an
intermediate holding company organized pursuant to Section 512A.14 of
the Iowa Code.
Subsidiaries wholly-owned by Principal Financial Services, Inc.
a. Principal Life Insurance Company (an Iowa corporation) a stock
life insurance company engaged in the business of insurance and
retirement services.
b. Princor Financial Services Corporation (an Iowa Corporation) a
registered broker-dealer.
c. PFG DO Brasil LTDA (Brazil) a Brazilian holding company.
d. Principal Financial Group (Mauritius) Ltd. a Mauritius holding
company.
e. Principal Pensions Co., Ltd. (Japan) a Japan company who engages
in the management, investment and administration of financial
assets and any services incident thereto.
f. Principal Financial Services (Australia), Inc. (an Iowa holding
company) formed to facilitate the acquisition of the Australian
business of BT Australia.
g. Principal Financial Services (NZ), Inc. (an Iowa holding company)
formed to facilitate the acquisition of the New Zealand business
of BT Australia.
h. Principal Capital Management (Singapore) Limited (a Singapore
corporation) a company engaging in funds management.
i. Principal Capital Management (Europe) Limited a United Kingdom
company that engages in European representation and distributor
of the Principal Investments Funds.
j. Principal Capital Management (Ireland) Limited an Ireland company
that engages in fund management.
k. Principal Financial Group Investments (Australia) Pty Limited an
Australia holding company.
Subsidiary wholly-owned by Princor Financial Services Corporation:
a. Principal Management Corporation (an Iowa Corporation) a
registered investment advisor.
Subsidiary 42% owned by PFG DO Brasil LTDA
a. Brasilprev Previdencia Privada S.A.(Brazil) a pension
fund company.
Subsidiary wholly-owned by Principal Financial Group (Mauritius) Ltd.
a. IDBI Principal Asset Management Company (India) a India asset
management company.
Subsidiary wholly-owned by Principal Financial Services (Australia),
Inc.:
a. Principal Financial Group (Australia) Holdings Pty Ltd. an
Australian holding company organized in connection with the
contemplated acquisition of BT Australia Funds Management.
Subsidiary wholly-owned by Principal Financial Group (Australia)
Holdings Pty Ltd:
a. BT Financial Group Pty Ltd. an Australia holding company.
Subsidiary wholly-owned by BT Financial Group Pty Ltd:
a. BT Investments (Australia) Limited a Delaware holding
company.
Subsidiary wholly-owned by BT Investments (Australia) Limited:
a. BT Australia (Holdings) Ltd an Australia commercial and
investment banking and asset management company.
Subsidiary wholly-owned by BT Australia (Holdings) Ltd:
a. BT Australia Limited an Australia company engaged in asset
management and trustee/administrative activites.
Subsidiaries wholly-owned by BT Financial Group Limited:
a. BT Life Limited an Australia company engaged in commercial and
investment linked life insurance policies.
b. BT Funds Management Limited an Australia company engaged in
institutional and retail money management.
c. BT Funds Management (International) Limited an Australia company
who manages international funds (New Zealand, Singapore, Asia,
North America and United Kingdom).
d. BT Securities Limited an Australia company that engages in loan
finance secured against share and managed fund portfolios.
e. BT (Queensland) Pty Limited an Australia trustee company.
f. BT Portfolio Services Limited an Australia company that engages
in processing and transaction services for financial planners and
financial intermediaries.
g. BT Australia Corporate Services Pty Limited an Australia holding
company for internal service companies.
h. Oniston Pty Ltd an Australia company that is a financial services
investment vehicle.
i. QV1 Pty Limited an Australia company.
Subsidiaries wholly-owned by BT Portfolio Services Limited:
a. BT Custodial Services Pty Ltd an Australia custodian nominee for
investment management activities.
b. National Registry Services Pty Ltd. an Australia company that
engages in registry services.
c. National Registry Services (WA) Pty Limited an Australia company
that engages in registry services.
d. BT Finance & Investments Pty Ltd an Australia trustee of
wholesale cash management trust.
Subsidiaries organized and wholly-owned by BT Australia Corporate
Services Pty Limited:
a. BT Finance Pty Limited an Australia provider of finance by loans
and leases.
b. Chifley Services Pty Limited an Australia company that engages in
staff car leasing management.
c. BT Nominees Pty Limited an Australia company that operates as a
trustee of staff superannuation fund (pension plan).
Subsidiary organized and wholly-owned by BT Funds Management Limited:
a. BT Tactical Asset Management Pty Limited an Australia company
that engages in management of futures positions.
