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FIXED INCOME FUND
IAI Institutional Bond Fund
Prospectus Dated
April 1, 1996
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Mutual Funds
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Table of Contents
IAI Institutional Bond Fund
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Fund Expense Information.............................................. 2
Fund Directors........................................................ 2
Financial Highlights.................................................. 3
Investment Performance................................................ 4
Investment Objective and Policies..................................... 5
Risk Factors.......................................................... 8
Management............................................................ 11
Computation of Net Asset
Value and Pricing..................................................... 12
Purchase of Shares.................................................... 13
Retirement Plans...................................................... 14
Redemption of Shares.................................................. 14
Authorized Telephone Trading.......................................... 15
Dividends, Distributions and
Tax Status............................................................ 15
Description of Common Stock........................................... 16
Counsel and Auditors.................................................. 16
Custodian, Transfer Agent and
Dividend Disbursing Agent............................................. 17
Additional Information................................................ 17
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IAI Mutual Funds
IAI Institutional Bond Fund
Prospectus Dated April 1, 1996
IAI Institutional Bond Fund (the "Fund") is a separate portfolio of IAI
Investment Funds I, Inc., a registered investment company authorized to issue
its shares of common stock in more than one series. The Fund's investment
objective is to provide shareholders with a high level of total return derived
from a combination of capital appreciation and current income. The Fund pursues
its objective by investing primarily in a diversified portfolio of investment
grade bonds and other debt securities of similar quality.
This Prospectus sets forth concisely the information which a prospective
investor should know about the Fund before investing and it should be retained
for future reference. A "Statement of Additional Information" dated April 1,
1996 which provides a further discussion of certain areas in this Prospectus and
other matters which may be of interest to some investors, has been filed with
the Securities and Exchange Commission and is incorporated herein by reference.
For a free copy, call or write the Fund at the address or telephone number shown
on the inside back cover of this prospectus.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
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Fund Expense Information
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Shareholder Transaction Expenses
Sales Load Imposed on Purchases None
Sales Load Imposed on Reinvested Dividends None
Redemption Fees None
Exchange Fees None
Annual Fund Operating Expenses (net of reimbursements)
(as a percentage of average daily net assets)
Management Fee .50%
Other Expenses -
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Total Fund Operating Expenses .50%
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Example: Based upon the levels of total fund operating expenses listed above,
you would pay the following expenses on a $1,000 investment, assuming a five
percent annual return and redemption at the end of each period:
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1 Year 3 Years 5 Years 10 Years
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$5 $16 $28 $63
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The purpose of the above table is to assist you in understanding the various
costs and expenses that an investor in the Fund will bear directly or
indirectly. The information in the table is based upon actual expenses by the
Fund incurred for the fiscal year ended November 30, 1995. THE EXAMPLE SHOULD
NOT BE CONSIDERED A REPRESENTATION OF PAST OR FUTURE EXPENSES. ACTUAL EXPENSES
MAY BE GREATER OR LESS THAN THOSE SHOWN. Under the Fund's Investment Advisory
and Administrative Services Agreement, the Fund's investment manager has agreed
to bear all the Fund's operating expenses (other than interest and, in certain
circumstances, taxes and extraordinary expenses). Additional information on such
agreement is set forth in the section "Management."
Fund Directors
Madeline Betsch
W. William Hodgson
George R. Long
Noel P. Rahn
Richard E. Struthers
J. Peter Thompson
Charles H. Withers
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Financial Highlights
The following information has been audited by KPMG Peat Marwick LLP, independent
auditors, whose report is included in the Fund's Annual Report. The financial
statements in the Annual Report are incorporated by reference in (and are a part
of) the Statement of Additional Information. Such Annual Report may be obtained
by shareholders on request from the Fund at no charge.
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Year ended Period from Period from
November 30, April 1, 1994+ to November 1, 1993***
1995 November 30, 1994 to March 31, 1994
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Net Asset Value:
Beginning of period $ 8.85 $ 9.36 $ 10.00
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Operations:
Net investment income .62 .38 .22
Net realized and unrealized losses .66 (.51) (.65)
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Total from operations 1.28 (.13) (.43)
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Distributions to shareholders from:
Net investment income (.63) (.38) (.21)
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Total distributions (.63) (.38) (.21)
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Net Asset Value:
End of period $ 9.50 $ 8.85 $ 9.36
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Total investment return* 14.95% (1.44%) (4.35%)
Net assets at end of period (000's omitted) $101,429 $ 73,724 $ 31,478
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Ratios:
Expenses to average daily net assets .50% .50%** .50%**
Net investment income to average daily net assets 6.76% 6.42%** 5.84%**
Portfolio turnover rate
(excluding short-term securities) 358.8% 235.10% 127.10%
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* Total investment return is based on the change in net asset value of a
share during the period and assumes reinvestment of distributions at net
asset value.
** Annualized.
*** Commencement of operations.
+ Reflects fiscal year-end change from March 31 to November 30.
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Investment Performance
From time to time the Fund may advertise performance data including monthly,
quarterly, yearly or cumulative total return, average annual total return and
yield figures. All such figures are based on historical earnings and performance
and are not intended to be indicative of future performance. The investment
return on and principal value of an investment in the Fund will fluctuate, so
that an investor's shares, when redeemed, may be worth more or less than their
original cost.
Total return is the change in value of an investment in the Fund over a given
period, assuming reinvestment of any dividends and capital gains. A cumulative
total return reflects actual performance over a stated period of time. An
average annual total return is a hypothetical rate of return that, if achieved
annually, would have produced the same cumulative total return if performance
had been constant over the entire period.
Yield refers to the income generated by an investment in the Fund over a given
period of time, expressed as an annual percentage rate. Yields are calculated
according to a standard that is required for all stock and bond funds. Because
this differs from other accounting methods, the quoted yield may not equal the
income actually paid to shareholders.
For additional information regarding the calculation of such total return and
yield figures, see "Investment Performance" in the Statement of Additional
Information. Further information about the performance of the Fund is contained
in the Fund's annual report to shareholders which may be obtained without charge
from the Fund.
Comparative performance information may be used from time to time in advertising
or marketing the Fund's shares, including data on the performance of other
mutual funds, indexes or averages of other mutual funds, indexes of related
financial assets or data, and other competing investment and deposit products
available from or through other financial institutions. The composition of these
indexes, averages or products differs from that of the Fund. The comparison of
the Fund to an alternative investment should be made with consideration of
differences in features and expected performance. The Fund may also note its
mention in newspapers, magazines, or other media from time to time. The Fund
assumes no responsibility for the accuracy of such data. For additional
information on the types of indexes, averages and periodicals that might be
utilized by the Fund in advertising and sales literature, see the section
"Investment Performance" in the Statement of Additional Information.
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Investment Objective and Policies
The Fund's investment objective is to provide shareholders with a high level of
total return derived from a combination of capital appreciation and current
income. Such objective may not be changed without shareholder approval. There
can be no assurance that the Fund's investment objective will be attained.
The Fund pursues its objective by investing primarily in a diversified portfolio
of investment grade bonds and other debt securities of similar quality.
Investment grade securities are those securities rated within the four highest
grades assigned by Moody's Investors Service, Inc. ("Moody's") or Standard &
Poor's Corporation ("S&P").
The Fund may also invest in below investment grade securities. Such securities
are commonly referred to as junk bonds. The Fund currently intends to limit such
investments to 15% of its total assets and not to invest in junk bonds rated
lower than B by Moody's or S&P. Securities rated in the medium to lower rating
categories of nationally recognized statistical rating organizations and unrated
securities of comparable quality are predominately speculative with respect to
the capacity to pay interest and repay principal in accordance with the terms of
the security and generally involve a greater volatility of price than securities
in higher rating categories. See "Investment Objective and Policies" in the
Statement of Additional Information for additional information regarding ratings
of debt securities. In purchasing such securities, the Fund will rely on IAI's
judgement, analysis and experience in evaluating the creditworthiness of an
issuer of such securities. IAI will take into consideration, among other things,
the issuer's financial resources, its sensitivity to economic conditions and
trends, its operating history, the quality of the issuer's management and
regulatory matters.
Other debt securities in which the Fund may invest include securities of, or
guaranteed by, the United States Government, its agencies or instrumentalities,
debt securities of foreign issuers, commercial paper, asset-backed securities,
mortgage-backed securities, and below investment grade securities. Under normal
market conditions, at least 65% of the Fund's total assets will be invested in
debt obligations and government securities with maturities at the time of
acquisition of one year or more.
Although the Fund generally will not make direct purchases of common stock, the
Fund may purchase preferred stock and convertible securities. Preferred stocks
are securities that represent an ownership interest in a corporation and that
give the owner a prior claim over common stock on the company's earnings or
assets. Convertible securities are debt obligations of corporations convertible
into or exchangeable for equity securities or debt obligations that carry with
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them the right to acquire equity securities, as evidenced by warrants attached
to such securities, or acquired as part of units of the securities. The risks
associated with investing in preferred stock and convertible securities are
different from those traditionally associated with investments in debt
securities. Such risks are similar instead to the risks associated with
investments in equity securities, including the risk that the value of the
equity security will fluctuate in response to the activities of the issuing
company or in response to general market and/or economic conditions.
See "Investment Objective and Policies" in the Statement of Additional
Information for further information on certain of the Fund's portfolio
securities.
Other Investment Techniques
The Fund's ability to utilize certain of the investment techniques discussed
below may be subject to limitations and may subject the Fund to additional
risks. Please refer to the section "Risk Factors" below and the Statement of
Additional Information for more information regarding such risks.
Repurchase Agreements
The Fund may invest in repurchase agreements relating to the securities in which
it may invest. In a repurchase agreement, the Fund buys a security at one price
and simultaneously agrees to sell it back at a higher price. Delays or losses
could result if the other party to the agreement defaults or becomes bankrupt.
When-Issued/Delayed
Delivery Transactions
The Fund may purchase securities on a "when-issued" or delayed delivery basis
and purchase or sell securities on a "forward commitment" basis. When such
transactions are negotiated, the price is fixed at the time the commitment is
made, but delivery and payment for the securities take place at a later date.
Normally, the settlement date occurs within two months after the transaction,
but delayed settlements beyond two months may be negotiated. At the time the
Fund enters into a transaction on a when-issued or forward commitment basis, a
segregated account consisting of cash, government securities or liquid high-
grade debt securities equal to the value of the when-issued or forward
commitment securities will be established and maintained with the custodian and
will be marked to the market daily. During the period between a commitment and a
settlement, no payment is made for the securities and, thus, no interest accrues
to the purchaser from the transaction. If the Fund disposes of the right to
acquire a when-issued security prior to its acquisition or disposes of its right
to deliver or receive against a forward commitment, it can incur a gain or loss
due to market fluctuation. The use of when-issued transactions and forward
commitments enables the Fund to hedge against anticipated changes in interest
rates and prices. The Fund may also enter into such transactions to generate
incremental income. In some instances,
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the third-party seller of when-issued or forward commitment securities may
determine prior to the settlement date that it will be unable or unwilling to
meet its existing transaction commitments without borrowing securities. If
advantageous from a yield perspective, the Fund may, in that event, agree to
resell its purchase commitment to the third-party seller at the current market
price on the date of sale and concurrently enter into another purchase
commitment for such securities at a later date. As an inducement for the Fund to
"roll over" its purchase commitment, the Fund may receive a negotiated fee. No
more than 20% of the Fund's net assets may be invested in when-issued, delayed
delivery or forward commitment transactions, and of such 20%, no more than one-
half (i.e. 10% of its net assets) may be invested in when-issued, delayed
delivery or forward commitment transactions without the intention of actually
acquiring securities (i.e. dollar rolls or "roll" transactions). For additional
information on roll transactions, see "Investment Objectives and
Policies--Dollar Rolls" in the Statement of Additional Information.
Illiquid Securities
The Fund may invest up to 15% of its net assets in securities that are
considered illiquid because of the absence of a readily available market or due
to legal or contractual restrictions. However, certain restricted securities
that are not registered for sale to the general public but that can be resold to
institutional investors may be considered liquid pursuant to guidelines adopted
by the Board of Directors. The institutional trading market is relatively new,
and the liquidity of the Fund's investments could be impaired if trading does
not develop or declines.
Zero Coupon Obligations
The Fund may also invest in zero coupon obligations of the U.S. Government or
its agencies, tax exempt issuers and corporate issuers, including rights to
stripped coupon and principal payments ("STRIPS"). Zero coupon bonds do not make
regular interest payments; rather, they are sold at a discount from face value.
Principal and accreted discount (representing interest accrued but not paid) are
paid at maturity. STRIPS are the components of debt securities that are stripped
of their interest after the securities are issued, but otherwise are comparable
to zero coupon bonds. The market values of STRIPS and zero coupon bonds
generally fluctuate in response to changes in interest rates to a greater degree
than do interest-paying securities of comparable term and quality.
Foreign Securities
The Fund may invest in securities issued by foreign issuers, whether dollar-
denominated or not, including securities issued or guaranteed by one or more
foreign governments or any of their political subdivisions, agencies or
instrumentalities, including obligations of supranational
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entities, that are determined by Investment Advisers, Inc. ("IAI"), the Fund's
investment adviser and manager, to be of comparable quality to the other
obligations in which the Fund may invest.
Adjusting Investment
Exposure
The Fund can use various techniques to increase or decrease its exposure to
changing security prices, interest rates, currency exchange rates, commodity
prices, or other factors that affect security values. These techniques include
buying and selling options and futures contracts, entering into currency
exchange contracts or swap agreements, purchasing indexed securities, and
selling securities short.
Borrowing
The Fund may borrow from banks (or through reverse repurchase agreements) for
temporary or emergency purposes. If the Fund borrows money, its share price may
be subject to greater fluctuation until the borrowing is paid off. If the Fund
makes additional investments while borrowings are outstanding, this may be
considered a form of leverage.
Portfolio Turnover
The Fund will dispose of securities without regard to the time they have been
held when such action appears advisable to management either as a result of
securities having reached a price objective, or by reason of developments not
foreseen at the time of the investment decision. Since investment changes
usually will be made without reference to the length of time a security has been
held, a significant number of short-term transactions may result. Accordingly,
the Fund's annual portfolio turnover rate cannot be anticipated and may be
relatively high, as it was for the last fiscal year. High turnover rates (100%
or more) increase transaction costs, and may increase taxable capital gains. The
Fund's historical portfolio turnover rates are set forth in the section
"Financial Highlights."
Risk Factors
Interest Rate Risk
As a mutual fund investing in fixed-income securities, the Fund is subject to
interest rate risk. Interest rate risk is the potential for a decline in bond
prices due to rising interest rates. In general, bond prices vary inversely with
interest rates. When interest rates rise, bond prices generally fall.
