1933 Act Registration No. 002-59115
1940 Act Registration No. 811-2747
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MARCH 31, 2000
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM N-1A
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
Pre-Effective Amendment No. __
Post-Effective Amendment No. 41
AND/OR
REGISTRATION STATEMENT UNDER THE INVESTMENT COMPANY ACT OF 1940
Amendment No. 41
(Check appropriate box or boxes)
IAI INVESTMENT FUNDS I, INC.
(Exact Name of Registrant as Specified in Charter)
3700 U.S. Bank Place
P.O. Box 357
Minneapolis, Minnesota 55440
(Address of Principal Executive Offices, Zip Code)
(612) 376-2000
(Registrant's Telephone Number, including Area Code)
Steven G. Lentz, Esq.
3700 U.S. Bank Place
P.O. Box 357
Minneapolis, Minnesota 55440
(Name and Address of Agent for Service)
COPY TO:
Kathleen L. Prudhomme, Esq.
Dorsey & Whitney LLP
220 South Sixth Street
Minneapolis, Minnesota 55402-1498
It is proposed that this filing will become effective (check appropriate box):
_X_ immediately upon filing pursuant to paragraph (b)
____ on (date) pursuant to paragraph (b)
____ 60 days after filing pursuant to paragraph (a)(1)
____ on (date) pursuant to paragraph (a)(1)
____ 75 days after filing pursuant to paragraph (a)(2)
____ on (date) pursuant to paragraph (a)(2) of Rule 485.
If appropriate, check the following box:
____ this post-effective amendment designates a new effective date for a
previously filed post-effective amendment.
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IAI MUTUAL FUNDS
IAI BOND FUND
PROSPECTUS April 1, 2000
As with all mutual funds, the Securities and Exchange Commission has not
approved or disapproved the shares of this Fund, or determined if the
information in this prospectus is accurate or complete. Any statement to the
contrary is a criminal offense.
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TABLE OF CONTENTS
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Page
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Fund Summary.............................................................................................. 3
Objective............................................................................................ 3
Principal Investment Strategies...................................................................... 3
Principal Risks...................................................................................... 3
Fund Performance..................................................................................... 5
Fees and Expenses.................................................................................... 5
Buying and Selling Shares................................................................................. 6
How to Buy Shares.................................................................................... 6
How to Sell Shares................................................................................... 8
Exchange Privilege................................................................................... 11
Authorized Telephone Trading......................................................................... 11
Statements and Confirmations......................................................................... 12
Shareholder Reports.................................................................................. 12
Dividend and Capital Gains Distributions.................................................................. 12
Taxes..................................................................................................... 13
Taxes on Distributions............................................................................... 13
Taxes on Transactions................................................................................ 13
Fund Management........................................................................................... 13
Investment Adviser................................................................................... 13
Portfolio Manager.................................................................................... 14
More Information on Investment Strategies and Risks....................................................... 14
Investment Strategies................................................................................ 14
Effective Duration................................................................................... 15
Temporary Defensive Investments...................................................................... 15
Portfolio Turnover................................................................................... 15
Principal Risks...................................................................................... 16
Financial Highlights...................................................................................... 19
</TABLE>
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FUND SUMMARY
This section briefly describes the objective, principal investment strategies
and principal risks of IAI Bond Fund ("the Fund"). It also provides you with
information on the Fund's performance and expenses. For further information on
the Fund, please read the section entitled "More Information on Investment
Strategies and Risks."
OBJECTIVE
The Fund's investment objective is to provide shareholders with a high level of
current income consistent with preservation of capital.
PRINCIPAL INVESTMENT STRATEGIES
The Fund invests primarily in bonds and other debt securities that are rated
investment grade at the time of purchase or that are unrated and judged to be of
comparable quality by the Fund's adviser. At least 65% of the Fund's total
assets will be invested in debt securities. Although the Fund generally does not
purchase common stocks directly, it may invest up to 10% of its net assets in
convertible securities and preferred stock. The Fund's investments may include
foreign securities. However, the Fund does not expect to invest more than 25% of
its total assets in foreign securities, or more than 15% of its total assets in
non-dollar denominated foreign securities.
Although the Fund invests primarily in investment grade securities, it also may
invest up to 15% of its total assets in securities rated lower than investment
grade at the time of purchase, or "junk bonds." However, the Fund will not
invest in junk bonds rated lower than B by Moody's Investors Service, Inc. or
Standard & Poor's Corporation or, if unrated, judged to be of comparable quality
by the Fund's adviser.
The Fund may enter into futures contracts, options on futures contracts and
currency forward contracts. The Fund intends to use these derivative instruments
primarily for hedging purposes, although it may use them for non-hedging
purposes to a limited extent. To generate additional income, the Fund may invest
up to 10% of its net assets in mortgage dollar roll transactions.
The Fund's adviser employs a "top-down" approach in selecting securities for the
Fund. First, the adviser determines its economic outlook and the direction in
which it expects interest rates to move. Based on these factors, the adviser
makes duration and yield curve decisions and determines the Fund's sector
allocation. Selections of individual securities that fall within the appropriate
parameters are based on the adviser's analysis of the individual security and
its relative value compared to other securities in the marketplace. The Fund's
adviser anticipates that the average effective duration for the Fund's portfolio
securities will range from 3 1/2 to 7 1/2 years. This range may change, however,
due to market conditions and other economic factors.
PRINCIPAL RISKS
The principal risks that could adversely affect the Fund's share price and yield
include:
o INTEREST RATE RISK. Prices of the Fund's debt securities will generally
fall when interest rates rise. One measure of interest rate risk is
effective duration, explained under "More Information on Investment
Strategies and Risks -- Investment Strategies." The longer the Fund's
effective duration, the greater its interest rate risk.
o INCOME RISK. The Fund's income could decline due to falling market
interest rates.
3
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o CREDIT RISK. The Fund is subject to the risk that the issuers of debt
securities it holds will not make timely payments of interest or
principal on the securities. Securities rated the lowest investment
grade have speculative characteristics. In adverse economic or other
circumstances, issuers of these lower rated securities are more likely
to have difficulty making principal and interest payments than issuers
of higher rated securities. Non-investment grade securities are subject
to additional risk. See "Risks of Non-Investment Grade Securities"
below.
o RISKS OF NON-INVESTMENT GRADE SECURITIES. Non-investment grade
securities, or "junk bonds," generally have more volatile prices and
carry more risk to principal than investment grade securities.
o CALL RISK. The Fund is subject to the risk that, during periods of
falling interest rates, an issuer of debt securities will "call" -- or
repay -- its high-yielding bonds before their maturity date. The Fund
would then be forced to invest the unanticipated proceeds at lower
interest rates, resulting in a decline in the Fund's income.
o RISKS OF MORTGAGE- AND ASSET-BACKED SECURITIES. Falling interest rates
could cause faster than expected prepayments of the obligations
underlying the Fund's mortgage- and asset-backed securities. These
prepayments pass through to the Fund, which must reinvest them at a
time when interest rates on new investments are falling, reducing the
Fund's income. On the other hand, rising interest rates could cause
prepayments of the obligations to slow, which would lengthen the
duration of the Fund's mortgage- and asset-backed securities and cause
their prices to decline.
o RISKS OF FOREIGN SECURITIES. Investing in foreign securities typically
involves risks not associated with U.S. investing. Risks of foreign
investing include the risk that the Fund may experience a decline in
net asset value resulting from changes in exchange rates between the
U.S. dollar and foreign currencies, the risk of adverse political and
economic developments, and the possibility of expropriation,
nationalization or confiscatory taxation or limitations on the removal
of Fund assets.
o RISKS OF PREFERRED STOCKS AND CONVERTIBLE SECURITIES. The risks
associated with investing in preferred stocks and convertible
securities are similar to the risks of investing in equity securities,
including the risk that the prices of the securities will decline in
response to the activities of the issuing company or in response to
general market and/or economic conditions.
o RISKS OF DERIVATIVE INSTRUMENTS. The use of derivative instruments
exposes the Fund to additional risks and transaction costs. Successful
use of these instruments depends on the adviser's ability to correctly
forecast the direction of market movements. The Fund's performance
could be worse than if the Fund had not used these instruments if the
adviser's judgment proves incorrect. In addition, even if the adviser's
forecast is correct, there may be an imperfect correlation between the
price of derivative instruments and movements in the prices of the
securities, interest rates or currencies being hedged.
o RISKS OF DOLLAR ROLL TRANSACTIONS. The use of mortgage dollar rolls
could increase the volatility of the Fund's share price. It could also
diminish the Fund's investment performance if the adviser does not
predict mortgage prepayments and interest rates correctly.
You can lose money by investing in the Fund. An investment in the Fund is not a
deposit of any bank and is not insured or guaranteed by the Federal Deposit
Insurance Corporation or any other government agency.
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FUND PERFORMANCE
The bar chart and table on the left provide you with information on the Fund's
volatility and performance. The bar chart shows how the Fund's performance has
varied from year to year. This information provides some indication of the risks
of investing in the Fund by showing changes in performance from year to year.
The table compares the Fund's average annual returns for 1, 5 and 10 years to
that of a broad measure of market performance. The Fund's past performance is
not necessarily an indication of how it will perform in the future.
ANNUAL TOTAL RETURNS AS OF 12/31 EACH YEAR
20%--
15%
10%--
5%--
0%--
- 5%--
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<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
7.07% 17.32% 6.80% 12.32% (4.92%) 16.25% 4.12% 10.85% 5.58% (3.47%)
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999
</TABLE>
Best Quarter: Quarter ended December 31, 1990 7.67%
Worst Quarter: Quarter ended March 31, 1992 (3.68)%
AVERAGE ANNUAL TOTAL RETURNS AS OF 12/31/99
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<CAPTION>
1 YEAR 5 YEARS 10 YEARS
<S> <C> <C> <C>
BOND FUND (3.47%) 6.46% 6.96%
LEHMAN BROTHERS AGGREGATE (0.82%) 7.73% 7.70%
BOND INDEX *
</TABLE>
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* Includes U.S. Treasury and government agency securities, mortgage-backed
obligations and corporate bonds rated investment grade or higher. All issues
must have at least one year left to maturity and an outstanding par value of at
least $100 million.
FEES AND EXPENSES
As an investor, you pay certain fees and expenses if you buy and hold shares of
the Fund. Shareholder fees are fees you pay directly when buying or selling
shares. Annual fund operating expenses are deducted from Fund assets. The
figures below are based on expenses during the fiscal year ended November 30,
1999.