Subsidiary organized and wholly-owned by BT Custodial Services Pty
Ltd:
a. BT Hotel Group Pty Ltd an Australia corporation - an inactive
shelf corporation to be wound up.
b. BT Custodians Ltd an Australia manager and trustee of various
unit trusts.
c. Dellarak Pty Ltd an Australia trustee company.
Subsidiary organized and wholly-owned by Principal Financial Services
(NZ), Inc.
a. BT Financial Group (NZ) Limited a New Zealand holding company.
Subsidiary organized and wholly-owned by BT Financial Group (NZ)
Limited:
a. BT Portfolio Service (NZ) Limited a New Zealand company that
provides third party administration and registry services.
b. BT New Zealand Nominees Limited a New Zealand company who acts as
a custodian for local assets.
c. BT Funds Management (NZ) Limited a New Zealand funds manager.
Subsidiary organized and wholly-owned by Principal Financial Group
Investments (Australia) Pty Limited:
a. Principal Hotels Holdings Pty Ltd. a holding company.
b. Principal Hotels Holdings Trust an Australia trust company.
Subsidiary organized and wholly-owned by Principal Hotels Holdings
Trust:
a. Principal Hotels Australia Pty Ltd. a holding company.
b. Principal Hotels Australia Trust a trust company.
Subsidiary organized and wholly-owned by Principal Hotels Australia
Trust:
a. BT Hotel Limited an Australia corporation, which is the hotel
operating/managing company of the BT Hotel Group.
b. BT Hotel Trust an Australia trust.
Principal Life Insurance Company sponsored the organization of the
following mutual funds, some of which it controls by virtue of owning
voting securities:
Principal Balanced Fund, Inc.(a Maryland Corporation) 0.18% of
shares outstanding owned by Principal Life Insurance Company
(including subsidiaries and affiliates) on June 21, 2000.
Principal Blue Chip Fund, Inc.(a Maryland Corporation) 0.37% of
shares outstanding owned by Principal Life Insurance Company
(including subsidiaries and affiliates) on June 21, 2000.
Principal Bond Fund, Inc.(a Maryland Corporation) 0.73% of shares
outstanding owned by Principal Life Insurance Company (including
subsidiaries and affiliates) on June 21, 2000.
Principal Capital Value Fund, Inc. (a Maryland Corporation)
26.57% of outstanding shares owned by Principal Life Insurance
Company (including subsidiaries and affiliates)on June 21,
2000.
Principal Cash Management Fund, Inc. (a Maryland Corporation)
7.41% of outstanding shares owned by Principal Life Insurance
Company (including subsidiaries and affiliates) on June 21,
2000.
Principal European Equity Fund, Inc. (a Maryland Corporation)
93.60% of outstanding shares owned by Principal Life Insurance
Company (including subsidiaries and affiliates) on June 21,
2000.
Principal Government Securities Income Fund, Inc. (a Maryland
Corporation) 0.04% of shares outstanding owned by Principal Life
Insurance Company (including subsidiaries and affiliates) on
June 21, 2000.
Principal Growth Fund, Inc. (a Maryland Corporation) 0.01% of
outstanding shares owned by Principal Life Insurance Company
(including subsidiaries and affiliates) on June 21, 2000.
Principal High Yield Fund, Inc. (a Maryland Corporation) 8.33%
of shares outstanding owned by Principal Life Insurance Company
(including subsidiaries and affiliates) on June 21, 2000.
Principal International Emerging Markets Fund, Inc. (a Maryland
Corporation) 29.77% of shares outstanding owned by Principal Life
Insurance Company (including subsidiaries and affiliates) on
June 21, 2000.
Principal International Fund, Inc. (a Maryland Corporation)
24.21% of shares outstanding owned by Principal Life Insurance
Company (including subsidiaries and affiliates) on June 21,
2000.
Principal International SmallCap Fund, Inc. (a Maryland
Corporation) 14.56% of shares outstanding owned by Principal Life
Insurance Company (including subsidiaries and affiliates) on
June 21, 2000.
Principal Limited Term Bond Fund, Inc. (a Maryland Corporation)
17.23% of shares outstanding owned by Principal Life Insurance
Company (including subsidiaries and affiliates) on June 21,
2000.
Principal LargeCap Stock Index Fund, Inc. (a Maryland
Corporation) 31.94% of shares outstanding owned by Principal
Life Insurance Company (including subsidiaries and affiliates) on
June 21, 2000.
