FIXED INCOME FUNDS
IAI Bond Fund
IAI Government Fund
APRIL 1, 1997
Includes Brochure and Prospectus
[LOGO]
MUTUAL FUNDS
<PAGE>
[ART]
IAI MUTUAL FUNDS
IAI Bond Fund, IAI Government Fund
FUND INFORMATION
LOW MINIMUM INVESTMENT
You can open an account with IAI for only $5,000 ($2,000 for an IRA). The
minimum investment per Fund is $1,000. Subsequent investments can be made for
only $100 per Fund.
NO-LOAD
With IAI, you pay no commissions to buy, sell, or exchange shares.
NO-FEE IRA
Unlike many others, IAI charges no annual fee for maintaining your IRA.
FAMILY OF FUNDS
Whatever your investment needs, IAI's diverse Mutual Fund family has the
right Fund for you. Call for a free Prospectus for the IAI Developing Countries
Fund, IAI International Fund, IAI Capital Appreciation Fund, IAI Midcap Growth
Fund, IAI Regional Fund, IAI Growth Fund, IAI Value Fund, IAI Growth and Income
Fund, IAI Balanced Fund, IAI Bond Fund, IAI Government Fund, IAI Reserve Fund
and IAI Money Market Fund. Read the Prospectus carefully before investing or
sending money.
FREE EXCHANGES
Money can be exchanged between IAI Mutual Funds free of charge.
AUTOMATIC INVESTMENT PROGRAM
Regular monthly investments ($100 minimum) can be made automatically into the
Fund from your checking or savings account. Shareholders in other Funds may
arrange to invest regularly through monthly exchanges into any of the IAI Mutual
Funds.
LIQUIDITY
You can redeem part or all of your Fund shares at any time at the then current
share price (which may be more or less than your original cost). Special rules
apply to IRAs.
RETIREMENT PROGRAMS
IAI offers a variety of retirement investment programs including Individual
Retirement Accounts (IRAs), Direct Rollovers for persons receiving distributions
from Qualified Retirement Plans, SEP (Simplified Employee Pension) Plans for
small business owners.
TOLL-FREE TELEPHONE TRANSACTIONS
IAI offers a convenient toll-free telephone service for investors to find out
more about IAI Mutual Funds and services and to carry out transactions such as
buying or selling shares or exchanging assets from one fund to another. The
toll-free number, 1-800-945-3863, is available from anywhere in the United
States, weekdays from 7:30 a.m. - 5:30 p.m. Central Time.
IAI INVESTOR LIBRARY
The IAI Investor Library provides free practical and objective information on
investing and investment strategies to investors who call 1-800-945-3863 and
request the Adviser Special Reports.
QUARTERLY NEWSLETTER
IAI's free quarterly newsletter keeps shareholders up to date on IAI Mutual
Funds' performance and economic conditions and provides helpful tips on
investing.
CHECKWRITING
Investors in IAI Money Market Fund or IAI Reserve Fund receive free checkwriting
privileges, for checks written for $500 or more, with no check printing fees.
IAI PREFERRED
IAI shareholders with balances in excess of $100,000 receive unique privileges,
including an exclusive toll-free telephone number, an individually assigned
account representative, an "Investing for Retirement" brochure and an IAI
Preferred portfolio organizer to conveniently house all IAI correspondence.
EASY-TO-READ STATEMENTS
IAI provides complete, easy to read quarterly account statements which include
summaries of all transactions and portfolio allocations for all of your IAI Fund
holdings on one report.
DIVIDEND OPTIONS
Shareholders may receive dividends in cash, have them electronically directed to
their personal bank account or arrange to automatically reinvest them in
additional IAI Mutual Fund shares.
INFORMATION AND ASSISTANCE
Our knowledgeable investment representatives are available to help you -- with
no sales pressure.
This text is not part of the prospectus. Additional information, including
fees and expenses, is included in the attached prospectus. Please read it
carefully before investing or sending money.
<PAGE>
IAI Mutual Funds
IAI Bond Fund
FUND INFORMATION
HIGH CURRENT INCOME
IAI Bond Fund is designed for investors who want a high level of current income
consistent with capital preservation. The Fund seeks to achieve its objective by
investing primarily in a diversified portfolio of investment-grade bonds and
other debt securities of similar quality.
CORPORATE AND
GOVERNMENT BONDS
The Fund invests primarily in corporate, government, and mortgage-backed
securities, which vary in weighting depending on market conditions. The maturity
of the portfolio is also managed to take full advantage of market opportunities.
DIVERSIFIED PORTFOLIO
The Fund's portfolio is fully diversified with holdings spread across a wide
range of securities to minimize risk. Please see the Fund's prospectus, which
accompanies this material, for more information on the Fund's investment
policies and techniques, as well as the risks associated with investing in the
Fund.
MONTHLY DIVIDENDS
Dividends are paid monthly. You may receive your dividends in cash or
automatically reinvest them in additional shres which compounds your return.
PROFESSIONAL MANAGEMENT
IAI Bond Fund is a member of the IAI Mutual Fund family. Founded in 1947, IAI
currently manages nearly $17 billion in assets for thousands of individual
investors, as well as Fortune 500 companies, leading colleges, universities, and
religious organizations. IAI's portfolio managers monitor the market daily and
select the most appropriate issues available for the Fund's portfolio.
IT'S EASY TO START
To open an account, simply complete the enclosed application and return it in
the enclosed postage-paid envelope with a check payable to "IAI Mutual Funds."
If you are a current shareholder in any IAI Mutual Fund, the minimum investment
is $1,000. If not, the minimum investment is $5,000 (this can be allocated among
IAI Funds, with $1,000 minimum per Fund).
call 1-800-945-3863
[PHOTO OF]
LARRY R. HILL, CFA
Fund Co-Manager
[PHOTO OF]
STEPHEN C. COLEMAN, CFA
Fund Co-Manager
[PHOTO OF]
Livingston G. DOUGLAS, CFA
Fund Co-Manager
This text is not part of the prospectus. Additional information, including
fees and expenses, is included in the attached prospectus. Please
read it carefully before investing or sending money.
<PAGE>
IAI MUTUAL FUNDS
IAI Bond Fund
IAI Bond Fund's portfolio managers actively vary the composition of the Fund's
portfolio to take advantage of market opportunities. While always maintaining a
fully diversified portfolio to minimize risk, IAI varies the sectors and the
maturities in which the Fund invests.
CHOOSING THE BEST SECTORS
IAI Bond Fund invests in a variety of high quality fixed-income securities.
These are typically investment grade or similar quality, to minimize credit
risk. However, the Fund will invest in limited amounts of below-investment grade
debt, foreign issues and preferred stock to diversify and enhance portfolio
returns. The Fund invests in three broad sectors.
- Corporate
- Government
- Mortgage-Backed Securities
The weighting of each sector changes as the Fund's managers invest in the
sectors which offer the greatest potential return which offer the greatest
potential return with the least potentail risk. Further, within each sector, the
Fund's managers conduct a rigorous analysis to identify the most promising
individual securities.
VARYING MATURITIES
The Fund's managers actively manage the Fund's maturity depending on economic
conditions and market outlook. For example, if interest rates are expected to
fall, maturity might be lengthened because bond prices tend to rise as interest
rates fall, and longer-term bonds are the most sensitive to interest rate
changes. Shown in the chart below if the change in value of various maturity
bonds when interest rates change by 1%. The chart assumes an 8% coupon for each
bond.
BOND PRICES VS. INTEREST RATES
Bond Bond Price Change
Maturity if Interest Rates
- ------------------------------------------------------
Fall 1% Rise 1%
------------------------------
1 year 1.0% (.9%)
5 year 4.2% (4.0%)
10 year 7.1% (6.5%)
Source: IAI
Active asset
management ... to
maximize return and
minimize risk
This text is not part of the prospectus. Additional information, including
fees and expenses, is included in the attached prospectus. Please read it
carefully before investing or sending money.
<PAGE>
IAI MUTUAL FUNDS
IAI Government Fund
FUND INFORMATION
HIGH CURRENT INCOME
IAI Government Fund seeks to provide shareholders with a high level of current
income and with preservation of capital. The Fund seeks to achieve its
objectives by investing primarily in U.S. Government securities.
INCOME/PRESERVATION
OF CAPITAL
The Fund strives to achieve these objectives in two ways:
1. High Quality
The Fund invests primarily in U.S. Government securities, which are among the
highest quality and most liquid securities in the world.
2. Intermediate Maturity
The dollar-weighted average maturity of the Fund's portfolio will generally not
exceed ten years. Intermeditate-term securities generally provide higher income
than short-term fixed income securities without the volatility of longer-term
bonds.
Please see the Fund's prospectus, which accompanies this material, for more
information on the Fund's investment policies and techniques, as well as the
risks associated with investing in the Fund.
MONTHLY DIVIDENDS
Dividends are paid monthly. You may receive your dividends in cash or
automatically reinvest them in additional shares which compounds your return.
PROFESSIONAL MANAGEMENT
IAI Government Fund is a member of the IAI Mutual Fund family. Founded in 1947,
IAI currently manages nearly $17 billion in assets for thousands of individual
investors, as well as Fortune 500 companies, leading colleges, universities, and
religious organizations. IAI's fixed income experts monitor the market daily and
select the best issues available for the Fund's portfolio.
IT'S EASY TO START
To open an account, simply complete the enclosed application and return it in
the enclosed postage-paid envelope with a check payable to "IAI Mutual Funds."
If you are a current shareholder in any IAI Mutual Fund, the minimum investment
is $1,000. If not, the minimum investment is $5,000 (this can be allocated among
IAI Funds, with $1,000 minimum per Fund).
[PHOTO OF]
SCOTT A. BETTIN, CFA
Fund Co-Manager
[PHOTO OF]
LIVINGSTON DOUGLAS, CFA
Fund Co-Manager
CALL 1-800-945-3863
This text is not part of the prospectus. Additional information, including
fees and expenses, is included in the attached prospectus. Please
read it carefully before investing or sending money.
<PAGE>
IAI MUTUAL FUNDS
IAI Government Fund
U.S. GOVERNMENT SECURITIES
U.S. Government securities are popular with investors because they offer both
income and high credit quality. To maximize return and minimize price
fluctuation, IAI Government Fund invests in a diversified portfolio of U.S.
Government securities. Under normal market conditions, the Fund invests at least
65% of its assets in U.S. Government securities, including the following
obligations:
U.S. Treasury - these include:
- Treasury Bills
(original maturities up to one year)
- Treasury Notes
(original maturities of one to ten years)
- Treasury Bonds
(original maturities generally over ten years)
U.S. Government Agencies and Instrumentalities -
these include securities such as those issued by:
- Government National Mortgage
Association ("Ginnie Mae")
- Federal National Mortgage
Association ("Fannie Mae")
- Federal Home Loan Mortgage
Corporation ("Freddie Mac")
- Farm Credit Banks
- Resolution Funding Corporation
The securities above are all backed by either the "full faith and credit" of the
U.S. Government, or by the right of the issuing agency to borrow from the U.S.
Treasury. This backing helps ensure timely payment of principal and interest. Of
course, shares of the Fund itself are not guaranteed, and the Fund's yield,
return and share value will fluctuate with market conditions.
INTERMEDIATE-TERM BONDS
For investors who can tolerate a moderate amount of share price fluctuation,
intermediate-term bonds may offer the best combination of return and risk. That
is why IAI Government Fund's portfolio generally maintain an average maturity of
ten years or less.
Higher Returns
Historically, intermediate-term bonds have higher returns than short-term
instruments, as shown in the chart below.
AVERAGE ANNUAL HISTORICAL RETURNS*
Periods ending 12/31/96
- -------------------------------------------------------------------------------
15 yrs. 10 yrs. 5 yrs.
- -------------------------------------------------------------------------------
Intermediate-term
U.S. Government Bonds 10.3% 7.7% 6.2%
Treasury Bills 6.9% 5.7% 4.4%
* These returns are historical returns and do not represent projected or
anticipated returns from the Fund. Actual returns may be higher or lower
than the historical returns. Intermediate-term bonds may be more volatile
than Treasury Bills.
Source: Ibbotson Associates. Intermediate-term bond maturity
approximates five years.
Lower Volatilty
Intermediate-term bonds are less volatile than long-term bonds in response to
interest rate changes. The chart below shows the percentage change in principal
value for bonds of various maturities when interest rates rise by one percentage
point. The chart assumes an 8% coupon for each bond.
BOND PRICES VS. INTEREST RATES
Maturity in yrs. If rates rise 1% bond prices fall by:
- ------------------------------------------------------------------------------
Treasury Bill 1 (.9%)
Intermediate Bond 5 (4.0%)
Long-term Bond 30 (11.0%)
Income
and low credit risk
from U.S. Government
securities
This text is not part of the prospectus. Additional information, including
fees and expenses, is included in the attached prospectus. Please
read it carefully before investing or sending money.
<PAGE>
TABLE OF CONTENTS
IAI BOND FUND, IAI GOVERNMENT FUND
<TABLE>
<CAPTION>
<S> <C>
FUND EXPENSE INFORMATION...................................................2
FUND DIRECTORS.............................................................2
FINANCIAL HIGHLIGHTS.......................................................3
INVESTMENT OBJECTIVES AND POLICIES
IAI BOND FUND...........................................................5
IAI GOVERNMENT FUND.....................................................6
OTHER FUND INVESTMENT TECHNIQUES...........................................9
FUND RISK FACTORS..........................................................13
MANAGEMENT.................................................................17
INVESTMENT PERFORMANCE.....................................................18
COMPUTATION OF NET ASSET VALUE AND PRICING.................................19
PURCHASE OF SHARES.........................................................19
RETIREMENT PLANS...........................................................21
AUTOMATIC INVESTMENT PLAN..................................................21
REDEMPTION OF SHARES.......................................................21
EXCHANGE PRIVILEGE.........................................................23
AUTOMATIC EXCHANGE PLAN....................................................23
AUTHORIZED TELEPHONE TRADING...............................................24
SYSTEMATIC CASH WITHDRAWAL PLAN............................................24
DIVIDENDS, DISTRIBUTIONS AND TAX STATUS....................................25
DESCRIPTION OF COMMON STOCK................................................26
COUNSEL AND AUDITORS.......................................................27
CUSTODIAN, TRANSFER AGENT AND DIVIDEND DISBURSING AGENT....................27
ADDITIONAL INFORMATION.....................................................27
</TABLE>
<PAGE>
IAI MUTUAL FUNDS
IAI Bond Fund, IAI Government Fund
PROSPECTUS DATED APRIL 1, 1997
IAI Bond Fund ("Bond Fund") is a separate portfolio of IAI Investment Funds I,
Inc. and IAI Government Fund ("Government Fund") is a separate portfolio of IAI
Investment Funds VI, Inc. IAI Investment Funds I, Inc. and IAI Investment Funds
VI, Inc. are open-end diversified management investment companies authorized to
issue their shares of common stock in more than one series. Investment Advisers,
Inc. ("IAI") serves as each Fund's investment adviser and manager.
Bond Fund's investment objective is to provide shareholders with a high level of
current income consistent with preservation of capital. Bond Fund pursues its
objective by investing primarily in a diversified portfolio of investment grade
bonds and other debt securities of similar quality.
Government Fund's investment objectives are to provide shareholders with a high
level of current income and with preservation of capital. Government Fund
pursues its objectives by investing its assets primarily in securities issued,
guaranteed or collateralized by the United States Government, its agencies or
instrumentalities, whether or not backed by the "full faith and credit" pledge
of the United States Government, and in repurchase agreements pertaining to such
securities.
This Prospectus sets forth concisely the information which a prospective
investor should know about each Fund before investing and it should be retained
for future reference. A "Statement of Additional Information" dated April 1,
1997, 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 Funds 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.
-1-
<PAGE>
IAI MUTUAL FUNDS
IAI Bond Fund, IAI Government Fund
FUND EXPENSE INFORMATION
<TABLE>
<CAPTION>
<S> <C> <C>
Shareholder Transaction Expenses Bond Fund Government Fund
- -------------------------------- --------- ---------------
Sales Load Imposed on Purchases......................... None None
Sales Load Imposed on Reinvested Dividends.............. None None
Redemption Fees*........................................ None None
Exchange Fees........................................... None None
- ----------------------------------------
</TABLE>
* Each Fund charges a $10.00 fee for the
payment of redemption proceeds by wire.
<TABLE>
<CAPTION>
<S>
Annual Fund Operating Expenses
- ------------------------------------------------------ <C> <C>
(as a percentage of average daily net assets) Bond Fund Government Fund
--------- ---------------
Management Fee 1.10% 1.10%
Rule 12b-1 Fee None None
Other Expenses None None
----- -----
Total Fund Operating Expenses 1.10% 1.10%
===== =====
</TABLE>
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:
1 Year 3 Years 5 Years 10 Years
------ ------- ------- --------
Bond Fund $ 11 $ 35 $ 61 $ 134
Government Fund $ 11 $ 35 $ 61 $ 134
The purpose of the above table is to assist you in understanding the
various costs and expenses that an investor in the Funds will bear directly or
indirectly. The information in the table is based upon actual expenses incurred
by the Funds for the fiscal year ended November 30, 1996. THE EXAMPLE SHOULD NOT
BE CONSIDERED A REPRESENTATION OF PAST OR FUTURE EXPENSES. ACTUAL EXPENSES MAY
BE GREATER OR LESS THAN THOSE SHOWN.
Further information concerning fees paid by the Funds is set forth in the
Statement of Additional Information.
FUND DIRECTORS
Madeline Betsch Richard E. Struthers
W. William Hodgson J. Peter Thompson
George R. Long Charles H. Withers
Noel P. Rahn
-2-
<PAGE>
IAI MUTUAL FUNDS
IAI Bond Fund, IAI Government Fund
FINANCIAL HIGHLIGHTS
The following information has been audited by KMPG Peat Marwick LLP, independent
auditors, whose report is included in each 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 a Fund at no charge.