Conversely, when interest rates fall, bond prices generally rise. The change in
price depends on several factors, including the bond's maturity date. In
general, bonds with longer maturities are more sensitive to changes in interest
rates than bonds with shorter maturities. In managing the Fund, IAI will adjust
the duration of the investment portfolio in response to economic and market
conditions. Duration is generally considered a better measure of interest rate
risk than is maturity. Duration is a measure of the expected change in value of
a fixed-income security (or portfolio) for a given change in interest rates. For
example, if interest rates rise by one percent, the
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IAI Institutional Bond Fund
market value of a security (or portfolio) having a duration of two generally
will fall by approximately two percent. In some situations, the standard
duration calculation does not properly reflect the interest rate risk of a
security. In such situations, IAI will use more sophisticated analytical
techniques, such as modeling principal and interest payments based upon
historical experience or expected volatility, to arrive at an effective duration
that incorporates the additional variables into the determination of interest
rate risk. These techniques may involve estimates of future economic parameters
which may vary from actual future outcomes. IAI anticipates that the duration of
the Fund will be from 3.5 to 7 years. This range is merely an expectation as of
the date of this Prospectus. Such range may change due to market conditions and
other economic factors. Therefore, the expected duration range does not limit
IAI in how it manages the Fund.
Credit Risk
The Fund is also subject to credit risk. Credit risk, also known as default
risk, is the possibility that a bond issuer will fail to make timely payments of
interest or principal to the Fund. The credit risk of a Fund depends on the
quality of its investments. Reflecting their higher risks, lower-quality bonds
generally offer higher yields (all other factors being equal).
Call Risk
The Fund is also subject to call risk. Call risk is the possibility that
corporate bonds held by the Fund will be repaid prior to maturity. Call
provisions, common in many corporate bonds held by the Fund, allow bond issuers
to redeem bonds prior to maturity (at a specified price). When interest rates
are falling, bond issuers often exercise these call provisions, paying off bonds
that carry high stated interest rates and often issuing new bonds at lower
rates. For the Fund, the result would be that bonds with high interest rates are
"called" and must be replaced with lower-yielding instruments. In these
circumstances, the income of the Fund would decline.
Lower-Rated Debt Securities
The Fund may invest in debt securities commonly known as "junk" bonds. Such
securities are subject to higher risks and greater market fluctuations than are
lower-yielding, higher-rated securities. The price of junk bonds has been found
to be less sensitive to changes in prevailing interest rates than higher-rated
investments, but is likely to be more sensitive to adverse economic changes or
individual corporate developments. During an economic downturn or substantial
period of rising interest rates, highly leveraged issuers may experience
financial stress which would adversely affect their ability to service their
principal and interest payment obligations, to meet their projected business
goals or to obtain additional financing. If the issuers of a fixed-income
security owned by the Fund were to default, the Fund might incur additional
expenses to seek recov-
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ery. The risk of loss due to default by issuers of junk bonds is significantly
greater than that associated with higher-rated securities because such
securities generally are unsecured and frequently are subordinated to the prior
payment of senior indebtedness. In addition, periods of economic uncertainty and
change can be expected to result in an increased volatility of market prices of
junk bonds and a concomitant volatility in the net asset value of a share of the
Fund.
The secondary market for junk bonds is less liquid than the markets for higher
quality securities and, as such, may have an adverse effect on the market prices
of certain securities. The limited liquidity of the market may also adversely
affect the ability of the Fund to arrive at a fair value for certain junk bonds
at certain times and could make it difficult for the Fund to sell certain
securities. For a description of Moody's and S&P ratings, see Appendix A to the
Statement of Additional Information.
Foreign Investment
Risk Factors
Investments in foreign securities involve risks that are different in some
respects from investments in securities of U.S. issuers, such as the risk of
fluctuations in the value of the currencies in which they are denominated, the
risk of adverse political and economic developments and, with respect to certain
countries, the possibility of expropriation, nationalization or confiscatory
taxation or limitations on the removal of funds or other assets of the Fund.
Securities of some foreign companies are less liquid and more volatile than
securities of comparable domestic companies. There also may be less publicly
available information about foreign issuers than domestic issuers, and foreign
issuers generally are not subject to the uniform accounting, auditing and
financial reporting standards, practices and requirements applicable to domestic
issuers. Because the Fund can invest in securities denominated or quoted in
currencies other than the U.S. dollar, changes in foreign currency exchange
rates may affect the value of securities in the portfolio. Foreign currency
exchange rates are determined by forces of supply and demand in the foreign
exchange markets and other economic and financial conditions affecting the world
economy. A decline in the value of any particular currency against the U.S.
dollar will cause a decline in the U.S. dollar value of the Fund's holdings of
securities denominated in such currency and, therefore, will cause an overall
decline in the Fund's net asset value and net investment income and capital
gains, if any, to be distributed in U.S. dollars to shareholders by the Fund.
Delays may be encountered in settling securities transactions in certain foreign
markets, and the Fund will incur costs in converting foreign currencies into
U.S. dollars. Custody charges are generally higher for foreign securities.
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Risks of Transactions
in Derivatives
The Fund will spread investment risk by limiting its holdings in any one company
or industry. IAI may use futures, options, swap and currency exchange agreements
as well as short sales to adjust the risk and return characteristics of the
Fund's portfolio of investments. If IAI judges market conditions incorrectly or
employs a strategy that does not correlate well with the Fund's investments, use
of these techniques could result in a loss, regardless of whether the intent was
to reduce risk or increase return. Use of these techniques may increase the
volatility of the Fund and may involve a small investment of cash relative to
the magnitude of risk assumed. In addition, these techniques could result in a
loss if the counterparty to the transaction is unable to perform as promised.
Moreover, a liquid secondary market for any futures or options contract may not
be available when a futures or options position is sought to be closed. Please
refer to the Statement of Additional Information which further describes these
risks.
Manager Risk
IAI manages the Fund according to the traditional methods of "active" investment
management, which involve the buying and selling of securities based upon
economic, financial and market analysis and investment judgement. Manager risk
refers to the possibility that IAI may fail to execute the Fund's investment
strategy effectively. As a result, the Fund may fail to achieve its stated
objective.
Investment Restrictions
The Fund is subject to certain other investment policies and restrictions
described in the Statement of Additional Information, some of which are
fundamental and may not be changed without the approval of the shareholders of
the Fund. Please refer to the Statement of Additional Information for a further
discussion of these policies and restrictions.
Management
The Fund was created on September 27, 1993, as a separate portfolio represented
by a separate class of common stock of IAI Investment Funds I, Inc., a Minnesota
corporation created on April 22, 1977. Under Minnesota law, the Fund's Board of
Directors is generally responsible for the overall management and operation of
the Fund. IAI serves as the investment adviser and manager of the Fund pursuant
to a written agreement (the "Management Agreement"). IAI's ultimate corporate
parent is Lloyds TSB Group plc, a publicly-held financial services organization
headquartered in London, England. Lloyds TSB Group plc is one of the largest
personal and corporate financial services groups in the United Kingdom and is
engaged in a wide range of activities including commercial and retail banking.
The address of IAI is that of the Fund. IAI also furnishes investment advice to
other concerns including other investment compa-
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IAI Institutional Bond Fund
nies, pension and profit sharing plans, foundations, religious, educational and
charitable institutions, trusts, municipalities and individuals, having total
assets in excess of $14.5 billion.
Under the Management Agreement, IAI provides the Fund with investment advice,
statistical and research facilities, and certain equipment and services,
including, but not limited to, office space and necessary office facilities,
equipment, and the services of required personnel. IAI also provides all
required administrative, stock transfer, redemption, dividend disbursing and
accounting services, including, for example, the maintenance of the Fund's
accounts, books and records, the daily calculation of the Fund's net asset
value, daily and periodic reports, all information necessary to complete tax
returns, questionnaires and other reports requested by the Fund, the maintenance
of stock registry records, the processing of requested account registration
changes and redemption requests, and the administration of payments of dividends
and distributions declared by the Fund. In addition, the Management Agreement
provides that, except for interest and, in certain circumstances, taxes and
extraordinary expenses, IAI shall bear the Fund's operating expenses. As
compensation for these services, the Fund paid IAI a fee of .50% of the Fund's
average daily net assets for the fiscal year ended November 30, 1995. IAI shall
not be liable for any loss suffered by the Fund in the absence of willful
misfeasance, bad faith or gross negligence in the performance of its duties and
obligations.
The Fund is managed by a team of IAI investment professionals which is
responsible for making day-to-day investment decisions for the Fund. Larry Hill,
Timothy Palmer and Mark Simenstad have been responsible for the management of
the Fund since its inception. Mr. Hill is IAI's Chief Fixed Income Officer and a
member of its Board of Directors, and has served as a fixed income portfolio
manager since joining IAI in 1984. Mr. Palmer is a Senior Vice President of IAI
and has served as a fixed income portfolio manager since joining IAI in 1990.
Mr. Simenstad is a Vice President of IAI and has served as a fixed income
portfolio manager since joining IAI in 1993. Prior to joining IAI, Mr. Simenstad
served as a fixed income portfolio manager for Lutheran Brotherhood.
Computation of Net Asset
Value and Pricing
The Fund is open for business each day the New York Stock Exchange ("NYSE") is
open. IAI normally calculates the Fund's net asset value ("NAV") as of the close
of business of the NYSE, normally 3 p.m. Central time.
The Fund's NAV is the value of a single share. The NAV is computed by adding up
the value of the Fund's investments, cash, and other assets, subtracting its
liabilities, and then
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IAI Institutional Bond Fund
dividing the result by the number of shares outstanding.
The Fund's investments with remaining maturities of 60 days or less may be
valued on the basis of amortized cost. This method minimizes the effect of
changes in a security's market value. Other portfolio securities and assets are
valued primarily on the basis of market quotations or, if quotations are not
readily available, by a method that the Board of Directors believes accurately
reflects fair value. Foreign securities are valued on the basis of quotations
from the primary market in which they are traded, and are translated from the
local currency into U.S. dollars using current exchange rates.
The offering price (price to buy one share) and redemption price (price to sell
one share) are the Fund's NAV next computed after receipt by the Fund of a
purchase or redemption order.
Purchase of Shares
The Fund offers its shares continually to the public at the net asset value of
such shares. Shares may be purchased directly from the Fund or through certain
security dealers who have responsibility to promptly transmit orders and may
charge a processing fee. No sales load or commission is charged in connection
with the purchase of Fund shares.
The minimum initial investment in the Fund is $2 million. The minimum investment
requirement may be waived or lowered for investments effected on a group basis
by certain entities and their employees, such as pursuant to a payroll deduction
plan.
Shares may be purchased for cash or in exchange for securities which are
permissible investments of the Fund, subject to IAI's discretion and its
determination that the securities are acceptable. Securities accepted in
exchange will be valued on the basis of market quotations or, if market
quotations are not available, by a method that IAI believes accurately reflects
fair value. In addition, securities accepted in exchange are required to be
liquid securities that are not restricted as to transfer.
Purchases of shares are subject to acceptance or rejection by the Fund on the
same day the purchase order is received and are not binding until so accepted.
It is the policy of the Fund to keep confidential information contained in the
application and regarding the account of an investor or potential investor in
the Fund. All funds will be invested in full and fractional shares of the Fund.
Share certificates will not be issued.
All correspondence relating to the purchase of shares should be directed to the
office of the Fund, P.O. Box 357, Minneapolis, Minnesota 55440 or, if using
overnight delivery, to 3700 First Bank Place, 601 Second Avenue South,
Minneapolis, Minnesota 55402. For assistance in completing the application
please contact IAI Mutual Fund Shareholder Services at 1-800-945-3863.
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Retirement Plans
Shares of the Fund may be an appropriate investment medium for various
retirement plans. Persons desiring information about establishing an Individual
Retirement Account ("IRA") (for employed persons and their spouses) or other
retirement plans should contact the Fund at 1-800-945-3863. All retirement plans
involve a long-term commitment of assets and are subject to various legal
requirements and restrictions. The legal and tax implications may vary according
to the circumstances of the individual investor. Therefore, you are urged to
consult with an attorney or tax advisor prior to the establishment of such a
plan.
Redemption of Shares
Registered holders of Fund shares may at any time require the Fund to redeem
their shares upon their written request that the Fund redeem such shares.
Shareholders may redeem shares by phone (subject to a limit of $50,000) provided
such shareholders have authorized the Fund to accept telephone instructions.
Redemption instructions must be made by the person(s) in whose name the shares
are registered. If the redemption proceeds are to be paid or mailed to any
person other than the shareholder of record or if redemption proceeds are in
excess of $50,000, the Fund will require that the signature on the written
instructions be guaranteed by a participant in a signature guarantee program,
which may include certain national banks or trust companies or certain member
firms of national securities exchanges. (Notarization by a Notary Public is NOT
ACCEPTED.) If the shares are held of record in the name of a corporation,
partnership, trust or fiduciary, the Fund may require additional evidence of
authority prior to accepting a request for redemption. The Fund will not send
redemption proceeds until checks (including certified checks or cashiers checks)
received in payment for shares have cleared.
The redemption proceeds received by the investor are based on the net asset
value next determined after redemption instructions in good order are received
by the Fund. Since the value of shares redeemed is based upon the value of the
Fund investment at the time of redemption, it may be more or less than the price
originally paid for the shares.
Payment for shares redeemed will ordinarily be made within seven days after a
request for redemption has been made. Normally the Fund will mail payment for
shares redeemed on the business day following receipt of the redemption request.
Following a redemption or transfer request, if the value of a shareholder's
interest in the Fund falls below $2 million, the Fund reserves the right to
redeem such shareholder's entire interest and remit such amount. Such a
redemption will only be effected following: (a) a redemption or transfer by a
shareholder which causes the value of such shareholder's interest in the Fund to
fall below
14
<PAGE>
IAI Mutual Funds
IAI Institutional Bond Fund
$2 million; (b) the mailing by the Fund to such shareholder of a notice of
intention to redeem; and (c) the passage of at least sixty days from the date of
such mailing, during which time the investor will have the opportunity to make
an additional investment in the Fund to increase the value of such investor's
account to at least $2 million.
Authorized Telephone Trading
Investors can transact account exchanges and redemptions via the telephone by
completing the Authorized Telephone Trading section of the IAI Mutual Fund
application and returning it to the Fund. Investors requesting telephone trading
privileges will be provided with a personal identification number ("PIN") that
must accompany any instructions by phone. Shares will be redeemed or exchanged
at the next determined net asset value. All proceeds must be made payable to the
owner(s) of record and delivered to the address of record.