<TABLE>
SHAREHOLDER FEES (FEES PAID DIRECTLY FROM YOUR INVESTMENT)
<S> <C>
Maximum Sales Charge (Load) None
Imposed on Purchases
Maximum Deferred Sales Charge (Load) None
ANNUAL FUND OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM
FUND ASSETS) (as a % of average net assets)
Management Fees 1.10%*
Distribution and Service (12b-1) Fees None
Other Expenses None
Total Annual Fund Operating Expenses 1.10%*
</TABLE>
5
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* Actual management fees and total Fund operating
expenses were 1.07% for the fiscal year ended
November 30, 1999 as a result of fee waivers by the
Fund's adviser, Investment Advisers, Inc. ("IAI").
IAI will limit its management fee to 0.90% of average
daily net assets through March 31, 2001. Although it
has no current intention of doing so, IAI may
discontinue this limitation at any time after March
31, 2001, upon 30 days written notice to
shareholders.
EXAMPLE
This example is intended to help you compare the cost of investing in the Fund
with the cost of investing in other mutual funds. It assumes that you invest
$10,000 in the Fund for the time periods indicated, that your investment has a
5% return each year and that the Fund's operating expenses remain the same.
Although your actual costs may be higher or lower, based on these assumptions
your costs would be:
1 year $ 112
3 years $ 350
5 years $ 606
10 years $ 1,340
BUYING AND SELLING SHARES
HOW TO BUY SHARES
You may purchase Fund shares either directly through the Fund or through certain
securities dealers. These dealers have the responsibility to promptly transmit
orders and may charge a processing fee. The Fund may reject any purchase order
at any time.
MINIMUM INVESTMENTS
The Fund is a member of the IAI Family of Funds, a family of mutual funds
advised by Investment Advisers, Inc. ("IAI"). The minimum initial investment to
establish an account with the IAI Family of Funds is $5,000 for a retail account
and $2,000 for an IRA account. In each case, your initial investment may be
allocated in any way you wish among the Fund and other funds in the IAI Family
of Funds, so long as no less than $1,000 is allocated to any one fund. Once you
have met the account minimum, subsequent purchases can be made for as little as
$100.
DETERMINING YOUR PURCHASE PRICE
Your purchase price will be equal to the Fund's net asset value ("NAV") per
share next calculated after your order is placed in proper form. To make sure
that your order is in proper form, please follow the directions for purchasing
shares given below. No sales load or commission is charged when you purchase
shares. NAV is determined as of the close of regular trading on the New York
Stock Exchange each day the exchange is open.
The Fund's NAV per share 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 values
investments for which market quotations are readily available at market value.
It values short-term investments maturing within 60 days at amortized cost,
which approximates market value. It values all other investments and assets at
their fair value.
6
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The Fund translates prices for its investments quoted in foreign currencies into
U.S. dollars at current exchange rates. As a result, changes in the value of
those currencies in relation to the U.S. dollar will affect the Fund's NAV.
Because foreign markets may be open at different times than the New York Stock
Exchange, the value of the Fund's shares may change on days when shareholders
are not able to buy or sell them. If events materially affecting the values of
the Fund's foreign investments occur between the close of foreign markets and
the close of regular trading on the New York Stock Exchange, these investments
will be valued at their fair value by the Fund's Board of Directors or its
delegates.
INVESTING BY MAIL
To invest by mail, send a completed, signed application and a check payable to
"IAI Funds" to one of the following addresses:
Regular Mail Overnight Mail
- ------------ --------------
IAI Mutual Funds IAI Mutual Funds
c/o Firstar Mutual Fund Services, LLC c/o Firstar Mutual Fund Services, LLC
P.O. Box 701 615 E. Michigan St., Third Floor
Milwaukee, WI 53201-0701 Milwaukee, WI 53202
Third party checks will not be accepted for initial account investments. After
the Fund receives your completed purchase order, your account will be credited
with the number of full and fractional shares that can be purchased at the next
determined net asset value.
For assistance in completing the application, please contact IAI Shareholder
Services at 1-800-945-3863.
INVESTING BY WIRE
If you have an account with a commercial bank that is a member of the Federal
Reserve System, you may purchase shares by requesting your bank to wire funds
to:
Firstar Bank, N.A.
777 E. Wisconsin Ave.
Milwaukee, WI 55302
ABA Number: 075000022
Credit: Firstar Mutual Fund Services, LLC
Account #112-952-137
For further credit to IAI Mutual Funds
(Shareholder Account #, Shareholder Name)
If you are purchasing by wire for a new account, you must do the following
before you wire funds:
o call IAI Shareholder Services at 1-800-945-3863 to advise them of your
investment;
o obtain instructions and an application form; and
o complete the application and send it to:
IAI Mutual Funds
c/o Firstar Mutual Fund Services, LLC
P.O. Box 701
Milwaukee, WI 53201-0701
Your completed application must be received by the Fund before your wire is
sent.
7
<PAGE>
Before initiating any subsequent wires, please call IAI Shareholder Services and
advise them of your name, account number and the name of the bank transmitting
the federal funds.
Wire orders will be accepted only on days when your bank, the Fund, the Fund's
transfer agent and Firstar Bank, N.A. are open for business. A wired purchase
will be considered made when the wired amount is received and the purchase is
accepted by the Fund. The Fund must receive payment before the close of business
for the purchase to be credited to your account on that day. Otherwise, your
purchase will be processed the next business day. The Fund may reject your wire
order if it does not contain the required information stated above. If the Fund
rejects your wire order, your money will be returned promptly, less any costs
incurred by the Fund or the Fund's transfer agent in rejecting the order. You
must pay any charges assessed by your bank for the wire service. 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 Fund's transfer agent.
MAKING ADDITIONAL INVESTMENTS
You can make additional investments to your existing account by mail, by wire or
by exchanging shares of another fund in the IAI Family of Funds for Fund shares.
You also can make additional investments to your existing account directly from
your bank account by utilizing the Automated Clearing House (ACH) system. If you
did not establish this option when you opened your account, call IAI Shareholder
Services at 1-800-945-3863.
RETIREMENT PLANS
Shares of the Fund may be an appropriate investment for various retirement
plans. If you would like information about establishing an Individual Retirement
Account or other retirement plan, please call IAI Shareholder Services at
1-800-945-3863.
All retirement plans involve a long-term commitment of assets and are subject to
various legal requirements and restrictions. You are urged to consult an
attorney or tax adviser before establishing such a plan.
AUTOMATIC INVESTMENT PLAN
Following a minimum initial investment, you may arrange to make regular
investments of $100 or more each month through automatic deductions from your
checking or savings account. To participate in this program, simply complete the
Automatic Investment Plan portion of your application and return it to the Fund.
You can set up the Automatic Investment Plan if your financial institution is a
member of ACH. You will receive quarterly confirmations of all transactions and
dividends under the Plan.
If you wish to change or terminate your participation in the Automatic
Investment Plan you must provide the Fund with written notice. Your instructions
must be received by 10 days prior to the date the change or termination is to
take place.
HOW TO SELL SHARES
You may redeem your shares on any day the New York Stock Exchange is open. Your
redemption price will be the net asset value of your shares next determined
after your redemption request is received in proper form by the Fund. To make
sure that your request is in proper form, please follow the directions for
selling shares given below.
BY MAIL
If you redeem by mail, your redemption price will be equal to the Fund's net
asset value per share next determined following receipt by the Fund of your
written redemption request in the form shown below (and a properly endorsed
stock certificate if one has been issued).
8
<PAGE>
To redeem by mail, send a written request to the Fund at one of the following
addresses:
Regular Mail Overnight Mail
- ------------ --------------
IAI Mutual Funds IAI Mutual Funds
c/o Firstar Mutual Fund Services, LLC c/o Firstar Mutual Fund Services, LLC
P.O. Box 701 615 E Michigan St., Third Floor
Milwaukee, WI 53201-0701 Milwaukee, WI 53202
Your request should include the following information:
o name of the Fund,
o account number,
o dollar amount or number of shares to be redeemed,
o name on the account, and
o signatures of all registered account owners.
If you hold certificates for your shares, they must be included with your
request. They must be endorsed on the back with the signature of the person
whose name appears on the certificate and must be signature guaranteed.
Signatures on your written request must be guaranteed if:
o you would like the proceeds from the sale to be paid to
someone other than the shareholder of record, or
o you have changed your address over the telephone within the
last 15 calendar days.
A signature guarantee assures that a signature is genuine and protects
shareholders from unauthorized account transfers. Banks, savings and loan
associations, trust companies, credit unions, broker-dealers and member firms of
a national securities exchange may guarantee signatures. NOTARIZATION BY A
NOTARY PUBLIC IS NOT ACCEPTED.
If Fund 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 redemption request.
To redeem money from your IRA account, an IRA Distribution Form must be
completed and returned to IAI. To receive a copy of the form, please call IAI
Shareholder Services at 1-800-945-3863.
BY PHONE
You may redeem shares by phone, subject to the following conditions:
o You must have completed the Telephone Options section of the
account application.
o Telephonic redemptions are limited to $50,000.
o Redemption proceeds must be made payable to the owner(s) of
record and delivered to the address of record.
o Telephone redemptions are not permitted for IRAs.
For assistance, please contact IAI Shareholder Services at 1-800-945-3863.
9
<PAGE>
PAYMENT OF REDEMPTION PROCEEDS
BY WIRE. When you redeem by telephone, you may have the proceeds wired
to your bank account if you provided the required information at the time you
opened your account. Wire redemption requests will only be processed on days
your bank, the Fund, the Fund's transfer agent and Firstar Bank, N.A. are open
for business. If you choose to have your redemption proceeds wired to your bank,
please note the following:
o A minimum amount of $1,000 is required to wire redemption
proceeds.
o Proceeds will be wired on the next business day after your
redemption request.
o 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 wire.
To add the ability to receive proceeds by wire to your account, or to change
existing bank account information, please submit a letter of instruction,
including your bank information and a signature guarantee, to:
IAI Mutual Funds
c/o Firstar Mutual Fund Services, LLC
P.O. Box 701
Milwaukee, WI 53201-0701
BY ACH. When you redeem by telephone, you may have the proceeds sent to
your bank account by an Automatic Clearing House Transfer if you provided the
required information at the time you opened your account. Proceeds sent by ACH
transfer should be credited the second day after the redemption. ACH is an
automated method of initializing payments from, and receiving payments in, your
financial institution account. The ACH system is supported by over 20,000 banks,
savings banks and credit unions. For assistance, please contact IAI Shareholder
Services at 1-800-945-3863.