BOND FUND
<TABLE>
<CAPTION>
Years ended March 31,
-----------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Years Ended
November 30,
1996 1995 1994*** 1994 1993 1992 1991 1990 1989 1988
---- ---- ------- ---- ---- ---- ---- ---- ---- ----
NET ASSET VALUE
Beginning of period $9.34 $8.65 $9.32 $10.42 $10.25 $10.02 $9.66 $9.31 $9.63 $10.29
----- ----- ----- ------ ------ ------ ----- ----- ----- ------
OPERATIONS
Net investment income .56 .58 .36 .62 .64 .73 .73 .73 .72 .76
Net realized and unrealized
gains (losses) .04 .72 (.55) (.25) .93 .34 .43 .32 (.32) (.37)
--- --- ---- ---- --- --- --- --- ---- ----
Total from operations .60 1.30 (.19) .37 1.57 1.07 1.16 1.05 .40 .39
--- ---- ---- --- ---- ---- ---- ---- --- ---
DISTRIBUTIONS TO SHAREHOLDERS
FROM:
Net investment income (.62) (.61) (.35) (.66) (.64) (.74) (.80) (.67) (.72) (.95)
Net realized gains -- -- (.13) (.81) (.76) (.10) -- (.03) -- (.10)
---- ---- ---- ---- ---- ---- ---- ----- ----- -----
Total distributions (.62) (.61) (.48) (1.47) (1.40) (.84) (.80) (.70) (.72) (1.05)
---- ---- ---- ----- ----- ---- ---- ---- ---- -----
NET ASSET VALUE
End of period $9.32 $9.34 $8.65 $9.32 $10.42 $10.25 $10.02 $9.66 $9.31 $9.63
===== ===== ===== ===== ====== ====== ====== ===== ===== =====
Total investment return * 6.85% 15.46% (2.10%) 3.16% 16.44% 10.80% 12.62% 11.18% 4.29% 4.19%
Net assets at end of period
(000's omitted) $86,803 $77,526 $80,622 $97,139 $119,371 $107,634 $108,589 $79,982 $50,187 $41,080
RATIOS
Expenses to average
net assets 1.10% 1.09% 1.10%** 1.09% 1.10% 1.10% .88% .89% .80%
Net investment income to
average net assets 6.20% 6.32% 6.03%** 5.63% 6.03% 7.43% 7.56% 7.50% 7.70% 7.70%
Portfolio turnover rate
(excluding short-term
securities) 342.4% 424.7% 226.7% 333.1% 160.8% 126.2% 43.0% 78.3% 115.3% 20.2%
</TABLE>
- ---------------------------------
* 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
*** Period from April 1, 1994 to November 30, 1994. Reflects fiscal year-end
change from March 31 to November 30.
-3-
<PAGE>
IAI MUTUAL FUNDS
IAI Bond Fund, IAI Government Fund
GOVERNMENT FUND
<TABLE>
<CAPTION>
Years Ended November 30, Years ended March 31,
------------ ------------- ----------------------------------
<S> <C> <C> <C> <C> <C> <C>
1996 1995 1994**** 1994 1993 1992*
---- ---- -------- ---- ---- -----
NET ASSET VALUE
Beginning of period $10.06 $9.62 $9.98 $10.46 $10.22 $10.00
------ ----- ----- ------ ------ ------
OPERATIONS
Net investment income .58 .60 .33 .47 .57 .30
Net realized and unrealized
gains (losses) (.10) .43 (.34) (.24) .59 .24
---- --- ---- ---- --- ---
Total from operations .48 1.03 (.01) .23 1.16 .54
--- ---- ---- --- --- ---
DISTRIBUTIONS TO
SHAREHOLDERS FROM:
Net investment income (.59) (.59) (.32) (.49) (.58) (.30)
Net realized gains --- ---- (.03) (.22) (.34) (.02)
----- ----- ---- ---- ---- ----
Total distributions (.59) (.59) (.35) (.71) (.92) (.32)
---- ---- ---- ---- ---- ----
NET ASSET VALUE
End of period $9.95 $10.06 $9.62 $9.98 $10.46 $10.22
===== ====== ===== ===== ====== ======
Total investment return*** 4.99% 10.99% (0.09%) 2.02% 11.70% 5.51%
Net Assets at end of period $29,751 $48,121 $38,438 $41,027 $43,704 $30,707
(000's omitted)
RATIOS:
Expenses to average net assets 1.10% 1.10% 1.10%** 1.10% 1.10% 1.10%**
Net investment income to
average net assets 5.78% 5.97% 5.12%** 4.40% 5.40% 5.16%**
Portfolio turnover rate
(excluding short-term
securities) 152.0% 284.1% 121.5% 641.0% 236.3% 169.6%
</TABLE>
- -------------------------------
* Period from August 8, 1991 (commencement of operations) to March 31, 1992
** Annualized
*** Total investment return is based on the change in net asset value
of a share during the period and assumes reinvestment of all
distributions at net asset value.
**** Period from April 1, 1994 to November 30, 1994. Reflects fiscal year-end
change from March 31 to November 30.
-4-
<PAGE>
IAI MUTUAL FUNDS
IAI Bond Fund, IAI Government Fund
INVESTMENT OBJECTIVES
AND POLICIES
BOND FUND
Bond Fund's investment objective is to provide a high level of current income
consistent with preservation of capital. Such objective may not be changed
without shareholder approval. There can be no assurance that Bond Fund's
investment objective will be attained.
Bond 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").
Bond Fund may also invest in below investment grade securities. Such securities
are commonly referred to as junk bonds. Bond 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 of 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 Objectives and
Policies" in the Statement of Additional Information for additional information
regarding ratings of debt securities. In purchasing such securities, Bond Fund
will rely on IAI's judgment, 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 Bond Fund may invest include, but are not limited
to, securities of, or guaranteed by, the United States Government, its agencies
or instrumentalities, bank certificates of deposit, bankers' acceptances, debt
securities of foreign issuers, and commercial paper rated at least Prime-2 by
Moody's or A-2 by S&P or otherwise issued by companies having an outstanding
unsecured debt issue currently rated A or better by Moody's or S&P. Bond Fund
may also invest in U.S. Treasury inflation-protection securities. The value of
such inflation-protection securities is adjusted for inflation and periodic
interest payments are in amounts equal to a fixed percentage of the
inflation-adjusted value of the principal. Under normal market conditions, at
least 65% of Bond 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 Bond Fund generally will not make direct purchases of common stock,
Bond Fund may purchase preferred stock and convertible securities. Preferred
stock are securities that the 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
-5-
<PAGE>
IAI MUTUAL FUNDS
IAI Bond Fund, IAI Government Fund
carry with 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. Bond Fund
will limit its investments in such securities to a maximum of 10% of its net
assets.
Bond 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 entities, that are
determined by IAI to be of comparable quality to the other obligations in which
Bond Fund may invest. Bond Fund currently intends to invest no more than 25% of
the value of its total assets in non-dollar denominated securities of foreign
issuers.
Bond Fund may employ certain other investment techniques, as described in the
section "Other Fund Investment Techniques." Please see the Prospectus section
"Fund Risk Factors" and the Statement of Additional Information section
"Investment Objectives and Policies" for a discussion of the risks associated
with investing in Bond Fund.
GOVERNMENT FUND
The investment objectives of Government Fund are to provide shareholders with a
high level of current income and with preservation of capital. In seeking to
achieve its objectives, Government Fund will invest its assets primarily in
securities issued, guaranteed or collateralized by the United States Government,
its agencies or instrumentalities whether or not backed by the "full faith and
credit" pledge of the United States Government and in repurchase agreements
pertaining to such securities. Such securities may include U.S. Treasury
inflation-protection securities. The value of such inflation-protection
securities is adjusted for inflation and periodic interest payments are in
amounts equal to a fixed percentage of the inflation-adjusted value of the
principal. IAI anticipates that each of Government Fund's objectives will be
given approximately equal consideration in the selection of Fund investments.
Government Fund's investment objectives may not be changed without shareholder
approval. There can be no assurance that Government Fund's investment objectives
will be attained.
Under normal market conditions, Government Fund will invest at least 65% of its
total assets in securities issued, guaranteed or collateralized by the United
States Government, its agencies or instrumentalities (excluding, for purposes of
calculating this minimum, CMOs as described below, which are secured by
obligations of the U.S. Government, its agencies or instrumentalities but are
issued by private issuers), including:
-6-
<PAGE>
IAI MUTUAL FUNDS
IAI Bond Fund, IAI Government Fund
1. United States Treasury obligations, such as Treasury Bills (which have
original maturities of one year or less), Treasury Notes (which have original
maturities of one to ten years) and Treasury Bonds (which have original
maturities generally greater than ten years);
2. Obligations of United States Government agencies and instrumentalities
which are secured by the full faith and credit of the United States Treasury,
such as Government National Mortgage Association ("Ginnie Mae") modified
pass-through certificates;
3. Obligations which are secured by the right of the issuer to borrow from
the United States Treasury, such as securities issued by the Federal Financing
Bank or the United States Postal Service; and
4. Obligations which are supported by the credit of the government agency
or instrumentality itself (but are not backed by the full faith and credit of
the United States Government) such as securities of the Federal Home Loan
Mortgage Corporation ("Freddie Mac") or the Federal National Mortgage
Association ("Fannie Mae"), including pass-through securities and participation
certificates thereof.
Guarantees as to the timely payment of principal and interest do not extend to
the value or yield of such securities nor do they extend to the value of
Government Fund's shares. In the case of securities in which Government Fund
invests that are not backed by the "full faith and credit" of the United States
Government, the investor must look principally to the agency issuing or
guaranteeing the obligation for ultimate repayment and may not be able to assert
a claim against the United States Government itself in the event the agency or
instrumentality does not meet its commitment. Except as specifically set forth
below, there are no percentage limitations with regard to the purchase of any of
Government Fund's investments.
The dollar-weighted average maturity of Government Fund's portfolio will
generally not exceed, and may be substantially less than, ten years. As
discussed below, mortgage-related securities generally have an average life less
than their maturity. Because of variations in prepayment rights, it is not
possible to accurately predict the life of a particular mortgage-related
investment. For purposes of determining the dollar-weighted average maturity of
Government Fund's portfolio, IAI will consider the statistical average remaining
life of mortgage-related securities.
The mortgage-related securities in which Government Fund may invest include
pass-through securities. Mortgage pass-through securities are issued by
government agencies such as Ginnie Mae, Freddie Mac and Fannie Mae. Such
securities are formed when mortgages are pooled together and undivided interests
in the pool are sold to investors (such as Government Fund) by various
governmental and government-related organizations. The cash flow from the
underlying mortgages is "passed through" to the holders of the securities in the
form of monthly payments of interest, principal and prepayments. Timely payment
-7-
<PAGE>
IAI MUTUAL FUNDS
IAI Bond Fund, IAI Government Fund
of the principal and interest on such securities is guaranteed either by the
full faith and credit of the United States Government (as in the case of Ginnie
Mae securities) or by the agency itself (as in the case of Freddie Mac and
Fannie Mae securities). In addition, Government Fund may invest up to 35% of its
assets in securities of private issuers that are collateralized by pools of
mortgages issued or guaranteed by the United States Government, its agencies or
instrumentalities, called collateralized mortgage obligations ("CMOs"). CMOs of
private issuers, even though collateralized by Government securities, are not
guaranteed by the U.S. Government or any agency or instrumentality of the U.S.
Government. Government Fund will invest in privately issued CMOs only if rated
at the time of investment Aaa by Moody's Investors Service, Inc. ("Moody's"), or
AAA by Standard & Poor's Corporation ("S&P"). CMOs are more fully described in
the Statement of Additional Information under "Investment Objectives and
Policies--Mortgage-Backed Securities."
The average life of such mortgage pools varies with the maturities of the
underlying mortgage instruments. In addition, a pool's term may be shortened by
unscheduled or early payments of principal and interest on the underlying
mortgages. The occurrence of mortgage prepayment is affected by factors
including the level of interest rates, general economic conditions, the location
and age of the mortgage and other social and demographic conditions.
Accordingly, the life of an individual mortgage-related security is likely to be
substantially shorter than the stated maturity of the mortgages in the
underlying pool. Yields on mortgage-related securities are typically quoted
based on the maturity of the underlying instruments and the associated average
life assumption. Actual prepayment experience may cause the yield to differ from
the assumed average life yield. See the Statement of Additional Information for
more information about the characteristics of these instruments.
Instrumentalities of the United States Government which issue or guarantee
securities in which Government Fund may invest include, but are not limited to,
the Federal Farm Credit System, the Student Loan Marketing Association, Federal
Home Loan Banks, Federal Land Banks, Freddie Mac and Fannie Mae. Since the
United States Treasury is not obligated by law to provide support to all United
States Government instrumentalities and agencies, Government Fund will invest in
securities issued by such instrumentalities and agencies only when IAI
determines that the credit risk with respect to the instrumentality or agency
does not make its securities unsuitable investments for Government Fund.
Government Fund may also invest in non-U.S. Government bonds and other fixed
income securities including fixed income securities issued by corporations and
foreign entities, whether dollar-denominated or not, securities issued or
guaranteed by one or more foreign governments or any of their political
subdivisions, agencies or instrumentalities, and obligations of supranational
entities, that are rated within the four highest grades by Moody's or S&P or are
-8-
<PAGE>
IAI MUTUAL FUNDS
IAI Bond Fund, IAI Government Fund
determined by IAI to be of comparable quality. For a description of Moody's and
S&P ratings, see Appendix A to the Statement of Additional Information.
Government Fund may employ certain other investment techniques, as described in
the section "Other Fund Investment Techniques." Please see the Prospectus
section "Fund Risk Factors" and the Statement of Additional Information section
"Investment Objectives and Policies" for a discussion of the risks associated
with investing in Government Fund.
OTHER FUND INVESTMENT TECHNIQUES
REPURCHASE AGREEMENTS
Each Fund is permitted to invest in repurchase agreements. A repurchase
agreement is a contract by which a Fund acquires the security ("collateral")
subject to the obligation of the seller to repurchase the security at a fixed
price and date (within seven days). A repurchase agreement may be construed as a
loan under relevant law. The Funds may enter into repurchase agreements with
respect to any securities whcih they may acquire consistent with their
investment policies and restrictions. The Funds' custodian will hold the
securities underlying any repurchase agreement in a segregated account. In
investing in repurchase agreements, the Funds' risk is limited to the ability of
the seller to pay the agreed-upon price at the maturity of the repurchase
agreement. In the opinion of IAI, such risk is not material, since in the event
of default, barring extraordinary circumstances, the Funds would be entitled to
sell the underlying securities or otherwise receive adequate protection under
federal bankruptcy laws for their interest in such securities. However, to the
extent that proceeds from any sale upon a default are less than the repurchase
price, the Funds could suffer a loss. In addition, the Funds may incur certain
delays in obtaining direct ownership of the collateral.
WHEN-ISSUED/DELAYED DELIVERY TRANSACTIONS
Each 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 a 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
settlement, no payment is made for the securities and, thus, no interest accrues
to the purchaser from the transaction. If a 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 a Fund to hedge against anticipated changes in interest
-9-
<PAGE>
IAI MUTUAL FUNDS
IAI Bond Fund, IAI Government Fund
rates and prices. A Fund may also enter into such transactions to generate
incremental income. In some instances, 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, a 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 a
Fund to "roll over" its purchase commitment, a Fund may receive a negotiated
fee. As to each Fund, no more than 20% of its 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
Each 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 a Fund's investments could be impaired if trading does not
develop or declines.
ZERO COUPON OBLIGATIONS
Each 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 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.
MORTGAGE-BACKED SECURITIES
Each Fund may invest in pass-through securities which are sold by various
private, governmental and government-related organizations. Pass-through
securities are formed when mortgages and other debt instruments are pooled
together and undivided interests in the pool are sold to investors such as the
Fund. The cash flow from the underlying debt instruments is "passed through" to
the holders of the securities in the form of periodic (generally monthly)
payments of interest, principal and prepayments. Prepayments occur when the
-10-
<PAGE>
IAI MUTUAL FUNDS
IAI Bond Fund, IAI Government Fund
holder of an individual debt instrument prepays the remaining principal and
interest before the final scheduled payment month. Therefore, each Fund may be
subject to a higher rate of prepayments during periods of declining interest
rates when mortgages and other debt instruments may be more frequently prepaid.
Mortgage pass-through securities include (1) obligations of U.S. government
agencies and instrumentalities which are secured by the full faith and credit of
the U.S. Treasury such as Government National Mortgage Association ("GNMA")
pass-through certificates; (2) obligations which are secured by the right of the
issuer to borrow from the Treasury, such as securities issued by the Federal
Financing Bank, the Federal Home Loan Banks and the United States Postal
Service; and (3) obligations which have the principal and interest payments
guaranteed by the government agency or instrumentality itself (but are not
backed by the full faith and credit of the U.S. government), such as securities
of the Federal National Mortgage Association ("FNMA") and Federal Home Loan
Mortgage Corporation ("FHLMC"); and (4) obligations of private corporations.
ASSET-BACKED SECURITIES
Each Fund may invest in types of asset-backed securities which represent forms
of consumer credit such as automobile and credit card receivables, manufactured
(mobile) home loans, home improvement loans and home equity loans. Asset-backed
securities are generally privately issued and pass through cash flows to
investors. Generally, asset-backed securities include many of the risks
associated with mortgage-related securities. In general, however, the collateral
supporting asset-backed securities is of shorter maturity than mortgage loans
and is less likely to experience substantial prepayments. Asset-backed
securities involve certain risks that are not posed by mortgage-backed
securities, resulting mainly from the fact that asset-backed securities do not
usually contain the complete benefit of a security interest in the related
collateral. For example, credit card receivables generally are unsecured and the
debtors are entitled to the protection of a number of state and federal consumer
credit laws, including the bankruptcy laws, some of which may reduce the ability
to obtain full payment. In the case of automobile receivables, due to various
legal and economic factors, proceeds for repossessed collateral may not always
be sufficient to support payments on these securities.
ADJUSTING INVESTMENT EXPOSURE
Each Fund may, but is not required to, utilize various other investment
strategies as described below to hedge various market risks (such as interest
rates, currency exchange rates, and broad or specific fixed-income market
movements), to manage the effective maturity or duration of a Fund's portfolio
or to enhance potential gain. These strategies may be executed through the use
of derivative contracts. Such strategies are generally accepted as a part of
modern portfolio management and are regularly utilized by many mutual funds and
other institutional investors. Techniques and instruments may change over time
as new instruments and strategies are developed or regulatory changes occur.
In the course of pursuing these investment strategies, a Fund may purchase and
sell exchange-listed and over-the-counter put and call options on securities,
-11-
<PAGE>
IAI MUTUAL FUNDS
IAI Bond Fund, IAI Government Fund
fixed-income indices and other financial instruments, purchase and sell
financial futures contracts and options thereon, enter into various interest
rate transactions such as swaps and enter into various currency transactions
such as currency forward contracts, currency futures contracts, currency swaps
or options on currencies or currency futures.
Such techniques and instruments may be used without limit to attempt to protect
against possible changes in the market value of securities held in or to be
purchased for a Fund's portfolio resulting from securities markets or currency
exchange rate fluctuations, to protect a Fund's unrealized gains in the value of
its portfolio securities, to facilitate the sale of such securities for
investment purposes, to manage the effective maturity or duration of a Fund's
portfolio, or to establish a position in the derivatives markets as a temporary
substitute for purchasing or selling particular securities. Some may also be
used to enhance potential gain although no more than 5% of a Fund's assets will
be committed to techniques and instruments entered into for non-hedging
purposes. Any or all of these investment techniques may be used at any time and
in any combination, and there is no particular strategy that dictates the use of
one technique rather than another, as use of any technique or instruments is a
function of numerous variables including market conditions. The ability of a
Fund to utilize these techniques and instruments successfully will depend on
IAI's ability to predict pertinent market movements, which cannot be assured.