Principal MidCap Fund, Inc. (a Maryland Corporation) 0.39% of
shares outstanding owned by Principal Life Insurance Company
(including subsidiaries and affiliates) on June 21, 2000
Principal Pacific Basin Fund, Inc. (a Maryland Corporation)
94.23% of outstanding shares owned by Principal Life Insurance
Company (including subsidiaries and affiliates) on June 21,
2000.
Principal Partners Aggressive Growth Fund, Inc.(a Maryland
Corporation) 6.88% of shares outstanding owned by Principal Life
Insurance Company (including subsidiaries and affiliates) on
June 21, 2000
Principal Partners LargeCap Growth Fund, Inc.(a Maryland
Corporation) 42.01% of shares outstanding owned by Principal
Life Insurance Company (including subsidiaries and affiliates) on
June 21, 2000
Principal Partners MidCap Growth Fund, Inc.(a Maryland
Corporation) 38.30% of shares outstanding owned by Principal
Life Insurance Company (including subsidiaries and affiliates) on
June 21, 2000
Principal Real Estate Fund, Inc. (a Maryland Corporation) 59.76%
of shares outstanding owned by Principal Life Insurance Company
(including subsidiaries and affiliates) on June 21, 2000
Principal SmallCap Fund, Inc.(a Maryland Corporation) 7.50% of
shares outstanding owned by Principal Life Insurance Company
(including subsidiaries and affiliates) on June 21, 2000.
Principal Special Markets Fund, Inc. (a Maryland Corporation)
83.56% of shares outstanding of the International Emerging
Markets Portfolio, 46.61% of the shares outstanding of the
International Securities Portfolio, 98.66% of shares outstanding
of the International SmallCap Portfolio and 100% of the shares
outstanding of the Mortgage-Backed Securities Portfolio were
owned by Principal Life Insurance Company (including subsidiaries
and affiliates) on June 21, 2000
Principal Tax-Exempt Bond Fund, Inc. (a Maryland Corporation)
0.05% of shares outstanding owned by Principal Life Insurance
Company (including subsidiaries and affiliates) on June 21,
2000.
Principal Utilities Fund, Inc. (a Maryland Corporation) 0.31% of
shares outstanding owned by Principal Life Insurance Company
(including subsidiaries and affiliates) on June 21, 2000.
Principal Variable Contracts Fund, Inc. (a Maryland Corporation)
100% of shares outstanding of the following Accounts owned by
Principal Life Insurance Company and its Separate Accounts on
June 21, 2000: Aggressive Growth, Asset Allocation, Balanced,
Blue Chip, Bond, Capital Value, Government Securities, Growth,
High Yield, International, International Emerging Markets,
International SmallCap, LargeCap Growth, LargeCap Growth Equity,
MicroCap, MidCap, MidCap Growth, MidCap Growth Equity, MidCap
Value, Money Market, Real Estate, SmallCap, SmallCap Growth,
SmallCap Value Stock Index 500, and Utilities.
Subsidiaries organized and wholly-owned by Principal Life Insurance
Company:
a. Principal Holding Company (an Iowa Corporation) a downstream
holding company for Principal Life Insurance Company.
b. Principal Development Investors, LLC (a Delaware Corporation) a
limited liability company engaged in acquiring and improving real
property through development and redevelopment.
c. Principal Capital Management, LLC (a Delaware Corporation) a
limited liability company that provides private mortgage, real
estate & fixed-income securities services to institutional
clients.
d. Principal Net Lease Investors, LLC (a Delaware Corporation) a
limited liability company which operates as a buyer and seller of
net leased investments.
Subsidiaries organized and 90% owned by Principal Life Insurance
Company:
a. PT Asuransi Jiwa Principal Indonesia (an Indonesia Corporation) a
life insuranced corporation which offers group and individual
products.
Subsidiaries wholly-owned by Principal Capital Management, LLC:
a. Principal Structured Investments, LLC (a Delaware Corporation) a
limited liability company that provides product development
administration, marketing and asset management services
associated with stable value products together with other related
institutional financial services including derivatives,
asset-liability management, fixed income investment management
and ancillary money management products.
b. Principal Enterprise Capital, LLC (a Delaware Corporation) a
company engaged in portfolio management on behalf of
institutional clients for structuring, underwriting and
management of entity-level investments in real estate operating
companies (REOCs).
c. Principal Commercial Acceptance, LLC (a Delaware Corporation) a
limited liability company that provides private market bridge
financing and other secondary market opportunities.
d. Principal Real Estate Investors, LLC (a Delaware Corporation) a
registered investment advisor.
e. Principal Commercial Funding, LLC (a Delaware Corporation) a
limited liability company engaged in the structuring,
warehousing, securitization and sale of commercial
mortgage-backed securities.
f. Principal Generation Plant, LLC an inactive Delaware limited
liability company.
g. Principal Income Investors, LLC a Delaware limited liability
company which provides investment and financial services.
h. Principal Capital Futures Trading Advisor, LLC a Delaware funds
management limited liability company.