BY CHECK. Normally the Fund will mail payment for shares redeemed on
the business day following the receipt of your redemption request, although
payment may be made as late as seven days after your request. However, the Fund
will not send redemption proceeds until checks (including certified checks,
cashiers checks or automatic investment credits) received in payment for shares
have cleared. This may take up to 15 days from the date of purchase.
INVOLUNTARY REDEMPTIONS
If your account balance falls below $500 as a result of selling or exchanging
shares, the Fund has the right to redeem your shares and send you the proceeds.
Before redeeming your account, the Fund will mail you a notice of its intention
to redeem, which will give you an opportunity to make an additional investment.
If you do not increase the value of your account to at least $500 within six
months of the date the notice was mailed, the Fund may redeem your account.
SYSTEMATIC CASH WITHDRAWAL PLAN
The Fund has a Systematic Cash Withdrawal Plan under which you may automatically
redeem a fixed dollar amount of Fund shares on either a monthly or quarterly
basis. Under the Systematic Cash Withdrawal Plan:
o Automatic redemptions must be for $100 or more.
o Shares will be redeemed at the net asset value determined on
the 15th of the applicable month (or the next business day).
10
<PAGE>
o All income dividends and capital gains distributions must be
reinvested in Fund shares.
o Confirmations of all transactions and distributions will be
sent to you quarterly.
Plan application forms are available through the Fund. If you would like
assistance in completing the application, contact IAI Shareholder Services at
1-800-945-3863.
EXCHANGE PRIVILEGE
You may exchange your Fund shares for shares of another fund in the IAI Family
of Funds if you satisfy that Fund's purchase requirements. There currently is no
fee to exchange shares.
The Fund generally limits exchanges to four per calendar year. This limit may be
modified for certain retirement plan accounts and for those participating in the
Automatic Exchange Plan described below. The Fund may change or cancel its
exchange privilege at any time.
When you exchange your Fund shares for shares of another fund in the IAI Family
of Funds the exchange is considered a sale of your Fund shares for federal
income tax purposes, and you may have a taxable capital gain or loss.
You may exchange shares by notifying the Fund in writing or, if you have
authorized the Fund to accept telephone instructions, by telephone. See "How to
Sell Shares -- By Telephone."
AUTOMATIC EXCHANGE PLAN
You may arrange to make regular exchanges of $100 or more between any
of the funds in the IAI Family of Funds on a monthly basis. Please note the
following about automatic exchanges:
o If you wish to participate in the Plan, you must complete the
Automatic Exchange Plan portion of your IAI Mutual Fund
application.
o Exchanges will take place at the net asset value determined on
the fifth day of each month (or the next business day).
o If you participate in the Automatic Exchange Plan you will
receive quarterly confirmations of all transactions and
dividends.
o You may not close an account through the Automatic Exchange
Plan.
AUTHORIZED TELEPHONE TRADING
As discussed above, you may exchange and redeem shares by telephone if you have
completed the Telephone Options section of the IAI Mutual Fund application.
Telephone redemptions are not permitted for IRAs.
Address changes may also be made over the telephone. During the 15 calendar days
following an address change by telephone, you may only redeem shares in your
account with a signature guaranteed letter of instruction.
The Fund and its agents will not be responsible for any losses that may result
from acting on telephone instructions that they reasonably believe to be
genuine. The Fund will follow reasonable procedures to confirm that instructions
received by telephone are genuine. These procedures include tape recording all
redemption and exchange requests.
11
<PAGE>
STATEMENTS AND CONFIRMATIONS
Whenever you buy or sell shares of the Fund, IAI will send you a confirmation
statement showing how many shares you bought or sold and at what price. You will
also receive an account statement quarterly and a consolidated transaction
statement annually. Please review carefully all of the information relating to
transactions on your statements and confirmations to ensure that your
instructions were acted on properly. Please notify the Fund immediately in
writing if there is an error. If you do not provide the Fund with notice of an
error within 60 days of non-automatic transactions, or within 60 days of the
date of your consolidated quarterly statement in the case of automatic
transactions, you will be deemed to have ratified the transaction.
SHAREHOLDER REPORTS
Shareholder reports will be sent to you semi-annually. These reports contain
financial information about the Fund, including a list of investment securities
held. To reduce the volume of mail you receive, only one copy of Fund reports
may be mailed to your household (same surname and address). Please call IAI
Shareholder Services at 1-800-945-3863 if you wish to receive additional
shareholder reports.
DIVIDEND AND CAPITAL GAINS DISTRIBUTIONS
The Fund pays dividends from net investment income monthly and distributes
realized capital gains, if any, annually.
When you open an account, you should specify on your application how you want to
receive your distributions. The Fund offers three options:
o full reinvestment -- your dividend and capital gain
distributions are automatically reinvested in additional
shares of the Fund;
o capital gains reinvestment -- your capital gain distributions
will be automatically reinvested, but your income dividend
distributions will be paid in cash; or
o cash-- your income dividends and capital gain distributions
will be paid in cash.
If you elect to receive distributions in cash, they can be sent to you by 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.
If you do not select an option when you open your account, the Fund will
automatically reinvest all distributions in additional Fund shares.
The Fund also has a Directed Dividend service which allows you to invest your
dividends and/or capital gain distributions into another IAI Mutual Fund.
Contact IAI Shareholder Services at 1-800-945-3863 for details.
Prior to purchasing shares of the Fund, you should consider the impact of
dividend or capital gains distributions which are expected to be announced, or
which have been announced but not paid. If you purchase shares shortly before
the record date for such a distribution, you will pay the full price for the
shares and then receive a portion of that price back shortly thereafter as a
taxable distribution.
12
<PAGE>
TAXES
Some of the common tax consequences of investing in the Fund are discussed
below. More information about taxes is in the Statement of Additional
Information. Because everyone's tax situation is unique, be sure to consult with
your tax adviser.
TAXES ON DISTRIBUTIONS
The Fund pays its shareholders distributions from its net investment income and
any net capital gains that it has realized. For most investors, these
distributions will be taxable, whether paid in cash or reinvested (unless your
investment is in an IRA or other tax advantaged account).
Distributions paid from the Fund's net investment income and short-term capital
gains are taxable as ordinary income. Distributions paid from the Fund's
long-term capital gains are taxable as long-term gains, regardless of how long
you have held your shares. The Fund's distributions are expected to consist
primarily of ordinary income.
TAXES ON TRANSACTIONS
The sale or exchange of Fund shares will be a taxable event for you and may
result in a capital gain or loss. The gain or loss will be considered long-term
if you have held your shares for more than one year. A gain or loss on shares
held for one year or less is considered short-term and is taxed at the same
rates as ordinary income.
Information about the tax status of each year's distributions will be mailed
annually.
FUND MANAGEMENT
INVESTMENT ADVISER
Investment Advisers, Inc. ("IAI") is the Fund's investment adviser. IAI, which
has been in the investment advisory business since 1947, also furnishes
investment advice to other concerns including other investment companies,
pension and profit sharing plans, portfolios of foundations, religious,
educational and charitable institutions, trusts, municipalities and individuals.
IAI is located at 601 Second Avenue South, Suite 3600, Minneapolis, Minnesota
55402.
The Fund has entered into a Management Agreement with IAI under which IAI
provides the Fund with investment advisory services and is responsible for
managing the Fund's business affairs, subject to the authority of the Board of
Directors. IAI also is responsible under the Management Agreement for providing
or arranging for the provision of all required administrative, stock transfer,
redemption, dividend disbursing, accounting and shareholder services. IAI may
directly or indirectly pay qualifying broker-dealers, financial institutions and
other entities for providing some of these services to Fund shareholders. The
Management Agreement requires IAI to pay all of the Fund's operating expenses,
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. The Fund pays IAI an annual fee
under the Management Agreement. During its most recent fiscal year, the Fund
paid IAI a management fee equal to 1.07% of the Fund's average daily net assets
(after voluntary fee waivers). Because IAI is paying the Fund's operating
expenses, this fee represents the Fund's total expenses for the fiscal year. IAI
has agreed to limit its management fee to 0.90% of average daily net assets
through March 31, 2001.
13
<PAGE>
PORTFOLIO MANAGER
Larry Hill is responsible for the Fund's day-to-day investment decisions. Mr.
Hill is IAI's Chief Fixed Income Officer and has managed the Fund since joining
IAI in 1984.
MORE INFORMATION ON INVESTMENT STRATEGIES AND RISKS
INVESTMENT STRATEGIES
The principal investment strategies of the Fund, which are summarized above
under "Fund Summary," are described in more detail below. These are the
strategies that IAI believes are most likely to be important in trying the
achieve the Fund's objective. Of course, there is no guarantee that the Fund
will achieve its objective. Although not considered principal strategies, you
should be aware that the Fund may also use strategies and invest in securities
that are not described in this prospectus, but that are described in the
statement of additional information.
The Fund invests primarily in bonds and other debt securities that are rated
investment grade at the time of purchase or that are unrated and judged by IAI
to be of comparable quality. Investment grade securities are rated within the
four highest grades assigned by Moody's Investors Service, Inc. ("Moody's") or
Standard & Poor's Corporation ("S&P"). Commercial paper in which the Fund
invests must be rated at lease Prime-2 by Moody's or A-2 by S&P or be issued by
companies having an outstanding unsecured debt issue currently rated A or better
by Moody's or S&P.
Debt securities in which the Fund invests may include:
CORPORATE DEBT OBLIGATIONS. These are debt securities such as
bonds, debentures and notes issued by corporations for the
purpose of raising capital by borrowing. These securities
generally represent a promise by the corporation to make
periodic payments of interest and to repay principal on a
specified date.
U.S. GOVERNMENT SECURITIES. The Fund may invest in U.S.
Treasury securities, and in other securities issued or
guaranteed by the U.S. government or its agencies or
instrumentalities.
MORTGAGE-BACKED SECURITIES. The Fund may invest in
mortgage-backed securities issued by government and
non-government entities. These securities are secured by and
payable from pools of mortgage loans. The Fund's investments
in mortgage-backed securities may include collateralized
mortgage obligations (CMOs). These are derivative mortgage
securities secured by pools of mortgage loans or other
mortgage-backed securities.
ASSET-BACKED SECURITIES. Asset-backed securities are bonds or
notes backed by loan paper (such as automobile loans or home
equity loans) or accounts receivable originated by banks,
credit card companies or other providers of credit.
ZERO COUPON SECURITIES. These securities do not pay interest
currently. They are issued at deep discounts from their face
value and mature at their face value.