Each Fund will comply with applicable regulatory requirements when implementing
these strategies, techniques and instruments. Such techniques and instruments
involving financial futures and options thereon will be purchased, sold or
entered into only for bona fide hedging, risk management or portfolio management
purposes and not for speculative purposes.
TEMPORARY INVESTMENTS
Each Fund reserves the right, as a temporary defensive measure, such as during
periods of adverse market conditions or when debt securities are deemed
overvalued, to hold up to 100% of its total assets in cash or cash equivalents
and short-term securities, including money market securities.
BORROWING
Each Fund may borrow from banks (or through reverse repurchase agreements) for
temporary or emergency purposes. If a Fund borrows money, its share price may be
subject to greater fluctuation until the borrowing is paid off. If a Fund makes
additional investments while borrowings are outstanding, this may be considered
a form of leverage. Each Fund does not intend its borrowings to exceed 5% of its
net assets.
PORTFOLIO TURNOVER
Each 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, a
-12-
<PAGE>
IAI MUTUAL FUNDS
IAI Bond Fund, IAI Government Fund
Fund's annual portfolio turnover rate cannot be anticipated and may be
relatively high, as the rates were for Bond and Government Funds for the last
fiscal year. High turnover rates (100% or more) increase transaction costs, and
may increase taxable capital gains. Each Fund's historical portfolio turnover
rates are set forth in the section "Financial Highlights.
Further information regarding these and other techniques is contained in the
Statement of Additional Information.
FUND RISK FACTORS
INTEREST RATE RISK
As a mutual fund investing in fixed-income securities, each 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 a 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 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 the following duration ranges for the Funds: Bond Fund - 3.5 to 7.5
years; and Government Fund - 2.5 to 5 years. These ranges are merely
expectations as of the date of this Prospectus. Such ranges may change due to
market conditions and other economic factors. Therefore, the expected duration
ranges do not limit IAI in how it manages each Fund.
These principals of interest rate risk also apply to U.S. Treasury and U.S.
Government agency securities. As with other bond investments, U.S. Government
securities will rise and fall in value as interest rates change. A security
backed by the U.S. Treasury or the full faith and credit of the United States is
guaranteed only as to the timely payment of interest and principal when held to
maturity. The current market prices for such securities are not guaranteed and
will fluctuate.
CREDIT RISK
Each 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
-13-
<PAGE>
IAI MUTUAL FUNDS
IAI Bond Fund, IAI Government Fund
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
Each Fund is also subject to call risk. Call risk is the possibility that
corporate bonds held by a Fund will be repaid prior to maturity. Call
provisions, common in many corporate bonds held by a 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 a 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 a Fund would decline.
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 a 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 a 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 a Fund's holdings of
securities denominated in such currency and, therefore, will cause an overall
decline in a Fund's net asset value and net investment income and capital gains,
if any, to be distributed in U.S. dollars to shareholders by a Fund. Delays may
be encountered in settling securities transactions in certain foreign markets,
and a Fund will incur costs in converting foreign currencies into U.S. dollars.
Custody charges are generally higher for foreign securities.
RISKS ASSOCIATED WITH
ADJUSTING INVESTMENT
EXPOSURE
The techniques and instruments described in the section "Adjusting Investment
Exposure", including derivative contracts, have risks associated with them
including possible default by the other party to the transaction, illiquidity
and, to the extent IAI's view as to certain market movements is incorrect, the
-14-
<PAGE>
IAI MUTUAL FUNDS
IAI Bond Fund, IAI Government Fund
risk that the use of such techniques and instruments could result in losses
greater than if they had not been used. Use of put and call options may result
in losses to a Fund, force the sale or purchase of portfolio securities at
inopportune times or for prices higher than (in the case of put options) or
lower than (in the case of call options), current market values, limit the
amount of appreciation a Fund can realize on its investments or cause a Fund to
hold a security it might otherwise sell. The use of currency transactions can
result in a Fund incurring losses as a result of a number of factors including
the imposition of exchange controls, suspension of settlements or the inability
to deliver or receive a specified currency. The use of options and futures
transactions entails certain other risks. In particular, the variable degree of
correlation between price movements of futures contracts and price movements in
the related portfolio position of a Fund creates the possibility that losses on
the hedging instrument may be greater than gains in the value of a Fund's
position. In addition, futures and options markets may not be liquid in all
circumstances and certain over-the-counter options may not have markets. As a
result, in certain markets, a Fund might not be able to close out a transaction
without incurring substantial losses, if at all. Although the use of futures
contracts and options transactions for hedging should tend to minimize the risk
of loss due to a decline in the value of the hedged position, at the same time
they tend to limit any potential gain which might result from an increase in
value of such position. Finally, the daily variation margin requirements for
futures contracts would create a greater ongoing potential financial risk than
would purchases of options, where the exposure is limited to the cost of the
initial premium. Losses resulting from the use of these techniques would reduce
net asset value, and possibly income, and such losses can be greater than if the
techniques and instruments had not been utilized.
MANAGER RISK
IAI manages each 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 judgment. Manager
risk refers to the possibility that IAI may fail to execute each Fund's
investment strategy effectively. As a result, each Fund may fail to achieve its
stated objective.
PREPAYMENT RISKS
To the extent they invest in mortgage-backed securities, each Fund is subject to
prepayment risk. Prepayment risk is the possibility that, as interest rates
fall, homeowners are more likely to refinance their home mortgages. When home
mortgages are refinanced, the principal on GNMA certificates held by a Fund is
"prepaid" earlier than expected. A Fund must then reinvest the unanticipated
principal in new GNMA certificates, or other securities, just at a time when
interest rates on new mortgage investments are falling.
Prepayment risk has two important effects on a Fund:
- When interest rates fall and additional mortgage prepayments must be
reinvested at lower interest rates, the income of a Fund will be reduced.
-15-
<PAGE>
IAI MUTUAL FUNDS
IAI Bond Fund, IAI Government Fund
- When interest rates fall, prices on GNMA securities will not rise as much
as comparable Treasury bonds, as bond market investors anticipate an increase in
mortgage prepayments and a likely decline in income.
RISKS OF LOWER-RATED DEBT SECURITIES
Bond 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 a Fund were to default, such Fund might incur additional
expenses to seek recovery. 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 a 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 a Fund to arrive at a fair value for certain junk bonds at
certain times and could make it difficult for a Fund to sell certain securities.
For a description of Moody's and S&P ratings, see Appendix A to the Statement of
Additional Information.
INVESTMENT RESTRICTIONS
Each 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 a
Fund. Each Fund is a diversified investment company and has a fundamental policy
that, with respect to 75% of its total assets, it may not invest more than 5% of
its total assets in any one issuer. Each Fund, also as fundamental policies, may
not invest 25% or more of its assets in any one industry and may borrow only for
temporary or emergency purposes in an amount not exceeding one-third of its
total assets. Please refer to the Statement of Additional Information for a
further discussion of each Fund's investment restrictions.
-16-
<PAGE>
IAI MUTUAL FUNDS
IAI Bond Fund, IAI Government Fund
MANAGEMENT
Bond Fund was created on August 18, 1977, 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. Government Fund was created on April 6,
1992 as a separate portfolio represented by separate class of common stock of
IAI Investment Funds VI, Inc., a Minnesota corporation created on April 30,
1991. Under Minnesota law, each Fund's Board of Directors is generally
responsible for the overall operation and management of each Fund. IAI serves as
the investment adviser of each Fund. IAI also furnishes investment advice to
other concerns including other investment companies, pension and profit sharing
plans, foundations, religious, educational and charitable institutions, trusts,
municipalities and individuals, having total assets in excess of $16 billion.
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 Funds.
Pursuant to a written agreement with each Fund (the "Management Agreement"), IAI
provides each Fund with investment advisory services and is responsible for the
overall management of each Fund's business affairs subject to the authority of
the Board of Directors. The Management Agreement also provides that, except for
brokerage commissions and other expenditures in connection with the purchase and
sale of portfolio securities, interest and, in certain circumstances, taxes and
extraordinary expenses, IAI shall pay all of a Fund's operating expenses. As
compensation under the Management Agreement, each Fund will pay IAI 1.10% of its
average daily net assets. The Management Agreement further provides that IAI
will either reimburse a Fund for the fees and expenses it pays to directors who
are not "interested persons" of a Fund or reduce its fee by an equivalent
amount. Because IAI is paying Fund operating expenses, these fees represent each
Fund's total expenses. With respect to certain of the services for which it is
responsible under the Management Agreement, IAI may also pay qualifying
broker-dealers, financial institutions and other entities for providing such
services to Fund shareholders. IAI shall not be liable for any loss suffered by
a Fund in the absence of willful misfeasance, bad faith or negligence in the
performance of its duties and obligations.
Each Fund is managed by a team of IAI investment professionals. The teams
managing the Funds are as follows.
Larry Hill, Stephen Coleman and Livingston Douglas are responsible for Bond
Fund's day-to-day investment decisions. Mr. Hill is IAI's Chief Fixed Income
Officer and has managed Bond Fund since joining IAI in 1984. Mr. Coleman is a
Senior Vice President of IAI and has served as a fixed income portfolio manager
since joining IAI in 1987. Mr. Coleman has been involved in Bond Fund's
management since mid-1996. Mr. Douglas is a Vice President of IAI and has
managed Bond Fund since joining IAI as a fixed income portfolio manager in 1993.
-17-
<PAGE>
IAI MUTUAL FUNDS
IAI Bond Fund, IAI Government Fund
Prior to joining IAI, Mr. Douglas served as a fixed income portfolio manager for
Mackey-Shields Financial Corporation.
Scott Bettin and Livingston Douglas are responsible for Government Fund's
day-to-day investment decisions. Mr. Bettin is a Senior Vice President of IAI
and has served as a fixed income portfolio manager since joining IAI in 1987.
Mr. Bettin has managed Government Fund since its inception. Mr. Douglas has been
involved in Government Fund's management since mid-1996.
Consistent with the Rules of Fair Practice of the National Association of
Securities Dealers, Inc., IAI may consider sales of shares of a Fund as a factor
in the selection of broker-dealers to execute a Funds' securities transactions.
INVESTMENT
PERFORMANCE
From time to time the Funds 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 a 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 a 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 a 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 bond funds. Because this
differs from other accounting methods, the quoted yield may not equal the income
actually paid to shareholders. The tax equivalent yield is computed by dividing
the portion of the yield that is tax-exempt by one minus a stated income tax
rate and adding the product to that portion, if any, of the yield that is not
tax-exempt.
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 Funds is contained
in the Funds' Annual Report to shareholders which may be obtained without charge
from the Funds.
Comparative performance information may be used from time to time in advertising
or marketing a 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 Funds. The comparison of a Fund to
an alternative investment should be made with consideration of differences in
-18-
<PAGE>
IAI MUTUAL FUNDS
IAI Bond Fund, IAI Government Fund
features and expected performance. A Fund may also note its mention in
newspapers, magazines, or other media from time to time. The Funds assume 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 Funds
in advertising and sales literature, see the section "Investment Performance" in
the Statement of Additional Information.
COMPUTATION OF NET
ASSET VALUE AND
PRICING
Each Fund is open for business each day the New York Stock Exchange ("NYSE") is
open. IAI normally calculates a Fund's net asset value ("NAV") as of the close
of business of the NYSE, normally 3 p.m. Central time.
A Fund's NAV is the value of a single share. The NAV is computed by adding up
the value of a Fund's investments, cash, and other assets, subtracting its
liabilities, and then dividing the result by the number of shares outstanding.
A 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 referred to as a Fund's NAV.
PURCHASE OF SHARES
GENERAL
Each Fund offers its shares continually to the public at the net asset value of
such shares. Shares may be purchased directly from a Fund or through certain
security dealers who have responsibility to promptly transmit orders and may
charge a processing fee, provided that the Fund whose shares are being purchased
is duly registered in the state of the purchaser's residence, if required, and
the purchaser otherwise satisfies the Fund's purchase requirements. No sales
load or commission is charged investors in connection with the purchase of Fund
shares.
The minimum initial investment to establish a retail account with the IAI Family
of Funds is $5,000. Such initial investment may be allocated among a Fund and
other funds in the IAI Family of Funds as desired, provided that no less than
$1,000 is allocated to any one fund. The minimum initial investment for IRA
accounts is $2,000, provided that the minimum amount that may be allocated to
any one fund is $1,000. Once the account minimum has been met, subsequent
purchases can be made in a Fund for $100 or more. Such minimums may be waived
for participants in the IAI Investment Club.
Investors may satisfy the minimum investment requirement by participating in the
STAR Program. Participation in the STAR Program requires an initial investment
of $1,000 per Fund and a commitment to invest an aggregate of $5,000 within 24
-19-
<PAGE>
IAI MUTUAL FUNDS
IAI Bond Fund, IAI Government Fund
months. If a STAR Program participant does not invest an aggregate of $5,000 in
the IAI Family of Funds within 24 months, IAI may, at its option, redeem such
shareholder's interest. Investors wishing to participate in the STAR Program
should contact a Fund to obtain a STAR Program application.
To purchase shares, forward the completed application and a check payable to
"IAI Funds" to a Fund. No third-party checks are accepted to open new accounts.
Upon receipt, your account will be credited with the number of full and
fractional shares which can be purchased at the net asset value next determined
after receipt of the purchase order by a Fund.
Purchases of shares are subject to acceptance or rejection by a Fund on the same
day the purchase order is received and are not binding until so accepted. It is
the policy of the Funds and the Underwriter to keep confidential information
contained in the application and regarding the account of an investor or
potential investor in the Funds.
All correspondence relating to the purchase of shares should be directed to the
office of the Funds, P.O. Box 357, Minneapolis, Minnesota 55440 or, if using
overnight delivery, to 3700 First Bank Place, 601 Second Ave. South,
Minneapolis, Minnesota 55402. For assistance in completing the application
please contact IAI Mutual Fund Shareholder Services at 1-800-945-3863.
BANK WIRE PURCHASES
Shares may be purchased by having your bank wire federal funds (funds of the
Federal Reserve System) to Norwest Bank, Minnesota.
Wire orders will be accepted only on days your bank, the transfer agent, a Fund
and Norwest Bank Minnesota are open for business. The payment must be received
by a Fund before the close of business to be credited to you account that day.
Otherwise, it will be processed the next business day. The wire purchase will
not be considered made until the wired amount is received and the purchase is
accepted by such Fund. If the wire order does not contain the information stated
below, such Fund may reject it. Any delays that may occur in wiring federal
funds, including delays in processing by the banks, are not the responsibility
of such Fund or the transfer agent.
You must pay any charges assessed by your bank for the wire service. If a wire
order is rejected, all money received by the Fund, less any costs incurred by
the Fund or the transfer agent in rejecting it, will be returned promptly.
If the wire order is for a new account, you should call IAI Shareholder Services
at 1-800-945-3863 to advise them of the investment and to obtain an account
number and instructions. The wire should be sent to: Norwest Bank Minnesota,
Routing Number 091000019, Minneapolis, Minnesota, Attn: IAI Mutual Funds Account
Number 6355002264. It should state the following:
-20-
<PAGE>
"Credit IAI Funds Account # ___________ for future credit to personal
account # ______________ (your account number) for
____________________________ (your name) and __________________ (Fund
name)."
A completed application must be sent and received by the Fund before the wire is
sent.
If the wire order is for an addition to an existing account, the wire must
include the information required above for the new accounts. As soon as the wire
is sent, you should call IAI Shareholder Services, as described above, and
advise them of your name, your account number and the name of the bank
transmitting the federal funds.
RETIREMENT PLANS
Shares of Bond and Government Funds 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.
AUTOMATIC
INVESTMENT PLAN
Investors may arrange to make regular investments of $100 or more per fund on a
monthly basis, effective as of the 4th and/or 18th day of each month (or the
next business day), through automatic deductions from their checking or savings
accounts. Such investors may, of course, terminate their participation in the
Automatic Investment Plan at any time upon written notice to a Fund. Any changes
or instructions to terminate existing Automatic Investment Plans must be
received by the last business day of the preceding month in which the change or
termination is to take place. Investors interested in participating in the
Automatic Investment Plan should complete the Automatic Investment Plan
application and return it to a Fund.
REDEMPTION OF SHARES
Registered holders of Fund shares may at any time require a Fund to redeem their
shares upon their written request All correspondence relating to the redemption
of shares should be directed to the office of IAI Mutual Funds, P.O. Box 357,
Minneapolis, Minnesota 55440. Shareholders may redeem shares by phone, subject
to a limit of $50,000, provided such shareholders have authorized such Fund to
accept telephone instructions. For assistance in redeeming shares by phone,
please contact the IAI Mutual Funds Shareholder Services at 1-800-945-3863.
Certificates presented for redemption must be endorsed on the back with the
signature of the person whose name appears on the certificate. If no certificate
has been issued, redemption instructions must be signed 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, a Fund will require that the signature on the
-21-
<PAGE>
IAI MUTUAL FUNDS
IAI Bond Fund, IAI Government Fund
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, a Fund may require additional evidence of
authority prior to accepting a request for redemption.
For shareholders who established receiving proceeds by Federal Funds Wire at the
time they opened their account, telephone instructions will be accepted for
redemption of amount up to $50,000 ($1,000 Minimum) and proceeds will be wired
on the next business day to a predesignated bank account. Wire redemption
requests will only be processed on days your bank, the transfer agent, the
Portfolios and Norwest Bank Minnesota are open for business.
In order to add this feature to an existing account or to change existing bank
account information, please submit a letter of instructions including your bank
information to IAI Shareholder Services at the address listed in the section
"Additional Information." The letter must be signed by all registered owners,
and their signatures must be guaranteed.
Your account will be charged a fee of $10 each time redemption proceeds are
wired to your bank. Your bank may also charge you a fee for receiving a Federal
Funds Wire.
Neither the transfer agent nor any of the Portfolios can be responsible for the
efficiency of the Federal Funds wire system or the shareholder's bank.
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 a Fund. Since the value of shares redeemed is based upon the value of a 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 a Fund will mail payment for
shares redeemed on the business day following receipt of the redemption request.
A Fund will not send redemption proceeds until checks (including certified
checks or cashiers checks) received in payment for shares have cleared, which
may take up to ten days or more.
Following a redemption or transfer request, if the value of a shareholder's
interest in a Ffund falls below $500, such 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 such Fund to fall below $500;
(b) the mailing by such Fund to such shareholder of a notice of intention to
redeem; and (c) the passage of at least six months from the date of such
mailing, during which time the investor will have the opportunity to make an
additional investment in such Fund to increase the value of such investor's
account to at least $500.