Subsidiaries wholly-owned by Principal Holding Company:
a. Principal Bank (a Federal Corporation) a Federally chartered
direct delivery savings bank.
b. Patrician Associates, Inc. (a California Corporation) a real
estate development company.
c. Petula Associates, Ltd. (an Iowa Corporation) a real estate
development company.
d. Principal Development Associates, Inc. (a California Corporation)
a real estate development company.
e. Principal Spectrum Associates, Inc. (a California Corporation) a
real estate development company.
f. Principal FC, Ltd. (an Iowa Corporation) a limited purpose
investment corporation.
g. Equity FC, Ltd. (an Iowa Corporation) engaged in investment
transactions, including limited partnerships and limited
liability companies.
h. HealthRisk Resource Group, Inc. (an Iowa Corporation) a general
business corporation that engages in investment transactions,
including limited partnerships and limited liability companies
i. Invista Capital Management, LLC (an Delaware Corporation) a
limited liability company which is a registered investment
adviser.
j. Principal Residential Mortgage, Inc. (an Iowa Corporation) a full
service mortgage banking company that makes and services a wide
variety of loan types on a nationwide basis.
k. Principal Asset Markets, Inc. (an Iowa Corporation) a corporation
which is currently inactive.
l. Principal Portfolio Services, Inc. (an Iowa Corporation) a
corporation which is currently inactive.
m. The Admar Group, Inc. (a Florida Corporation) a national managed
care service organization that develops and manages preferred
provider organizations.
n. The Principal Financial Group, Inc. (a Delaware corporation) a
corporation which is currently inactive.
o. Principal Product Network, Inc. (a Delaware corporation) an
insurance broker.
p. Principal Health Care, Inc. (an Iowa Corporation) a managed care
company.
q. Dental-Net, Inc. (an Arizona Corporation) a managed dental care
services organization. HMO and dental group practice.
r. Principal Financial Advisors, Inc. (an Iowa Corporation) a
registered investment advisor.
s. Delaware Charter Guarantee & Trust Company, d/b/a Trustar
Retirement Services (a Delaware Corporation) a corporation that
administers individual and group retirement plans for stock
brokerage firm clients and mutual fund distributors.
t. Professional Pensions, Inc. d/b/a Northeast Plan Administrators
(a Connecticut Corporation) a corporation engaged in sales,
marketing and administration of group insurance plans and
third-party administrator for defined contribution plans.
u. Principal Investors Corporation (a New Jersey Corporation) a
corporation which is currently inactive.
v. Principal International, Inc. (an Iowa Corporation) a company
engaged in international business development.
Subsidiaries organized and wholly-owned by PT Asuransi Jiwa
Principal Indonesia:
a. PT Jasa Principal Indonesia an Indonesia pension company.
b. PT Principal Capital Management Indonesia an Indonesia funds
management company.
Subsidiary wholly-owned by Invista Capital Management, LLC:
a. Principal Capital Trust. (a Delaware Corporation) a business
trust and private investment company offering non-registered
units, initially, to tax-exempt entities.
Subsidiary wholly-owned by Principal Residential Mortgage, Inc.:
a. Principal Wholesale Mortgage, Inc. (an Iowa Corporation) a
brokerage and servicer of residential mortgages.
b. Principal Mortgage Reinsurance Company (a Vermont corporation)
a mortgage reinsurance company.
Subsidiaries wholly-owned by The Admar Group, Inc.:
a. Admar Corporation (a California Corporation) a managed care
services organization.
Subsidiaries wholly-owned by Dental-Net, Inc.
a. Employers Dental Services, Inc. (an Arizona corporation) a
prepaid dental plan organization.
Subsidiaries wholly-owned by Professional Pensions, Inc.:
a. Benefit Fiduciary Corporation (a Rhode Island corporation) serves
as a corporate trustee for retirement trusts.
b. PPI Employee Benefits Corporation (a Connecticut corporation) a
registered broker-dealer limited to the sale of open-end mutual
funds and variable insurance products.
c. Boston Insurance Trust, Inc. (a Massachusetts corporation) a
corporation which serves as a trustee and administrator of
insurance trusts and arrangements.