PAYMENT-IN-KIND BONDS. These securities pay interest through
the issuance of additional securities, rather than paying
cash.
SHORT-TERM DEBT SECURITIES. These investments may include bank
certificates of deposit, bankers' acceptances and commercial
paper.
14
<PAGE>
Although the Fund invests primarily in investment grade securities, it also may
invest up to 15% of its total assets in non-investment grade securities, or
"junk bonds." However, the Fund will not invest in junk bonds rated lower than B
by Moody's or S&P or, if unrated, judged to be of comparable quality by IAI. If
a security is downgraded to a rating below B or, if unrated, is no longer of a
quality comparable to a security rated B, as determined by IAI, the Fund may
retain the security if IAI believes it to be in the Fund's best interest.
The Fund may invest in securities issued by foreign governments, supranational
entities and other foreign issuers, consistent with the rating requirements
discussed above. The Fund does not expect to invest more than 25% of its total
assets in foreign securities, or more than 15% of its total assets in non-dollar
denominated foreign securities.
The Fund may enter into futures contracts on securities, financial indexes and
foreign currencies and options on those contracts, and it may enter into
currency forward contracts. The Fund intends to use these derivative instruments
primarily to hedge the value of its portfolio against potential adverse
movements in securities prices, foreign currency markets or interest rates.
However, the Fund may also use derivative instruments for non-hedging purposes
such as seeking to increase the Fund's income or otherwise seeking to enhance
return, provided that no more than 5% of the Fund's assets will be committed to
initial margin deposits and option premiums on futures and options contracts
entered into for non-hedging purposes (not including any options that are
in-the-money).
To generate additional income, the Fund may invest up to 10% of its net assets
in mortgage dollar roll transactions. In this type of transaction, the Fund
sells mortgage-backed securities for delivery in the current month while
contracting with the same party to repurchase similar securities at a future
date.
EFFECTIVE DURATION
The Fund anticipates that the average effective duration for its portfolio
securities will range from 3 1/2 to 7 1/2 years. Effective duration, one measure
of interest rate risk, measures how much the value of a security is expected to
change with a given change in interest rates. The longer a security's effective
duration, the more sensitive its price to changes in interest rates. For
example, if interest rates were to increase by one percentage point, the market
value of a bond with an effective duration of five years would decrease by 5%,
with all other factors being constant. Effective duration is based on
assumptions and subject to a number of limitations. It is most useful when
interest rate changes are small, rapid and occur equally in short-term and
long-term securities. In addition, it is difficult to calculate precisely for
bonds with prepayment options, such as mortgage-backed securities, because the
calculation requires assumptions about prepayment rates.
TEMPORARY DEFENSIVE INVESTMENTS
In an attempt to respond to adverse market, economic, political or other
conditions, the Fund, as a temporary defensive measure, may hold up to 100% of
its total assets in cash or cash equivalents and short-term securities,
including money market securities. These investments may result in a lower yield
than would be available from longer-term investments and may prevent the Fund
from achieving its investment objective.
PORTFOLIO TURNOVER
Fund managers actively trade portfolio securities, resulting in very high
portfolio turnover rates. Trading of securities may produce capital gains, which
are taxable to shareholders when distributed. Active trading may also increase
the amount of commissions or mark-ups to broker-dealers that the Fund pays when
it buys and sells securities, which could decrease Fund performance. The
"Financial Highlights" section of this prospectus shows the Fund's historical
portfolio turnover rate.
15
<PAGE>
PRINCIPAL RISKS
The principal risks of investing in the Fund are summarized above under "Fund
Summary." More information about Fund risks is presented below.
INTEREST RATE RISK
Debt securities in the Fund's portfolio will fluctuate in value with changes in
interest rates. In general, debt securities will increase in value when interest
rates fall and decrease in value when interest rates rise. Longer-term debt
securities are generally more sensitive to interest rate changes. Securities
which do not pay interest on a current basis, such as zero coupon securities,
may be highly volatile as interest rates rise or fall. Payment-in-kind bonds,
which pay interest in other securities rather than in cash, also may be highly
volatile.
INCOME RISK
The Fund's income could decline due to falling market interest rates. This is
because, in a falling interest rate environment, the Fund generally will have to
invest the proceeds from sales of Fund shares, as well as the proceeds from
maturing portfolio securities (or portfolio securities that have been called,
see "Call Risk," or prepaid, see "Prepayment Risk") in lower-yielding
securities.
CREDIT RISK
The Fund is subject to the risk that the issuers of debt securities it holds
will not make payments on the securities or that the other party to a contract
will default on its obligations. There is also the risk that an issuer could
suffer adverse changes in financial condition that could lower the credit
quality of a security. This could lead to greater volatility in the price of the
security and the shares of the Fund. Also, a change in the credit quality rating
of a bond can affect the bond's liquidity and make it more difficult for the
Fund to sell. Securities rated the lowest investment grade have speculative
characteristics. In adverse economic or other circumstances, issuers of these
lower rated securities are more likely to have difficulty making principal and
interest payments than issuers of higher rated securities. Non-investment grade
securities are subject to additional risk. See "Risks of Non-Investment Grade
Securities" below. When the Fund purchases unrated securities, it will depend on
IAI's analysis of credit risk more heavily than usual.
RISKS OF NON-INVESTMENT GRADE SECURITIES
The Fund may invest in non-investment grade debt securities, which are commonly
known as "junk bonds." Although these securities usually offer higher yields
than investment grade securities, they also involve more risk. Junk bonds
generally have more volatile prices and carry more risk to principal than
investment grade securities. Junk bonds may be more susceptible to real or
perceived adverse economic changes (for instance, an economic downturn or
prolonged period of rising interest rates), political changes or adverse
developments specific to the issuer. In addition, the secondary trading market
may be less liquid than the market for investment grade securities. Adverse
publicity and investor perceptions as well as new or proposed laws also may have
a greater negative impact on the market for junk bonds.
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, 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. If bonds in the Fund's portfolio were called, the Fund
would most likely be forced to invest the unanticipated proceeds in lower
yielding securities, resulting in a decline in the Fund's income.
16
<PAGE>
PREPAYMENT RISK
Mortgage-backed securities are secured by and payable from pools of mortgage
loans. Similarly, asset-backed securities are supported by obligations such as
automobile loans or home equity loans. These mortgages and other obligations
generally can be prepaid at any time without penalty. As a result, mortgage- and
asset-backed securities are subject to prepayment risk, which is the risk that
falling interest rates could cause prepayments of the securities to occur more
quickly than expected. This occurs because, as interest rates fall, more
homeowners refinance the mortgages underlying mortgage-backed securities or
prepay the debt obligations underlying asset-backed securities. The Fund must
reinvest the prepayments at a time when interest rates on new investments are
falling, reducing the income of the Fund. In addition, when interest rates fall,
prices on mortgage- and asset-backed securities may not rise as much as for
other types of comparable debt securities because investors may anticipate an
increase in prepayments.
EXTENSION RISK
Mortgage- and asset-backed securities also are subject to extension risk, which
is the risk that rising interest rates could cause mortgages and other
obligations underlying the securities to be prepaid more slowly than expected,
resulting in slower prepayments of the securities. This would, in effect,
convert a short or medium duration mortgage- or asset-backed security into a
longer duration security, increasing its sensitivity to interest rate changes
and causing its price to decline.
RISKS OF FOREIGN SECURITIES
Investments in foreign securities involve risks that are different in some
respects from investments in securities of U.S. 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 Fund's 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 that currency and, therefore, will cause an overall decline in
the Fund's net asset value and net investment income and capital gains, if any.
Other risks include 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. 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 OF PREFERRED STOCKS 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 that are convertible into or exchangeable for equity securities or
debt obligations that carry the right to acquire equity securities. The risks
associated with investing in preferred stocks and convertible securities are
different from those traditionally associated with investing in debt securities.
These risks are similar instead to the risks associated with investing in equity
securities, including the risk that the prices of the securities will decline in
response to the activities of the issuing company or in response to general
market and/or economic conditions.
17
<PAGE>
RISKS OF DOLLAR ROLL TRANSACTIONS
In a dollar roll transaction, the Fund sells mortgage-backed securities for
delivery in the current month while contracting with the same party to
repurchase similar securities at a future date. Because the Fund gives up the
right to receive principal and interest paid on the securities sold, a mortgage
dollar roll transaction will diminish the investment performance of the Fund
unless the difference between the price received for the securities sold and the
price to be paid for the securities to be purchased in the future, plus any fee
income received, exceeds any income, principal payments and appreciation on the
securities sold as part of the mortgage dollar roll. Whether mortgage dollar
rolls will benefit the Fund will depend upon IAI's ability to predict mortgage
prepayments and interest rates. In addition, the use of mortgage dollar rolls by
the Fund increases the amount of the Fund's assets that are subject to market
risk, which could increase the volatility of the Fund's share price.
RISKS OF DERIVATIVE INSTRUMENTS
The use of derivative instruments exposes the Fund to additional investment
risks and transaction costs. Risks inherent in the use of derivative instruments
include:
o the risk that interest rates, securities prices and currency markets
will not move in the direction that IAI anticipates;
o an imperfect correlation between the price of derivative instruments
and movements in the prices of the securities, interest rates or
currencies being hedged;
o the inability to close out certain hedged positions to avoid adverse
tax consequences;
o the possible absence of a liquid secondary market for any particular
instrument and possible exchange-imposed price fluctuation limits,
either of which may make it difficult or impossible to close out a
position when desired;
o leverage risk, which is the risk that adverse price movements in an
instrument can result in a loss substantially greater than the Fund's
initial investment in that instrument; and
o particularly in the case of privately negotiated instruments, the risk
that the counterparty will fail to perform its obligations, which could
leave the Fund worse off than if it had not entered into the position.
If the Fund uses derivative instruments and if IAI's judgment proves incorrect,
the Fund's performance could be worse than if it had not used these instruments.
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.
18
<PAGE>
FINANCIAL HIGHLIGHTS
The table that follows presents performance information about the Fund. This
information is intended to help you understand the Fund's financial performance
for the past five years. Some of this information reflects financial results for
a single Fund share. The total returns in the table represent the rate that you
would have earned or lost on an investment in the Fund, assuming you reinvested
all of your dividends and distributions. This information has been audited by
KPMG LLP, independent auditors, whose report, along with the Fund's financial
statements, is included in the Fund's annual report, which is available upon
request.