In order to confirm that telephone instructions for redemptions and exchanges
are genuine, the Fund has established reasonable procedures including the
requirement that a personal identification number accompany telephone
instructions. If the Fund or the transfer agent fail to follow these procedures,
the Fund may be liable for losses due to unauthorized or fraudulent
instructions. To the extent the reasonable procedures are followed, none of the
Fund, its transfer agent, IAI or any affiliated broker/dealer will be liable for
any loss, injury, damage or expense for acting upon telephone instructions
believed to be genuine and will otherwise not be responsible for the
authenticity of any telephone instructions and, accordingly, the investor bears
the risk of loss resulting from telephone instructions. All telephone
redemptions and exchange requests will be tape recorded.
Dividends, Distributions
and Tax Status
The policy of the Fund is to pay dividends from net investment income monthly
and to make distributions of realized capital gains, if any, annually. However,
provisions in the Internal Revenue Code of 1986, as amended (the "Code"), may
result in additional net investment income and capital gains distributions by
the Fund. When you open an account, you should specify on your application how
you want to receive your distributions. Normally, all dividend and capital gain
distributions are automatically reinvested in additional shares of the Fund.
The Fund intends to qualify for tax purposes as a regulated investment company
under the Internal Revenue Code during the current taxable year. If so
qualified, the Fund will not be subject to federal income tax on income that it
distributes to its shareholders.
Generally, dividends and capital gain distributions with respect to shares held
by a tax-deferred or qualified pension plan, such as an IRA, Section 403(b)(7)
retire-
15
<PAGE>
IAI Mutual Funds
IAI Institutional Bond Fund
ment plan or corporate pension or profit sharing plan, will not be taxable to
the plan. Distributions from such plans will be taxable to individual
participants under applicable tax rules without regard to the character of the
income earned by the qualified plan. If you participate in such a plan, consult
your plan administrator, your plan's Summary Plan Description, or a professional
tax advisor regarding the tax consequences of your participation in the plan,
and of any plan contributions or withdrawals.
Description of Common Stock
All shares of the Fund have equal rights as to redemption, dividends and
liquidation, and will be fully paid and nonassessable when issued and will have
no preemptive or conversion rights.
The shares of the Fund have noncumulative voting rights, which means that the
holders of more than 50% of the shares voting for the election of directors can
elect 100% of the directors if they choose to do so. On some issues, such as the
election of directors, all shares of IAI Investment Funds I, Inc., vote together
as one series. On an issue affecting only a particular series, such as voting on
an investment advisory agreement, only the approval of a particular series is
required to make the agreement effective with respect to such series.
Annual or periodically scheduled regular meetings of shareholders will not be
held except as required by law. Minnesota corporation law does not require an
annual meeting; instead, it provides for the Board of Directors to convene
shareholder meetings when it deems appropriate. In addition, if a regular
meeting of shareholders has not been held during the immediately preceding
fifteen months, shareholders holding three percent or more of the voting shares
of the Fund may demand a regular meeting of shareholders of the Fund by written
notice of demand given to the chief executive officer or the chief financial
officer of the Fund. Within thirty days after receipt of the demand by one of
those officers, the Board of Directors shall cause a regular meeting of
shareholders to be called and held no later than ninety days after receipt of
the demand, all at the expense of the Fund. An annual meeting will be held on
the removal of a director or directors of the Fund if requested in writing by
holders of not less than 10% of the outstanding shares of the Fund.
Counsel and Auditors
The firm of Dorsey & Whitney LLP, 220 South Sixth Street, Minneapolis, Minnesota
55402, provides legal counsel to the Fund. KPMG Peat Marwick LLP, 4200 Norwest
Center, Minneapolis, Minnesota 55402, serves as the independent auditors for the
Fund.
16
<PAGE>
IAI Mutual Funds
IAI Institutional Bond Fund
Custodian, Transfer Agent and Dividend Disbursing Agent
The Custodian for the Fund is Norwest Bank Minnesota, N.A., Norwest Center,
Sixth and Marquette, Minneapolis, Minnesota 55479. Norwest employs foreign
subcustodians and depositories, which were approved by the Fund's Board of
Directors in accordance with the rules and regulations of the Securities and
Exchange Commission, for the purpose of providing custodial services for the
Fund's assets held outside the United States. For a listing of the subcustodians
and depositories currently employed by the Fund, see the Statement of Additional
Information. IAI acts as the Fund's transfer agent, dividend disbursing agent
and IRA Custodian, at P.O. Box 357, Minneapolis, Minnesota 55440.
Additional Information
The Fund sends to its shareholders a six-month unaudited and an annual audited
financial report, each of which includes a list of investment securities held.
Shareholder inquiries should be directed to the Fund at the telephone number or
mailing address listed on the inside back cover of this Prospectus.
The following table sets forth the percentage of securities holdings by rating
category based upon a weighted monthly average for the Fund for the fiscal year
ended November 30, 1995.
<TABLE>
<CAPTION>
Bonds - Moody's Rating IAI Institutional Bond Fund
- -------------------------------------------------------------------------------
<S> <C>
Aaa 27%
Aa 6%
A 8%
Baa 5%
Ba 3%
B 4%
Caa 0%
Ca 0%
C 0%
U.S. Government 47%
- -------------------------------------------------------------------------------
Total 100%
===============================================================================
</TABLE>
17
<PAGE>
To Open An
Account
1.800.945.3863
612.376.2700
IAI
P.O. Box 357
Minneapolis, MN 55440
Overnight
Delivery Address
IAI
3700 First Bank Place
601 Second Avenue South
Minneapolis, MN 55402
Distributed by IAI Securities, Inc.
<PAGE>
[LOGO]
Mutual Funds
Investment Advisers, Inc.
3700 First Bank Place, P.O. Box 357, Minneapolis, Minnesota 55440-0357
USA fax 612.376.2737
800.945.3863
612.376.2700
<PAGE>
IAI INSTITUTIONAL BOND FUND
STATEMENT OF ADDITIONAL INFORMATION
DATED APRIL 1, 1996
THIS STATEMENT OF ADDITIONAL INFORMATION IS NOT A PROSPECTUS. THIS
STATEMENT OF ADDITIONAL INFORMATION RELATES TO A PROSPECTUS DATED APRIL 1, 1996
AND SHOULD BE READ IN CONJUNCTION THEREWITH. A COPY OF THE PROSPECTUS MAY BE
OBTAINED FROM THE FUND, 3700 FIRST BANK PLACE, P.O. BOX 357, MINNEAPOLIS,
MINNESOTA 55440 (TELEPHONE: 1-612-376-2700 OR 1-800-945-3863).
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
<S> <C>
INVESTMENT OBJECTIVE AND POLICIES......................................... 3
Repurchase Agreements................................................ 3
Reverse Repurchase Agreements........................................ 3
Securities of Foreign Issuers........................................ 3
Lending Portfolio Securities......................................... 4
Illiquid Securities.................................................. 4
Variable or Floating Rate Instruments................................ 4
Delayed-Delivery Transactions........................................ 4
Dollar Rolls......................................................... 5
Mortgage-Backed Securities........................................... 5
Stripped Mortgage Backed Securities.................................. 6
Asset-Backed Securities.............................................. 6
Zero Coupon Bonds.................................................... 6
Lower-Rated Debt Securities.......................................... 6
Swap Agreements...................................................... 7
Indexed Securities................................................... 7
Loans and Other Direct Debt Instruments.............................. 8
Foreign Currency Transactions........................................ 9
Limitations on Futures and Options Transactions...................... 10
Futures Contracts.................................................... 10
Futures Margin Payments.............................................. 10
Purchasing Put and Call Options...................................... 10
Writing Put and Call Options......................................... 11
Combined Positions................................................... 11
Correlation of Price Changes......................................... 11
Liquidity of Options and Futures Contracts........................... 12
OTC Options.......................................................... 12
Options and Futures Relating to Foreign Currencies................... 12
Asset Coverage for Futures and Options Positions..................... 13
INVESTMENT RESTRICTIONS................................................... 13
Portfolio Turnover................................................... 15
INVESTMENT PERFORMANCE.................................................... 15
MANAGEMENT................................................................ 17
Management Agreement................................................. 20
CUSTODIAL SERVICE......................................................... 21
PORTFOLIO TRANSACTIONS AND ALLOCATION OF BROKERAGE........................ 25
CAPITAL STOCK............................................................. 25
NET ASSET VALUE AND PUBLIC OFFERING PRICE................................. 26
TAX STATUS................................................................ 27
LIMITATION OF DIRECTOR LIABILITY.......................................... 28
FINANCIAL STATEMENTS...................................................... 28
Appendix A--Ratings of Debt Securities.................................... A-1
2
</TABLE>
<PAGE>
INVESTMENT OBJECTIVE AND POLICIES
The investment objective and policies of IAI Institutional Bond Fund (the
"Fund") are summarized on the front page of the Prospectus and in the text of
the Prospectus under "Investment Objective and Policies." Investors should
understand that all investments have a risk factor. There can be no guarantee
against loss resulting from an investment in the Fund, and there can be no
assurance that the Fund's investment policies will be successful, or that its
investment objective will be attained. Certain of the investment practices of
the Fund are further explained below.
REPURCHASE AGREEMENTS
The Fund may invest in repurchase agreements relating to the securities in
which it may invest. A repurchase agreement involves the purchase of securities
with the condition that, after a stated period of time, the original seller will
buy back the securities at a predetermined price or yield. The Fund's custodian
will have custody of, and will hold in a segregated account, securities acquired
by the Fund under a repurchase agreement or other securities as collateral. In
the case of a security registered on a book entry system, the book entry will be
maintained in the Fund's name or that of its custodian. Repurchase agreements
involve certain risks not associated with direct investments in securities. For
example, if the seller of the agreement defaults on its obligation to repurchase
the underlying securities at a time when the value of the securities has
declined, the Fund may incur a loss upon disposition of such securities. In the
event that bankruptcy proceedings are commenced with respect to the seller of
the agreement, the Fund's ability to dispose of the collateral to recover its
investment may be restricted or delayed. While collateral will at all times be
maintained in an amount equal to the repurchase price under the agreement
(including accrued interest due thereunder), to the extent proceeds from the
sale of collateral were less than the repurchase price, the Fund could suffer a
loss.
REVERSE REPURCHASE AGREEMENTS
The Fund may invest in reverse repurchase agreements as a form of
borrowing. In a reverse repurchase agreement, a fund sells a portfolio
instrument to another party, such as a bank or broker-dealer, in return for cash
and agrees to repurchase the instrument at a particular price and time. While a
reverse repurchase agreement is outstanding, the Fund will comply with
guidelines established by the Securities and Exchange Commission regarding the
segregation of assets. The Fund will enter into reverse repurchase agreements
only with parties whose creditworthiness has been found satisfactory by
Investment Advisers, Inc. ("IAI"), the Fund's investment adviser and manager.
Such transactions may increase fluctuations in the market value of the Fund's
assets and may be viewed as a form of leverage.
SECURITIES OF FOREIGN ISSUERS
The Fund may invest in securities of foreign issuers in accordance with its
investment objectives and policies. Investing in foreign securities may result
in greater risk than that incurred by investing in domestic securities. There is
generally less publicly available information about foreign issuers comparable
to reports and ratings that are published about companies in the United States.
Also, foreign issuers are not subject to uniform accounting and auditing and
financial reporting standards, practices and requirements comparable to those
applicable to United States companies. Furthermore, volume and liquidity in most
foreign bond markets is less than in the United States and at times volatility
of price can be greater than in the United States. There is generally less
government supervision and regulation of foreign bond markets, brokers and
companies than in the United States.
With respect to certain foreign countries, there is the possibility of
adverse changes in investment or exchange control regulations, expropriation or
confiscatory taxation, limitations on the removal of funds or other assets of
the Fund, political or social instability, or diplomatic developments which
could affect United States investments in those countries. Moreover, individual
foreign economies may differ favorably or unfavorably from the United States'
economy in such respects as growth of gross national product, rate of inflation,
capital reinvestment, resource self-sufficiency and balance of payments
position.
3
<PAGE>
The Fund is not aware at this time of the existence of any investment or
exchange control regulations which might substantially impair the operations of
the Fund as described in the Prospectus and this Statement of Additional
Information. It should be noted, however, that this situation could change at
any time.
The dividends and interest payable on certain of the Fund's foreign
portfolio securities may be subject to foreign withholding taxes, thus reducing
the net amount of income available for distribution to the Fund's shareholders.
The expense ratio of the Fund should not be materially affected by the Fund's
investment in foreign securities.
LENDING PORTFOLIO SECURITIES
In order to generate additional income, the Fund may lend portfolio
securities to broker-dealers, banks or other financial borrowers of securities.
As with other extensions of credit, there are risks of delay in recovery or even
loss of rights in the collateral should the borrower of the securities fail
financially. However, the Fund will only enter into loan arrangements with
broker-dealers, banks or other institutions which IAI has determined are
creditworthy under guidelines established by the Fund's Board of Directors. The
Fund may also experience a loss if, upon the failure of a borrower to return
loaned securities, the collateral is not sufficient in value or liquidity to
cover the value of such loaned securities (including accrued interest thereon).
However, the Fund will receive collateral in the form of cash, United States
Government securities, certificates of deposit or other high-grade, short-term
obligations or interest-bearing cash equivalents equal to at least 102% of the
value of the securities loaned. The value of the collateral and of the
securities loaned will be marked to market on a daily basis. During the time
portfolio securities are on loan, the borrower pays the Fund an amount
equivalent to any dividends or interest paid on the securities and the Fund may
invest the cash collateral and earn additional income or may receive an agreed
upon amount of interest income from the borrower. However, the amounts received
by the Fund may be reduced by finders' fees paid to broker-dealers and related
expenses.
ILLIQUID SECURITIES
The Fund may also invest up to 15% of its net assets in securities that are
considered illiquid because of the absence of a readily available market or due
to legal or contractual restrictions. However, certain restricted securities
that are not registered for sale to the general public but that can be resold to
institutional investors may be considered liquid pursuant to guidelines adopted
by the Board of Directors. It is not possible to predict with assurance the
maintenance of an institutional trading market for such securities and the
liquidity of the Fund's investments could be impaired if trading declines.
VARIABLE OR FLOATING RATE INSTRUMENTS
Such instruments (including notes purchased directly from issuers) bear
variable or floating interest rates and may carry rights that permit holders to
demand payment of the unpaid principal balance plus accrued interest from the
issuers or certain financial intermediaries. Floating rate securities have
interest rates that change whenever there is a change in a designated base rate
while variable rate instruments provide for a specified periodic adjustment in
the interest rate. These formulas are designed to result in a market value for
the instrument that approximates its par value.