Subsidiaries wholly-owned by Principal International, Inc.:
a. Principal International Espana, S.A. de Seguros de Vida (Spain) a
life insurance, annuity, and accident and health company.
b. Zao Principal International (a Russia Corporation) inactive.
c. Principal International Argentina, S.A. (an Argentina
corporation) a holding company that owns Argentina corporations
offering annuities, group and individual insurance policies.
d. Principal Asset Management Company (Asia) Ltd. (Hong Kong) an
asset management company.
e. Principal International (Asia) Limited (Hong Kong) a corporation
operating as a regional headquarters for Asia.
f. Principal Trust Company (Asia) Limited (Hong Kong) (an Asia trust
company).
g. Principal International de Chile, S.A. (Chile) a holding company.
h. Principal Mexico Compania de Seguros, S.A. de C.V. (Mexico) a
life insurance company.
i. Principal Pensiones, S.A. de C.V. (Mexico) a pension company.
j. Principal Afore, S.A. de C.V. (Mexico), a pension company.
k. Principal Consulting (India) Private Limited (an India
corporation) an India consulting company.
Subsidiaries 88% owned by Principal International, Inc.:
a. Principal Insurance Company (Hong Kong) Limited (a Hong Kong
Corporation) a company that sells insurance and pension products.
Subsidiary wholly-owned by Principal International Espana, S.A. de
Seguros de Vida (Spain):
a. Princor International Espana S.A. de Agencia de Seguros (Spain)
an insurance agency.
Subsidiary wholly-owned by Principal International (Asia) Limited
(Hong Kong):
a. Principal Capital Management (Asia) Limited (Hong Kong) Asian
representative and distributor for the Principal Investment
Funds.
Subsidiaries wholly-owned by Principal International Argentina, S.A.
(Argentina):
a. Principal Retiro Compania de Seguros de Retiro, S.A. (Argentina)
an annuity company.
b. Principal Life Compania de Seguros, S.A. (Argentina) a life
insurance company.
Subsidiary wholly-owned by Principal International de Chile, S.A.:
a. Principal Compania de Seguros de Vida Chile S.A. (Chile) life
insurance company.
Subsidiary 60% owned by Principal Compania de Seguros de Vida Chile
S.A. (Chile):
a. Andueza & Principal Creditos Hipotecarios S.A. (Chile) a
residential mortgage company.
Subsidiary wholly-owned by Principal Afore, S.A. de C.V.:
a. Siefore Principal, S.A. de C.V. (Mexico) an investment fund
company.
Item 25. Indemnification
Under Section 2-418 of the Maryland General Corporation Law, with respect
to any proceedings against a present or former director, officer, agent or
employee (a "corporate representative") of the Registrant, the Registrant may
indemnify the corporate representative against judgments, fines, penalties, and
amounts paid in settlement, and against expenses, including attorneys' fees, if
such expenses were actually incurred by the corporate representative in
connection with the proceeding, unless it is established that:
(i) The act or omission of the corporate representative was
material to the matter giving rise to the proceeding; and
1. Was committed in bad faith; or
2. Was the result of active and deliberate dishonesty; or
(ii) The corporate representative actually received an improper
personal benefit in money, property, or services; or
(iii) In the case of any criminal proceeding, the corporate
representative had reasonable cause to believe that the act or
omission was unlawful.
If a proceeding is brought by or on behalf of the Registrant, however, the
Registrant may not indemnify a corporate representative who has been adjudged to
be liable to the Registrant. Under the Registrant's Articles of Incorporation
and Bylaws, directors and officers of Registrant are entitled to indemnification
by the Registrant to the fullest extent permitted under Maryland law and the
Investment Company Act of 1940. Reference is made to Article VI, Section 7 of
the Registrant's Articles of Incorporation, Article 12 of Registrant's Bylaws
and Section 2-418 of the Maryland General Corporation Law.