BOND FUND
<TABLE>
<CAPTION>
YEARS ENDED NOVEMBER 30,
1999 1998 1997 1996 1995
---------------------------------------------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE
Beginning of period $ 9.53 $ 9.49 $ 9.32 $ 9.34 $ 8.65
OPERATIONS
Net investment income .61** .58 .54 .56 .58
Net realized and unrealized gains (losses) (.83) .04 .19 .04 .72
---------------------------------------------
TOTAL FROM OPERATIONS (.22) .62 .73 .60 1.30
---------------------------------------------
DISTRIBUTIONS TO SHAREHOLDERS FROM:
Net investment income (.69) (.58) (.56) (.62) (.61)
---------------------------------------------
TOTAL DISTRIBUTIONS (.69) (.58) (.56) (.62) (.61)
---------------------------------------------
NET ASSET VALUE
End of period $ 8.62 $ 9.53 $ 9.49 $ 9.32 $9.34
=============================================
Total investment return* (2.46)% 6.68% 8.15% 6.85% 15.46%
Net assets at end of period (000's omitted) $ 19,083 $ 51,359 $ 68,620 $ 86,803 $77,526
RATIOS
Expenses to average daily net assets 1.07%*** 1.10% 1.10% 1.10% 1.09%
Net investment income to average net daily assets 6.76% 5.85% 5.74% 6.20% 6.32%
Portfolio turnover rate (excluding short-term
securities) 147.8% 280.3% 482.2% 342.4% 424.7%
</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.
** Net investment income per share represents net investment income
divided by the average shares outstanding throughout the year
*** Effective September 1, 1999, Advisers agreed to limit the fee to 0.90%
of average net assets. Absent this voluntary limitation the ratio of
expenses to average net assets would have been 1.10%.
19
<PAGE>
FOR MORE INFORMATION ABOUT IAI BOND FUND
The Fund's statement of additional information ("SAI") and annual and
semi-annual reports to shareholders include additional information about the
Fund. The SAI provides more details about the Fund and its policies. A current
SAI is on file with the Securities and Exchange Commission (SEC) and is
incorporated into this prospectus by reference (which means that it is legally
considered part of this prospectus). Additional information about the Fund's
investments is available in the Fund's annual and semiannual reports to
shareholders. In the Fund's annual report, you will find a discussion of the
market conditions and investment strategies that significantly affected the
Fund's performance during its last fiscal year. You may obtain free copies of
these materials by calling the Fund toll free at 1-800-945-3863.
You may also obtain copies by visiting the SEC's Public Reference Room in
Washington, DC or by sending your request and a duplicating fee to the SEC's
Public Reference Section, Washington, DC 20549-6009. For more information, call
1/800-SEC-0330.
Information about the Fund is also available on the Internet. Text only versions
of Fund documents can be viewed online or downloaded from the SEC's Internet
site at http://www.sec.gov.
SEC file number: 811 - 2747
20
<PAGE>
IAI BOND FUND
A SERIES OF
IAI INVESTMENT FUNDS I, INC.
STATEMENT OF ADDITIONAL INFORMATION
DATED APRIL 1, 2000
THIS STATEMENT OF ADDITIONAL INFORMATION IS NOT A PROSPECTUS. THIS
STATEMENT OF ADDITIONAL INFORMATION RELATES TO A PROSPECTUS FOR IAI BOND FUND
(THE "FUND") DATED APRIL 1, 2000, AND SHOULD BE READ IN CONJUNCTION THEREWITH.
THE FINANCIAL STATEMENTS INCLUDED AS PART OF THE FUND'S ANNUAL REPORT TO
SHAREHOLDERS FOR THE FISCAL YEAR ENDED NOVEMBER 30, 1999 ARE INCORPORATED BY
REFERENCE INTO THIS STATEMENT OF ADDITIONAL INFORMATION. COPIES OF THE FUND'S
PROSPECTUS AND/OR ANNUAL REPORT ARE AVAILABLE, WITHOUT CHARGE, BY WRITING OR
CALLING THE FUND'S TRANSFER AGENT, FIRSTAR MUTUAL FUND SERVICES, LLC, P.O. BOX
701, MILWAUKEE, WISCONSIN 53201-0701 (TELEPHONE NUMBER 1-800-945-3863).
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
INVESTMENT OBJECTIVE AND STRATEGIES..................................................................... 2
INVESTMENT RESTRICTIONS................................................................................. 18
INVESTMENT PERFORMANCE.................................................................................. 20
MANAGEMENT.............................................................................................. 22
CUSTODIAN, TRANSFER AGENT AND DIVIDEND DISBURSING AGENT................................................. 25
LEGAL COUNSEL........................................................................................... 25
INDEPENDENT AUDITORS.................................................................................... 25
PORTFOLIO TRANSACTIONS AND ALLOCATION OF BROKERAGE...................................................... 26
CAPITAL STOCK........................................................................................... 27
CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES..................................................... 27
NET ASSET VALUE AND PUBLIC OFFERING PRICE............................................................... 27
PURCHASES AND REDEMPTIONS OF SHARES..................................................................... 28
TAX STATUS.............................................................................................. 28
LIMITATION OF DIRECTOR LIABILITY........................................................................ 30
SHAREHOLDER MEETINGS.................................................................................... 31
FINANCIAL STATEMENTS.................................................................................... 31
APPENDIX A - RATINGS OF DEBT SECURITIES................................................................. A-1
</TABLE>
1
<PAGE>
INVESTMENT OBJECTIVE AND STRATEGIES
IAI Bond Fund (the "Fund") is a diversified series of an open-end,
management investment company. The investment objective and principal investment
strategies of the Fund are discussed in the Prospectus under "Fund Summary" and
"More Information on Investment Strategies and Risks." The Fund's investment
objective may not be changed without shareholder approval.
Investors should understand that all investments are subject to various
risks. 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 strategies
will be successful, or that its investment objective will be attained. Certain
of the Fund's principal investment strategies are discussed in more detail
below. In addition, the Fund may also use strategies and invest in securities
that are not described in the Prospectus, but that are described below.
REPURCHASE AGREEMENTS
The Fund may engage in repurchase agreements relating to the securities
in which it may invest. A repurchase agreement, which is functionally equivalent
to a loan by the Fund, involves the purchase of securities by the Fund 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 engage in reverse repurchase agreements as a form of
borrowing. In a reverse repurchase agreement, the 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 segregate appropriate
liquid assets to cover its obligation under the agreement. 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.
BANK BORROWING
The Fund may borrow from banks 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
currently has a line of credit with a bank at the prime interest rate. To the
extent funds are drawn against the line of credit, securities are held in a
segregated account. No compensating balances or commitment fees are required
under the line of credit. The Fund does not currently intend to borrow (either
from banks or through reverse repurchase agreements) an amount exceeding 5% of
its net assets.
2
<PAGE>
SECURITIES OF FOREIGN ISSUERS
The Fund may invest in securities of foreign issuers. However, the Fund
does not intend to invest more than 25% of the value of its total assets in
non-dollar denominated securities of foreign issuers. Investing in foreign
securities may result in greater risk than that incurred by investing in
domestic securities. There is generally less publicly available information
about foreign issuers comparable to reports and ratings that are published about
companies in the United States. Also, foreign issuers are not subject to uniform
accounting and auditing and financial reporting standards, practices and
requirements comparable to those applicable to United States companies.
Furthermore, volume and liquidity in most foreign bond markets is less than in
the United States and at times volatility of price can be greater than in the
United States. There is generally less government supervision and regulation of
foreign bond markets, brokers and companies than in the United States.
With respect to certain foreign countries, there is the possibility of
adverse changes in investment or exchange control regulations, expropriation or
confiscatory taxation, limitations on the removal of funds or other assets of
the Fund, political or social instability, or diplomatic developments which
could affect United States investments in those countries. Moreover, individual
foreign economies may differ favorably or unfavorably from the United States'
economy in such respects as growth of gross national product, rate of inflation,
capital reinvestment, resource self-sufficiency and balance of payments
position.
The Fund is not aware at this time of the existence of any investment
or exchange control regulations which might substantially impair its 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 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. GOVERNMENT SECURITIES
The Fund may invest in securities of, or guaranteed by, the United
States Government, its agencies or instrumentalities. These securities include:
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.
3
<PAGE>
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 the Fund's shares. In the case of securities in which the 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.
The Fund's investments in U.S. government securities may include U.S.
Treasury inflation-protection securities. Inflation-protection securities are a
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 are auctioned and issued on a quarterly
basis on the 15th of January, April, July, and October. They have been issued as
10-year notes, with other maturities added thereafter. The index used to measure
inflation is the non-seasonally adjusted U.S. City Average All Items Consumer
Price Index for All Urban Consumers ("CPI-U").
The value of the principal is adjusted for inflation, and every six
months the security will pay interest, which is 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 is 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.
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.
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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
(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 Fund has 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
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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
The 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.
WHEN-ISSUED/DELAYED-DELIVERY TRANSACTIONS
The Fund may purchase securities on a delayed-delivery or when-issued
basis and purchase or sell securities on a "forward commitment" 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 set aside appropriate liquid assets in a segregated
custodial account to cover its purchase obligations. When the 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, 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.
No more than 20% of the Fund's net assets may be invested in
when-issued, delayed delivery or forward commitment transactions. Of such 20%,
no more than one-half (i.e., 10% of net assets) may be invested in when-issued,
delayed delivery or forward commitment transactions without the intention of
actually acquiring securities (i.e., dollar roll transactions).
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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
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. 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 appropriate liquid assets 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 invest in mortgage-backed securities that are Agency
Pass-Through Certificates, Private Pass-Throughs or collateralized mortgage
obligations ("CMOs") as defined and described below.
Agency Pass-Through Certificates are mortgage pass-through certificates
representing undivided interests in pools of residential mortgage loans.
Distribution of principal and interest on the mortgage loans underlying an
Agency Pass-Through Certificate is an obligation of or guaranteed by GNMA, FNMA
or FHLMC. GNMA is a wholly-owned corporate instrumentality of the United States
within the Department of Housing and Urban Development. The guarantee of GNMA
with respect to GNMA certificates is backed by the full faith and credit of the
United States, and GNMA is authorized to borrow from the United States Treasury
in an amount which is at any time sufficient to enable GNMA, with no limitation
as to amount, to perform its guarantee.
FNMA is a federally chartered and privately owned corporation organized
and existing under federal law. Although the Secretary of the Treasury of the
United States has discretionary authority to lend funds to FNMA, neither the
United States nor any agency thereof is obligated to finance FNMA's operations
or to assist FNMA in any other manner.