-22-
<PAGE>
IAI MUTUAL FUNDS
IAI Bond Fund, IAI Government Fund
EXCHANGE PRIVILEGE
The Exchange Privilege enables shareholders to purchase, in exchange for shares
of a Fund, shares of certain other funds managed by IAI. These funds have
different investment objectives from the Funds. Shareholders may exchange shares
of a Fund for shares of another fund managed by IAI, provided that the fund
whose shares will be acquired is duly registered in the state of the
shareholder's residence, if required, and the shareholder otherwise satisfies
the fund's purchase requirements. Although the Funds do not currently charge a
fee for use of the Exchange Privilege, they reserve the right to do so in the
future.
Because excessive trading can hurt Fund performance and shareholders, there is a
limit of four exchanges out of each Fund per calendar year per account. Accounts
under common ownership or control, including accounts with the same taxpayer
identification number, will be counted together for purposes of the four
exchange limit. Each Fund reserves the right to temporarily or permanently
terminate the Exchange Privilege of any investor who exceeds this limit. The
limit may be modified for certain retirement plan accounts, as required by the
applicable plan document and/or relevant Department of Labor regulations, and
for Automatic Exchange Plan participants. Each Fund also reserves the right to
refuse or limit exchange purchases by any investor if, in IAI's judgment, such
Fund would be unable to invest the money effectively in accordance with its
investment objectives and policies, or would otherwise potentially be adversely
affected.
Fund shareholders wishing to exercise the Exchange Privilege should notify a
Fund in writing or, provided such shareholders have authorized a Fund to accept
telephone instructions, by telephone. At the time of the exchange, if the net
asset value of the shares redeemed in connection with the exchange is greater
than the investor's cost, a taxable capital gain will be realized. A capital
loss will be realized if at the time of the exchange the net asset value of the
shares redeemed in the exchange is less than the investor's cost. Each Fund
reserves the right to terminate or modify the Exchange Privilege in the future.
AUTOMATIC
EXCHANGE PLAN
Investors may arrange to make regular exchanges of $100 or more between any of
the funds in the IAI Mutual Fund Family on a monthly basis. Exchanges will take
place at the closing price of the fifth day of each month (or the next business
day). Shareholders are responsible for making sure sufficient shares exist in
the Fund account from which the exchange takes place. If there are not
sufficient funds in a Fund account to meet the requested exchange amount, the
Automatic Exchange Plan will be suspended. Shareholders may not close Fund
accounts through the Automatic Exchange Plan. Investors interested in
participating in the Automatic Exchange Plan should complete the Automatic
Exchange Plan portion of their application. For assistance in completing the
application contact IAI Mutual Fund Shareholder Services at 1-800-945-3863.
-23-
<PAGE>
IAI MUTUAL FUNDS
IAI Bond Fund, IAI Government Fund
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 a 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. Telephone redemption proceeds are
subject to a $50,000 limit and 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 Funds have established reasonable procedures, including the
requirement that a personal identification number accompany telephone
instructions. If a Fund or the transfer agent fails to follow these procedures,
such Fund may be liable for losses due to unauthorized or fraudulent
instructions. To the extent the reasonable procedures are followed, none of the
Funds, their 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.
SYSTEMATIC CASH
WITHDRAWAL PLAN
Each Fund has available a Systematic Cash Withdrawal Plan for any investor
desiring to follow a program of systematically withdrawing a fixed amount of
money from an investment in shares of a Fund. Payments under the plan will be
made monthly or quarterly in amounts of $100 or more. Shares will be sold with
the closing price of the 15th of the applicable month (or the next business
day). To provide funds for payment, a Fund will redeem as many full and
fractional shares as necessary at the redemption price, which is Net Asset
Value. The holder of a Systematic Cash Withdrawal Plan must have income
dividends and any capital gains distributions reinvested in full and fractional
shares at net asset value.
Payments under this plan, unless pursuant to a retirement plan, should not be
considered income. Withdrawal payments may exceed dividends and distributions
and, to this extent, there will be a reduction in the investor's equity. An
investor should also understand that this plan cannot insure profit, nor does it
protect against any loss in a declining market. Careful consideration should be
given to the amount withdrawn each month. Excessive withdrawals could lead to a
serious depletion of equity, especially during periods of declining market
values. Fund management will be available for consultation in this matter.
Plan application forms are available through the Funds. If you would like
assistance in completing the application contact IAI Mutual Fund Shareholder
Services at 1-800-945-3863.
-24-
<PAGE>
IAI MUTUAL FUNDS
IAI Bond Fund, IAI Government Fund
DIVIDENDS, DISTRIBUTIONS AND TAX STATUS
DIVIDENDS
The policy of each 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 a
Fund. When you open an account, you should specify on your application how you
want to receive your distributions. Each Fund offers three options: Full
Reinvestment--your dividend and capital gain distributions will be automatically
reinvested in additional shares of such Fund; Capital Gains Reinvestment--your
capital gain distributions will be automatically reinvested, but your income
dividend distribution will be paid in cash; and Cash--your income dividends and
capital gain distributions will be paid in cash. Distributions taken in cash can
be sent via check or transferred directly to your account at any bank, savings
and loan or credit union that is a member of the Automated Clearing House (ACH)
network. Unless indicated otherwise by the shareholder, the Fund will
automatically reinvest all such distributions into full and fractional shares at
net asset value.
The Funds' Directed Dividend service allows you to invest your dividends and/or
capital gain distributions directly into another IAI Mutual Fund. Contact IAI
Mutual Fund Shareholder Services at 1-800-945-3863 for details.
Each Fund intends to qualify as a regulated investment company under Subchapter
M of the Internal Revenue Code during the current taxable year. If so qualified,
each Fund will not be subject to federal income tax on income that it
distributes to its shareholders.
Distributions are subject to federal income tax, and may also be subject to
state or local taxes. If you live outside the United States, your distributions
could also be taxed by the country in which you reside. Your distributions are
taxable when they are paid, whether you take them in cash or reinvest them in
additional shares.
For federal income tax purposes, each Fund's income and short-term capital gain
distributions are taxed as dividends; long-term capital gain distributions
designated as capital gain dividends are taxed as long-term capital gains.
Upon redemption of shares of a Fund the shareholder will generally recognize a
capital gain or loss equal to the difference between the amount realized on the
redemption and the shareholder's adjusted basis in such shares. Such gain or
loss will be long-term if the shares have been held for more than one year.
Under the Code, the deductibility of capital losses is subject to certain
limitations.
Annually, IAI will send you and the IRS a statement showing the amount of each
taxable distribution you received in the previous year. Whenever you sell shares
of a Fund, IAI will send you a confirmation statement showing how many shares
you sold and at what price. You will also receive an account statement quarterly
-25-
<PAGE>
IAI MUTUAL FUNDS
IAI Bond Fund, IAI Government Fund
and a consolidated transaction statement annually. However, it is up to you or
your tax preparer to determine whether this sale resulted in a capital gain and,
if so, the amount of tax to be paid. Be sure to keep your regular account
statements; the information they contain will be essential in calculating the
amount of your capital gains.
The foregoing relates to federal income taxation as in effect as of the date of
this Prospectus. For a more detailed discussion of the federal income tax
consequences of investing in shares of the Funds, see "Tax Status" in the
Statement of Additional Information.
DESCRIPTION OF COMMON STOCK
All shares of each 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 each 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 each corporation vote together as one
series. On an issue affecting only a particular series, such as voting on the
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 each Fund may demand a regular meeting of shareholders of such Fund by
written notice of demand given to the Chief Executive Officer or the Chief
Financial Officer of such 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 such Fund. An annual meeting will be held on
the removal of a director or directors of a Fund if requested in writing by
holders of not less than 10% of the outstanding shares of a Fund.
The shares of each Fund are transferable by endorsement of the certificate if
held by the shareholders, or if the certificate is held by such Fund, by
delivery to such Fund of transfer instructions. Transfer instructions or
certificates should be delivered to the office of such Fund. A Fund is not bound
to recognize any transfer until it is recorded on the stock transfer books
maintained by such Fund.
-26-
<PAGE>
IAI MUTUAL FUNDS
IAI Bond Fund, IAI Government Fund
COUNSEL AND AUDITORS
The firm of Dorsey & Whitney LLP, 220 South Sixth Street, Minneapolis, Minnesota
55402, provides legal counsel for the Funds. KPMG Peat Marwick LLP, 4200 Norwest
Center, Minneapolis, Minnesota 55402, serves as the independent auditors for the
Funds.
CUSTODIAN, TRANSFER AGENT AND DIVIDEND DISBURSING AGENT
The Custodian for each 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 such 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
Funds' assets held outside the United States. For a listing of the subcustodians
and depositories currently employed by the Funds, see the Statement of
Additional Information. IAI acts as each Fund's transfer agent, dividend
disbursing agent and IRA Custodian at P.O. Box 357, Minneapolis, Minnesota
55440.
ADDITIONAL INFORMATION
Each 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.
To reduce the volume of mail you receive, only one copy of most Fund reports,
such as a Fund's Annual Report, may be mailed to your household (same surname
and address). Please call IAI Mutual Fund Shareholder Services at 1-800-945-3863
if you wish to receive additional shareholder reports.
In the opinion of the staff of the Securities and Exchange Commission, the use
of this combined Prospectus may possibly subject all Funds to a certain amount
of liability for any losses arising out of any statement or omission in this
Prospectus regarding a particular Fund. In the opinion of the Funds' management,
however, the risk of such liability is not materially increased by the use of a
combined Prospectus.
Shareholder inquiries should be directed to the Funds at the telephone number or
mailing address listed on the back inside 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 fiscal year ended
November 30, 1996 for IAI Bond Fund. The Government Fund did not hold 5% or more
of its assets in bonds rated below investment grade for the most recent fiscal
year.
-27-
<PAGE>
IAI MUTUAL FUNDS
IAI Bond Fund, IAI Government Fund
<TABLE>
<CAPTION>
<S> <C>
Bonds - Moody's Rating IAI Bond Fund
---------------------- -------------
Aaa 7%
Aa 3%
A 13%
Baa 25%
Ba 7%
B 4%
Caa 0%
Ca 0%
C 0%
U.S. Government 41%
--------------------------------------------------------
Total 100%
========================================================
</TABLE>
-28-
<PAGE>
(This page intentionally left blank)
<PAGE>
(This page intentionally left blank)
<PAGE>
TO OPEN
AN ACCOUNT
1.800.945.3863
612.376.2700
P.O. BOX 357
Minneapolis, MN 55440
OVERNIGHT
DELIVERY
EXPRESS
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>
[LOGO]
IAI MUTUAL FUNDS
IAI BOND FUND
IAI GOVERNMENT FUND
Statement of Additional Information
dated April 1, 1997
This Statement of Additional Information is not a prospectus. This
Statement of Additional Information relates to a Prospectus dated April 1, 1997,
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).
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>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
INVESTMENT OBJECTIVE AND POLICIES............................................3
INVESTMENT RESTRICTIONS......................................................15
INVESTMENT PERFORMANCE.......................................................17
MANAGEMENT...................................................................20
CUSTODIAL SERVICE............................................................25
PORTFOLIO TRANSACTIONS AND ALLOCATION OF BROKERAGE...........................25
CAPITAL STOCK................................................................26
NET ASSET VALUE AND PUBLIC OFFERING PRICE....................................27
PURCHASES AND REDEMPTIONS IN KIND............................................28
TAX STATUS...................................................................28
LIMITATION OF DIRECTOR LIABILITY.............................................30
FINANCIAL STATEMENTS.........................................................30
Appendix A-- Ratings of Debt Securities.....................................A-1
</TABLE>
-2-
<PAGE>
INVESTMENT OBJECTIVE AND POLICIES
The investment objective and policies of IAI Bond Fund (the "Bond Fund")
and IAI Government Fund ("Government Fund") are summarized on the front page of
the Prospectus and in the text of the Prospectus under "Investment Objectives
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 Funds, and there can be no assurance that a Fund's investment policies will
be successful, or that its investment objective will be attained. Certain of the
investment practices of the Funds are further explained below.
REPURCHASE AGREEMENTS
The Funds 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. A Fund's custodian
will have custody of, and will hold in a segregated account, securities acquired
by such 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 a 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, a 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, a 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, a Fund could suffer a
loss.
REVERSE REPURCHASE AGREEMENTS
The Funds 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, a Fund will maintain appropriate
liquid assets in a segregated custodial account to cover its obligation under
the agreement. The Funds will enter into reverse repurchase agreements only with
parties whose creditworthiness has been found satisfactory by Investment
Advisers, Inc. ("IAI"), the Funds' investment adviser and manager. As a result,
such transactions may increase fluctuations in the market value of the Fund's
assets and may be viewed as a form of leverage. The Funds do not currently
intend to invest more than 5% of its net assets in reverse repurchase
agreements.
SECURITIES OF FOREIGN ISSUERS
Each of Bond and Government Funds 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 a
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>
Bond and Government Funds are not aware at this time of the existence of
any investment or exchange control regulations which might substantially impair
their operations 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 a Fund's foreign portfolio
securities may be subject to foreign withholding taxes, thus reducing the net
amount of income available for distribution to such Fund's shareholders. The
expense ratio of a Fund should not be materially affected by such Fund's
investment in foreign securities.
U.S. TREASURY INFLATION PROTECTION SECURITIES
Both the Bond Fund and the Government Fund may purchase securities issued
by the United States government, which include U.S. Treasury
inflation-protection securities.
Inflation-protection securities are a new type of marketable book-entry
security issued by the United States Department of Treasury ("Treasury") with a
nominal return linked to the inflation rate in prices. Inflation-protection
securities will be auctioned and issued on a quarterly basis on the 15th of
January, April, July, and October, beginning on January 15, 1997. Initially,
they will be issued as 10-year notes, with other maturities added thereafter.
The index used to measure inflation will be the non-seasonally adjusted U.S.
City Average All Items Consumer Price Index for All Urban Consumers ("CPI-U").
The value of the principal will be adjusted for inflation, and every six
months the security will pay interest, which will be an amount equal to a fixed
percentage of the inflation-adjusted value of the principal. The final payment
of principal of the security will not be less than the original par amount of
the security at issuance.
The principal of the inflation-protection security will be indexed to the
non-seasonally adjusted CPI-U. To calculate the inflation-adjusted principal
value for a particular valuation date, the value of the principal at issuance is
multiplied by the index ratio applicable to that valuation date. The index ratio
for any date is the ratio of the reference CPI applicable to such date to the
reference CPI applicable to the original issue date. Semiannual coupon interest
is determined by multiplying the inflation-adjusted principal amount by one-half
of the stated rate of interest on each interest payment date.
Inflation-adjusted principal or the original par amount, whichever is
larger, will be paid on the maturity date as specified in the applicable
offering announcement. If at maturity the inflation-adjusted principal is less
than the original principal value of the security an additional amount will be
paid at maturity so that the additional amount plus the inflation-adjusted
principal equals the original principal amount. Some inflation-protection
securities may be stripped into principal and interest components. In the case
of a stripped security, the holder of the stripped principal would receive this
additional amount. The final interest payment, however, will be based on the
final inflation-adjusted principal value, not the original par amount.
The reference CPI for the first day of any calendar month is the CPI-U for
the third preceding calendar month. (For example, the reference CPI for December
1 is the CPI-U reported for September of the same year, which is released in
October.) The reference CPI for any other day of the month is calculated by a
linear interpolation between the reference CPI applicable to the first day of
the month and the reference CPI applicable to the first day of the following
month.
-4-
<PAGE>
Any revisions the Bureau of Labor Statistics (or successor agency) makes to
any CPI-U number that has been previously released will not be used in
calculations of the value of outstanding inflation-protection securities. In the
case that the CPI-U for a particular month is not reported by the last day of
the following month, the Treasury will announce an index number based on the
last year-over-year CPI-U inflation rate available. Any calculations of the
Treasury's payment obligations on the inflation-protection security that need
that month's CPI-U number will be based on the index number that the Treasury
has announced. If the CPI-U is based to a different year, the Treasury will
continue to use the CPI-U series based on the base reference period in effect
when the security was first issued as long as that series continues to be
published. If the CPI-U is discontinued during the period the
inflation-protection security is outstanding, the Treasury will, in consultation
with the Bureau of Labor Statistics (or successor agency), determine an
appropriate substitute index and methodology for linking the discontinued series
with the new price index series. Determinations of the Secretary of the Treasury
in this regard are final.
Inflation-protection securities will be held and transferred in either of
two book-entry systems: the commercial book-entry system (TRADES) and TREASURY
DIRECT. The securities will be maintained and transferred at their original par
amount, i.e., not at their inflation-adjusted value. STRIPS components will be
maintained and transferred in TRADES at their value based on the original par
amount of the fully constituted security.
LENDING PORTFOLIO SECURITIES
In order to generate additional income, the Funds 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, a 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 Funds' Board of Directors. The
Funds 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, a 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 a Fund an amount equivalent
to any dividends or interest paid on the securities and a 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 a Fund
may be reduced by finders' fees paid to broker-dealers and related expenses.
ILLIQUID SECURITIES
Each 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 that can be resold to
institutional investors may be considered liquid pursuant to guidelines adopted
by the Board of Directors. In the case of a Rule 144A Security, such security is
deemed to be liquid if:
(1) IAI reasonably expects to be able to resell the security to a qualified
institutional buyer, as defined in paragraph (a)(1) of Rule 144A, who is aware
of the Fund's reliance upon Rule 144A in selling the security without
registration, as required by paragraph (d)(2) of Rule 144A;
(2) the Rule 144A Security is not (a) of the same class as securities
listed on any national securities exchange or quoted in NASDAQ as determined
under paragraph (d)(3)(i) of Rule 144A, or (b) a security of a registered
investment company (other than a closed-end investment company); and
-5-
<PAGE>
(3) the issuer (a) is a foreign government eligible to register securities
under Schedule B of the Securities Act of 1933, (b) is a company that files
periodic reports under the Securities Act of 1934 on Forms 8-K, 10-Q, 10-K or
20-F or provides information under Rule 12g3-2(b) thereunder, or (c) has agreed
in writing to provide the holder and any prospective purchaser of the Rule 144A
Security with reasonably current financial information as required under
paragraph (d)(4)(i) of Rule 144A.
Other securities are deemed to be liquid if IAI determines that the
security can be disposed of within seven days in the ordinary course of business
at approximately the amount at which the Funds have valued the instrument for
purposes of calculating a Fund's net asset value. In making this determination,
IAI will consider such factors as may be relevant to a Fund's ability to dispose
of the security, including but not limited to, the following factors (none of
which, standing alone, would necessarily be determinative):
1. the frequency of trades and quotes for the security;
2. the number of dealers willing to purchase or sell the security and the
number of potential purchasers;
3. dealer undertakings to make a market in the security; and
4. the nature of the security and the nature of the marketplace trades
(e.g., the time needed to dispose of the security, the method of soliciting
offers and the mechanics of transfer).
It is not possible to predict with assurance the maintenance of an
institutional trading market for such securities and the liquidity of a Fund's
investments could be impaired if trading declines.