The Registrant has agreed to indemnify, defend and hold the Distributor,
its officers and directors, and any person who controls the Distributor within
the meaning of Section 15 of the Securities Act of 1933, free and harmless from
and against any and all claims, demands, liabilities and expenses (including the
cost of investigating or defending such claims, demands or liabilities and any
counsel fees incurred in connection therewith) which the Distributor, its
officers, directors or any such controlling person may incur under the
Securities Act of 1933, or under common law or otherwise, arising out of or
based upon any untrue statement of a material fact contained in the Registrant's
registration statement or prospectus or arising out of or based upon any alleged
omission to state a material fact required to be stated in either thereof or
necessary to make the statements in either thereof not misleading, except
insofar as such claims, demands, liabilities or expenses arise out of or are
based upon any such untrue statement or omission made in conformity with
information furnished in writing by the Distributor to the Registrant for use in
the Registrant's registration statement or prospectus: provided, however, that
this indemnity agreement, to the extent that it might require indemnity of any
person who is also an officer or director of the Registrant or who controls the
Registrant within the meaning of Section 15 of the Securities Act of 1933, shall
not inure to the benefit of such officer, director or controlling person unless
a court of competent jurisdiction shall determine, or it shall have been
determined by controlling precedent that such result would not be against public
policy as expressed in the Securities Act of 1933, and further provided, that in
no event shall anything contained herein be so construed as to protect the
Distributor against any liability to the Registrant or to its security holders
to which the Distributor would otherwise be subject by reason of willful
misfeasance, bad faith, or gross negligence, in the performance of its duties,
or by reason of its reckless disregard of its obligations under this Agreement.
The Registrant's agreement to indemnify the Distributor, its officers and
directors and any such controlling person as aforesaid is expressly conditioned
upon the Registrant being promptly notified of any action brought against the
Distributor, its officers or directors, or any such controlling person, such
notification to be given by letter or telegram addressed to the Registrant.
Item 26. Business or Other Connection of Investment Adviser
A complete list of the officers and directors of the investment adviser,
Principal Management Corporation, are set out below. This list includes some of
the same people (designated by an *), who are serving as officers and directors
of the Registrant. For these people the information as set out in the Statement
of Additional Information (See Part B) under the caption "Directors and Officers
of the Fund" is incorporated by reference.
John E. Aschenbrenner Principal Executive Vice President
Director Financial Group Principal Life Insurance
Company
Craig R. Barnes Same President & Chief Executive
Vice President Officer, Invista Capital
Management LLC
*Craig L. Bassett Same See Part B
Treasurer
*Michael J. Beer Same See Part B
Executive Vice President
David J. Drury Same Chairman of the Board
Director Principal Life
Insurance Company
*Ralph C. Eucher Same See Part B
President and Director
*Arthur S. Filean Same See Part B
Vice President
Dennis P. Francis Same Senior Vice President
Director Principal Life
Insurance Company
Paul N. Germain Same Vice President -
Vice President - Mutual Fund Operations
Mutual Fund Operations Princor Financial Services
Corporation
*Ernest H. Gillum Same See Part B
Vice President - Compliance
& Product Development
Thomas J. Graf Same Senior Vice President
Director Principal Life
Insurance Company
*J. Barry Griswell Same See Part B
Chairman of the Board
and Director
Joyce N. Hoffman Same Vice President and
Vice President and Corporate Secretary
Corporate Secretary Principal Life
Insurance Company
Ellen Z. Lamale Same Senior Vice President &
Director Chief Actuary Principal Life
Insurance Company
Julia M. Lawler Same Vice President
Director Principal Life Insurance
Company
Richard L. Prey Same Executive Vice President
Director Principal Life Insurance
Company
Layne A. Rasmussen Same Controller
Controller - Princor Financial Services
Mutual Funds Corporation
Elizabeth R. Ring Same Controller- Broker Dealer
Controller Operations
Princor Financial Services
Corporation
*Michael D. Roughton Same See Part B
Counsel
Jean B. Schustek Same Product Compliance Officer -
Product Compliance Officer - Princor Financial Services
Registered Products Corporation
Principal Management Corporation serves as investment adviser and dividend
disbursing and transfer agent for, Principal Balanced Fund, Inc., Principal Blue
Chip Fund, Inc., Principal Bond Fund, Inc., Principal Capital Value Fund, Inc.,
Principal Cash Management Fund, Inc., Principal Government Securities Income
Fund, Inc., Principal Growth Fund, Inc., Principal High Yield Fund, Inc.,
Principal International Emerging Markets Fund, Inc., Principal European Equity
Fund, Inc., Principal International Fund, Inc., Principal International SmallCap
Fund, Inc., Principal LargeCap Stock Index Fund, Inc., Principal Limited Term
Bond Fund, Inc., Principal Pacific Basin Fund, Inc., Principal MidCap Fund,
Inc., Principal Partners Aggressive Growth Fund, Inc., Principal Partners
LargeCap Growth Fund, Inc., Principal Partners MidCap Growth Fund, Inc.,
Principal Real Estate Fund, Inc., Principal SmallCap Fund, Inc., Principal
Special Markets Fund, Inc., Principal Tax-Exempt Bond Fund, Inc., Principal
Utilities Fund, Inc., Principal Variable Contracts Fund, Inc. - funds sponsored
by Principal Life Insurance Company.