FHLMC is a federally chartered corporation organized and existing under
federal law, the common stock of which is owned by the Federal Home Loan Banks.
Neither the United States nor any agency thereof is obligated to finance FHLMC's
operations or to assist FHLMC in any other manner.
The mortgage loans underlying GNMA certificates are partially or fully
guaranteed by the Federal Housing Administration or the Veterans Administration,
while the mortgage loans underlying FNMA certificates and FHLMC certificates are
conventional mortgage loans which are, in some cases, insured by private
mortgage insurance companies. Agency Pass-Through Certificates may be issued in
a single class with respect to a given pool of mortgage loans or in multiple
classes.
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The residential mortgage loans evidenced by Agency Pass-Through
Certificates and upon which CMOs are based generally are secured by first
mortgages on one- to four-family residential dwellings. Such mortgage loans
generally have final maturities ranging from 15 to 30 years and provide for
monthly payments in amounts sufficient to amortize their original principal
amounts by the maturity dates. Each monthly payment on such mortgage loans
generally includes both an interest component and a principal component, so that
the holder of the mortgage loans receives both interest and a partial return of
principal in each monthly payment. In general, such mortgage loans can be
prepaid by the borrowers at any time without any prepayment penalty. In
addition, many such mortgage loans contain a "due-on-sale" clause requiring the
loans to be repaid in full upon the sale of the property securing the loans.
Because residential mortgage loans generally provide for monthly amortization
and may be prepaid in full at any time, the weighted average maturity of a pool
of residential mortgage loans is likely to be substantially shorter than its
stated final maturity date. The rate at which a pool of residential mortgage
loans is prepaid may be influenced by many factors and is not predictable with
precision.
Private mortgage pass-through securities ("Private Pass-Throughs") are
structured similarly to GNMA, FNMA and FHLMC mortgage pass-through securities
and are issued by originators of and investors in mortgage loans, including
savings and loan associations, mortgage bankers, commercial banks, investment
banks and special purpose subsidiaries of the foregoing. These securities
usually are backed by a pool of conventional fixed rate or adjustable loans.
Since Private Pass-Throughs typically are not guaranteed by an entity having the
credit status of GNMA, FNMA or FHLMC, such securities generally are structured
with one or more types of credit enhancement. Such credit support falls into two
categories: (i) liquidity protection and (ii) protection against losses
resulting from ultimate default by an obligor on the underlying assets.
Liquidity protection refers to the provisions of advances, generally by the
entity administering the pool of assets, to ensure that the pass-through of
payments due on the underlying pool occurs in a timely fashion. Protection
against losses resulting from ultimate default enhances the likelihood of
ultimate payment of the obligations on at least a portion of the assets in the
pool. Such protection may be provided through guarantees, insurance policies or
letters of credit obtained by the issuer or sponsor from third parties, through
various means of structuring the transaction or through a combination of such
approaches. The Fund will not pay any additional fees for such credit support,
although the existence of credit support may increase the price of a security.
The ratings of securities for which third-party credit enhancement
provides liquidity protection or protection against losses from default are
generally dependent upon the continued creditworthiness of the enhancement
provider. The ratings of such securities could be subject to reduction in the
event of deterioration in the creditworthiness of the credit enhancement
provider even in cases where the delinquency and loss experience on the
underlying pool of assets is better than expected.
The Fund 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.
CMOs are debt obligations typically issued by a private special-purpose
entity and collateralized by residential or commercial mortgage loans or Agency
Pass-Through Certificates. Because CMOs are debt obligations of private
entities, payments on CMOs generally are not obligations of or guaranteed by any
governmental entity, and their ratings and creditworthiness typically depend,
among other factors, on the legal insulation of the issuer and transaction from
the consequences of a sponsoring entity's bankruptcy.
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<PAGE>
CMOs generally are issued in multiple classes, with holders of each
class entitled to receive specified portions of the principal payments and
prepayments and/or of the interest payments on the underlying mortgage loans.
These entitlements can be specified in a wide variety of ways, so that the
payment characteristics of various classes may differ greatly from one another.
For instance, holders may hold interests in CMO tranches called Z-tranches which
defer interest and principal payments until one or other classes of the CMO have
been paid in full. In addition, for example:
o In a sequential-pay CMO structure, one class is entitled to
receive all principal payments and prepayments on the
underlying mortgage loans (and interest on unpaid principal)
until the principal of the class is repaid in full, while the
remaining classes receive only interest; when the first class
is repaid in full, a second class becomes entitled to receive
all principal payments and prepayments on the underlying
mortgage loans until the class is repaid in full, and so
forth.
o A planned amortization class ("PAC") of CMOs is entitled to
receive principal on a stated schedule to the extent that it
is available from the underlying mortgage loans, thus
providing a greater (but not absolute) degree of certainty as
to the schedule upon which principal will be repaid.
o An accrual class of CMOs provides for interest to accrue and
be added to principal (but not be paid currently) until
specified payments have been made on prior classes, at which
time the principal of the accrual class (including the accrued
interest which was added to principal) and interest thereon
begins to be paid from payments on the underlying mortgage
loans.
o As discussed above with respect to pass-through
mortgage-backed securities, an interest-only class of CMOs
entitles the holder to receive all of the interest and none of
the principal on the underlying mortgage loans, while a
principal-only class of CMOs entitles the holder to receive
all of the principal payments and prepayments and none of the
interest on the underlying mortgage loans.
o A floating rate class of CMOs entitles the holder to receive
interest at a rate which changes in the same direction and
magnitude as changes in a specified index rate. An inverse
floating rate class of CMOs entitles the holder to receive
interest at a rate which changes in the opposite direction
from, and in the same magnitude as or in a multiple of,
changes in a specified index rate. Floating rate and inverse
floating rate classes also may be subject to "caps" and
"floors" on adjustments to the interest rates which they bear.
o A subordinated class of CMOs is subordinated in right of
payment to one or more other classes. Such a subordinated
class provides some or all of the credit support for the
classes that are senior to it by absorbing losses on the
underlying mortgage loans before the senior classes absorb any
losses. A subordinated class which is subordinated to one or
more classes but senior to one or more other classes is
sometimes referred to as a "mezzanine" class. A subordinated
class generally carries a lower rating than the classes that
are senior to it, but may still carry an investment grade
rating.
It generally is more difficult to predict the effect of changes in
market interest rates on the return on mortgage-backed securities than to
predict the effect of such changes on the return of a conventional fixed-rate
debt instrument, and the magnitude of such effects may be greater in some cases.
The return on interest-only and principal-only mortgage-backed securities is
particularly sensitive to changes in interest rates and prepayment speeds. When
interest rates decline and prepayment speeds increase, the holder of an
interest-only mortgage-backed security may not even recover its initial
investment. Similarly, the return on an inverse floating rate CMO is likely to
decline more sharply in periods of increasing interest rates than that of a
fixed-rate security. For these reasons, interest-only, principal-only and
inverse floating rate mortgage-backed securities generally have greater risk
than more conventional classes of mortgage-backed securities.
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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. Interest and principal payments 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.
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.
ZERO COUPON BONDS
The 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, 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.
PAYMENT-IN-KIND BONDS
The Fund may invest in bonds the interest on which may be paid in other
securities rather than cash (PIKs). Typically, during a specified term prior to
the bond's maturity, the issuer of a PIK may provide for the option or the
obligation to make interest payments in bonds, common stock or other instruments
(i.e., "in kind" rather than in cash). The type of instrument in which interest
may or will be paid would be known by the Fund at the time of investment. While
PIKs generate income for purposes of generally accepted accounting principles,
they do not generate cash flow and thus could cause the Fund to be forced to
liquidate securities at an inopportune time in order to distribute cash, as
required by the Internal Revenue Code.
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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 such Fund's liquidity needs or in
response to a specific economic event such as a deterioration in the
creditworthiness of the issuer.
Adverse publicity and investor perceptions, which may not be based on
fundamental analysis, also may decrease the value and liquidity of high yield
securities, particularly in a thinly traded market. Factors adversely affecting
the market value of high yield securities are likely to adversely affect the
Fund's net asset value. In addition, the Fund may incur additional expenses to
the extent it is required to seek recovery upon a default on a portfolio holding
or participate in the restructuring of the obligation.
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.
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.
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LOANS AND OTHER DIRECT DEBT INSTRUMENTS
The Fund 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 the Fund's policies
regarding the quality of debt securities.
Purchasers of loans and other forms of direct indebtedness depend
primarily upon the creditworthiness of the borrower for payment of principal and
interest. Direct debt instruments may not be rated by any nationally recognized
rating service. If the Fund does not receive scheduled interest or principal
payments on such indebtedness, the Fund's share price and yield could be
adversely affected. Loans that are fully secured offer the Fund more protection
than an unsecured loan in the event of non-payment of scheduled interest or
principal. However, there is no assurance that the liquidation of collateral
from a secured loan would satisfy the borrower's obligation, or that the
collateral can be liquidated. Indebtedness of borrowers whose creditworthiness
is poor involves substantially greater risks, and may be highly speculative.
Borrowers that are in bankruptcy or restructuring may never pay off their
indebtedness, or may pay only a small fraction of the amount owed. Direct
indebtedness of developing countries will also involve a risk that the
governmental entities responsible for the repayment of the debt may be unable,
or unwilling, to pay interest and repay principal when due.
Investments in loans through direct assignment of a financial
institution's interests with respect to a loan may involve additional risks to
the Fund. For example, if a loan is foreclosed, the Fund could become part owner
of any collateral, and would bear the costs and liabilities associated with
owning and disposing of the collateral. In addition, it is conceivable that
under emerging legal theories of lender liability, the Fund could be held liable
as a co-lender. Direct debt instruments may also involve a risk of insolvency of
the lending bank or other intermediaries. Direct debt instruments that are not
in the form of securities may offer less legal protection to the Fund in the
event of fraud or misrepresentation. In the absence of definitive regulatory
guidance, the Fund relies on IAI's research in an attempt to avoid situations
where fraud or misrepresentation could adversely affect the Fund.
A loan is often administered by a bank or other financial institution
that acts as agent for all holders. The agent administers the terms of the loan,
as specified in the loan agreement. Unless, under the terms of the loan or other
indebtedness, the Fund has direct recourse against the borrower, it may have to
rely on the agent to apply appropriate credit remedies against a borrower. If
assets held by the agent for the benefit of the Fund were determined to be
subject to the claims of the agent's general creditors, the Fund might incur
certain costs and delays in rendering payment on the loan or loan participation
and could suffer a loss of principal or interest.