DELAYED-DELIVERY TRANSACTIONS
The Fund may buy and sell securities on a delayed-delivery or when-issued
basis. These transactions involve a commitment by the Fund to purchase or sell
specific securities at a predetermined price or yield, with payment and delivery
taking place after the customary settlement period for that type of security
(and more than seven days in the future). Typically, no interest accrues to the
purchaser until the security is delivered. The Fund may receive fees for
entering into delayed-delivery transactions.
4
<PAGE>
When purchasing securities on a delayed-delivery basis, the Fund assumes
the rights and risks of ownership, including the risk of price and yield
fluctuations. Because the Fund is not required to pay for securities until the
delivery date, these risks are in addition to the risks associated with the
Fund's other investments. If the Fund remains substantially fully invested at a
time when delayed delivery purchases are outstanding, the delayed-delivery
purchases may result in a form of leverage. When delayed-delivery purchases are
outstanding, the Fund will comply with guidelines established by the Securities
and Exchange Commission regarding the segregation of assets. When the Fund has
sold a security on a delayed-delivery basis, the Fund does not participate in
further gains or losses with respect to the security. If the other party to a
delayed-delivery transaction fails to deliver or pay for the securities, the
Fund could miss a favorable price or yield opportunity, or could suffer a loss.
The Fund may renegotiate delayed-delivery transactions after they are
entered into, and may sell underlying securities before they are delivered,
which may result in capital gains or losses.
DOLLAR ROLLS
In connection with its ability to purchase securities on a when-issued or
forward commitment basis, the Fund may enter into "dollar rolls" in which the
Fund sells securities for delivery in the current month and simultaneously
contracts with the same counterparty to repurchase similar (same type, coupon
and maturity) but not identical securities on a specified future date. The Fund
gives up the right to receive principal and interest paid on the securities
sold. However, the Fund would benefit to the extent of any difference between
the price received for the securities sold and lower forward price for the
futures purchase plus any fee income received. Unless such benefits exceed the
income and capital appreciation that would have been realized on the securities
sold as part of the dollar roll, the use of this technique will diminish the
investment performance of the Fund compared with what such performance would
have been without the use of dollar rolls. The Fund will hold and maintain in a
segregated account until the settlement date cash, government securities, or
liquid high-grade debt securities in an amount equal to the value of the when-
issued or forward commitment securities. The benefits derived from the use of
dollar rolls may depend, among other things, upon IAI's ability to predict
interest rates correctly. There is no assurance that dollar rolls can be
successfully employed. In addition, the use of dollar rolls by the Fund while
remaining substantially fully invested increases the amount of the Fund's assets
that are subject to market risk to an amount that is greater than the Fund's net
asset value, which could result in increased volatility of the price of the
Fund's shares.
MORTGAGE-BACKED SECURITIES
The Fund may purchase mortgage-backed securities issued by government and
non-government entities such as banks, mortgage lenders, or other financial
institutions. A mortgage-backed security may be an obligation of the issuer
backed by a mortgage or pool of mortgages or a direct interest in an underlying
pool of mortgages. Some mortgage-backed securities, such as collateralized
mortgage obligations or CMOs, make payments of both principal and interest at a
variety of intervals; others make semiannual interest payments at a
predetermined rate and repay principal at maturity (like a typical bond).
Mortgage-backed securities are based on different types of mortgages including
those on commercial real estate or residential properties. Other types of
mortgage-backed securities will likely be developed in the future, and the Fund
may invest in them if IAI determines they are consistent with the Fund's
investment objective and policies.
The value of mortgage-backed securities may change due to shifts in the
market's perception of issuers. In addition, regulatory or tax changes may
adversely affect the mortgage securities market as a whole. Non-government
mortgage-backed securities may offer higher yields than those issued by
government entities, but also may be subject to greater price changes than
government issues. Mortgage-backed securities are subject to prepayment risk.
Prepayment, which occurs when unscheduled or early payments are made on the
underlying mortgages, may shorten the effective maturities of these securities
and may lower their total returns.
5
<PAGE>
STRIPPED MORTGAGE BACKED SECURITIES
Such securities are created when a U.S. government agency or a financial
institution separates the interest and principal components of a mortgage-backed
security and sells them as individual securities. The holder of the "principal-
only" security (PO) receives the principal payments made by the underlying
mortgage-backed security, while the holder of the "interest-only" security (IO)
receives interest payments from the same underlying security. The prices of
stripped mortgage-backed securities may be particularly affected by changes in
interest rates. As interest rates fall, prepayment rates tend to increase, which
tends to reduce prices of IOs and increase prices of POs. Rising interest rates
can have the opposite effect.
ASSET-BACKED SECURITIES
Asset-backed securities represent interests in pools of consumer loans
(generally unrelated to mortgage loans) and often are structured as pass-through
securities. Interest and principal payments alternately depend upon payment of
the underlying loans by individuals, although the securities may be supported by
letters of credit or other credit enhancements. The value of asset-backed
securities may also depend on the creditworthiness of the servicing agent for
the loan pool, the originator of the loans, or the financial institution
providing the credit enhancement.
ZERO COUPON BONDS
Zero coupon bonds do not make interest payments; instead, they are sold at
a deep discount from their face value and are redeemed at face value when they
mature. Because zero coupon bonds do not pay current income, their prices can be
very volatile when interest rates change. In calculating its dividends, the Fund
takes into account as income a portion of the difference between a zero coupon
bond's purchase price and its face value.
A broker-dealer creates a derivative zero by separating the interest and
principal components of a U.S. Treasury security and selling them as two
individual securities. CATS (Certificates of Accrual on Treasury Securities),
TIGRs (Treasury Investment Growth Receipts), and TRs (Treasury Receipts) are
examples of derivative zeros.
The Federal Reserve Bank creates STRIPS (Separate Trading of Registered
Interest and Principal of Securities) by separating the interest and principal
components of an outstanding U.S. Treasury bond and selling them as individual
securities. Bonds issued by the Resolution Funding Corporation (REFCORP) and the
Financing Corporation (FICO) can also be separated in this fashion. Original
issue zeroes are zero coupon securities originally issued by the U.S.
government, a government agency, or a corporation in zero coupon form.
LOWER-RATED DEBT SECURITIES
Issuers of high yield securities may be highly leveraged and may not have
available to them more traditional methods of financing. Therefore, the risks
associated with acquiring the securities of such issuers generally are greater
than is the case with higher rated securities. For example, during an economic
downturn or a sustained period of rising interest rates, issuers of high yield
securities may be more likely to experience financial stress, especially if such
issuers are highly leveraged. During such periods, such issuers may not have
sufficient revenues to meet their interest payment obligations. The issuer's
ability to service its debt obligations also may be adversely affected by
specific issuer developments or the issuer's inability to meet specific
projected business forecasts or the unavailability of additional financing. The
risk of loss due to default by the issuer is significantly greater for the
holders of high yield securities because such securities may be unsecured and
may be subordinated to other creditors of the issuer.
High yield securities frequently have call or redemption features which
would permit an issuer to repurchase the security from the Fund. If a call were
exercised by the issuer during a period of declining interest rates, the Fund
likely would have to replace such called security with a lower yielding
security, thus decreasing the net investment income to the Fund and dividends to
shareholders.
6
<PAGE>
The Fund may have difficulty disposing of certain high yield securities
because there may be a thin trading market for such securities. The secondary
trading market for high yield securities is generally not as liquid as the
secondary market for higher rated securities. Reduced secondary market liquidity
may have an adverse impact on market price and the Fund's ability to dispose of
particular issues when necessary to meet the Fund's liquidity needs or in
response to a specific economic event such as a deterioration in the
creditworthiness of the issuer.
Adverse publicity and investor perceptions, which may not be based on
fundamental analysis, also may decrease the value and liquidity of high yield
securities, particularly in a thinly traded market. Factors adversely affecting
the market value of high yield securities are likely to adversely affect the
Fund's net asset value. In addition, the Fund may incur additional expenses to
the extent it is required to seek recovery upon a default on a portfolio holding
or participate in the restructuring of the obligation.
SWAP AGREEMENTS
Swap agreements can be individually negotiated and structured to include
exposure to a variety of different types of investments or market factors.
Depending on their structure, swap agreements may increase or decrease the
Fund's exposure to long- or short-term interest rates (in the U.S. or abroad),
foreign currency values, mortgage securities, corporate borrowing rates, or
other factors such as security prices or inflation rates. Swap agreements can
take many different forms and are known by a variety of names. The Fund is not
limited to any particular form of swap agreement if IAI determines it is
consistent with the Fund's investment objectives and policies.
Swap agreements will tend to shift the Fund's investment exposure from one
type of investment to another. For example, if the Fund agrees to exchange
payments in dollars for payments in foreign currency, the swap agreement would
tend to decrease the Fund's exposure to U.S. interest rates and increase its
exposure to foreign currency and interest rates. Depending on how they are used,
swap agreements may increase or decrease the overall volatility of the Fund's
investments and its share price.
The most significant factor in the performance of swap agreements is the
change in the specific interest rate, currency, or other factors that determine
the amounts of payments due to and from the Fund. If a swap agreement calls for
payments by the Fund, the Fund must be prepared to make such payments when due.
In addition, if the counterparty's creditworthiness declined, the value of a
swap agreement would be likely to decline, potentially resulting in losses. The
Fund expects to be able to eliminate its exposure under swap agreements either
by assignment or other disposition, or by entering into an offsetting swap
agreement with the same party or a similarly creditworthy party. While a swap
agreement is outstanding, the Fund will comply with guidelines established by
the Securities and Exchange Commission regarding the segregation of assets.
INDEXED SECURITIES
The Fund may purchase securities whose prices are indexed to the prices of
other securities, securities indexes, currencies, precious metals or other
commodities, or other financial indicators. Indexed securities typically, but
not always, are debt securities or deposits whose value at maturity or coupon
rate is determined by reference to a specific instrument or statistic. Gold-
indexed securities, for example, typically provide for a maturity value that
depends on the price of gold, resulting in a security whose price tends to rise
and fall together with gold prices. Currency-indexed securities typically are
short-term to intermediate-term debt securities whose maturity values or
interest rates are determined by reference to the values of one or more
specified foreign currencies, and may offer higher yields than U.S. dollar-
denominated securities of equivalent issuers. Currency-indexed securities may be
positively or negatively indexed; that is, their maturity value may increase
when the specified currency value increases, resulting in a security that
performs similarly to a foreign-denominated instrument, or their maturity value
may decline when foreign currencies increase, resulting in a security whose
price characteristics are similar to a put on the underlying currency. Currency-
indexed securities may also have prices that depend on the values of a number of
different foreign currencies relative to each other.
7
<PAGE>
The performance of indexed securities depends to a great extent on the
performance of the security, currency, or other instrument to which they are
indexed, and may also be influenced by interest rate changes in the U.S. and
abroad. At the same time, indexed securities are subject to the credit risks
associated with the issuer of the security, and their values may decline
substantially if the issuer's creditworthiness deteriorates. Recent issuers of
indexed securities have included banks, corporations, and certain U.S.
government agencies. IAI will use its judgment in determining whether indexed
securities should be treated as short-term instruments, bonds, stocks, or as a
separate asset class for purposes of the Fund's investment policies, depending
on the individual characteristics of the securities. Indexed securities may be
more volatile than the underlying instruments.
LOANS AND OTHER DIRECT DEBT INSTRUMENTS
Direct debt instruments are interests in amounts owed by a corporate,
governmental, or other borrower to lenders or lending syndicates (loans and loan
participations), to suppliers of goods or services (trade claims or other
receivable), or to other parties. Direct debt instruments are subject to the
Fund's policies regarding the quality of debt securities.
Purchasers of loans and other forms of direct indebtedness depend primarily
upon the creditworthiness of the borrower for payment of principal and interest.
Direct debt instruments may not be rated by any nationally recognized rating
service. If the Fund does not receive scheduled interest or principal payments
on such indebtedness, the Fund's share price and yield could be adversely
affected. Loans that are fully secured offer the Fund more protection than an
unsecured loan in the event of non-payment of scheduled interest or principal.
However, there is no assurance that the liquidation of collateral from a secured
loan would satisfy the borrower's obligation, or that the collateral can be
liquidated. Indebtedness of borrowers whose creditworthiness is poor involves
substantially greater risks, and may be highly speculative. Borrowers that are
in bankruptcy or restructuring may never pay off their indebtedness, or may pay
only a small fraction of the amount owed. Direct indebtedness of developing
countries will also involve a risk that the governmental entities responsible
for the repayment of the debt may be unable, or unwilling, to pay interest and
repay principal when due.
Investments in loans through direct assignment of a financial institution's
interests with respect to a loan may involve additional risks to the Fund. For
example, if a loan is foreclosed, the Fund could become part owner of any
collateral, and would bear the costs and liabilities associated with owning and
disposing of the collateral. In addition, it is conceivable that under emerging
legal theories of lender liability, the Fund could be held liable as a co-
lender. Direct debt instruments may also involve a risk of insolvency of the
lending bank or other intermediaries. Direct debt instruments that are not in
the form of securities may offer less legal protection to the Fund in the event
of fraud or misrepresentation. In the absence of definitive regulatory guidance,
the Fund relies on IAI's research in an attempt to avoid situations where fraud
or misrepresentation could adversely affect the Fund.
A loan is often administered by a bank or other financial institution that
acts as agent for all holders. The agent administers the terms of the loan, as
specified in the loan agreement. Unless, under the terms of the loan or other
indebtedness, the Fund has direct recourse against the borrower, it may have to
rely on the agent to apply appropriate credit remedies against a borrower. If
assets held by the agent for the benefit of the Fund were determined to be
subject to the claims of the agent's general creditors, the Fund might incur
certain costs and delays in rendering payment on the loan or loan participation
and could suffer a loss of principal or interest.
The Fund limits the amount of the assets that it invests in any one issuer
or in issuers within the same industry. For purposes of these limitations, the
Fund generally will treat the borrower as the "issuer" of indebtedness held by
the Fund. In the case of loan participations where a bank or other lending
institution serves as financial intermediary between the Fund and the borrower,
if the participation does not shift to the Fund the direct debtor/creditor
relationship with the borrower, SEC interpretations require the Fund, in
appropriate circumstances, to treat both the lending bank or other lending
institution and the borrower as "issuers" for the purpose of determining whether
the Fund has invested more than 5% of its total assets in a single issuer.
Treating a financial intermediary as an issuer of indebtedness may restrict the
Fund's ability to invest in indebtedness
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<PAGE>
related to a single financial intermediary, or a group of intermediaries engaged
in the same industry, even if the underlying borrowers represent many different
companies and industries.