VARIABLE OR FLOATING RATE INSTRUMENTS
Each Fund may invest in variable or floating rate instruments. Such
instruments (including notes purchased directly from issuers) bear variable or
floating interest rates and 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
Each Fund may buy and sell securities on a delayed-delivery or when-issued
basis. These transactions involve a commitment by a 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. Each Fund may receive fees for
entering into delayed-delivery transactions.
When purchasing securities on a delayed-delivery basis, each Fund assumes
the rights and risks of ownership, including the risk of price and yield
fluctuations. Because a Fund is not required to pay for securities until the
delivery date, these risks are in addition to the risks associated with such
Fund's other investments. If a 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, a Fund will set aside appropriate liquid assets in a segregated
custodial account to cover its purchase obligations. When a Fund has sold a
security on a delayed-delivery basis, such 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, a Fund
could miss a favorable price or yield opportunity, or could suffer a loss.
Each 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.
-6-
<PAGE>
DOLLAR ROLLS
In connection with its ability to purchase securities on a when-issued or
forward commitment basis, a Fund may enter into "dollar rolls" in which such
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. A Fund
gives up the right to receive principal and interest paid on the securities
sold. However, a 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 a Fund compared with what such performance would have been
without the use of dollar rolls. Each 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 a Fund while
remaining substantially fully invested increases the amount of a Fund's assets
that are subject to market risk to an amount that is greater than such Fund's
net asset value, which could result in increased volatility of the price of such
Fund's shares.
MORTGAGE-BACKED SECURITIES
Each 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 a Fund
may invest in them if IAI determines they are consistent with such 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.
STRIPPED MORTGAGE-BACKED SECURITIES
Government and Bond Funds may invest in 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.
-7-
<PAGE>
ASSET-BACKED SECURITIES
Government and Bond Funds may invest in stripped asset-backed securities.
Asset-backed securities represent interests in pools of consumer loans
(generally unrelated to mortgage loans) and most 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
Each Fund may invest in 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, a 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 a Fund. If a call were
exercised by the issuer during a period of declining interest rates, a Fund
likely would have to replace such called security with a lower yielding
security, thus decreasing the net investment income to a Fund and dividends to
shareholders.
A 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 a Fund's ability to dispose of
particular issues when necessary to meet such Fund's liquidity needs or in
response to a specific economic event such as a deterioration in the
creditworthiness of the issuer.
-8-
<PAGE>
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 a
Fund's net asset value. In addition, a 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
Each Fund may enter into 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 a 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. A Fund is not limited to any
particular form of swap agreement if IAI determines it is consistent with such
Fund's investment objectives and policies.
Swap agreements will tend to shift a Fund's investment exposure from one
type of investment to another. For example, if a Fund agrees to exchange
payments in dollars for payments in foreign currency, the swap agreement would
tend to decrease a 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 a 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 a Fund. If a swap agreement calls for
payments by a Fund, such 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. Each
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.
Each Fund will maintain appropriate liquid assets in a segregated custodial
account to cover its current obligations under swap agreements. If a Fund enters
into a swap agreement on a net basis, it will segregate assets with a daily
value at least equal to the excess, if any, of such Fund's accrued obligations
under the swap agreement over the accrued amount such Fund is entitled to
receive under the agreement. If a Fund enters into a swap agreement on other
than a net basis, it will segregate assets with a value equal to the full amount
of such Fund's accrued obligations under the agreement.
INDEXED SECURITIES
Bond and Government Funds 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.
-9-
<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 a 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
Bond and Government Funds may invest in 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 a 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 a Fund does not receive scheduled interest or principal payments on
such indebtedness, a Fund's share price and yield could be adversely affected.
Loans that are fully secured offer a 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 a Fund. For
example, if a loan is foreclosed, a 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, a 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, a Fund
relies on IAI's research in an attempt to avoid situations where fraud or
misrepresentation could adversely affect such 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, a 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 a Fund were determined to be subject
to the claims of the agent's general creditors, such 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.
Bond and Government Funds limit the amount of the assets that they invest
in any one issuer or in issuers within the same industry. For purposes of these
limitations, a Fund generally will treat the borrower as the "issuer" of
indebtedness held by such Fund. In the case of loan participations where a bank
or other lending institution serves as financial intermediary between a Fund and
the borrower, if the participation does not shift to such Fund the direct
debtor/creditor relationship with the borrower, SEC interpretations require such
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 such Fund has invested more than 5% of its total assets in a single
issuer. Treating the financial intermediary as an issuer of indebtedness may
restrict a Fund's ability to invest in indebtedness 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.
-10-
<PAGE>
EXTENDIBLE NOTES
Government Fund is permitted to invest in extendible notes in accordance
with its investment objectives and policies. An extendible note is a debt
arrangement under which the holder, at its option, may require the issuer to
repurchase the note for a predetermined fixed price at one or more times prior
to the ultimate maturity date of the note. Typically, an extendible note is
issued at an interest rate that can be adjusted at fixed times throughout its
term. At the same times as the interest rate is adjusted by the issuer, the
holder of the note is typically given the option to "put" the note back to the
issuer at a predetermined price (e.g., at 100% of the outstanding principal
amount plus unpaid accrued interest) if the extended interest rate is
undesirable to the holder. This option to put the note back to the issuer (i.e.,
to require the issuer to repurchase the note) provides the holder with an
optional maturity date that is shorter than the actual maturity date of the
note.
Extendible notes may be issued with maturity dates in excess of ten years
from the date of issuance. However, if such extendible notes provide for an
optional maturity date of ten years or less, then such notes are deemed by
Government Fund to have been issued for the shorter optional maturity date.
Investment in extendible notes is not expected to have a material impact on the
effective portfolio maturity of Government Fund.
An investment in an extendible note is liquid, and the note may be resold
to another investor prior to its optional maturity date at its market value. The
market value of an extendible note with a given optional maturity date is
determined and fluctuates in a similar manner as the market value of a fixed
maturity note with a maturity equivalent to the optional maturity of the
extendible note. Compared to fixed term notes of the same issuer, however,
extendible notes with equivalent optional maturities generally yield higher
returns without a material increase in risk to Government Fund.
The creditworthiness of the issuers of extendible notes is monitored and
rated by Moody's and by S&P. The creditworthiness of such issuers is also
monitored by IAI. Government Fund does not have a current intention of investing
in the coming year more than 5% of its net assets in extendible notes.
FOREIGN CURRENCY TRANSACTIONS
Bond and Government Funds 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.
Such Funds 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 Funds.
In connection with purchases and sales of securities denominated in foreign
currencies, a 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 a Fund's foreign investments. A 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.
-11-
<PAGE>
Each Fund may also use forward contracts to hedge against a decline in the
value of existing investments denominated in foreign currency. For example, if a
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. A 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, each Fund will segregate
assets to cover currency forward contracts, if any, whose purpose is essentially
speculative. Each 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 a Fund's investment exposure to changes in currency exchange rates, and
could result in losses to a Fund if currencies do not perform as IAI
anticipates. For example, if a currency's value rose at a time when IAI had
hedged a Fund by selling that currency in exchange for dollars, such Fund would
be unable to participate in the currency's appreciation. If IAI hedges currency
exposure through proxy hedges, a 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 a Fund's exposure to a foreign
currency, and that currency's value declines, such Fund will realize a loss.
There is no assurance that IAI's use of forward currency contracts will be
advantageous to a Fund or that it will hedge at an appropriate time. The
policies described in this section are non-fundamental policies of the Funds.
LIMITATIONS ON FUTURES AND OPTIONS TRANSACTIONS
Each 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. Each Fund intends to comply
with Section 4.5 of the regulations under the Commodity Exchange Act, which
limits the extent to which a Fund can commit assets to initial margin deposits
and option premiums.
The above limitations on a Fund's investments in futures contracts and
options, and such Fund's policies regarding futures contracts and options
discussed elsewhere in this Statement of Additional Information may be changed
as regulatory agencies permit. With respect to positions in commodity futures or
commodity option contracts which do not come within the meaning and intent of
bona fide hedging in the CFTC rules, the aggregate initial margin and premiums
required to establish such positions will not exceed five percent of the
liquidation value of the a Fund's portfolio, after taking into account
unrealized profits and unrealized losses on any such contracts it has entered
into; and, provided further, that in the case of an option that is in-the-money,
such amount may be excluded in computing such 5 percent.
FUTURES CONTRACTS
When a Fund purchases a futures contract, it agrees to purchase a
specified underlying instrument at a specified future date. When a 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 a 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.
-12-
<PAGE>
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 a Fund's exposure to positive and negative price
fluctuations in the underlying instrument, much as if it had purchased the
underlying instrument directly. When a 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 a Fund's investment limitations. In the event of the bankruptcy of
an FCM that holds margin on behalf of a Fund, such 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 such Fund.
PURCHASING PUT AND CALL OPTIONS
By purchasing a put option, a 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, a 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. A 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, a Fund will lose the entire premium it paid. If a Fund
exercises the option, it completes the sale of the underlying instrument at the
strike price. A 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.
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 a 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,
such 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 a Fund would be required to make
margin payments to an FCM as described above for futures contracts. A 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 a Fund has written, however,
such 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.
-13-
<PAGE>
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 a 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
Each 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, a 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 a Fund's current or anticipated investments exactly. Each 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 such Fund's other investments.
Options and futures prices can also diverge from the prices of their
underlying instruments, even if the underlying instruments match a 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. A 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 a 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 a 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 a Fund to continue to hold a position until delivery
or expiration regardless of changes in its value. As a result, a Fund's access
to other assets held to cover its options or futures positions could also be
impaired.
-14-
<PAGE>
OTC OPTIONS
Bond and Government Funds may engage in OTC options transactions. 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 a 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
Bond and Government Funds may engage in options and futures transactions
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. A Fund may
purchase and sell currency futures and may purchase and write currency options
to increase or decrease its exposure to different foreign currencies. A 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 a Fund's investments. A currency hedge, for example,
should protect a yen-denominated security from a decline in the yen, but will
not protect a Fund against a price decline resulting from deterioration in the
issuer's creditworthiness. Because the value of a 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 a Fund's investments exactly over time.
ASSET COVERAGE FOR FUTURES AND OPTIONS POSITIONS
Each 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 a Fund's assets could impede portfolio management or a Fund's
ability to meet redemption requests or other current obligations.
INVESTMENT RESTRICTIONS
As indicated in the Prospectus, each 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 a 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 each Fund and may be changed by the Board of Directors without
shareholder approval.
-15-
<PAGE>
Each 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").
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, a 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 a Fund engages in reverse repurchase agreements, because such
transactions are considered borrowing, reverse repurchase agreements are
included in the 33-1/3% limitation.
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, a 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.
-16-
<PAGE>
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 a 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 (other than Restriction 4) 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
Restriction 14, each 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 a Fund's liquid assets.
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. Each Fund's historical portfolio turnover
rates are set forth in the Prospectus section "Financial Highlights". The
increases in the portfolio turnover rates for Bond Fund and Government Fund for
the last fiscal year were due to increased bond market volatility and falling
interest rates.
INVESTMENT PERFORMANCE
Advertisements and other sales literature for each 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.
-17-
<PAGE>
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. A "tax-equivalent yield" is computed by dividing the portion of the
yield that is tax-exempt by one minus a stated income tax rate and adding the
product to that portion, if any, of the yield that is not tax-exempt.
The yield formula is as follows:
YIELD = 2[(a-b + 1)6 -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.
-18-
<PAGE>
The table below shows the yearly total return for the Funds for the periods
indicated.
<TABLE>
<CAPTION>
<S> <C> <C>
Bond Fund Government Fund
Year Ended 12/31 Yearly Total Return Yearly Total Return
---------------- ------------------- -------------------
1981 3.0%
1982 32.6%
1983 8.0%
1984 15.9%
1985 20.2%
1986 12.2%
1987 2.0%
1988 6.4%
1989 15.9%
1990 7.1%
1991 17.3% 7.7%*
1992 6.8% 5.7%
1993 12.32% 8.54%
1994 (4.92%) (2.27%)
1995 16.25% 11.54%
1996 4.12% 2.91%
--------------------------------------
* For the period commencing August 8, 1991.
</TABLE>
The average annual total returns of Bond Fund for the one, five and ten
year periods ended November 30, 1996 were 6.85%, 7.90% and 8.30%, respectively.
Bond Fund's yield for the thirty-day period ended November 30, 1996 was 5.95%.
The average annual total returns of Government Fund for the one and five
year periods ended November 30, 1996 and from inception of the Government Fund
through November 30, 1996, were 4.99%, 5.33% and 6.53%, respectively. Government
Fund's yield for the thirty-day period ended November 30, 1996 was 5.50%.
In advertising and sales literature, each 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 a Fund.
The comparison of a 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.
Each Fund may also note its mention in newspapers, magazines, or other media
from time to time. However, each Fund assumes no responsibility for the accuracy
of such data.
For example, (1) a 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 a Fund; (3)
other U.S. government statistics such as GNP, and net import and export figures
-19-
<PAGE>
derived from governmental publications, e.g., The Survey of Current Business,
may be used to illustrate investment attributes of a Fund or the general
economic business, investment, or financial environment in which a Fund
operates; (4) the effect of tax-deferred compounding on a 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 a 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
a Fund invests may be compared to relevant indices or surveys in order to
evaluate a Fund's historical performance or current or potential value with
respect to the particular instruments.
MANAGEMENT
The names, addresses, positions and principal occupations of the
directors and executive officers of the Funds are given below.
<TABLE>
<CAPTION>
<S> <C> <C> <C>
Name and Address Age Position Principal Occupation(s) During Past 5 Years
- ---------------- --- -------- -------------------------------------------
Noel P. Rahn* 57 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* 44 President, Director Executive Vice President of IAI and has served
3700 First Bank Place IAI in many capacities since 1979. Mr.
P.O. Box 357 Struthers is also President of the other IAI
Minneapolis, Minnesota 55440 Mutual Funds.
Madeline Betsch 54 Director Executive Vice President, Director of Client
19 South 1st Street Services, of CME-KHBB Advertising since May
Minneapolis, Minnesota 55401 1985, and prior thereto was a Vice President
with Campbell-Mithun, Inc. (advertising
agency) since February 1977. Ms. Betsch is
currently retired. Ms. Betsch is also a
Director of the IAI Mutual Funds.
W. William Hodgson 72 Director W. William Hodgson served as information
1698 Dodd Road manager for the North Central Home Office of
Mendota Heights, Minnesota 55118 the Prudential Insurance Company of America
from 1961 until 1984; he is currently
retired. Mr. Hodgson is also a Director of
the IAI Mutual Funds.
George R. Long 66 Director George R. Long serves as Director of Pacific
29 Las Brisas Way Industries and has been Chairman of Mayfield
Naples, Florida 33963 International (financial consultants and
venture capitalists) since 1973. Mr. Long is
also a Director of the IAI Mutual Funds.
J. Peter Thompson 65 Director J. Peter Thompson has been a grain farmer in
Route 1 southwestern Minnesota since 1974. Prior to
Mountain Lake, Minnesota 56159 that, Mr. Thompson was employed by Paine
Webber, Jackson & Curtis, Incorporated,(a
diversified financial services concern), most
recently as Senior Vice President and General
Partner. Mr. Thompson is also a Director of the IAI
Mutual Funds.
-20-
<PAGE>
Name and Address Age Position Principal Occupation(s) During Past 5 Years
- ---------------- --- -------- -------------------------------------------
Charles H. Withers 66 Director Charles H. Withers was Editor of the Rochester
Rochester Post Bulletin Post-Bulletin, Rochester, Minnesota from 1960
P.O. Box 6118 through March 31, 1980; he is currently
Rochester, Minnesota 55903 retired. Mr. Withers is also a Director of
the IAI Mutual Funds.
Archie C. Black, III 34 Treasurer Senior Vice President and Chief Financial
3700 First Bank Place Officer of the Adviser and has served the
P.O. Box 357 Adviser in several capacities since 1987. Mr.
Minneapolis, Minnesota 55440 Black is also Treasurer of the IAI Mutual
Funds.
William C. Joas 34 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 Chief Fixed
3700 First Bank Place Investments Income Officer of IAI and has served as a
P.O. Box 357 (Bond Fund) fixed income portfolio manager since 1984.
Minneapolis, Minnesota 55440 Mr. Hill also serves as a Vice President of IAI
Institutional Bond Fund.
Scott Bettin 41 Vice President, Senior Vice President of IAI and has served
3700 First Bank Place Investments IAI as a fixed income portfolio manager since 1987.
P.O. Box 357 (Government Fund) Mr. Bettin also serves as a Vice President of IAI
Minneapolis, Minnesota 55440 Institutional Bond Fund.
Stephen Coleman 48 Vice President, Senior Vice President of IAI and has served
3700 First Bank Place Investments IAI as a fixed income portfolio manager since 1991.
P.O. Box 357 (Bond Fund)
Minneapolis, Minnesota 55440
Livingston Douglas 35 Vice President, Vice President of IAI. Prior to joining IAI
3700 First Bank Place Investments in 1993, Mr. Douglas served as a fixed income
P.O. Box 357 (Bond Fund) portfolio manager for Mackay-Shields Financial
Minneapolis, Minnesota 55440 (Government Fund) Corporation since 1987. Mr. Douglas also serves
as a Vice President of IAI Reserve Fund.
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 Vice
P.O. Box 357 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.
-21-
<PAGE>
Name and Address Age Position Principal Occupation(s) During Past 5 Years
- ---------------- --- -------- -------------------------------------------
Susan J. Haedt 34 Vice President, Vice President of the Adviser and Director of
3700 First Bank Place Director of Mutual Fund Operations . Prior to joining the
P.O. Box 357 Fund Operations Adviser in 1992, Ms. Haedt served as a Senior
Minneapolis, Minnesota 55440 Manager at KPMG Peat Marwick LLP, (an
international tax, accounting and consulting
firm). Ms. Haedt is also Vice President,
Director of Operations of the IAI Mutual Funds.
</TABLE>
- -------------------------------
* Directors of each Fund who are interested persons (as that term is
defined by the Investment Company Act of 1940)of IAI and each Fund.
Each Fund has agreed to reduced initial subscription requirements for
employees and directors of a 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.
No compensation is paid by the Fund to any of its officers. 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. Each 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>
<S> <C> <C> <C>
Name of Person, Position Compensation Aggregate Compensation
- ------------------------ ---------------------- from the
Bond Fund Government Fund 19 IAI Mutual Funds**
--------- --------------- ---------------------
Betsch, Madeline - Director $1,376 $695 $34,700
Hodgson, W. William - Director $1,376 $695 $34,700
Long, George R. - Director $1,365 $685 $34,700
Thompson, J. Peter - Director $1,376 $695 $34,700
Withers, Charles H. - Director $1,365 $685 $34,700
- -------------------------
</TABLE>
* For the fiscal year ended November 30, 1996.