Item 27. Principal Underwriters
(a) Princor Financial Services Corporation, principal underwriter for
Registrant, acts as principal underwriter for, Principal Balanced Fund, Inc.,
Principal Blue Chip Fund, Inc., Principal Bond Fund, Inc., Principal Capital
Value Fund, Inc., Principal Cash Management Fund, Inc., Principal European
Equity Fund, Inc., Principal Government Securities Income Fund, Inc., Principal
Growth Fund, Inc., Principal High Yield Fund, Inc., Principal International
Emerging Markets Fund, Inc., Principal International Fund, Inc., Principal
International SmallCap Fund, Inc., Principal LargeCap Stock Index Fund, Inc.,
Principal Limited Term Bond Fund, Inc., Principal MidCap Fund, Inc., Principal
Pacific Basin Fund Inc., Principal Partners Aggressive Growth Fund, Inc.,
Principal Partners LargeCap Growth Fund, Inc., Principal Partners MidCap Growth
Fund, Inc., Principal Real Estate Fund, Inc., Principal SmallCap Fund, Inc.,
Principal Special Markets Fund, Inc., Principal Tax-Exempt Bond Fund, Inc.,
Principal Utilities Fund, Inc., Principal Variable Contracts Fund, Inc. and for
variable annuity contracts participating in Principal Life Insurance Company
Separate Account B, a registered unit investment trust for retirement plans
adopted by public school systems or certain tax-exempt organizations pursuant to
Section 403(b) of the Internal Revenue Code, Section 457 retirement plans,
Section 401(a) retirement plans, certain non- qualified deferred compensation
plans and Individual Retirement Annuity Plans adopted pursuant to Section 408 of
the Internal Revenue Code, and for variable life insurance contracts issued by
Principal Life Insurance Company Variable Life Separate Account, a registered
unit investment trust.
(b) (1) (2)
Positions
and offices
Name and principal with principal
business address underwriter
John E. Aschenbrenner Director
The Principal
Financial Group
Des Moines, IA 50392
Robert W. Baehr Marketing Services
The Principal Officer
Financial Group
Des Moines, IA 50392
Craig L. Bassett Treasurer
The Principal
Financial Group
Des Moines, IA 50392
Michael J. Beer Executive Vice President
The Principal
Financial Group
Des Moines, IA 50392
Jerald L. Bogart Insurance License Officer
The Principal
Financial Group
Des Moines, IA 50392
David J. Drury Director
The Principal
Financial Group
Des Moines, IA 50392
Ralph C. Eucher Director and
The Principal President
Financial Group
Des Moines, IA 50392
Arthur S. Filean Vice President
The Principal
Financial Group
Des Moines, IA 50392
Dennis P. Francis Director
The Principal
Financial Group
Des Moines, IA 50392
Paul N. Germain Vice President -
The Principal Mutual Fund Operations
Financial Group
Des Moines, IA 50392
Ernest H. Gillum Vice President -
The Principal Compliance and Product Development
Financial Group
Des Moines, IA 50392
Thomas J. Graf Director
The Principal
Financial Group
Des Moines, IA 50392
J. Barry Griswell Director and
The Principal Chairman of the
Financial Group Board
Des Moines, IA 50392
Susan R. Haupts Marketing Officer
The Principal
Financial Group
Des Moines, IA 50392
Joyce N. Hoffman Vice President and
The Principal Corporate Secretary
Financial Group
Des Moines, IA 50392
Kraig L. Kuhlers Marketing Officer
The Principal
Financial Group
Des Moines, IA 50392
Ellen Z. Lamale Director
The Principal
Financial Group
Des Moines, IA 50392
Julia M. Lawler Director
The Principal
Financial Group
Des Moines, IA 50392
John R. Lepley Senior Vice
The Principal President - Marketing
Financial Group and Distribution
Des Moines, IA 50392
Kelly A. Paul Systems and Technology
The Principal Officer
Financial Group
Des Moines, IA 50392
Elise M. Pilkington Assistant Director -
The Principal Retirement Consulting
Financial Group
Des Moines, IA 50392
Richard L. Prey Director
The Principal
Financial Group
Des Moines, IA 50392
Layne A. Rasmussen Controller -
The Principal Mutual Funds
Financial Group
Des Moines, IA 50392
Martin R. Richardson Operations Officer -
The Principal Broker/Dealer Services
Financial Group
Des Moines, IA 50392
Elizabeth R. Ring Controller
The Principal
Financial Group
Des Moines, IA 50392
Michael D. Roughton Counsel
The Principal
Financial Group
Des Moines, IA 50392
Jean B. Schustek Product Compliance Officer -
The Principal Registered Products
Financial Group
Des Moines, IA 50392
Kyle R. Selberg Vice President-Marketing
The Principal
Financial Group
Des Moines, IA 50392
Minoo Spellerberg Compliance Officer
The Principal
Financial Group
Des Moines, IA 50392
(c) Inapplicable.