FOREIGN CURRENCY TRANSACTIONS
The Fund may hold foreign currency deposits from time to time and may
convert dollars and foreign currencies in the foreign exchange markets. Currency
conversion involves dealer spreads and other costs, although commissions usually
are not charged. Currencies may be exchanged on a spot (i.e., cash) basis, or by
entering into forward contracts to purchase or sell foreign currencies at a
future date and price. Forward contracts generally are traded in an interbank
market conducted directly between currency traders (usually large commercial
banks) and their customers. The parties to a forward contract may agree to
offset or terminate the contract before its maturity, or may hold the contract
to maturity and complete the contemplated currency exchange.
The Fund may use currency forward contracts to manage currency risks and to
facilitate transactions in foreign securities. The following discussion
summarizes the principal currency management strategies involving forward
contracts that could be used by the Fund.
In connection with purchases and sales of securities denominated in foreign
currencies, the Fund may enter into currency forward contracts to fix a definite
price for the purchase or sale in advance of the trade's settlement date. This
technique is sometimes referred to as a "settlement hedge" or "transaction
hedge." IAI expects to enter into settlement hedges in the normal course of
managing the Fund's foreign investments. The Fund could also enter into forward
contracts to purchase or sell a foreign currency in anticipation of future
purchases or sales of securities denominated in foreign currency, even if the
specific investments have not yet been selected by IAI.
The Fund may also use forward contracts to hedge against a decline in the
value of existing investments denominated in foreign currency. For example, if
the Fund owned securities denominated in pounds sterling, it could enter into a
forward contract to sell pounds sterling in return for U.S. dollars to hedge
against possible declines in the pound's value. Such a hedge, sometimes referred
to as a "position hedge," would tend to offset both positive and negative
currency fluctuations but would not offset changes in security values caused by
other factors. The Fund could also hedge the position by selling another
currency expected to perform similarly to the pound sterling -- for example, by
entering into a forward contract to sell Deutschemarks or European Currency
Units in return for U.S. dollars. This type of hedge, sometimes referred to as a
"proxy hedge," could offer advantages in terms of cost, yield, or efficiency,
but generally would not hedge currency exposure as effectively as a simple hedge
into U.S. dollars. Proxy hedges may result in losses if the currency used to
hedge does not perform similarly to the currency in which the hedged securities
are denominated.
Under certain conditions, SEC guidelines require mutual funds to set aside
appropriate liquid assets in a segregated custodial account to cover currency
forward contracts. As required by SEC guidelines, the Fund will segregate assets
to cover currency forward contracts, if any, whose purpose is essentially
speculative. The Fund will not segregate assets to cover forward contracts
entered into for hedging purposes, including settlement hedges, position hedges,
and proxy hedges.
Successful use of forward currency contracts will depend on IAI's skill in
analyzing and predicting currency values. Forward contracts may substantially
change the Fund's investment exposure to changes in currency exchange rates, and
could result in losses to the Fund if currencies do not perform as IAI
anticipates. For example, if a currency's value rose at a time when IAI had
hedged the Fund by selling that currency in exchange for dollars, the Fund would
be unable to participate in the currency's appreciation. If IAI hedges currency
exposure through proxy hedges, the Fund could realize currency losses from the
hedge and the security position at the same time if the two currencies do not
move in tandem. Similarly, if IAI increases the Fund's exposure to a foreign
currency, and that currency's value declines, the Fund will realize a loss.
There is no assurance that IAI's use of forward currency contracts will be
advantageous to the Fund or that it will hedge at an appropriate time. The
policies described in this section are non-fundamental policies of the Fund.
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<PAGE>
LIMITATIONS ON FUTURES AND OPTIONS TRANSACTIONS
The Fund has filed a notice of eligibility for exclusion from the
definition of the term "commodity pool operator" with the Commodity Futures
Trading Commission (CFTC) and the National Futures Association, which regulate
trading in the futures markets, before engaging in any purchases or sales of
futures contracts or options on futures contracts. The Fund intends to comply
with Section 4.5 of the regulations under the Commodity Exchange Act, which
limits the extent to which the Fund can commit assets to initial margin deposits
and option premiums.
The above limitations on the Fund's investments in futures contracts and
options, and the Fund's policies regarding futures contracts and options
discussed elsewhere in this Statement of Additional Information may be changed
as regulatory agencies permit.
FUTURES CONTRACTS
When the Fund purchases a futures contract, it agrees to purchase a
specified underlying instrument at a specified future date. When the Fund sells
a futures contract, it agrees to sell the underlying instrument at a specified
future date. The price at which the purchase and sale will take place is fixed
when the Fund enters into the contract. Some currently available futures
contracts are based on specific securities, such as U.S. Treasury bonds or
notes, and some are based on indexes of securities prices, such as the Standard
& Poor's 500 Composite Stock Price Index (S&P 500). Futures can be held until
their delivery dates, or can be closed out before then if a liquid secondary
market is available.
The value of a futures contract tends to increase and decrease in tandem
with the value of its underlying instrument. Therefore, purchasing futures
contracts will tend to increase the Fund's exposure to positive and negative
price fluctuations in the underlying instrument, much as if it had purchased the
underlying instrument directly. When the Fund sells a futures contract, by
contrast, the value of its futures position will tend to move in a direction
contrary to the market. Selling futures contracts, therefore, will tend to
offset both positive and negative market price changes, much as if the
underlying instrument had been sold.
FUTURES MARGIN PAYMENTS
The purchaser or seller of a futures contract is not required to deliver or
pay for the underlying instrument unless the contract is held until the delivery
date. However, both the purchaser and seller are required to deposit "initial
margin" with a futures broker, known as a futures commission merchant (FCM),
when the contract is entered into. Initial margin deposits are typically equal
to a percentage of the contract's value. If the value of either party's position
declines, that party will be required to make additional "variation margin"
payments to settle the change in value on a daily basis. The party that has a
gain may be entitled to receive all or a portion of this amount. Initial and
variation margin payments do not constitute purchasing securities on margin for
purposes of the Fund's investment limitations. In the event of the bankruptcy of
an FCM that holds margin on behalf of the Fund, the Fund may be entitled to
return of margin owed to it only in proportion to the amount received by the
FMC's other customers, potentially resulting in losses to the Fund.
PURCHASING PUT AND CALL OPTIONS
By purchasing a put option, the Fund obtains the right (but not the
obligation) to sell the option's underlying instrument at a fixed strike price.
In return for this right, the Fund pays the current market price for the option
(known as the option premium). Options have various types of underlying
instruments, including specific securities, indexes of securities prices, and
futures contracts. The Fund may terminate its position in a put option it has
purchased by allowing it to expire or by exercising the option. If the option is
allowed to expire, the Fund will lose the entire premium it paid. If the Fund
exercises the option, it completes the sale of the underlying instrument at the
strike price. The Fund may also terminate a put option position by closing it
out in the secondary market at its current price, if a liquid secondary market
exists.
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<PAGE>
The buyer of a typical put option can expect to realize a gain if security
prices fall substantially. However, if the underlying instrument's price does
not fall enough to offset the cost of purchasing the option, a put buyer can
expect to suffer a loss (limited to the amount of the premium paid, plus related
transaction costs).
The features of call options are essentially the same as those of put
options, except that the purchaser of a call option obtains the right to
purchase, rather than sell, the underlying instrument at the option's strike
price. A call buyer typically attempts to participate in potential price
increases of the underlying instrument with risk limited to the cost of the
option if security prices fall. At the same time, the buyer can expect to suffer
a loss if security prices do not rise sufficiently to offset the cost of the
option.
WRITING PUT AND CALL OPTIONS
When the Fund writes a put option, it takes the opposite side of the
transaction from the option's purchaser. In return for receipt of the premium,
the Fund assumes the obligation to pay the strike price for the option's
underlying instrument if the other party to the option chooses to exercise it.
When writing an option on a futures contract the Fund would be required to make
margin payments to an FCM as described above for futures contracts. The Fund may
seek to terminate its position in a put option it writes before exercise by
closing out the option in the secondary market at its current price. If the
secondary market is not liquid for a put option the Fund has written, however,
the Fund must continue to be prepared to pay the strike price while the option
is outstanding, regardless of price changes, and must continue to set aside
assets to cover its position. If security prices rise, a put writer would
generally expect to profit, although its gain would be limited to the amount of
the premium it received.
If security prices remain the same over time, it is likely that the writer
will also profit, because it should be able to close out the option at a lower
price. If security prices fall, the put writer would expect to suffer a loss.
This loss should be less than the loss from purchasing the underlying instrument
directly, however, because the premium received for writing the option should
mitigate the effects of the decline.
Writing a call option obligates the Fund to sell or deliver the option's
underlying instrument, in return for the strike price, upon exercise of the
option. The characteristics of writing call options are similar to those of
writing put options, except that writing calls generally is a profitable
strategy if prices remain the same or falls. Through receipt of the option
premium, a call writer mitigates the effects of a price decline. At the same
time, because a call writer must be prepared to deliver the underlying
instrument in return for the strike price, even if its current value is greater,
a call writer gives up some ability to participate in security price increases.
COMBINED POSITIONS
The Fund may purchase and write options in combination with each other, or
in combination with futures or forward contracts, to adjust the risk and return
characteristics of the overall position. For example, the Fund may purchase a
put option and write a call option on the same underlying instrument, in order
to construct a combined position whose risk and return characteristics are
similar to selling a futures contract. Another possible combined position would
involve writing a call option at one strike price and buying a call option at a
lower price, in order to reduce the risk of the written call option in the event
of a substantial price increase. Because combined options positions involve
multiple trades, they result in higher transaction costs and may be more
difficult to open and close out.
CORRELATION OF PRICE CHANGES
Because there are a limited number of types of exchange-traded options and
futures contracts, it is likely that the standardized contracts available will
not match the Fund's current or anticipated investments exactly. The Fund may
invest in options and futures contracts based on securities with different
issuers, maturities, or other characteristics from the securities in which it
typically invests, which involves a risk that the options or futures position
will not track the performance of the Fund's other investments.
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<PAGE>
Options and futures prices can also diverge from the prices of their
underlying instruments, even if the underlying instruments match the Fund's
investments well. Options and futures prices are affected by such factors as
current and anticipated short-term interest rates, changes in volatility of the
underlying instrument, and the time remaining until expiration of the contract,
which may not affect security prices the same way. Imperfect correlation may
also result from differing levels of demand in the options and futures markets
and the securities markets, from structural differences in how options and
futures and securities are traded, or from imposition of daily price fluctuation
limits or trading halts. The Fund may purchase or sell options and futures
contracts with a greater or lesser value than the securities it wishes to hedge
or intends to purchase in order to attempt to compensate for differences in
volatility between the contract and the securities, although this may not be
successful in all cases. If price changes in the Fund's options or futures
positions are poorly correlated with its other investments, the positions may
fail to produce anticipated gains or result in losses that are not offset by
gains in other investments.
LIQUIDITY OF OPTIONS AND FUTURES CONTRACTS
There is no assurance a liquid secondary market will exist for any
particular options or futures contract at any particular time. Options may have
relatively low trading volume and liquidity if their strike prices are not close
to the underlying instrument's current price. In addition, exchanges may
establish daily price fluctuation limits for options and futures contracts, and
may halt trading if a contract's price moves upward or downward more than the
limit in a given day. On volatile trading days when the price fluctuation limit
is reached or a trading halt is imposed, it may be impossible for the Fund to
enter into new positions or close out existing positions. If the secondary
market for a contract is not liquid because of price fluctuation limits or
otherwise, it could prevent prompt liquidation of unfavorable positions, and
potentially could require the Fund to continue to hold a position until delivery
or expiration regardless of changes in its value. As a result, the Fund's access
to other assets held to cover its options or futures positions could also be
impaired.
OTC OPTIONS
Unlike exchange-traded options, which are standardized with respect to the
underlying instrument, expiration date, contract size, and strike price, the
terms of over-the-counter options (options not traded on exchanges) generally
are established through negotiation with the other party to the option contract.
While this type of arrangement allows the Fund greater flexibility to tailor an
option to its needs, OTC options generally involve greater credit risk than
exchange-traded options, which are guaranteed by the clearing organization of
the exchanges where they are traded.
OPTIONS AND FUTURES RELATING TO FOREIGN CURRENCIES
Currency futures contracts are similar to forward currency exchange
contracts, except that they are traded on exchanges (and have margin
requirements) and are standardized as to contract size and delivery date. Most
currency futures contracts call for payment or delivery in U.S. dollars. The
underlying instrument of a currency option may be a foreign currency, which
generally is purchased or delivered in exchange for U.S. dollars, or may be a
futures contract. The purchaser of a currency call obtains the right to purchase
the underlying currency, and the purchaser of a currency put obtains the right
to sell the underlying currency.
The uses and risks of currency options and futures are similar to options
and futures relating to securities or indexes, as discussed above. The Fund may
purchase and sell currency futures and may purchase and write currency options
to increase or decrease its exposure to different foreign currencies. The Fund
may also purchase and write currency options in conjunction with each other or
with currency futures or forward contracts. Currency futures and options values
can be expected to correlate with exchange rates, but may not reflect other
factors that affect the value of the Fund's investments. A currency hedge, for
example, should protect a yen-denominated security from a decline in the yen,
but will not protect the Fund against a price decline resulting from
deterioration in the issuer's creditworthiness. Because the value of the Fund's
foreign-denominated investments changes in response to many factors other than
exchange rates, it may not be possible to match the amount of currency options
and futures to the value of the Fund's investments exactly over time.
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<PAGE>
ASSET COVERAGE FOR FUTURES AND OPTIONS POSITIONS
The Fund will comply with guidelines established by the Securities and
Exchange Commission with respect to coverage of options and futures strategies
by mutual funds, and if the guidelines so require will set aside appropriate
liquid assets in a segregated custodial account in the amount prescribed.
Securities held in a segregated account cannot be sold while the futures or
option strategy is outstanding, unless they are replaced with other suitable
assets. As a result, there is a possibility that segregation of a large
percentage of the Fund's assets could impede portfolio management or the Fund's
ability to meet redemption requests or other current obligations.
INVESTMENT RESTRICTIONS
As indicated in the Prospectus, the Fund is subject to certain policies and
restrictions which are "fundamental" and may not be changed without shareholder
approval. Shareholder approval consists of the approval of the lesser of (i)
more than 50% of the outstanding voting securities of the Fund, or (ii) 67% or
more of the voting securities present at a meeting if the holders of more than
50% of the outstanding voting securities of the Fund are present or represented
by proxy. Limitations 1 through 8 below are deemed fundamental limitations. The
remaining limitations set forth below serve as operating policies of the Fund
and may be changed by the Board of Directors without shareholder approval.
The Fund may not:
1. Purchase the securities of any issuer if such purchase would cause the
Fund to fail to meet the requirements of a "diversified company" as defined
under the Investment Company Act of 1940, as amended (the "1940 Act").