** For the calendar year ended December 31, 1996.
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.
-22-
<PAGE>
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.
HISTORY
Bond Fund is a separate portfolio of IAI Investment Funds I, Inc., a
Minnesota corporation whose shares of common stock are currently issued in one
series (Series A). On June 25, 1993, Bond Fund's shareholders approved amended
and restated Articles of Incorporation, which provided that the registered
investment company whose corporate name had been IAI Bond Fund, Inc., be renamed
IAI Investment Funds I, Inc. The investment portfolio represented by Series A
common shares is referred to as "IAI Bond Fund."
Government Fund is a separate portfolio of IAI Investment Funds VI, Inc., a
Minnesota corporation whose shares of common stock are currently issued in six
series (Series A through F). On June 25, 1993, Government Fund's shareholders
approved amended and restated Articles of Incorporation, which provided that the
registered investment company whose corporate name had been IAI Series Fund,
Inc., be renamed IAI Investment Funds VI, Inc. The investment portfolio
represented by Series B common shares is referred to as "IAI Government Fund."
MANAGEMENT AGREEMENT
Effective April 1, 1996, pursuant to a Management Agreement between each
Fund and IAI, IAI has agreed to provide each 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 each Fund within the framework of a Fund's investment policies,
subject to review by the directors of a Fund. In addition, IAI has agreed to
provide or arrange for the provision of all required administrative, stock
transfer, redemption, dividend disbursing, accounting, and shareholder services
including, without limitation, the following: (1) the maintenance of a Fund's
accounts, books and records; (2) the calculations of the daily net asset value
in accordance with a 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 a 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 and dividends and distributions
declared by a Fund; (8) answering shareholder questions, (9) providing reports
and other information and (10) other services designed to maintain shareholder
accounts. IAI may also pay qualifying broker-dealers, financial institutions and
other entities that provide such services. In return for these services, each
Fund has agreed to pay IAI an annual fee as a percentage of the Fund's average
daily net assets as set forth below:
Daily Net Assets Fee IAI Receives Annually
---------------- -------------------------
For the first $100 million 1.10%
For the next $150 million 1.05%
Above $250 million 1.00%
-23-
<PAGE>
Under 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 a Fund, taxes and extraordinary expenses, IAI has
agreed to pay all of a Fund's other costs and expenses, including, for example,
costs incurred in the purchase and sale of assets, taxes, charges of the
custodian of a 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 a Fund's shares,
postage, insurance premiums, and costs of attending investment conferences. The
Management Agreement further provides that IAI will either reimburse a Fund for
the fees and expenses it pays to directors who are not "interested persons" of a
Fund or reduce its fee by an equivalent amount. IAI is not liable for any loss
suffered by a Fund in the absence of willful misfeasance, bad faith or
negligence in the performance of its duties and obligations.
As of November 30, 1996, Bond Fund had $86,803,251 in net assets, and
Government Fund had $29,750,714 in net assets. For the fiscal year ended
November 30, 1996, Bond Fund and Government Fund paid IAI $570, 078 and
$272,519, respectively, pursuant to the Management Agreement.
PRIOR AGREEMENTS
Effective March 31, 1996, the Investment Advisory Agreement and
Administrative Agreement between each Fund and IAI were terminated and replaced
by the Management Agreement described above. The services IAI provided under
these agreements were substantially similar to those provided under the new
Management Agreement.
Under the Investment Advisory Agreements, each Fund had agreed to pay IAI
an advisory fee at an annual rate of .55% of the Fund's average net assets. For
the fiscal period ended November 30, 1994, the fiscal years ended November 30,
1995 and 1996 (i.e., December 31, 1995 through March 31, 1996), Bond Fund paid
IAI $327,730, $441,516, and $141,722, respectively, under the Advisory
Agreement. For those same periods, Government Fund paid IAI $144,953, $238,633
and $84,410 under the Advisory Agreement.
With respect to the Administrative Agreements, each Fund was obligated to
pay IAI a monthly fee at the annual rate of .20% of the Fund's average month-end
assets. For the fiscal year ended November 30, 1996, Bond Fund and Government
Fund paid IAI administrative fees of $51,535 and $30,695, respectively, under
the Administrative Agreements.
ALLOCATION OF EXPENSES
Prior to the termination of the Advisory and Administrative Agreements on
March 31, 1996, each Fund paid all its other costs and expenses, including, for
example, costs incurred in the purchase and sale of assets, interest, taxes,
charges of the custodian of a 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
Fund shares, postage, fees to directors who are not "interested persons" of a
Fund, distribution expenses pursuant to each Fund's Rule 12b-1 plan, insurance
premiums, costs of attending investment conferences and such other costs which
may be designated as extraordinary. IAI agreed to reimburse each Fund for
expenses (other than 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) which exceed 1.10% per year of the
average month-end net assets of Bond and Government Funds, (the "expense
limit"). For the fiscal period ended November 30, 1994, the fiscal year ended
November 30, 1995, and the fiscal year ended November 30, 1996 (i.e., December
31, 1995 through March 31, 1996), IAI was not obligated to reimburse any Fund
expenses.
-24-
<PAGE>
DURATION OF AGREEMENTS
Each Management Agreement will terminate automatically in the event of its
assignment. In addition, each Agreement is terminable at any time without
penalty by the Board of Directors of a Fund or by vote of a majority of a Fund's
outstanding voting securities on not more than 60 days' written notice to IAI,
and by IAI on 60 days' notice to a Fund. Each 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.
Effective March 31, 1996, each Fund's Plan of Distribution (the "Plan")
terminated. Prior to termination, each Fund had entered into a Distribution and
Shareholder Services Agreement (the "Agreement") with IAI Securities, Inc.
("IAIS"). Pursuant to such Plan and Agreement, each Fund paid IAIS .25% of the
Fund's average month-end net assets to cover expenses incurred by IAIS in
connection with the servicing of shareholder accounts and the distribution of
such Fund's shares, subject to the contractual expense limitations discussed
above.
The net distribution fees paid by Bond and Government Funds pursuant to
their Plans of Distribution during the fiscal year ended November 30, 1996
(i.e., December 1, 1995 through March 31, 1996) were $55,213 and $38,368
respectively. All such distribution fees were paid to, and retained by, IAIS
pursuant to the Distribution and Shareholder Services Agreements discussed
above. During the fiscal year ended November 30, 1996, such distribution fees
(along with amounts paid out of IAIS' own assets) were paid by IAIS in
connection with the distribution of the Funds' shares as follows:
<TABLE>
<CAPTION>
<S> <C> <C>
Bond Fund Government Fund
--------- ---------------
Advertising $14,908 $10,359
Printing and mailing of prospectuses to other
than current shareholders $11,595 $8,057
Payments to brokers or dealers $17,668 $12,277
Direct payments to sales personnel $1,656 $1,151
Other $9,386 $6,523
</TABLE>
CUSTODIAL SERVICE
The custodian for the Funds 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 Bond and Government Funds to utilize the
subcustodian and depository network of Morgan Stanley. Such agreements,
subcustodians and depositories were approved by the Funds' 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 Funds'
assets held outside the United States.
PORTFOLIO TRANSACTIONS AND ALLOCATION OF BROKERAGE
Most of each 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 a 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.
-25-
<PAGE>
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 a 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 a 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
BOND FUND
Bond Fund is a separate portfolio of IAI Investment Funds I, Inc., a
Minnesota corporation whose shares of common stock are currently issued in one
series (Series A). 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 A
common shares. The investment portfolio represented by such shares is referred
to as IAI Bond Fund. As of November 30, 1996, Bond Fund had 9,312,923 shares
outstanding.
As of March 14, 1997, no person held of record or, to the knowledge of Bond
Fund, beneficially owned or held as of record more than 5% of the outstanding
shares of Bond Fund, except as set forth in the following table.
<TABLE>
<CAPTION>
<S> <C> <C>
==================================================================================
Name and Address Number of Percent of
of Shareholder Shares Class
==================================================================================
Charles Schwab & Co., Inc. 573,734.424 7%
SPL Custody A/C for excl bnft of Cust
Attn: Mutual Funds Dept. - Bond Rein
101 Montgomery Street
San Francisco, CA 94104
</TABLE>
As of March 149, 1997, the Fund's officers and directors as a group owned
less than 1% of the Fund's outstanding shares.
-26-
<PAGE>
GOVERNMENT FUND
Government Fund is a separate portfolio of IAI Investment Funds VI, Inc., a
Minnesota corporation whose shares of common stock are currently issued in six
series (Series A through F). 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 VI, 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 VI, 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 Government Fund. As of November 30, 1996, the Fund had
2,990,139 shares outstanding.
As of March 14, 1997, no person held of record or, to the knowledge of
Government Fund, beneficially owned more than 5% of the outstanding shares of
the Fund, except as set forth in the following table.
<TABLE>
<CAPTION>
<S> <C> <C>
==================================================================================
Name and Address Number of Percent of
of Shareholder Shares Class
==================================================================================
First Trust NA 159,638.896 6.4%
Trustee for Multi-Tech Systems, Inc. P/S
U/A DTD 1/1/84 Income Collections 736410
2205 Woodale Drive
Mounds View, MN 55112
Norwest Bank Minnesota NA TTEE 126,542.821 5.0%
for the Merrill Corp. Retirement Savings
PI DTD 21/1/94 #13115100
Attn: Dana Long
Sixth and Marquetter
Minneapolis, MN 55479-0035
</TABLE>
As of March 14, 1997, Government Fund's officers and directors as a group
owned 1.08% of the Fund's outstanding shares.
NET ASSET VALUE AND PUBLIC OFFERING PRICE
The portfolio securities in which each Fund invests fluctuate in value, and
hence, for each Fund, the net asset value per share also fluctuates.
The net asset value per share of a 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 York Stock Exchange is closed, and the net asset value per
share of a 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, 1996, the net asset value and public offering price per
share of each Fund was calculated as follows:
BOND FUND
NAV = Net Assets ($86,803,251) = $9.32
Shares Outstanding (9,312,923)
-27-
<PAGE>
GOVERNMENT FUND
NAV = Net Assets ($29,750,714) = $9.95
Shares Outstanding (2,990,139)
PURCHASES AND REDEMPTIONS IN KIND
In extraordinary circumstances, Fund shares may be purchased for cash or in
exchange for securities which are permissible investments of a 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. Also in extraordinary circumstances, if a shareholder so desires, and
IAI so agrees, Fund shares may be redeemed in exchange for securities held by a
Fund. Securities redeemed 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.
TAX STATUS
The tax status of the Funds and the distributions of the Funds are
summarized in the Prospectus under "Dividends, Distributions and Tax Status."
It is not expected that distributions from any of the Funds will qualify
for the dividends received deduction in the case of corporate shareholders since
the distributions will not be derived from dividends paid by domestic
corporations
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 Internal Revenue Code of 1986, as amended (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, each
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, each 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,
each Fund generally must declare dividends by the end of each calendar year
representing 98% of each 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 each Fund's policy not to distribute capital gains
until capital loss carryovers, if any, either are utilized or expire.
-28-
<PAGE>
In the case of Bond and Government Funds, 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 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 Bond or Government Fund to foreign countries
will reduce the amount of income available to such Fund for distributions to
shareholders.
If either Fund invests in zero coupon obligations upon their issuance, such
obligations will have original issue discount in the hands of the Fund.
Generally, the original issue discount equals the difference between the "stated
redemption price at maturity" of the obligation and its "issue price" as those
terms are defined in the Code. If the Fund acquires an already issued zero
coupon bond from another holder, the bond will have original issue discount in
the Fund's hands, equal to the difference between the "adjusted issue price" of
the bond at the time the Fund acquires it (that is, the original issue price of
the bond plus the amount of original issue discount accrued to date) and its
stated redemption price at maturity. In each case, the Fund is required to
accrue as ordinary interest income a portion of such original issue discount
even though it receives no cash currently as interest payment on the obligation.
If a Fund invests in U.S. Treasury inflation-protection securities, it will be
required to treat as original issue discount any increase in the principal
amount of the securities that occurs during the course of its taxable year. If a
Fund purchases such inflation-protection securities that are issued in stripped
form either as stripped bonds or coupons, it will be treated as if it had
purchased a newly issued debt instrument having original issue discount.
Because the Funds are required to distribute substantially all of their net
investment income in order to be taxed as regulated investment companies, they
may be required to distribute an amount greater than the total cash income the
Fund actually receives. Accordingly, in order to make the required distribution,
the Fund may be required to borrow or to liquidate securities. The extent to
which the Fund may liquidate securities at a gain may be limited by the
requirement that generally less than 30% of such Fund's gross income (on an
annual basis) consists of gains from the sale of securities held for less than
three months.
Except for the transactions a Fund has identified as hedging transactions,
each Fund is required for federal income tax purposes to recognize as income for
each taxable year its net unrealized gains and losses on futures contracts,
options, and forward currency contracts as of the end of the year, as well as
those actually realized during the year. Except for transactions in futures
contracts, options, or forward currency contracts that are classified as part of
a "mixed straddle," gain or loss recognized with respect to such contract or
contracts is considered to be 60% long-term capital gain or loss and 40%
short-term capital gain or loss, without regard to the holding period of the
contract. In the case of a transaction classified as a "mixed straddle", the
recognition of losses may be deferred to a later taxable year.
Sales of futures contracts, options, or forward currency contracts that are
intended to hedge against a change in the value of securities or currencies held
by a Fund may affect the holding period of such securities or currencies and,
consequently, the nature of the gain or loss on such securities or currencies
upon disposition.
It is expected that any net gain realized from the closing out of futures
contracts, options, or forward currency contracts will be considered gain from
the sale of securities or currencies and, therefore, qualifying income for
purposes of the requirement that a regulated investment company derive at least
90% of its gross income from dividends, interest and certain types of payment
related to its investment in stock or securities. In order to avoid realizing
excessive gains on securities or currencies held less than three months, each
Fund may be required to defer the closing out of futures contracts, options, or
forward currency contracts beyond the time when it would otherwise be
advantageous to do so. It is expected that unrealized gains on futures
contracts, options, or forward currency contracts, which have been open for less
than three months as of the end of a Fund's fiscal year and which are recognized
for tax purposes, will not be considered gains on securities or currencies held
less than three months for purposes of the 30% test, as discussed above.
-29-
<PAGE>
Any realized gain or loss on closing out a futures contracts, option, or
forward currency contract such as a forward commitment for the purchase or sale
of foreign currency will generally result in a recognized capital gain or loss
for tax purposes. Code Section 988 may also apply to forward currency contracts.
Under Section 988, each foreign currency gain or loss is generally computed
separately and treated as ordinary income or loss. In the case of overlap
between Sections 1256 and 988, special provisions determine the character and
timing of any income, gain or loss. The Funds will attempt to monitor Section
988 transactions to avoid an adverse tax impact.
The foregoing is a general and abbreviated summary of the Code and Treasury
regulations in effect as of the date of the Funds' Prospectus and this Statement
of Additional Information as applicable to the Funds and their shareholders. 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 a Fund.
LIMITATION OF DIRECTOR LIABILITY
Under Minnesota law, each 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.,
and IAI Investment Fund VI, 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 Funds' 1996 Annual Report
to shareholders, are incorporated herein by reference. Such Annual Report may be
obtained by shareholders on request from the Funds at no additional charge.
-30-
<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.
A-1
<PAGE>
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.
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
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.
A-2
<PAGE>
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.
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.
A-3
<PAGE>
FIXED INCOME FUNDS
IAI Institutional Bond Fund
Prospectus dated
April 1, 1997
[LOGO]
Mutual Funds
<PAGE>
[ART]
IAI Institutional Bond Fund
<PAGE>
TABLE OF CONTENTS
<TABLE>
<S> <C>
FUND EXPENSE INFORMATION....................................................3
FUND DIRECTORS..............................................................3
FINANCIAL HIGHLIGHTS........................................................4
INVESTMENT OBJECTIVE AND POLICIES...........................................5
OTHER INVESTMENT TECHNIQUES.................................................6
FUND RISK FACTORS...........................................................10
MANAGEMENT..................................................................13
INVESTMENT PERFORMANCE......................................................14
COMPUTATION OF NET ASSET VALUE AND PRICING..................................15
PURCHASE OF SHARES..........................................................15
RETIREMENT PLANS............................................................16
REDEMPTION OF SHARES........................................................17
AUTHORIZED TELEPHONE TRADING................................................18
DIVIDENDS, DISTRIBUTIONS AND TAX STATUS.....................................18
DESCRIPTION OF COMMON STOCK.................................................19
COUNSEL AND AUDITORS........................................................20
CUSTODIAN, TRANSFER AGENT AND DIVIDEND DISBURSING AGENT.....................20
ADDITIONAL INFORMATION......................................................20
</TABLE>
<PAGE>
IAI MUTUAL FUNDS
IAI Institutional Bond Fund
PROSPECTUS DATED APRIL 1, 1997
IAI Institutional Bond Fund (the "Fund") is a separate portfolio of IAI
Investment Funds I, Inc., an open-end diversified management 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. Investment Advisers, Inc. ("IAI") serves as the Fund's investment
adviser and manager.
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,
1997 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.
-2-
<PAGE>
IAI MUTUAL FUNDS
IAI Institutional Bond Fund
FUND EXPENSE INFORMATION
Shareholder Transaction Expenses
- --------------------------------
Sales Load Imposed on Purchases.................................. None
Sales Load Imposed on Reinvested Dividends....................... None
Redemption Fees*................................................. None
Exchange Fees.................................................... None
- ---------------------------
* The Fund charges a $10 fee for the payment
of redemption proceeds by wire.
Annual Fund Operating Expenses
- ------------------------------------------------------
(as a percentage of average daily net assets)
Management Fee.................................................... .50%
Other Expenses................................................... None
----
Total Fund Operating Expenses.................................. .50%
====
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:
1 Year 3 Years 5 Years 10 Years
------ ------- ------- --------
$ 5 $ 16 $ 28 $ 63
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, 1996. 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" and in the Statement of
Additional Information.
FUND DIRECTORS
Madeline Betsch Richard E. Struthers
W. William Hodgson J. Peter Thompson
George R. Long Charles H. Withers
Noel P. Rahn
-3-
<PAGE>
IAI MUTUAL FUNDS
IAI Institutional Bond Fund
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.