The Fund limits the amount of the assets that it invests in any one
issuer or in issuers within the same industry. For purposes of these
limitations, the Fund generally will treat the borrower as the "issuer" of
indebtedness held by the Fund. In the case of loan participations where a bank
or other lending institution serves as financial intermediary between the Fund
and the borrower, if the participation does not shift to the Fund the direct
debtor/creditor relationship with the borrower, SEC interpretations require the
Fund, in appropriate circumstances, to treat both the lending bank or other
lending institution and the borrower as "issuers" for the purpose of determining
whether the Fund has invested more than 5% of its total assets in a single
issuer. Treating the 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.
MUNICIPAL OBLIGATIONS
The Fund may invest in municipal bonds and other municipal obligations
when these securities appear to offer more attractive returns than taxable
securities. These bonds and other obligations are issued by the states and by
their local and special-purpose political subdivisions. The term "municipal
bond" includes short-term municipal notes issued by the states and their
political subdivision.
The two general classifications of municipal bonds are "general
obligation" bonds and "revenue" bonds.
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General obligation bonds are secured by the governmental issuer's pledge of its
faith, credit and taxing power for the payment of principal and interest. They
are usually paid from general revenues of the issuing governmental entity.
Revenue bonds, on the other hand, are usually payable only out of a specific a
revenue source rather than from general revenues. Revenue bonds ordinarily are
not backed by the faith, credit or general taxing power of the issuing
governmental entity. The principal and interest on revenue bonds for private
facilities are typically paid out of rents or other specified payments made to
the issuing governmental entity by a private company which uses or operates the
facilities. Examples of these types of obligations are industrial revenue bond
and pollution control revenue bonds. Industrial revenue bonds are issued by
governmental entities to provide financing aid to community facilities such as
hospitals, hotels, business or residential complexes, convention halls and sport
complexes. Pollution control revenue bonds are issued to finance air, water and
solids pollution control systems for privately operated industrial or commercial
facilities.
Revenue bonds for private facilities usually do not represent a pledge
of the credit, general revenues or taxing powers of the issuing governmental
entity. Instead, the private company operating the facility is the sole source
of payment of the obligation. Sometimes, the funds for payment of revenue bonds
come solely from revenue generated by operation of the facility. Revenue bonds
which are not backed by the credit of the issuing governmental entity frequently
provide a higher rate of return than other municipal obligations, but they
entail greater risk than obligations which are guaranteed by a governmental unit
with taxing power. Federal income tax laws place substantial limitations on
industrial revenue bonds, and particularly certain specified private activity
bonds issued after August 1986. In the future, legislation could be introduced
in Congress which could further restrict or eliminate the income tax exemption
for interest on municipal obligations in which the Funds may invest.
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 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
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 , consistent with any limitations imposed
by the Commodity Futures Trading Commission. See "Limitations on Futures and
Options Transactions" below. 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 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.
SWAP AGREEMENTS. The 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.
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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 objective 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.
The Fund will segregate appropriate liquid assets to cover its current
obligations under swap agreements. If the 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 the Fund's accrued obligations under the swap agreement over
the accrued amount the Fund is entitled to receive under the agreement. If the
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 the Fund's accrued obligations
under the agreement.
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.
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The Fund may also use forward contracts to hedge against a decline in
the value of existing investments denominated in a 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 European Currency Units in
return for U.S. dollars. This type of hedge, sometimes referred to as a "proxy
hedge," could offer advantages in terms of cost, yield, or efficiency, but
generally would not hedge currency exposure as effectively as a simple hedge
into U.S. dollars. Proxy hedges may result in losses if the currency used to
hedge does not perform similarly to the currency in which the hedged securities
are denominated.
Under certain conditions, SEC guidelines require mutual funds to set
aside appropriate liquid assets in a segregated custodial account to cover
currency forward contracts. As required by SEC guidelines, the Fund will
segregate assets to cover currency forward contracts, if any, whose purpose is
essentially speculative. The Fund will not segregate assets to cover forward
contracts entered into for hedging purposes, including settlement hedges,
position hedges, and proxy hedges.
Successful use of forward currency contracts will depend on IAI's skill
in analyzing and predicting currency values. Forward contracts may substantially
change the Fund's investment exposure to changes in currency exchange rates, and
could result in losses to the Fund if currencies do not perform as IAI
anticipates. For example, if a currency's value rose at a time when IAI had
hedged the Fund by selling that currency in exchange for dollars, the Fund would
be unable to participate in the currency's appreciation. If IAI hedges currency
exposure through proxy hedges, the Fund could realize currency losses from the
hedge and the security position at the same time if the two currencies do not
move in tandem. Similarly, if IAI increases the Fund's exposure to a foreign
currency, and that currency's value declines, the Fund will realize a loss.
There is no assurance that IAI's use of forward currency contracts will be
advantageous to the Fund or that it will hedge at an appropriate time. The
policies described in this section are non-fundamental policies of the Fund.
FUTURES CONTRACTS. When the Fund purchases a futures contract, it
agrees to purchase a specified underlying instrument at a specified future date.
When the Fund sells a futures contract, it agrees to sell the underlying
instrument at a specified future date. The price at which the purchase and sale
will take place is fixed when the Fund enters into the contract. Some currently
available futures contracts are based on specific securities, such as U.S.
Treasury bonds or notes, and some are based on indexes of securities prices,
such as the Standard & Poor's 500 Composite Stock Price Index (S&P 500). Futures
can be held until their delivery dates, or can be closed out before then if a
liquid secondary market is available.
The value of a futures contract tends to increase and decrease in
tandem with the value of its underlying instrument. Therefore, purchasing
futures contracts will tend to increase the Fund's exposure to positive and
negative price fluctuations in the underlying instrument, much as if it had
purchased the underlying instrument directly. When the Fund sells a futures
contract, by contrast, the value of its futures position will tend to move in a
direction contrary to the market. Selling futures contracts, therefore, will
tend to offset both positive and negative market price changes, much as if the
underlying instrument had been sold.
FUTURES MARGIN PAYMENTS. The purchaser or seller of a futures contract
is not required to deliver or pay for the underlying instrument unless the
contract is held until the delivery date. However, both the purchaser and seller
are required to deposit "initial margin" with a futures broker, known as a
futures commission merchant (FCM), when the contract is entered into. Initial
margin deposits are typically equal to a percentage of the contract's value. If
the value of either party's position declines, that party will be required to
make additional "variation margin" payments to settle the change in value on a
daily basis. The party that has a gain may be entitled to receive all or a
portion of this amount. Initial and variation margin payments do not constitute
purchasing securities on margin for purposes of the Fund's investment
limitations. In the event of the bankruptcy of an FCM that holds margin on
behalf of the Fund, the Fund may be entitled to a return of margin owed to it
only in proportion to the amount received by the FCM's other customers,
potentially resulting in losses to the Fund.
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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 (i.e., sells) a put
option, it takes the opposite side of the transaction from the option's
purchaser. In return for receipt of the premium, the Fund assumes the obligation
to pay the strike price for the option's underlying instrument if the other
party to the option chooses to exercise it. When writing an option on a futures
contract the Fund would be required to make margin payments to an FCM as
described above for futures contracts. The Fund may seek to terminate its
position in a put option it writes before exercise by closing out the option in
the secondary market at its current price. If the secondary market is not liquid
for a put option the Fund has written, however, the Fund must continue to be
prepared to pay the strike price while the option is outstanding, regardless of
price changes, and must continue to set aside assets to cover its position. If
security prices rise, a put writer would generally expect to profit, although
its gain would be limited to the amount of the premium it received.
If security prices remain the same over time, it is likely that the
writer will also profit, because it should be able to close out the option at a
lower price. If security prices fall, the put writer would expect to suffer a
loss. This loss should be less than the loss from purchasing the underlying
instrument directly, however, because the premium received for writing the
option should mitigate the effects of the decline.
Writing a call option obligates the Fund to sell or deliver the
option's underlying instrument, in return for the strike price, upon exercise of
the option. The characteristics of writing call options are similar to those of
writing put options, except that writing calls generally is a profitable
strategy if prices remain the same or fall. 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.
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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. Although the Fund intends
to purchase and sell options and futures only on exchanges or boards of trade
where there appears to be an active secondary market, there is no assurance a
liquid secondary market will exist for any particular options or futures
contract at any particular time. Options may have relatively low trading volume
and liquidity if their strike prices are not close to the underlying
instrument's current price. In addition, exchanges may establish daily price
fluctuation limits for options and futures contracts, and may halt trading if a
contract's price moves upward or downward more than the limit in a given day. On
volatile trading days when the price fluctuation limit is reached or a trading
halt is imposed, it may be impossible for the Fund to enter into new positions
or close out existing positions. If the secondary market for a contract is not
liquid because of price fluctuation limits or otherwise, it could prevent prompt
liquidation of unfavorable positions, and potentially could require the Fund to
continue to hold a position until delivery or expiration regardless of changes
in its value. As a result, the Fund's access to other assets held to cover its
options or futures positions could also be impaired.
OTC OPTIONS. The Fund 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 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. The Fund 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.
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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 segregate appropriate liquid assets in the amount
prescribed. These securities will be marked to market daily to assure that
coverage requirements are met. 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.
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. 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 five percent.
INVESTMENT RESTRICTIONS
The Fund is subject to certain policies and restrictions which, along with the
Fund's investment objective, are "fundamental" and may not be changed without
shareholder approval. Shareholder approval consists of the approval of the
lesser of (i) more than 50% of the outstanding voting securities of the Fund, or
(ii) 67% or more of the voting securities present at a meeting if the holders of
more than 50% of the outstanding voting securities of the Fund are present or
represented by proxy. Limitations 1 through 8 below are deemed fundamental
limitations. The remaining limitations set forth below serve as operating
policies of the Fund and may be changed by the Board of Directors without
shareholder approval.
The Fund may not:
1. Purchase the securities of any issuer if such purchase would cause
the Fund to fail to meet the requirements of a "diversified company" as defined
under the Investment Company Act of 1940, as amended (the "1940 Act").
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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.
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.
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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 strategies set forth 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 therefrom.
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 decrease in the Fund's portfolio turnover
rate over the two most recently completed fiscal years was the result of the
Fund's portfolio manager utilizing a market neutral approach in managing the
Fund. The Fund's historical portfolio turnover rates are set forth in the
Prospectus section "Financial Highlights".
INVESTMENT PERFORMANCE
Advertisements and other sales literature for the Fund may refer to
monthly, quarterly, yearly, cumulative and average annual total returns. 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. Monthly,
quarterly and yearly total returns are computed in the same manner as cumulative
total return, as set forth below.