As currently defined in the 1940 Act, "diversified company" means a
management company which meets the following requirements: at least 75% of the
value of its total assets is represented by cash and cash items (including
receivables), Government securities, securities of other investment companies
and other securities for the purposes of this calculation limited in respect of
any one issuer to an amount not greater in value than 5% of the value of the
total assets of such management company and not more than 10% of the outstanding
voting securities of such issuer.
2. Purchase the securities of any issuer (other than "Government
securities" as defined under the 1940 Act) if, as a result, more than 25% of the
value of the Fund's total assets would be invested in the securities of
companies whose principal business activities are in the same industry.
For purposes of applying this restriction, the Fund will not purchase
securities, as defined above, such that 25% or more of the value of the Fund's
total assets are invested in the securities of companies whose principal
business activities are in the same industry.
3. Issue any senior securities, except as permitted by the 1940 Act or
the Rules and Regulations of the Securities and Exchange Commission.
4. Borrow money, except from banks for temporary or emergency purposes
provided that such borrowings may not exceed 33-1/3% of the value of the Fund's
net assets (including the amount borrowed). Any borrowings that come to exceed
this amount will be reduced within three days (not including Sundays and
holidays) to the extent necessary to comply with the 33-1/3% limitation. This
limitation shall not prohibit the Fund from engaging in reverse repurchase
agreements, making deposits of assets to margin or guarantee positions in
futures, options, swaps or forward contracts, or segregating assets in
connection with such agreements or contracts. To the extent the Fund engages in
reverse repurchase agreements, because such transactions are considered
borrowing, reverse repurchase agreements are included in the 33 1/3% limitation.
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<PAGE>
5. Act as an underwriter of securities of other issuers, except to the
extent that in connection with the disposition of portfolio securities the Fund
may be deemed to be an underwriter under applicable laws.
6. Purchase or sell real estate unless acquired as a result of ownership
of securities or other instruments. This restriction shall not prevent the Fund
from investing in securities or other instruments backed by real estate or
securities of companies engaged in the real estate business.
7. Purchase or sell commodities other than foreign currencies unless
acquired as a result of ownership of securities. This limitation shall not
prevent the Fund from purchasing or selling options, futures, swaps and forward
contracts or from investing in securities or other instruments backed by
commodities.
For purposes of applying this restriction, "commodities" shall be
deemed to include commodity contracts.
8. Make loans to other persons except to the extent not inconsistent with
the 1940 Act or the Rules and Regulations of the Securities and Exchange
Commission. This limitation does not apply to purchases of commercial paper,
debt securities or repurchase agreements, or to the lending of portfolio
securities.
9. Purchase securities on margin, except that the Fund may obtain such
short-term credits as may be necessary for the clearance of purchases or sales
of securities and provided that margin payments in connection with transactions
in options, futures, swaps and forward contracts shall not be deemed to
constitute purchasing securities on margin.
10. Sell securities short, unless it owns or has the right to obtain
securities equivalent in kind and amount to the securities sold short, and
provided that transactions in options, swaps and forward futures contracts are
not deemed to constitute selling securities short.
For purposes of applying this restriction, the Fund will not sell
securities short except to the extent that it contemporaneously owns or has the
right to obtain at no added cost securities identical to those sold short.
11. Except as part of a merger, consolidation, acquisition, or
reorganization, invest more than 5% of the value of its total assets in the
securities of any one investment company or more than 10% of the value of its
total assets, in the aggregate, in the securities of two or more investment
companies, or acquire more than 3% of the total outstanding voting securities of
any one investment company.
12. Mortgage, pledge or hypothecate its assets except to the extent
necessary to secure permitted borrowings. This limitation does not apply to
reverse repurchase agreements or in the case of assets deposited to margin or
guarantee positions in futures, options, swaps or forward contracts or placed in
a segregated account in connection with such contracts.
13. Participate on a joint or a joint and several basis in any securities
trading account.
14. Invest more than 15% of its net assets in illiquid investments.
15. Invest directly in interests (including partnership interests) in
oil, gas or other mineral exploration or development leases or programs, except
the Fund may purchase or sell securities issued by corporations engaging in oil,
gas or other mineral exploration or development business.
Any of the Fund's investment policies set forth under "Investment Objective
and Policies" in the Prospectus, or any restriction set forth above under
"Investment Restrictions" which involves a maximum percentage of securities or
assets shall not be considered to be violated unless an excess over the
percentage occurs immediately after an acquisition of securities or utilization
of assets and results there from. With respect to
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<PAGE>
Restriction 14, the Fund is under a continuing obligation to ensure that it does
not violate the maximum percentage either by acquisition or by virtue of a
decrease in the value of the Fund's liquid securities.
PORTFOLIO TURNOVER
The portfolio turnover rate is calculated by dividing the lesser of
purchases or sales of portfolio securities for the particular fiscal year by the
monthly average of the value of portfolio securities owned by the Fund during
the same fiscal year. "Portfolio securities" for purposes of this calculation
do not include securities with a maturity date of less than twelve (12) months
from the date of investment. A 100% portfolio turnover rate would occur, for
example, if the lesser of the value of purchases or sales of portfolio
securities for a particular year were equal to the average monthly value of the
portfolio securities owned during such year. The Fund's portfolio turnover rate
is set forth in the Prospectus section "Financial Highlights". The increase in
the Fund's portfolio turnover rate for the last fiscal year was due to increased
bond market volatility and falling interest rates.
INVESTMENT PERFORMANCE
Advertisements and other sales literature for the Fund may refer to
monthly, quarterly, yearly, cumulative and average annual total return. Each
such calculation assumes all dividends and capital gain distributions are
reinvested at net asset value on the appropriate reinvestment dates as described
in the Prospectus, and includes all recurring fees, such as investment advisory
and management fees, charged as expenses to all shareholder accounts. Each of
monthly, quarterly and yearly total return are computed in the same manner as
cumulative total return, as set forth below.
Cumulative total return is computed by finding the cumulative rate of
return over the period indicated in the advertisement that would equate the
initial amount invested to the ending redeemable value, according to the
following formula:
CTR = (ERV-P) 100
-----
P
Where: CTR = Cumulative total return;
ERV = ending redeemable value at the end of the period of a
hypothetical $1,000 payment made at the beginning of
such period; and
P = initial payment of $1,000
Average annual total return is computed by finding the average annual
compounded rates of return over the periods indicated in the advertisement that
would equate the initial amount invested to the ending redeemable value,
according to the following formula:
P(1+T)n = ERV
Where: P = a hypothetical initial payment of $1,000;
T = average annual total return;
n = number of years; and
ERV = ending redeemable value at the end of the period
of a hypothetical $1,000 payment made at the beginning
of such period.
The Fund may quote yield figures from time to time. The "yield" is
computed by dividing the net investment income per share earned during a 30-day
period (using the average number of shares entitled to receive dividends) by the
net asset value per share on the last day of the period. The yield formula
provides for semiannual compounding which assumes that net investment income is
earned and reinvested at a constant rate and annualized at the end of a six-
month period.
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The yield formula is as follows:
6
YIELD = 2[(a-b + 1) -1]
---
cd
Where: a = dividends and interest earned during the period.
b = expenses accrued for the period (net of reimbursements).
c = the average daily number of shares outstanding during
the period that were entitled to receive dividends.
d = the net asset value of the Fund at the end of the
period.
The average annual total returns of the Fund for the year ended November
30, 1995 and for the period from the Fund's inception (November 1, 1993) through
November 30, 1995 were 14.95% and 3.94%, respectively. For the thirty-day
period ended November 30, 1995, the Fund's yield was 6.39%.
In advertising and sales literature, the Fund may compare its performance
with that of other mutual funds, indexes or averages of other mutual funds,
indexes of related financial assets or data, and other competing investment and
deposit products available from or through other financial institutions. The
composition of these indexes, averages or products differs from that of the
Fund. The comparison of the Fund to an alternative investment should be made
with consideration of differences in features and expected performance.
The indexes and averages noted below will be obtained from the indicated
sources or reporting services, which the Fund believes to be generally accurate.
The Fund may also note its mention in newspapers, magazines, or other media from
time to time. However, the Fund assumes no responsibility for the accuracy of
such data.
For example, (1) the Fund's performance or P/E ratio may be compared to any
one or a combination of the following: (i) other groups of mutual funds,
including the IAI Funds, tracked by: (A) Lipper Analytical Services, Inc., a
widely used independent research firm which ranks mutual funds by overall
performance, investment objectives, and assets; (B) Morningstar, Inc., another
widely used independent research firm which rates mutual funds; or (C) other
financial or business publications, which may include, but are not limited to,
Business Week, Money Magazine, Forbes and Barron's, which provide similar
information; (ii) the Salomon Brothers Broad Investment Grade Index; (iii) the
Shearson Lehman Brothers Government/Corporate Bond Index; and (iv) the
performance of U.S. government and corporate bonds, notes and bills. (The
purpose of these comparisons would be to illustrate historical trends in
different market sectors so as to allow potential investors to compare different
investment strategies.); (2) the Consumer Price Index (measure for inflation)
may be used to assess the real rate of return from an investment in the Fund;
(3) other U.S. government statistics such as GNP, and net import and export
figures derived from governmental publications, e.g., The Survey of Current
Business, may be used to illustrate investment attributes of the Fund or the
general economic business, investment, or financial environment in which the
Fund operates; (4) the effect of tax-deferred compounding on the Fund's
investment returns, or on returns in general, may be illustrated by graphs,
charts, etc. where such graphs or charts would compare, at various points in
time, the return from an investment in the Fund (or returns in general) on a
tax-deferred basis (assuming reinvestment of capital gains and dividends and
assuming one or more tax rates) with the return on a taxable basis; and (5) the
instruments in which the Fund invests may be compared to relevant indices or
surveys in order to evaluate the Fund's historical performance or current or
potential value with respect to the particular instruments.
16
<PAGE>
MANAGEMENT
The names, addresses, positions and principal occupations of the directors
and executive officers of the Fund are given below.
<TABLE>
<CAPTION>
Name and Address Age Position Principal Occupation(s) During Past 5 Years
- ---------------- --- -------- -------------------------------------------
<S> <C> <C> <C>
Noel P. Rahn* 53 Chairman of the Chief Executive Officer and a Director of IAI
3700 First Bank Place Board since 1974. Mr. Rahn is also Chairman of the
P.O. Box 357 other IAI Mutual Funds.
Minneapolis, Minnesota 55440
Richard E. Struthers* 43 President, Director Executive Vice President and a Director of IAI
3700 First Bank Place and has served IAI in many capacities since
P.O. Box 357 1979. Mr. Struthers is also President of the
Minneapolis, Minnesota 55440 other IAI Mutual Funds.
Madeline Betsch 53 Director Currently retired; until April 1994 was Executive
19 South 1st Street Vice President, Director of Client Services, of
Minneapolis, Minnesota 55401 CME-KHBB Advertising since May 1985, and President
with Campbell-Mithun, Inc. (an advertising agency)
since February 1977.
W. William Hodgson 71 Director Currently retired; served as information manager for the
1698 Dodd Road North Central Home Office of the Prudential Insurance
Mendota Heights, Minnesota 55118 Company of America from 1961 until 1984.
George R. Long 65 Director Chairman of Mayfield Corp. (financial consultants and
29 Las Brisas Way venture capitalists) since 1973.
Naples, Florida 33963
J. Peter Thompson 64 Director Grain farmer in southwestern Minnesota since 1974.
Route 1 Prior to that, Mr. Thompson was employed by Paine
Mountain Lake, Minnesota 56159 Webber, Jackson & Curtis, Incorporated, (a diversified
financial services concern), most recently as Senior
Vice President and General Partner.
Charles H. Withers 68 Director Currently retired; served as Editor of the Rochester
Rochester Post Bulletin Post-Bulletin, Rochester, Minnesota from 1960 through
P.O. Box 6118 March 31, 1980.
Rochester, Minnesota 55903
</TABLE>
17
<PAGE>
<TABLE>
<CAPTION>
Name and Address Age Position Principal Occupation(s) During Past 5 Years
- ---------------- --- -------- -------------------------------------------
<S> <C> <C> <C>
Archie C. Black, III 33 Treasurer Senior Vice President and Chief Financial
3700 First Bank Place Officer of IAI and has served IAI in several
P.O. Box 357 capacities since 1987. Mr. Black is also
Minneapolis, Minnesota 55440 Treasurer of the other IAI Mutual Funds.
William C. Joas 33 Secretary Vice President of IAI and has served as an
3700 First Bank Place attorney for IAI since 1990. Mr. Joas is also
P.O. Box 357 Secretary of the other IAI Mutual Funds.
Minneapolis, Minnesota 55440
Larry R. Hill 43 Vice President, Executive Vice President and a Director of IAI
3700 First Bank Place Investments and has served IAI in various capacities since
P.O. Box 357 1984.
Minneapolis, Minnesota 55440
Timothy Palmer 33 Vice President, Senior Vice President of IAI and has served IAI
3700 First Bank Place Investments as a fixed income portfolio manager since 1990.
P.O. Box 357
Minneapolis, Minnesota 55440
Mark Simenstad 37 Vice President, Vice President of IAI and has served as a fixed income
3700 First Bank Place Investments portfolio manager since joining IAI in 1993. Prior to
P.O. Box 357 joining IAI, Mr. Simenstad served as a fixed income
Minneapolis, Minnesota 55440 portfolio manager for Lutheran Brotherhood
(diversified financial services concern).
Kirk Gove 33 Vice President, Vice President of IAI. Prior to joining IAI
3700 First Bank Place Marketing in 1992, Mr. Gove served as an Associate
P.O. Box 357 Vice President of Dain Bosworth, Incorporated
Minneapolis, Minnesota 55440 (diversified financial services concern).
Mr. Gove is also Vice President, Marketing of the
other IAI Mutual Funds.
Susan J. Haedt 34 Vice President, Vice President of IAI and Director of Fund
3700 First Bank Place Director of Operations. Prior to joining IAI in 1992,
P.O. Box 357 Operations Ms. Haedt served as a Senior Manager at
Minneapolis, Minnesota 55440 KPMG Peat Marwick LLP (an international tax,
accounting and consulting firm.) Ms. Haedt is
also Vice President, Director of Fund Operations
of the other IAI Mutual Funds.
</TABLE>
- -----------
* Directors of the Fund who are interested persons (as that term is defined
by the Investment Company Act of 1940) of IAI and the Fund.
The Fund has agreed to reduced initial subscription requirements for
employees and directors of the Fund or IAI, their spouses, children and
grandchildren. With respect to such persons, the minimum initial investment in
one or more of the IAI Family of Funds is $500; provided that the minimum amount
that can be allocated to any one of the Funds is $250. Subsequent subscriptions
are limited to a minimum of $100 for each of the Funds.