Item 28. Location of Accounts and Records
All accounts, books or other documents of the Registrant are located at the
offices of the Registrant and its Investment Adviser in the Principal Life
Insurance Company home office building, The Principal Financial Group, Des
Moines, Iowa 50392.
Item 29. Management Services
Inapplicable.
Item 30. Undertakings
Indemnification
Reference is made to Item 27 above, which discusses circumstances under
which directors and officers of the Registrant shall be indemnified by the
Registrant against certain liabilities and expenses incurred by them by reason
of being a director or officer of the Registrant.
Notwithstanding the provisions of Registrant's Articles of Incorporation
and Bylaws, the Registrant hereby makes the following undertaking:
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
Registrant, pursuant to the foregoing provisions or otherwise, the Registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Act and is,
therefore, unenforceable. In the event that a claim for indemnification against
such liabilities (other than the payment by the Registrant of expenses incurred
or paid by a director, officer or controlling person of the Registrant, in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person of the Registrant, in connection with
the securities being registered, the Registrant will, unless in the opinion of
its counsel the matter has been settled by controlling precedent, submit to a
court of appropriate jurisdiction the question whether such indemnification by
it is against public policy as expressed in the Act and will be governed by the
final adjudication of such issue
Shareholder Communications
Registrant hereby undertakes to call a meeting of shareholders for the
purpose of voting upon the question of removal of a director or directors when
requested in writing to do so by the holders of at least 10% of the Registrant's
outstanding shares of common stock and in connection with such meeting to comply
with the provisions of Section 16(c) of the Investment Company Act of 1940
relating to shareholder communications
Delivery of Annual Report to Shareholders
The registrant hereby undertakes to furnish each person to whom a
prospectus is delivered a copy of the registrant's latest annual report to
shareholders, upon request and without charge.
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the
Investment Company Act of 1940 the Registrant certifies that it meets all of the
requirments for effectiveness of this Registration Statement and has duly caused
this Amendment to the Registration Statement to be signed on its behalf by the
undersigned, thereunto duly authorized in the City of Des Moines and State of
Iowa, on the 10th day of July, 2000.
Principal Variable Contracts Fund, Inc.
(Registrant)
By /s/ R. C. Eucher
______________________________________
R. C. Eucher
President and Director
Attest:
/s/ A. S. Filean
______________________________________
A. S. Filean
Senior Vice President and Secretary
Pursuant to the requirement of the Securities Act of 1933, this Amendment
to the Registration Statement has been signed below by the following persons in
the capacities and on the dates indicated.
Signature Title Date
/s/ R. C. Eucher
_____________________________ President and Director July 10, 2000
R. C. Eucher (Principal Executive _________________
Officer)
(J. B. Griswell)*
_____________________________ Director and July 10, 2000
J. B. Griswell Chairman of the Board _________________
_____________________________ Senior Vice President and July 10, 2000
K. L. Tibbetts Chief Financial Officer _________________
(Principal Fianncial
and Accounting Officer)
(J. D. Davis)*
_____________________________ Director July 10, 2000
J. D. Davis _________________
(P. A. Ferguson)*
_____________________________ Director July 10, 2000
P. A. Ferguson _________________
(R. W. Gilbert)*
_____________________________ Director July 10, 2000
R. W. Gilbert _________________
(W. C. Kimball)*
_____________________________ Director July 10, 2000
W. C. Kimball _________________
(B. A. Lukavsky)*
_____________________________ Director July 10, 2000
B. A. Lukavsky _________________
*By /s/ R. C. Eucher
_____________________________________
R. C. Eucher
President and Director
Pursuant to Powers of Attorney
Previously Filed or Included