<TABLE>
<CAPTION>
<S> <C> <C> <C>
Years Ended Period from Period from
November 30, 4/1/94+ 11/1/93***
----------------------------- to to
1996 1995 11/30/94 3/31/94
- -------------------------------------------------------------------------- -------------------- ------------------
NET ASSET VALUE
Beginning of period $9.50 $8.85 $9.36 $10.00
-------------- --------------- -------------------- ------------------
OPERATIONS
Net investment income .63 .62 .38 .22
Net realized and unrealized gains .04 .66 (.51) (.65)
(losses) ------------- -------------- ------------------- -----------------
Total from operations .67 1.28 (.13) (.43)
-------------- --------------- -------------------- ------------------
DISTRIBUTIONS TO SHAREHOLDERS FROM:
Net investment income (.63) (.63) (.38) (.21)
------------- -------------- -------------------- -----------------
Total distributions (.63) (.63) (.38) (.21)
-------------- --------------- -------------------- ------------------
NET ASSET VALUE
End of period $9.54 $9.50 $8.85 $9.36
============== =============== ==================== ================
Total investment return* 7.44% 14.95% (1.44%) (4.35%)
Net assets at end of period (000's omitted) $97,085 $101,429 $73,724 $31,478
============ =============== =================== =================
Ratios:
Expenses to average daily net assets 0.50% 0.50% 0.50%** 0.50%**
Net investment income to average daily 6.75% 6.76% 6.42%** 5.84%**
net assets
Portfolio turnover rate 323.0% 358.8% 235.1% 127.1%
(excluding short-term securities)
- --------------------------------------------
</TABLE>
* Total investment return is based on the change in net asset value of
a share during the period and assumes reinvestment of all distributions
at net asset value.
** Annualized.
*** Commencement of operations.
+ Reflects fiscal year-end change from March 31 to November 30.
-4-
<PAGE>
IAI MUTUAL FUNDS
IAI Institutional Bond Fund
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
of 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 judgment, 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 and commercial paper. The Fund may also
invest in U.S. Treasury inflation-protection securities. The value of such
inflation-protection securities is adjusted for inflation and periodic interest
payments are in amounts equal to a fixed percentage of the inflation-adjusted
value of the principal. 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
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
-5-
<PAGE>
IAI MUTUAL FUNDS
IAI Institutional Bond Fund
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. The Fund
will limit its investments in such securities to a maximum of 10% of its net
assets.
The Fund may employ certain other investment techniques, as described in the
section "Other Fund Investment Techniques." Please see the Prospectus section
"Fund Risk Factors" and the Statement of Additional Information section
"Investment Objective and Policies" for a discussion of the risks associated
with investing in the Fund.
OTHER FUND INVESTMENT
TECHNIQUES
REPURCHASE AGREEMENTS
The Fund is permitted to invest in repurchase agreements. A repurchase agreement
is a contract by which the Fund acquires the security ("collateral") subject to
the obligation of the seller to repurchase the security at a fixed price and
date (within seven days). A repurchase agreement may be construed as a loan
under relevant law. The Fund may enter into repurchase agreements with respect
to any securities which it may acquire consistent with its investment policies
and restrictions. The Fund's custodian will hold the securities underlying any
repurchase agreement in a segregated account. In investing in repurchase
agreements, the Fund's risk is limited to the ability of the seller to pay the
agreed-upon price at the maturity of the repurchase agreement. In the opinion of
IAI, such risk is not material, since in the event of default, barring
extraordinary circumstances, the Fund would be entitled to sell the underlying
securities or otherwise receive adequate protection under federal bankruptcy
laws for its interest in such securities. However, to the extent that proceeds
from any sale upon a default are less than the repurchase price, the Fund could
suffer a loss. In addition, the Fund may incur certain delays in obtaining
direct ownership of the collateral.
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
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
-6-
<PAGE>
IAI MUTUAL FUNDS
IAI Institutional Bond Fund
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, 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.
MORTGAGE-BACKED SECURITIES
The Fund may invest in pass-through securities which are sold by various
private, governmental and government-related organizations. Pass-through
securities are formed when mortgages and other debt instruments are pooled
together and undivided interests in the pool are sold to investors such as the
Fund. The cash flow from the underlying debt instruments is "passed through" to
the holders of the securities in the form of periodic (generally monthly)
payments of interest, principal and prepayments. Prepayments occur when the
holder of an individual debt instrument prepays the remaining principal and
-7-
<PAGE>
IAI MUTUAL FUNDS
IAI Institutional Bond Fund
interest before the final scheduled payment month. Therefore, the Fund may be
subject to a higher rate of prepayments during periods of declining interest
rates when mortgages and other debt instruments may be more frequently prepaid.
Mortgage pass-through securities include (1) obligations of U.S. government
agencies and instrumentalities which are secured by the full faith and credit of
the U.S. Treasury such as Government National Mortgage Association ("GNMA")
pass-through certificates; (2) obligations which are secured by the right of the
issuer to borrow from the Treasury, such as securities issued by the Federal
Financing Bank, the Federal Home Loan Banks and the United States Postal
Service; and (3) obligations which have the principal and interest payments
guaranteed by the government agency or instrumentality itself (but are not
backed by the full faith and credit of the U.S. government), such as securities
of the Federal National Mortgage Association ("FNMA") and Federal Home Loan
Mortgage Corporation ("FHLMC"); and (4) obligations of private corporations.
ASSET-BACKED SECURITIES
The Fund may invest in types of asset-backed securities which represent forms of
consumer credit such as automobile and credit card receivables, manufactured
(mobile) home loans, home improvement loans and home equity loans. Asset-backed
securities are generally privately issued and pass through cash flows to
investors. Generally, asset-backed securities include many of the risks
associated with mortgage-related securities. In general, however, the collateral
supporting asset-backed securities is of shorter maturity than mortgage loans
and is less likely to experience substantial prepayments. Asset-backed
securities involve certain risks that are not posed by mortgage-backed
securities, resulting mainly from the fact that asset-backed securities do not
usually contain the complete benefit of a security interest in the related
collateral. For example, credit card receivables generally are unsecured and the
debtors are entitled to the protection of a number of state and federal consumer
credit laws, including the bankruptcy laws, some of which may reduce the ability
to obtain full payment. In the case of automobile receivables, due to various
legal and economic factors, proceeds for repossessed collateral may not always
be sufficient to support payments on these securities.
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 entities, that are
determined by IAI to be of comparable quality to the other obligations in which
the Fund may invest.
ADJUSTING INVESTMENT
EXPOSURE
The Fund may, but is not required to, utilize various other investment
strategies as described below to hedge various market risks (such as interest
rates, currency exchange rates, and broad or specific fixed-income market
movements), to manage the effective maturity or duration of the Fund's portfolio
or to enhance potential gain. These strategies may be executed through the use
of derivative contracts. Such strategies are generally accepted as a part of
-8-
<PAGE>
IAI MUTUAL FUNDS
IAI Institutional Bond Fund
modern portfolio management and are regularly utilized by many mutual funds and
other institutional investors. Techniques and instruments may change over time
as new instruments and strategies are developed or regulatory changes occur.
In the course of pursuing these investment strategies, the Fund may purchase and
sell exchange-listed and over-the-counter put and call options on securities,
fixed-income indices and other financial instruments, purchase and sell
financial futures contracts and options thereon, enter into various interest
rate transactions such as swaps and enter into various currency transactions
such as currency forward contracts, currency futures contracts, currency swaps
or options on currencies or currency futures.
Such techniques and instruments may be used without limit to attempt to protect
against possible changes in the market value of securities held in or to be
purchased for the Fund's portfolio resulting from securities markets or currency
exchange rate fluctuations, to protect the Fund's unrealized gains in the value
of its portfolio securities, to facilitate the sale of such securities for
investment purposes, to manage the effective maturity or duration of the Fund's
portfolio, or to establish a position in the derivatives markets as a temporary
substitute for purchasing or selling particular securities. Some may also be
used to enhance potential gain although no more than 5% of the Fund's assets
will be committed to techniques and instruments entered into for non-hedging
purposes. Any or all of these investment techniques maybe used at any time and
in any combination, and there is no particular strategy that dictates the use of
one technique rather than another, as use of any technique or instruments is a
function of numerous variables including market conditions. The ability of the
Fund to utilize these techniques and instruments successfully will depend on
IAI's ability to predict pertinent market movements, which cannot be assured.
The Fund will comply with applicable regulatory requirements when implementing
these strategies, techniques and instruments. Such techniques and instruments
involving financial futures and options thereon will be purchased, sold or
entered into only for bona fide hedging, risk management or portfolio management
purposes and not for speculative purposes.
TEMPORARY INVESTMENTS
The Fund reserves the right, as a temporary defensive measure, such as during
periods of adverse market conditions or when debt securities are deemed
overvalued, to hold up to 100% of its total assets in cash or cash equivalents
and short-term securities, including money market securities.
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. The Fund does not intend its borrowings to exceed
5% of its total assets.
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
-9-
<PAGE>
IAI MUTUAL FUNDS
IAI Institutional Bond Fund
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."
Further information regarding these and other techniques is contained in the
Statement of Additional Information.
FUND 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 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
-10-
<PAGE>
IAI MUTUAL FUNDS
IAI Institutional Bond Fund
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 recovery. 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.
PREPAYMENT RISKS
To the extent it invests in mortgage-backed securities, the Fund is subject to
prepayment risk. Prepayment risk is the possibility that, as interest rates
fall, homeowners are more likely to refinance their home mortgages. When home
mortgages are refinanced, the principal on GNMA certificates held by the Fund is
"prepaid" earlier than expected. The Fund must then reinvest the unanticipated
principal in new GNMA certificates, just at a time when interest rates on new
mortgage investments are falling.
Prepayment risk has two important effects on the Fund:
- When interest rates fall and additional mortgage prepayments must be
reinvested at lower interest rates, the income of the Fund will be reduced.
- When interest rates fall, prices on GNMA securities will not rise as much
as comparable Treasury bonds, as bond market investors anticipate an increase in
mortgage prepayments and a likely decline in income.
-11-
<PAGE>
IAI MUTUAL FUNDS
IAI Institutional Bond Fund
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.
RISKS ASSOCIATED WITH
ADJUSTING INVESTMENT
EXPOSURE
The techniques and instruments described in the section "Adjusting Investment
Exposure", including derivative contracts, have risks associated with them
including possible default by the other party to the transaction, illiquidity
and, to the extent IAI's view as to certain market movements is incorrect, the
risk that the use of such techniques and instruments could result in losses
greater than if they had not been used. Use of put and call options may result
in losses to the Fund, force the sale or purchase of portfolio securities at
inopportune times or for prices higher than (in the case of put options) or
lower than (in the case of call options), current market values, limit the
amount of appreciation the Fund can realize on its investments or cause the Fund
to hold a security it might otherwise sell. The use of currency transactions can
result in the Fund incurring losses as a result of a number of factors including
the imposition of exchange controls, suspension of settlements or the inability
to deliver or receive a specified currency. The use of options and futures
transactions entails certain other risks. In particular, the variable degree of
correlation between price movements of futures contracts and price movements in
the related portfolio position of the Fund creates the possibility that losses
on the hedging instrument may be greater than gains in the value of the Fund's
position. In addition, futures and options markets may not be liquid in all
-12-
<PAGE>
IAI MUTUAL FUNDS
IAI Institutional Bond Fund
circumstances and certain over-the-counter options may not have markets. As a
result, in certain markets, the Fund might not be able to close out a
transaction without incurring substantial losses, if at all. Although the use of
futures contracts and options transactions for hedging should tend to minimize
the risk of loss due to a decline in the value of the hedged position, at the
same time they tend to limit any potential gain which might result from an
increase in value of such position. Finally, the daily variation margin
requirements for futures contracts would create a greater ongoing potential
financial risk than would purchases of options, where the exposure is limited to
the cost of the initial premium. Losses resulting from the use of these
techniques would reduce net asset value, and possibly income, and such losses
can be greater than if the techniques and instruments had not been utilized.
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 judgment. 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. The Fund is a diversified investment company and has a fundamental
policy that, with respect to 75% of its total assets, it may not invest more
than 5% of its total assets in any one issuer. The Fund, also as fundamental
policies, may not invest 25% or more of its assets in any one industry and may
borrow only for temporary or emergency purposes in an amount not exceeding
one-third of its total assets. Please refer to the Statement of Additional
Information for a further discussion of the Fund's investment 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 operation and management 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.
IAI also furnishes investment advice to other concerns including other
investment companies, pension and profit sharing plans, foundations, religious,
educational and charitable institutions, trusts, municipalities and individuals,
having total assets in excess of $16 billion. The address of IAI is that of the
Fund.
IAI provides the Fund with investment advisory services and is responsible
-13-
<PAGE>
IAI MUTUAL FUNDS
IAI Institutional Bond Fund
for the overall management of the Fund's business affairs subject to the
authority of the Board of Directors. The Management Agreement also provides
that, except for brokerage commissions and other expenditures in connection with
the purchase and sale of portfolio securities, interest and in certain
circumstances, taxes and extraordinary expenses, IAI shall bear all of the
Fund's operating expenses. As compensation for these services, the Fund paid IAI
0.50% of its average daily net assets for the fiscal year ended November 30,
1996. IAI shall not be liable for any loss suffered by the Fund in the absence
of willful misfeasance, bad faith or gross negligence in performance of its
duties and obligations.
The Fund is managed by a team of IAI investment professionals. Larry Hill,
Timothy Palmer and Scott Bettin are responsible for the Fund's day-to-day
investment decisions. Mr. Hill and Mr. Palmer have been responsible for the
management of the Fund since its inception; Mr. Bettin since mid-1996. Mr. Hill
is IAI's Chief Fixed Income Officer 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. Bettin is a Senior Vice President of IAI and has served as a fixed income
portfolio manager since joining IAI in 1987.
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
-14-
<PAGE>
IAI MUTUAL FUNDS
IAI Institutional Bond Fund
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.
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 dividing the result by the number of shares outstanding.
The Fund's investments with remaining maturities of 60 days or less at the date
of initial investment 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
GENERAL
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.
-15-
<PAGE>
IAI MUTUAL FUNDS
IAI Institutional Bond Fund
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 2nd Avenue South, Minneapolis,
Minnesota 55402. For assistance in completing the application please contact IAI
Mutual Fund Shareholder Services at 1-800-945-3863.
BANK WIRE PURCHASES
Shares may be purchased by having your bank wire federal funds (funds of the
Federal Reserve System) to Norwest Bank, Minnesota.
Wire orders will be accepted only on days your bank, the transfer agent, the
Fund and Norwest Bank Minnesota are open for business. The payment must be
received by the Fund before the close of business to be credited to you account
that day. Otherwise, it will be processed the next business day. The wire
purchase will not be considered made until the wired amount is received and the
purchase is accepted by the Fund. If the wire order does not contain the
information stated below, the Fund may reject it. Any delays that may occur in
wiring federal funds, including delays in processing by the banks, are not the
responsibility of the Fund or the transfer agent.
You must pay any charges assessed by your bank for the wire service. If a wire
order is rejected, all money received by the Fund, less any costs incurred by
the Fund or the transfer agent in rejecting it, will be returned promptly.
If the wire order is for a new account, you should call IAI Shareholder Services
at 1-800-945-3863 to advise them of the investment and to obtain an account
number and instructions. The wire should be sent to: Norwest Bank Minnesota,
Routing Number 091000019, Minneapolis, Minnesota, Attn: IAI Mutual Funds Account
Number 6355002264. It should state the following:
"Credit IAI Funds Account # ___________ for future credit to personal
account # ______________ (your account number) for ____________________________
(your name) and __________________ (Fund name)."
A completed application must be sent and received by the Fund before the wire is
sent.
If the wire order is for an addition to an existing account, the wire must
include the information required above for the new accounts. As soon as the wire
is sent, you should call IAI Shareholder Services, as described above, and
advise them of your name, your account number and the name of the bank
transmitting the federal funds.
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
-16-
<PAGE>
IAI MUTUAL FUNDS
IAI Institutional Bond Fund
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. All correspondence relating to the
redemption of shares should be directed to the office of IAI Mutual Funds, P.O.
Box 357, Minneapolis, Minnesota 55440. Shareholders may redeem shares by phone,
subject to a limit of $50,000, provided such shareholders have authorized the
Fund to accept telephone instructions. For assistance in redeeming shares by
phone, please contact the IAI Mutual Funds Shareholder Services at
1-800-945-3863.
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.
For shareholders who established receiving proceeds by Federal Funds Wire at the
time they opened their account, telephone instructions will be accepted for
redemption of amount up to $50,000 ($1,000 Minimum) and proceeds will be wired
on the next business day to a predesignated bank account. Wire redemption
requests will only be processed on days your bank, the transfer agent, the Fund
and Norwest Bank Minnesota are open for business.
In order to add this feature to an existing account or to change existing bank
account information, please submit a letter of instructions including your bank
information to IAI Shareholder Services. The letter must be signed by all
registered owners, and their signatures must be guaranteed.
Your account will be charged a fee of $10 each time redemption proceeds are
wired to your bank. Your bank may also charge you a fee for receiving a Federal
Funds wire.
Neither the transfer agent nor the Fund can be responsible for the efficiency of
the Federal Funds wire system or the shareholder's bank.
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.
The Fund will not send redemption proceeds until checks (including certified
-17-
<PAGE>
IAI MUTUAL FUNDS
IAI Institutional Bond Fund
checks or cashiers checks) received in payment for shares have cleared, which
may take up to ten days or more.
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 $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.
-18-
<PAGE>
IAI MUTUAL FUNDS
IAI Institutional Bond Fund
Distributions are subject to federal income tax in the hands of shareholders
subject to tax, and may also be subject to state or local taxes. If you live
outside the United States, your distributions could also be taxed by the country
in which you reside. Your distributions are taxable when they are paid, whether
you take them in cash or reinvest them in additional shares.
For federal income tax purposes, the Fund's income and short-term capital gain
distributions are taxed as dividends; long-term capital gain distributions
designated as capital gain dividends are taxed as long-term capital gains.
Upon redemption of shares of the Fund, a shareholder will generally recognize a
capital gain or loss equal to the difference between the amount realized on the
redemption and the shareholder's adjusted basis in such shares. Such gain will
be long-term if the shares have been held for more than one year. Under the
Code, deductibility of capital losses is subject to certain limitations.
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)
retirement 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
-19-
<PAGE>
IAI MUTUAL FUNDS
IAI Institutional Bond Fund
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.
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, 1996.
<TABLE>
<CAPTION>
<S> <C>
Bonds - Moody's Rating IAI Institutional Bond Fund
---------------------------- --------------------------------------------
Aaa 16%
Aa 3%
A 12%
Baa 18%
Ba 8%
B 3%
Caa 0%
Ca 0%
C 0%
U.S. Government 40%
---------------------------- --------------------------------------------
Total 100%
---------------------------- --------------------------------------------
</TABLE>
-20-
<PAGE>
TO OPEN
AN ACCOUNT
1.800.945.3863
612.376.2700
P.O. Box 357
Minneapollis, Minnesota 55440
OVERNIGHT
DELIVERY
ADDRESS
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>
[LOGO]
IAI MUTUAL FUNDS
IAI INSTITUTIONAL BOND FUND
Statement of Additional Information
dated April 1, 1997
This Statement of Additional Information is not a prospectus. This
Statement of Additional Information relates to a Prospectus dated April 1, 1997
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).