18
<PAGE>
No compensation is paid by the Fund to any of its officers. As of January
31, 1996, directors who are not affiliated with IAI receive from the IAI Mutual
Funds a $15,000 annual retainer, $2,500 for each Board meeting attended, $3,600
for each Audit Committee meeting attended (as applicable) and $1,800 for each
Securities Valuation Committee meeting attended. The Fund will pay its pro rata
share of these fees based on its net assets. Such unaffiliated directors also
are reimbursed for expenses incurred in connection with attending meetings.
<TABLE>
<CAPTION>
Aggregate Aggregate Compensation Projected Aggregate
Compensation from the Compensation from the
Name of Person, Position from the Fund* 18 IAI Mutual Funds** 19 IAI Mutual Funds***
------------------------ ------------- ---------------------- ----------------------
<S> <C> <C> <C>
Betsch, Madeline - Director $1,950 $28,725 $32,200
Hodgson, W. William - Director $1,950 $28,725 $32,200
Long, George R. - Director $1,550 $27,725 $32,200
Thompson, J. Peter - Director $1,950 $28,725 $32,200
Withers, Charles H. - Director $1,550 $27,725 $32,200
- -------------------------
</TABLE>
* For the fiscal year ended November 30, 1995.
** For all Funds for the calendar year ended December 31, 1995.
*** For the calendar year ending December 31, 1996 and includes the new IAI
Capital Appreciation Fund; provided that a director misses no meetings;
excludes expenses incurred in connection with attending meetings.
The Board of Directors for each of the Funds has approved a Code of Ethics.
The Code permits access persons to engage in personal securities transactions
subject to certain policies and procedures. Such procedures prohibit the
acquiring of any securities in an initial public offering. In addition, all
securities acquired through private placement must be pre-cleared. Procedures
have been adopted which would implement blackout periods for certain securities,
as well as a ban on short-term trading profits. Additional policies prohibit the
receipt of gifts in certain instances. Procedures have been implemented to
monitor employee trading. Each access person of the Adviser is required to
certify annually that they have read and understood the Code of Ethics. An
annual report is provided to the Funds' Board of Directors summarizing existing
procedures and changes, identifying material violations and recommending any
changes needed.
IAI, the Fund's investment adviser, is an affiliate of the Hill Samuel
Group ("Hill Samuel"). Hill Samuel is an international merchant banking and
financial services firm headquartered in London, England. In addition to its
ownership of IAI, Hill Samuel owns controlling interests in over seventy
insurance, merchant banking and financial services subsidiaries located in
Western Europe, Asia, the United States, Australia, New Zealand and Great
Britain. The principal offices of Hill Samuel are located at 100 Wood Street,
London EC2 P2AJ.
Hill Samuel, in turn, is owned by Lloyds TSB Group, plc ("Lloyds TSB"), a
publicly-held financial services organization headquartered in London, England.
Lloyds TSB is one of the largest personal and corporate financial services
groups in the United Kingdom, engaged in a wide range of activities including
commercial and retail banking. The principal offices of Lloyds TSB are located
at St. George's House, 6 - 8 Eastcheap, London, EC3M 1LL.
19
<PAGE>
MANAGEMENT AGREEMENT
Pursuant to an Investment Advisory and Administrative Services Agreement
between the Fund and IAI (the "Management Agreement"), IAI has agreed to provide
the Fund with investment advice, statistical and research facilities, and
certain equipment and services, including, but not limited to, office space and
necessary office facilities, equipment, and the services of required personnel
and, in connection therewith, IAI has the sole authority and responsibility to
make and execute investment decisions for the Fund within the framework of the
Fund's investment policies, subject to review by the directors of the Fund. In
addition, IAI has agreed to provide to the Fund all required administrative,
stock transfer, redemption, dividend disbursing and accounting services
including, without limitation, the following: (1) the maintenance of the Fund's
accounts, books and records; (2) the calculations of the daily net asset value
in accordance with the Fund's current Prospectus and Statement of Additional
Information; (3) daily and periodic reports; (4) all information necessary to
complete tax returns, questionnaires and other reports requested by the Fund;
(5) the maintenance of stock registry records; (6) the processing of requested
account registration changes, stock certificate issuances and redemption
requests; and (7) the administration of payments of dividends and distributions
declared by the Fund. In return for such services, the Fund has agreed to pay
IAI a fee of .50% per year of the Fund's average daily net assets.
As of November 30, 1995, the Fund had net assets of $101,428,912. For the
period from November 1, 1993 (commencement of operations) through March 31,
1994, for the fiscal period ended November 30, 1994, and for the fiscal year
ended November 30, 1995, the Fund paid IAI $48,292, $242,947, and $446,744,
respectively, pursuant to the Management Agreement.
Except for brokerage commissions and other expenditures in connection with
the purchase and sale of portfolio securities, interest expense, and, subject to
the specific approval of a majority of the disinterested directors of the Fund,
taxes and extraordinary expenses, IAI has agreed to pay all of the Fund's other
costs and expenses, including, for example, costs incurred in the purchase and
sale of assets, taxes, charges of the custodian of the Fund's assets, costs of
reports and proxy material sent to Fund shareholders, fees paid for independent
accounting and legal services, costs of printing Prospectuses for Fund
shareholders and registering the Fund's shares, postage, fees to directors who
are not "interested persons" of the Fund, insurance premiums, and costs of
attending investment conferences. IAI is not liable for any loss suffered by the
Fund in the absence of willful misfeasance, bad faith or gross negligence in the
performance of its duties and obligations.
The Management Agreement will terminate automatically in the event of its
assignment. In addition, the Agreement is terminable at any time without penalty
by the Board of Directors of the Fund or by vote of a majority of the Fund's
outstanding voting securities on not more than 60 days' written notice to IAI,
and by IAI on 60 days' notice to the Fund. The Agreement shall continue in
effect from year to year only so long as such continuance is specifically
approved at least annually by either the Board of Directors of the Fund or by
vote of a majority of the outstanding voting securities, provided that in either
event such continuance is also approved by the vote of a majority of directors
who are not parties to the Agreement or interested persons of such parties cast
in person at a meeting called for the purpose of voting on such approval.
Although investment decisions for the Fund are made independently from
those of the other funds and accounts as to which IAI gives investment advice,
it may occasionally develop that the same security is suitable for more than one
fund and/or other account. If and when more than one fund or other account
simultaneously purchase or sell the same security, the transactions will be
averaged as to price and allocated as to amount in accordance with arrangements
equitable to such funds and accounts. The simultaneous purchase or sale of the
same securities by more than one fund or by any fund and other accounts may have
detrimental effects on the Fund, as they may affect the price paid or received
by a fund or the size of the position obtainable by a fund.
20
<PAGE>
CUSTODIAL SERVICE
The custodian for the fund is Norwest Bank Minnesota, N.A. Norwest Center,
Sixth and Marquette, Minneapolis, MN 55479. Norwest has entered into an
agreement with Morgan Stanley Trust Company, 1 Pierrepont Plaza, Brooklyn, New
York ("Morgan Stanley") which enables the Fund to utilize the subcustodian and
depository network of Morgan Stanley. Such agreements, subcustodians and
depositories were approved by the Fund's Board of Directors in accordance with
the rules and regulations of the Securities and Exchange Commission, for the
purpose of providing custodial services for the Fund's assets held outside the
United States. The directors of the Fund monitor the activities of its custodian
and subcustodians as well as the economic conditions and applicable laws of the
foreign countries in which such Fund's assets are held.
The following is a listing of the subcustodians and depositories currently
approved by the Fund's directors and the countries in which such subcustodians
and depositories are located:
BRANCHES OF THE CUSTODIAN
AND SUBCUSTODIAN BANKS
----------------------
Argentina Citibank, N.A., Buenos Aires Branch
Australia Australia & New Zealand Banking Group, Ltd.
Austria Credit Austalt Bankverein
Bangladesh Standard Chartered Bank
Belgium Banque Bruxelles Lambert (BBL)
Botswana Barclays Bank of Botswana
Brazil Banco de Boston
Canada Toronto Dominion Bank
Chile Citibank, N.A., Santiago Branch
China Hong Kong & Shanghai Banking, Corp. Ltd.
Columbia Citibank, N.A./Cititrust Columbia S.A.
Cyprus Barclays Bank PLC
Czech Republic ING Bank
Denmark Den Danske Banke
Finland Merita Bank
France Banque Indosuez
Germany Berliner Handels-und-Frankfurter Bank
Ghana Barclays Bank of Ghana
Greece Citibank, N.A., Athens Branch
21
<PAGE>
Hong Kong Hong Kong & Shanghai Banking Corp. Ltd.
Hungary Citibank, N.A., Budapest Branch
India Standard Chartered Bank
Indonesia Hong Kong & Shanghai Banking Corp. Ltd.
Ireland Allied Irish Bank
Israel Bank Leumi
Italy Barclays Bank PLC
Japan The Mitsubishi Bank Limited
Jordan Arab Bank plc
Kenya Barclays Bank Kenya
Korea Standard Chartered Bank
Luxembourg Banque Bruxelles Lambert
Malaysia Oversea Chinese Banking Corporation
Mauritius Hong Kong and Shanghai Bank Corporation
Mexico Citibank, N.A., Mexico City Branch
Morocco Banque Commerciale du Maroc
Netherlands ABN Amro Bank
New Zealand Bank of New Zealand
Norway Den Norske Bank
Pakistan Standard Chartered Bank
Papua New Guinea Australia and New Zealand Banking Group
Peru Citibank N.A., Lima Branch
Philippines Hong Kong & Shanghai Banking Corp. Ltd.
Poland Citibank Poland, S.A.
Portugal Banco Commercial Portugues
Singapore Oversea Chinese Banking Corporation
South Africa First National Bank of Southern Africa
22
<PAGE>
Spain Banco Santader
Sri Lanka Hong Kong & Shanghai Banking, Corp. Ltd.
Swaziland Barclays Bank of Swaziland
Sweden Svenska Handelsbanken
Switzerland Bank Leu Ltd.
Taiwan Hong Kong & Shanghai Banking Corp. Ltd.
Thailand Standard Chartered Bank
Turkey Citibank, N.A., Istanbul Branch
United Kingdom Barclays Bank PLC
Uruguay Citibank, N.A., Montevideo Branch
Venezuela Citibank, N.A., Caracas Branch
Zambia Barclays Bank of Zambia
Zimbabwe Barclays Bank of Zimbabwe
DEPOSITORIES
------------
Argentina Caja de Valores
Australia Clearing House Electronic Subregister
System
Austria Wertpapiersammelbank
Belgium Caisse Interprofessionelle de Depot et de
Titres
Botswana Stock Exchange Talisman System
Brazil Bolsa de Valores de Sao Paulo
Bolsa de Valores de Rio de Janeiro
Canada The Canadian Depository for Securities
China Shangai Stock Exchange
Czech Republic Center for Securities (SCP)
Denmark Vaerdipapircentralen
23
<PAGE>
France SICOVAM (Societe Interprofessionelle la
Compensacion des Valuers Mobilieres)
Societe de Compensacion des Marches
Conditionnels
Chambre de Compensation des Instruments
Financiers de Paris
Germany Deutscher Kassenverein AG
Greece Central Clearing Office of Athens Stock
Exchange
Hong Kong Hong Kong Securities Clearing Company
Ireland Stock Exchange Talisman System
Israel SECH
Italy Monte Titoli, S.p.A
Japan Japan Securities Depository Center
Korea The Korean Central Depository
Malaysia The Malaysian Central Depository
Mexico Instituto para el Deposito de Valores
Morocco Casablanca Stock Exchange
Netherlands NECIGEF (Nederlands Centraal Institut
voor Giraal Effectenverkeer B.V.
New Zealand Austraclear New Zealand System
Norway Verdipapirsentralen
Pakistan The Karachi Stock Exchange Clearinghouse
Papua New Guinea Clearing House Electronic Subregister
System
Poland National Depository of Securities
Portugal Lisbon Stock Exchange (SICOB system)
Oporto Stock Exchange (CAMBIUM system)
Singapore Central Depository Pte Ltd.
South Africa Central Depository (Pty) Ltd.
Spain Servicio de Compensacion y Liquidacion de
Valores
Sri Lanka Central Depository System Piri Ltd.
24
<PAGE>
Sweden Vardepapperscentralen
Switzerland SEGA (Schweizerische Effekten Giro A.G.)
Taiwan Taiwan Securities Depository Co.
Thailand Share Depository Center
United Kingdom Stock Exchange Talisman System
Zimbabwe Stock Exchange Talisman System
PORTFOLIO TRANSACTIONS AND ALLOCATION OF BROKERAGE
Most of the Fund's portfolio transactions are effected with dealers without
the payment of brokerage commissions but at a net price which usually includes a
spread or markup. In effecting such portfolio transactions on behalf of the
Fund, IAI seeks the most favorable net price consistent with the best execution.
However, frequently IAI selects a dealer to effect a particular transaction
without contacting all dealers who might be able to effect such transaction
because of the volatility of the bond market and the desire of IAI to accept a
particular price for a security because the price offered by the dealer meets
its guidelines for profit, yield or both.
So long as IAI believes that it is obtaining the best net price (including
the spread or markup) consistent with the best execution, as described above, it
gives consideration in placing portfolio transactions to dealers furnishing
research, statistical information, or other services to IAI. This allows IAI to
supplement its own investment research activities and enables IAI to obtain the
views and information of individuals and research staffs of many different
securities firms prior to making investment decisions for the Fund. To the
extent portfolio transactions are effected with dealers who furnish research
services to it, IAI receives a benefit which is not capable of evaluation in
dollar amounts.
Consistent with the Rules of Fair Practice of the National Association of
Securities Dealers, Inc. and subject to the policies set forth in the preceding
paragraphs and such other policies as the Board of Directors of the Fund may
determine, IAI may consider sales of shares of the Fund as a factor in the
selection of broker-dealers to execute the Fund's securities transactions.
IAI believes that most research services obtained by it generally benefit
one or more of the investment companies or other accounts which it manages.
Research services obtained from transactions in fixed income securities would
primarily benefit the managed funds investing such fixed income securities and
managed accounts investing in fixed income securities.
CAPITAL STOCK
The Fund is a separate portfolio of IAI Investment Funds I, Inc., a
corporation organized on April 22, 1977, pursuant to the laws of the State of
Minnesota, whose shares of common stock are currently issued in two series
(Series A and B). Each share of a series is entitled to participate pro rata in
any dividends and other distributions of such series and all shares of a series
have equal rights in the event of liquidation of that series. The Board of
Directors of IAI Investment Funds I, Inc., is empowered under the Articles of
Incorporation of such company to issue other series of the company's common
stock without shareholder approval. IAI Investment Funds I, Inc., has
authorized 10,000,000,000 shares of $.01 par value common stock to be issued as
Series B common shares. The investment portfolio represented by such shares is
referred to as IAI Institutional Bond Fund. As of November 30, 1995, the Fund
had 10,676,597 shares outstanding.
25
<PAGE>
As of March 19, 1996, no person held of record or, to the knowledge of the
Fund, beneficially owned more than 5% of the Fund's outstanding shares, except
as set forth in the following table:
<TABLE>
<CAPTION>
Name and Address Number of Percent of
of Shareholder Shares Class
==================================== ============= ==========
<S> <C> <C>
Bank of America TTEE FBO 2,776,979.607 24.01
Tracor Inc. and Affiliates
P.O. Box 98622
Las Vegas, NV 89193
Greater Miami Jewish Federation 853,513.831 7.38
Attn: Steve Schwartz CFO
4200 Biscayne Blvd
Miami, FL 33137-3279
Blandin Paper Company 841,240.601 7.27
Defined Benefit Pension Plan
Attn: A. Eugene Radecki
115 SW First Street
Grand Rapids, MN 55744-3699
The Baptist Medical Centers 940,991.296 7.06
3500 Blue Lake Drive, Suite 105
Birmingham, AL 35243
Kansas Health Foundation 816,161.469 7.06
309 East Douglas
Wichita, KS 67207
Norwest Bank MN NA TTEE 809,531.590 7.00
University of St. Thomas #13222000
DTD 3/13/96
733 Marquette Ave. MS #0036
Minneapolis, MN 55479
Bank of America TTEE FBO 630,309 5.45
Littlefuse Inc. Retirement Plan
Attn: Susan Coyle
P.O. Box 98622
Las Vegas, NV 89193
</TABLE>
In addition, as of March 1, 1996, the Fund's officers and directors as a
group owned less than 1% of the Fund's outstanding shares.
NET ASSET VALUE AND PUBLIC OFFERING PRICE
The portfolio securities in which the Fund invests fluctuate in value, and
hence, for the Fund, the net asset value per share also fluctuates.
The net asset value per share of the Fund is determined once daily as of
the close of trading on the New York Stock Exchange on each business day on
which the New York Stock Exchange is open for trading, and may be determined on
additional days as required by the Rules of the Securities and Exchange
Commission. The New
26
<PAGE>
York Stock Exchange is closed, and the net asset value per share of the Fund is
not determined, on the following national holidays: New Year's Day, Presidents'
Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day,
and Christmas Day.
On November 30, 1995, the net asset value and public offering price per
share of the Fund was calculated as follows:
NAV = Net Assets ($101,428,912) = $9.50
-------------------------------
Shares Outstanding (10,676,597)
TAX STATUS
The tax status of the Fund and the distributions of the Fund are summarized
in the Prospectus under "Dividends, Distributions and Tax Status."
Under the Internal Revenue Code of 1986, as amended (the "Code"), individual
shareholders may not exclude any amount of distributions from Fund gross income
that is derived from dividends; corporate shareholders, however, are permitted
to deduct 70% of qualifying dividend distributions from domestic corporations.
Such a deduction by a corporate shareholder will depend upon the portion of the
Fund's gross income which is derived from dividends received from domestic
corporations. Since it is anticipated that a portion of the net investment
income of the Fund may derive from sources other than dividends from domestic
corporations, a portion of the Fund's dividends may not qualify for this
exclusion. Distributions designated as long-term capital gain distributions will
be taxable to the shareholder as long-term capital gains regardless of how long
the shareholder has held the shares. Such distributions will not be eligible for
the dividends received deduction referred to above.
If Fund shares are sold or otherwise disposed of more than one year from
the date of acquisition, the difference between the price paid for the shares
and the sales price will result in long-term capital gain or loss to the Fund
shareholder if, as is usually the case, the Fund shares are a capital asset in
the hands of the Fund shareholder at that time. However, under a special
provision in the Code, if Fund shares with respect to which a long-term capital
gain distribution has been, or will be, made are held for six months or less,
any loss on the sale or other disposition of such shares will be long-term
capital loss to the extent of such distribution.
Ordinarily, distributions and redemption proceeds earned by Fund
shareholders are not subject to withholding of federal income tax. However, the
Fund is required to withhold 31% of a shareholder's distributions and redemption
proceeds upon the occurrence of certain events specified in Section 3406 of the
Code and regulations promulgated thereunder. These events include the failure of
a Fund shareholder to supply the Fund with such shareholder's taxpayer
identification number, and the failure of a Fund shareholder who is otherwise
exempt from withholding to properly document such shareholder's status as an
exempt recipient. Additionally, distributions may be subject to state and local
income taxes, and the treatment thereunder may differ from the federal income
tax consequences discussed above.
Under the Code, the Fund will be subject to a non-deductible excise tax
equal to 4% of the excess, if any, of the amount of investment income and
capital gains required to be distributed pursuant to the Code for each calendar
year over the amount actually distributed. In order to avoid this excise tax,
the Fund generally must declare dividends by the end of each calendar year
representing 98% of the Fund's ordinary income for such calendar year and 98% of
its capital gain net income (both long-term and short-term) for the twelve-month
period ending October 31 of the same calendar year. The excise tax is not
imposed, however, on undistributed income that is already subject to corporate
income tax. It is the Fund's policy not to distribute capital gains until
capital loss carryovers, if any, either are utilized or expire.
Income received from sources within foreign countries may be subject to
withholding and other taxes imposed by such countries. Tax conventions between
certain countries and the United States may reduce or
27
<PAGE>
eliminate such taxes. It is impossible to determine the effective rate of
foreign tax applicable to such income in advance since the precise amount of a
Fund's assets to be invested in various countries is not known. Any amount of
taxes paid by the Fund to foreign countries will reduce the amount of income
available to the Fund for distributions to shareholders.
The foregoing is a general and abbreviated summary of the Code and Treasury
regulations in effect as of the date of the Fund's Prospectus and this Statement
of Additional Information. The foregoing relates solely to federal income tax
law applicable to "U.S. persons," i.e., U.S. citizens and residents and U.S.
domestic corporations, partnerships, trusts and estates. Shareholders who are
not U.S. persons are encouraged to consult a tax adviser regarding the income
tax consequences of acquiring shares of the Fund.
LIMITATION OF DIRECTOR LIABILITY
Under Minnesota law, the Fund's Board of Directors owes certain fiduciary
duties to the Fund and to its shareholders. Minnesota law provides that a
director "shall discharge the duties of the position of director in good faith,
in a manner the director reasonably believes to be in the best interest of the
corporation, and with the care an ordinarily prudent person in a like position
would exercise under similar circumstances." Fiduciary duties of a director of a
Minnesota corporation include, therefore, both a duty of "loyalty" (to act in
good faith and act in a manner reasonably believed to be in the best interests
of the corporation) and a duty of "care" (to act with the care an ordinarily
prudent person in a like position would exercise under similar circumstances).
Minnesota law authorizes corporations to eliminate or limit the personal
liability of a director to the corporation or its shareholders for monetary
damages for breach of the fiduciary duty of "care." Minnesota law does not,
however, permit a corporation to eliminate or limit the liability of a director
(i) for any breach of the director's duty of "loyalty" to the corporation or its
shareholders, (ii) for acts or omissions not in good faith or that involve
intentional misconduct or a knowing violation of law, (iii) for authorizing a
dividend, stock repurchase or redemption or other distribution in violation of
Minnesota law or for violation of certain provisions of Minnesota securities
laws, or (iv) for any transaction from which the director derived an improper
personal benefit. The Articles of Incorporation of IAI Investment Funds I, Inc.,
limit the liability of directors to the fullest extent permitted by Minnesota
statutes, except to the extent that such liability cannot be limited as provided
in the Investment Company Act of 1940 (which Act prohibits any provisions which
purport to limit the liability of directors arising from such directors' willful
misfeasance, bad faith, gross negligence, or reckless disregard of the duties
involved in the conduct of their role as directors).
Minnesota law does not eliminate the duty of "care" imposed upon a
director. It only authorizes a corporation to eliminate monetary liability for
violations of that duty. Minnesota law, further, does not permit elimination or
limitation of liability of "officers" of the corporation for breach of their
duties as officers (including the liability of directors who serve as officers
for breach of their duties as officers.) Minnesota law does not permit
elimination or limitation of the availability of equitable relief, such as
injunctive or rescissionary relief. Further, Minnesota law does not permit
elimination or limitation of a director's liability under the Securities Act of
1933 or the Securities Exchange Act of 1934, and it is uncertain whether and to
what extent the elimination of monetary liability would extend to violations of
duties imposed on directors by the Investment Company Act of 1940 and the rules
and regulations adopted under such Act.
FINANCIAL STATEMENTS
The financial statements, included as part of the Fund's 1995 Annual Report
to shareholders, are incorporated herein by reference. Such Annual Report may be
obtained by shareholders on request from the Fund at no additional charge.
28
<PAGE>
APPENDIX A
RATINGS OF DEBT SECURITIES
RATINGS BY MOODY'S
- ------------------
CORPORATE BONDS
Aaa. Bonds 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 rated Aa are judged to be of high quality by all standards.
Together with the Aaa group, they comprise what are generally known as high
grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in Aaa securities or fluctuation of protective
elements may be of greater amplitude or there may be other elements present
which make the long term risks appear somewhat larger than in Aaa securities.
A. Bonds rated A possess many favorable investment attributes and are to be
considered as upper medium grade obligations. Factors giving security to
principal and interest are considered adequate, but elements may be present
which suggest a susceptibility to impairment sometime in the future.
Baa. Bonds rated Baa are considered 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 which are rated Ba are judged to have speculative elements; their
future cannot be considered as well assured. Often the protection of interest
and principal payments may be very moderate, and thereby not well safeguarded
during other good and bad times over the future. Uncertainty of position
characteristizes bonds in this class.
B. Bonds rated B generally lack characteristics of the desirable
investment. Assurances of interest and principal payment or maintenance of other
terms of the contract over any long period of time may be small.
Caa. Bonds rated Caa are of poor standing. Such issues may be in default or
there may be present elements of danger with respect to principal or interest.
Ca. Bonds rated Ca represent obligations which are speculative in a high
degree. Such issues are often in default or have other marked shortcomings.
C. Bonds rated C are the lowest-rated class of bonds and issued so rated
can be regarded as having extremely poor prospects of ever attaining any real
investment standing.
Conditional Ratings. The designation "Con." followed by a rating indicates
bonds for which the security depends upon the completion of some act or the
fulfillment of some condition. These are bonds secured by (a) earnings of
projects under construction, (b) earnings or projects unseasoned in operating
experience, (c) rentals which begin when facilities are completed, or (d)
payments to which some other limiting condition attaches. Parenthetical rating
denotes probable credit stature upon completion of construction or elimination
of basis of condition.
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Note: Moody's applies numerical modifiers 1, 2, and 3 in the Aa and A
classifications of its corporate 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 the modifier 3 indicates that the
issue ranks in the lower end of its generic rating category. With respect to
municipal securities, those bonds in the Aa, A, Baa, Ba, and B groups which
Moody's believes possess the strongest investment attributes are designated by
the symbols Aa1, A1, Baa1, Ba1, and B1.
COMMERCIAL PAPER
Moody's employs the following three designations, all judged to be
investment grade, to indicate the relative repayment capacity of rated issuers:
Prime - 1 Superior ability for repayment of senior short-term
debt obligations
Prime - 2 Strong ability for repayment of senior short-term debt
obligations
Prime - 3 Acceptable ability for repayment of senior short-term
debt obligations
If an issuer represents to Moody's that its Commercial Paper
obligations are supported by the credit of another entity or entities, Moody's,
in assigning ratings to such issuers, evaluates the financial strength of the
indicated affiliated corporations, commercial banks, insurance companies,
foreign governments, or other entities, but only as one factor in the total
rating assessment.
RATINGS BY S&P
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CORPORATE BONDS
AAA. Debt rated AAA has the highest rating assigned by S&P. 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 higher rated issues only in small degree.
A. Debt rated A has a strong capacity to pay interest and repay principal
although it is somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions than debt in higher-rated categories.
BBB. Debt rated BBB is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than in higher-rated categories.
BB. Debt rated BB has less near-term vulnerability to default than other
speculative issues. However, it faces major ongoing uncertainties or exposure to
adverse business, financial, or economic conditions which could lead to
inadequate capacity to meet timely interest and principal payments.
B. Debt rated B has a greater vulnerability to default but currently has
the capacity to meet interest payments and principal repayments. Adverse
business, financial, or economic conditions will likely impair capacity or
willingness to pay interest and repay principal. The B rating category is also
used for debt subordinated to senior debt that is assigned an actual or implied
BB-rating.
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CCC. Debt rated CCC has a currently identifiable vulnerability to default,
and is dependent upon favorable business, financial, and economic conditions to
meet timely payment of interest and repayment of principal. In the event of
adverse business, financial or economic conditions, it is not likely to have the
capacity to pay interest and repay principal.
CC. Debt rated CC is typically applied to debt subordinated to senior debt
which is assigned an actual or implied CCC debt rating.
C. The rating C typically applied to debt subordinated to senior debt which
assigned an actual or implied CCC-debt rating. The C rating may be used to cover
a situation where a bankruptcy petition has been filed but debt service payments
are continued.
C1. The rating C1 is reserved for income bonds on which no interest is
being paid.
D. Debt rated D is in payment default. The D rating category is used when
interest payments or principal payments are not made on the date due even if the
applicable grace period has not expired, unless S & P believes that such
payments will be made during such grace period. The D rating will be used upon
the filing of a bankruptcy petition if debt service payments are jeopardized.
In order to provide more detailed indications of credit quality, S&P's bond
letter ratings described above (except for the AAA category) may be modified by
the addition of a plus or a minus sign to show relative standing within the
rating category.
COMMERCIAL PAPER
A. This highest rating category indicates the greatest capacity for timely
payment. Issues in this category are further defined with the designations 1, 2,
and 3 to indicate the relative degree to safety.
A-1. This designation indicates that the degree of safety regarding timely
payment is either overwhelming or very strong. Those issues determined to
possess overwhelming safety characteristics are designed A-1+.
A-2. Capacity for timely payments on issues with this designation is
satisfactory. However, the relative degree of safety is not as high as for
issues designed A-1.
A-3. Issues carrying this designation have adequate capacity for timely
repayment. They are, however, more vulnerable to the adverse effects of changes
in circumstances than obligations carrying the higher designations.
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