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>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
INVESTMENT OBJECTIVE AND POLICIES...........................................3
INVESTMENT RESTRICTIONS.....................................................15
INVESTMENT PERFORMANCE......................................................18
MANAGEMENT..................................................................19
CUSTODIAL SERVICE...........................................................23
PORTFOLIO TRANSACTIONS AND ALLOCATION OF BROKERAGE..........................23
CAPITAL STOCK...............................................................24
NET ASSET VALUE AND PUBLIC OFFERING PRICE...................................25
TAX STATUS..................................................................25
LIMITATION OF DIRECTOR LIABILITY............................................28
FINANCIAL STATEMENTS........................................................28
Appendix A-- Ratings of Debt Securities.....................................A-1
</TABLE>
-2-
<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. The Fund does not currently
intend to invest more than 5% of its net assets in reverse repurchase
agreements.
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.
-3-
<PAGE>
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.
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.
U.S. TREASURY INFLATION PROTECTION SECURITIES
The Bond Fund may purchase securities issued by the United States
government, which include U.S. Treasury inflation-protection securities.
Inflation-protection securities are a new type of marketable book-entry
security issued by the United States Department of Treasury ("Treasury") with a
nominal return linked to the inflation rate in prices. Inflation-protection
securities will be auctioned and issued on a quarterly basis on the 15th of
January, April, July, and October, beginning on January 15, 1997. Initially,
they will be issued as 10-year notes, with other maturities added thereafter.
The index used to measure inflation will be the non-seasonally adjusted U.S.
City Average All Items Consumer Price Index for All Urban Consumers ("CPI-U").
The value of the principal will be adjusted for inflation, and every six
months the security will pay interest, which will be an amount equal to a fixed
percentage of the inflation-adjusted value of the principal. The final payment
of principal of the security will not be less than the original par amount of
the security at issuance.
The principal of the inflation-protection security will be indexed to the
non-seasonally adjusted CPI-U. To calculate the inflation-adjusted principal
value for a particular valuation date, the value of the principal at issuance is
multiplied by the index ratio applicable to that valuation date. The index ratio
for any date is the ratio of the reference CPI applicable to such date to the
reference CPI applicable to the original issue date. Semiannual coupon interest
is determined by multiplying the inflation-adjusted principal amount by one-half
of the stated rate of interest on each interest payment date.
Inflation-adjusted principal or the original par amount, whichever is
larger, will be paid on the maturity date as specified in the applicable
offering announcement. If at maturity the inflation-adjusted principal is less
than the original principal value of the security an additional amount will be
paid at maturity so that the additional amount plus the inflation-adjusted
principal equals the original principal amount. Some inflation-protection
securities may be stripped into principal and interest components. In the case
of a stripped security, the holder of the stripped principal would receive this
additional amount. The final interest payment, however, will be based on the
final inflation-adjusted principal value, not the original par amount.
The reference CPI for the first day of any calendar month is the CPI-U for
the third preceding calendar month. (For example, the reference CPI for December
1 is the CPI-U reported for September of the same year, which is released in
October.) The reference CPI for any other day of the month is calculated by a
linear interpolation between the reference CPI applicable to the first day of
the month and the reference CPI applicable to the first day of the following
month.
-4-
<PAGE>
Any revisions the Bureau of Labor Statistics (or successor agency) makes to
any CPI-U number that has been previously released will not be used in
calculations of the value of outstanding inflation-protection securities. In the
case that the CPI-U for a particular month is not reported by the last day of
the following month, the Treasury will announce an index number based on the
last year-over-year CPI-U inflation rate available. Any calculations of the
Treasury's payment obligations on the inflation-protection security that need
that month's CPI-U number will be based on the index number that the Treasury
has announced. If the CPI-U is based to a different year, the Treasury will
continue to use the CPI-U series based on the base reference period in effect
when the security was first issued as long as that series continues to be
published. If the CPI-U is discontinued during the period the
inflation-protection security is outstanding, the Treasury will, in consultation
with the Bureau of Labor Statistics (or successor agency), determine an
appropriate substitute index and methodology for linking the discontinued series
with the new price index series. Determinations of the Secretary of the Treasury
in this regard are final.
Inflation-protection securities will be held and transferred in either of
two book-entry systems: the commercial book-entry system (TRADES) and TREASURY
DIRECT. The securities will be maintained and transferred at their original par
amount, i.e., not at their inflation-adjusted value. STRIPS components will be
maintained and transferred in TRADES at their value based on the original par
amount of the fully constituted security.
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 that can be resold to
institutional investors may be considered liquid pursuant to guidelines adopted
by the Board of Directors. In the case of a Rule 144A Security, such security is
deemed to be liquid if:
(1) IAI reasonably expects to be able to resell the security to a qualified
institutional buyer, as defined in paragraph (a)(1) of Rule 144A, who is aware
of the Fund's reliance upon Rule 144A in selling the security without
registration, as required by paragraph (d)(2) of Rule 144A;
(2) the Rule 144A Security is not (a) of the same class as securities
listed on any national securities exchange or quoted in NASDAQ as determined
under paragraph (d)(3)(i) of Rule 144A, or (b) a security of a registered
investment company (other than a closed-end investment company); and
-5-
<PAGE>
(3) the issuer (a) is a foreign government eligible to register securities
under Schedule B of the Securities Act of 1933, (b) is a company that files
periodic reports under the Securities Act of 1934 on Forms 8-K, 10-Q, 10-K or
20-F or provides information under Rule 12g3-2(b) thereunder, or (c) has agreed
in writing to provide the holder and any prospective purchaser of the Rule 144A
Security with reasonably current financial information as required under
paragraph (d)(4)(i) of Rule 144A.
Other securities are deemed to be liquid if IAI determines that the
security can be disposed of within seven days in the ordinary course of business
at approximately the amount at which the Funds have valued the instrument for
purposes of calculating the Fund's net asset value. In making this
determination, IAI will consider such factors as may be relevant to the Fund's
ability to dispose of the security, including but not limited to, the following
factors (none of which, standing alone, would necessarily be determinative):
1. the frequency of trades and quotes for the security;
2. the number of dealers willing to purchase or sell the security and the
number of potential purchasers;
3. dealer undertakings to make a market in the security; and
4. the nature of the security and the nature of the marketplace trades
(e.g., the time needed to dispose of the security, the method of soliciting
offers and the mechanics of transfer).
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.
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.
-6-
<PAGE>
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.
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.
-7-
<PAGE>
ASSET-BACKED SECURITIES
Asset-backed securities represent interests in pools of consumer or
commercial loans or payment streams (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.
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.
-8-
<PAGE>
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.
-9-
<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.
-10-
<PAGE>
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 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.
-11-
<PAGE>
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.
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. With respect to positions in commodity futures or
commodity option contracts which do not come within the meaning and intent of
bona fide hedging in the CFTC rules, the aggregate initial margin and premiums
required to establish such positions will not exceed five percent of the
liquidation value of the Fund's portfolio, after taking into account unrealized
profits and unrealized losses on any such contracts it has entered into; and,
provided further, that in the case of an option that is in-the-money, such
amount may be excluded in computing such 5 percent.
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.
-12-
<PAGE>
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.
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.
-13-
<PAGE>
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.
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.
-14-
<PAGE>
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.
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.
-15-
<PAGE>
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.
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.
-16-
<PAGE>
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 (other than Restriction 4) 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
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.
-17-
<PAGE>
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.
The yield formula is as follows:
YIELD = 2[(a-b + 1)6 -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.
-18-
<PAGE>
The Fund's yearly total returns as of December 31st of each year are as
follows: 1993 - (.84%); 1994 - (4.24%); 1995 - 15.69%; 1996 - 4.62%. The average
annual total returns of the Fund for the year ended November 30, 1996 and for
the period from the Fund's inception (November 1, 1993) through November 30,
1996 were 7.44% and 5.06%, respectively. For the thirty-day period ended
November 30, 1996, the Fund's yield was 6.52%.
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.
MANAGEMENT
The names, addresses, positions and principal occupations of the
directors and executive officers of the Funds are given below.
<TABLE>
<CAPTION>
<S> <C> <C> <C>
Name and Address Age Position Principal Occupation(s) During Past 5 Years
- ---------------- --- -------- -------------------------------------------
Noel P. Rahn* 57 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* 44 President, Director Executive Vice President of IAI and has served
3700 First Bank Place IAI in many capacities since 1979. Mr.
P.O. Box 357 Struthers is also President of the other IAI
Minneapolis, Minnesota 55440 Mutual Funds.
-19-
<PAGE>
Name and Address Age Position Principal Occupation(s) During Past 5 Years
- ---------------- --- -------- -------------------------------------------
Madeline Betsch 54 Director Executive Vice President, Director of Client
19 South 1st Street Services, of CME-KHBB Advertising since May
Minneapolis, Minnesota 55401 1985, and prior thereto was a Vice President
with Campbell-Mithun, Inc. (advertising
agency) since February 1977. Ms. Betsch is
currently retired. Ms. Betsch is also a
Director of the IAI Mutual Funds.
W. William Hodgson 72 Director W. William Hodgson served as information
1698 Dodd Road manager for the North Central Home Office of
Mendota Heights, Minnesota 55118 the Prudential Insurance Company of America
from 1961 until 1984; he is currently
retired. Mr. Hodgson is also a Director of
the IAI Mutual Funds.
George R. Long 66 Director George R. Long serves as Director of Pacific
29 Las Brisas Way Industries and has been Chairman of Mayfield
Naples, Florida 33963 International (financial consultants and
venture capitalists) since 1973. Mr. Long is
also a Director of the IAI Mutual Funds.
J. Peter Thompson 65 Director J. Peter Thompson has been a grain farmer in
Route 1 southwestern Minnesota since 1974. Prior to
Mountain Lake, Minnesota 56159 that, Mr. Thompson was employed by Paine
Webber, Jackson & Curtis, Incorporated, (a
diversified financial services concern), most
recently as Senior Vice President and General
Partner. Mr. Thompson is also a Director of
the IAI Mutual Funds.
Charles H. Withers 66 Director Charles H. Withers was Editor of the Rochester
Rochester Post Bulletin Post-Bulletin, Rochester, Minnesota from 1960
P.O. Box 6118 through March 31, 1980; he is currently
Rochester, Minnesota 55903 retired. Mr. Withers is also a Director of
the IAI Mutual Funds.
Archie C. Black, III 34 Treasurer Senior Vice President and Chief Financial
3700 First Bank Place Officer of the Adviser and has served the
P.O. Box 357 Adviser in several capacities since 1987. Mr.
Minneapolis, Minnesota 55440 Black is also Treasurer of the IAI Mutual
Funds.
William C. Joas 34 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
-20-
<PAGE>
Name and Address Age Position Principal Occupation(s) During Past 5 Years
- ---------------- --- -------- -------------------------------------------
Larry R. Hill 43 Vice President, Executive Vice President and Chief Fixed
3700 First Bank Place Investments Income Officer of IAI as a fixed income
P.O. Box 357 portfolio manager since 1984.
Minneapolis, Minnesota 55440
Timothy Palmer 33 Vice President, Senior Vice President of IAI and has served
3700 First Bank Place Investments IAI as a fixed income portfolio manager since
P.O. Box 357 1990.
Minneapolis, Minnesota 55440
Scott Bettin 42 Vice President, Senior Vice President of IAI and has served IAI
3700 First Bank Place as a fixed income portfolio manager since 1987.
P.O. Box 357 Mr. Bettin also serves as a Vice President of the
Minneapolis, Minnesota 55440 IAI Government Fund.
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 Vice
P.O. Box 357 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 the Adviser and Director of
3700 First Bank Place Director of Mutual Fund Operations . Prior to joining the
P.O. Box 357 Fund Operations Adviser in 1992, Ms. Haedt served as a Senior
Minneapolis, Minnesota 55440 Manager at KPMG Peat Marwick LLP, (an
international tax, accounting and consulting
firm). Ms. Haedt is also Vice President,
Director of Operations of the 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.
No compensation is paid by the Fund to any of its officers. 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.
-21-
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C>
Aggregate Compensation
Aggregate Compensation from the
Name of Person, Position from the Fund* 19 IAI Mutual Funds**
------------------------ -------------- -------------------
Betsch, Madeline - Director $1,735 $34,700
Hodgson, W. William - Director $1,735 $34,700
Long, George R. - Director $1,713 $34,700
Thompson, J. Peter - Director $1,735 $34,700
Withers, Charles H. - Director $1,713 $34,700
</TABLE>
- --------------------------------------------------------------
* For the fiscal year ended November 30, 1996.
** For all Funds for the calendar year ended December 31, 1996.
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.
INVESTMENT ADVISORY AND ADMINISTRATIVE SERVICES AGREEMENT
Pursuant to the Investment Advisory and Administrative Services Agreement
between the Fund and IAI, 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
-22-
<PAGE>
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, 1996, the Fund had net assets of $97,084,760. For the
fiscal period ended November 30, 1994, and for the fiscal years ended November
30, 1995 and 1996, the Fund paid IAI $242,947, $446,744 and $496,348
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 Investment Advisory and Administrative Services 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.
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.
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.
-23-
<PAGE>
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, 1996, the Fund had
10,171,815 shares outstanding.
As of March 14, 1997, 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>
<S> <C> <C>
=============================================================================
Name and Address Number of Percent of
of Shareholder Shares Class
=============================================================================
Bank Trust Co. of the Southwest TTEE 713,759.670 22.6%
Tracor Inc. Employee Retirement Plan
909 Fannin St., Suite 3000
Houston, TX 77010
The Baptist Medical Centers 1,022.753.106 10.9%
Attn: Robert E. Greene
3500 Blue Lake Drive, Suite 105
Birmingham, AL 35243
Blandin Paper Company 896,416.927 9.8%
Defined Benefit Pension Plan
Attn: Peter McDermott
115 SW First Street
Grand Rapids, MN 55744-3699
-24-
<PAGE>
=============================================================================
Name and Address Number of Percent of
of Shareholder Shares Class
=============================================================================
Norwest Bank MN NA TTEE 897,360.047 9.8%
University of St. Thomas #13222000
DTD 3/13/96
733 Marquette Ave. MS #0036
Minneapolis, MN 55479
Capinco 601,317.493 6.5%
c/o Firstar Trust Company
FO Banta Corporation
P.O. Box 1787
Milwaukee, WI 53201
Campbell Mithun Esty Advertising PST 522,755.418 5.7%
Incentive PST #12475704
Attn: Diane Munson
222 S. 9th St.
Piper Jaffary Tower
Minneapolis, MN 55402
</TABLE>
In addition, as of March 14, 1997, 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 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, 1996, the net asset value and public offering price per
share of the Fund was calculated as follows:
NAV = Net Assets ($97,084,609) = $9.54
Shares Outstanding (10,171,815)
-25-
<PAGE>
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. Sinec most of the dividends paid by the Fund will not be
attributable to dividends paid by domestic corporations, it is expected that
only a small portion of dividends paid to corporate shareholders will be
eligible for the dividends received deduction in the hands of shareholders that
are corporations. Distributions designated as long-term capital gain
distributions will be taxable to all shareholders 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 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.
-26-
<PAGE>
If the Fund invests in zero coupon obligations or STRIPS upon their
issuance, such obligations will have original issue discount in the hands of the
Fund. Generally, the original issue discount equals the difference between the
"stated redemption price at maturity" of the obligation and its "issue price" as
those terms are defined in the Code. If the Fund acquires an already issued zero
coupon bond or STRIPS from another holder, the bond will have original issue
discount in the Fund's hands, equal to the difference between the "adjusted
issue price" of the bond at the time the Fund acquires it (that is, the original
issue price of the bond plus the amount of original issue discount accrued to
date) and its stated redemption price at maturity. In each case, the Fund is
required to accrue as ordinary interest income a portion of such original issue
discount even though it receives no cash currently as interest payment on the
obligation. If the Fund invests in U.S. Treasury inflation-protection
securities, it will be required to treat as original issue discount any increase
in the principal amount of the securities that occurs during the course of its
taxable year. If the Fund purchases such inflation-protection securities that
are issued in stripped form either as stripped bonds or coupons, it will be
treated as if it had purchased a newly issued debt instrument having original
issue discount.
Because the Fund is required to distribute substantially all of its net
investment income in order to be taxed as a regulated investment company, it may
be required to distribute an amount greater than the total cash income the Fund
actually receives. Accordingly, in order to make the required distribution, the
Fund may be required to borrow or to liquidate securities. The extent to which
the Fund may liquidate securities at a gain may be limited by the requirement
that generally less than 30% of the Fund's gross income (on an annual basis)
consists of gains from the sale of securities held for less than three months.
Except for the transactions the Fund has identified as hedging
transactions, the Fund is required for federal income tax purposes to recognize
as income for each taxable year its net unrealized gains and losses on futures
contracts, options, and forward currency contracts as of the end of the year as
well as those actually realized during the year. Except for transactions in
futures contracts, options or forward currency contracts that are classified as
part of a "mixed straddle," gain or loss recognized with respect to such
contract or contracts is considered to be 60% long-term capital gain or loss and
40% short-term capital gain or loss, without regard to the holding period of the
contract. In the case of a transaction classified as a "mixed straddle," the
recognition of losses may be deferred to a later taxable year.
Sales of futures contracts, options, or forward currency contracts that are
intended to hedge against a change in the value of securities or currencies held
by the Fund may affect the holding period of such securities or currencies and,
consequently, the nature of the gain or loss on such securities or currencies
upon disposition.
It is expected that any net gain realized from the closing out of futures
contracts, options, or forward currency contracts will be considered gain from
the sale of securities or currencies and, therefore, qualifying income for
purposes of the requirement that a regulated investment company derive at least
90% of its gross income from dividends, interest and certain types of payment
related to its investment in stocks or securities. In order to avoid realizing
excessive gains on securities or currencies held less than three months, the
Fund may be required to defer the closing out of futures contracts, options, or
forward currency contracts beyond the time when it would otherwise be
advantageous to do so. It is expected that unrealized gains on futures
contracts, options, or forward currency contracts, which have been open for less
than three months as of the end of the Fund's fiscal year and which are
recognized for tax purposes, will not be considered gains on securities or
currencies held less than three months for purposes of the 30% test, as
discussed above.
Any unrealized gain or loss on closing out a futures contracts, option or
forward currency contract such as forward commitment for the purchase or sale of
foreign currency will generally result in a recognized capital gain or loss for
tax purposes. Code Section 988 may also apply to forward currency contracts.
Under Section 988, each foreign currency gain or loss is generally computed
separately and treated as ordinary income or loss. In the case of overlap
between Section 1256 and 988, special provisions determine the character and
timing of any income, gain or loss. The Fund will attempt to monitor Section 988
transactions to avoid an adverse tax impact.
-27-
<PAGE>
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 1996 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.
A-1
<PAGE>
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.
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
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.
A-2
<PAGE>
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.
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.
A-3