20
<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
The Fund's cumulative total return from the Fund's inception on August
18, 1977 through November 30, 1999 was 532.71%.
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:
n
P(1+T) = 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 average annual total returns of the Fund for the one, five and ten
year periods ended November 30, 1999 were (2.46%), 6.78% and 7.04%,
respectively.
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:
6
YIELD = 2[(a-b + 1) -1]
---
cd
Where: a = dividends and interest earned during the period.
b = expenses accrued for the period (net of
reimbursements).
c = the average daily number of shares outstanding
during the period that were entitled to receive
dividends.
d = the net asset value of the Fund.
The Fund's yield for the thirty-day period ended November 30, 1999 was
7.61%.
21
<PAGE>
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
Under Minnesota law, the Fund's Board of Directors is generally
responsible for the overall operation and management of the Fund.
The names, addresses, positions and principal occupations of the
directors and executive officers of the Fund are given below.
<TABLE>
<CAPTION>
Name and Address Age Position Principal Occupation(s) During Past 5 Years
- ---------------- --- -------- -------------------------------------------
<S> <C> <C> <C>
Madeline Betsch 57 Director Currently retired; until April 1994, was Executive
19 South 1st Street Vice President, Director of Client Services, of
Minneapolis, Minnesota 55401 CME-KHBB Advertising since May 1985, and prior
thereto was a Vice President with Campbell-Mithun,
Inc. (advertising agency) since February 1977.
W. William Hodgson 75 Director Currently retired; served as information manager
1698 Dodd Road for the North Central Home Office of the
Mendota Heights, Minnesota 55118 Prudential Insurance Company of America from 1961
until 1984.
22
<PAGE>
George R. Long 69 Director Chairman of Mayfield Corp. (financial consultants
29 Las Brisas Way and venture capitalists) since 1973.
Naples, Florida 33963
J. Peter Thompson 68 Director Grain farmer in southwestern Minnesota since
Route 1 1974. Prior to that, Mr. Thompson was employed by
Mountain Lake, Minnesota 56159 Paine Webber, Jackson & Curtis, Incorporated, (a
diversified financial services concern), most
recently as Senior Vice President and General Partner.
Charles H. Withers 73 Director Currently retired; was Editor of the Rochester
Rochester Post Bulletin Post-Bulletin, Rochester, Minnesota from 1960
P.O. Box 6118 through March 31, 1980.
Rochester, Minnesota 55903
Keith Wirtz 40 President President and Chief Investment Officer of IAI
601 Second Avenue South since 1999. Prior to that time, Mr. Wirtz was the
P.O. Box 357 Chief Investment Strategist for TradeStreet
Minneapolis, Minnesota 55440 Investment Associates, Inc.
David Koehler 62 Vice Independent training and marketing consultant from
601 Second Avenue South President 1993 to current. Prior to that time, Mr. Koehler
P.O. Box 357 was a partner at IAI Venture Capital Group.
Minneapolis, Minnesota 55440
Jill Stevenson 34 Treasurer Associate Vice President and Director of Fund
601 Second Avenue South Administration and Investment Accounting of IAI.
P.O. Box 357 Ms. Stevenson has served IAI in various capacities
Minneapolis, Minnesota 55440 since joining the firm in 1984.
Michael J. Radmer 54 Secretary Partner of Dorsey & Whitney LLP, a Minnesota based
220 South Sixth Street law firm which acts as General Counsel to the Fund.
Minneapolis, Minnesota 55402
</TABLE>
Each of the directors and executive officers of the Fund, other than
Mr. Koehler, also serves in the same capacity for each of the 14 other mutual
funds for which IAI serves as investment adviser (the "IAI Mutual Funds").
No compensation is paid by the Fund to any officer other than David
Koehler. 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.
23
<PAGE>
<TABLE>
<CAPTION>
Aggregate Compensation
Aggregate Compensation from the
Name of Person, Position from Bond Fund* 15 IAI Mutual Funds**
------------------------ --------------- -------------------
<S> <C> <C>
Koehler, David - Vice President $1,694 $35,000
Betsch, Madeline - Director $1,810 $37,200
Hodgson, W. William - Director $1,810 $37,200
Long, George R. - Director $1,691 $37,200
Thompson, J. Peter - Director $1,818 $37,200
Withers, Charles H. - Director $1,890 $37,200
</TABLE>
- -------------------------
* For the fiscal year ended November 30, 1999.
** For the calendar year ended December 31, 1999; excludes expenses incurred in
connection with attending meetings.
The Board of Directors of the Fund 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 Fund's Board of Directors summarizing existing
procedures and changes, identifying material violations and recommending any
changes needed.
MANAGEMENT AGREEMENT
Effective April 1, 1996, pursuant to a Management 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 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 the Fund's
accounts, books and records; (2) the calculations of the daily net asset value
in accordance with the Fund's current Prospectus and Statement of Additional
Information; (3) daily and periodic reports; (4) all information necessary to
complete tax returns, questionnaires and other reports requested by the Fund;
(5) the maintenance of stock registry records; (6) the processing of requested
account registration changes, stock certificate issuances and redemption
requests; and (7) the administration of payments and dividends and distributions
declared by the 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, the
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%*
* The Fund's adviser, Investment Advisers, Inc., will limit its
management fee to 0.90% of average daily net assets through
March 31, 2001. Although it has no current intention of doing
so, IAI may discontinue this limitation at any time after
March 31, 2001, upon 30 days written notice to shareholders.
24
<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 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, insurance premiums, and costs of
attending investment conferences. The Management Agreement further provides that
IAI will either reimburse the Fund for the fees and expenses it pays to
directors who are not "interested persons" of the Fund or reduce its fee by an
equivalent amount. IAI is not liable for any loss suffered by the Fund in the
absence of willful misfeasance, bad faith or negligence in the performance of
its duties and obligations.
For the fiscal years ended November 30, 1997, 1998 and 1999, the Fund
paid IAI $812,134, $651,900 and $343,615, respectively, under the Management
Agreement.
The Management Agreement will terminate automatically in the event of
its assignment. In addition, the Agreement is terminable at any time without
penalty by the Board of Directors of the Fund or by vote of a majority of the
Fund's outstanding voting securities on not more than 60 days' written notice to
IAI, and by IAI on 60 days' notice to the Fund. The Agreement shall continue in
effect from year to year only so long as such continuance is specifically
approved at least annually by either the Board of Directors of the Fund or by
vote of a majority of the outstanding voting securities, provided that in either
event such continuance is also approved by the vote of a majority of directors
who are not parties to the Agreement or interested persons of such parties cast
in person at a meeting called for the purpose of voting on such approval.
IAI's ultimate corporate parent is 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.
CUSTODIAN, TRANSFER AGENT AND DIVIDEND DISBURSING AGENT
The Funds' custodian is Firstar Bank, N.A., P.O. Box 510, Milwaukee,
Wisconsin 53201-0510.
Firstar Mutual Fund Services, LLC acts as the Funds' transfer agent and
dividend disbursing agent at P.O. Box 701, Milwaukee Wisconsin 53201-0701.
LEGAL COUNSEL
Dorsey & Whitney LLP, 220 South Sixth Street, Minneapolis, Minnesota
55402, acts as General Counsel to the Fund.
INDEPENDENT AUDITORS
KPMG LLP, 90 South Seventh Street, Minneapolis, Minnesota 55402, acts
as the Fund's independent auditors.
25
<PAGE>
PORTFOLIO TRANSACTIONS AND ALLOCATION OF BROKERAGE
IAI selects and (where applicable) negotiates commissions with the
brokers who execute the transactions for the Fund. The primary criteria for the
selection of a broker is the ability of the broker, in the opinion of IAI, to
secure prompt execution of the transactions on favorable terms, including the
reasonableness of the commission and considering the state of the market at the
time. In selecting a broker, IAI may consider whether such broker provides
brokerage and research services (as defined in the Securities Exchange Act of
1934). IAI may direct Fund transactions to brokers who furnish research services
to IAI. Such research services include advice, both directly and in writing, as
to the value of securities, the advisability of investing in, purchasing or
selling securities, and the availability of securities or purchasers or sellers
of securities, as well as analyses and reports concerning issues, industries,
securities, economic factors and trends, portfolio strategy, and the performance
of accounts. By allocating brokerage business in order to obtain research
services for IAI, the Fund enables IAI to supplement its own investment research
activities and allows IAI to obtain the views and information of individuals and
research staffs of many different securities research firms prior to making
investment decisions for the Fund. To the extent such commissions are directed
to brokers who furnish research services to IAI, IAI receives a benefit, not
capable of evaluation in dollar amounts, without providing any direct monetary
benefit to the Fund from these commissions. Generally the Fund pays higher than
the lowest commission rates available.
IAI believes that most research services obtained by it generally
benefit one or more of the investment companies or other accounts which it
manages. Normally research services obtained through commissions paid by a
managed fund or managed account investing in debt securities would primarily
benefit managed funds and accounts investing in debt securities.
There is no formula for the allocation by IAI of the Fund's brokerage
business to any broker-dealers for brokerage and research services. However, IAI
will authorize the Fund to pay an amount of commission for effecting a
securities transaction in excess of the amount of commission another broker
would have charged only if IAI determines in good faith that such amount of
commission is reasonable in relation to the value of the brokerage and research
services provided by such broker viewed in terms of either that particular
transaction or IAI's overall responsibilities with respect to the accounts as to
which it exercises investment discretion.
Although investment decisions for the Fund are made independently from
other accounts as to which IAI gives investment advice, it may occasionally
develop that the same security is suitable for more than one account. If and
when more than one 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 the Fund and such accounts. The
simultaneous purchase or sale of the same securities by the Fund and other
accounts may have detrimental effects on the Fund, as they may affect the price
paid or received by the Fund or the size of the position obtainable by the Fund.
Consistent with the Rules of Fair Conduct 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.
26
<PAGE>
The following table shows brokerage commissions paid by the Fund during
the indicated periods. During the Fund's most recent fiscal year, no commissions
were paid to brokerage firms that provided research services to IAI. Brokerage
commissions have decreased from year to year as a result of decreases in the
Fund's net assets.
Amount of Commissions
------------------------------------------------------------------------
Year Ended Year Ended Year Ended
November 30, November 30, November 30,
1999 1998 1997
---- ---- ----
$ 1,050 $ 3,075 $ 4,350
CAPITAL STOCK
The Fund, which was created on August 18, 1977, is a separate portfolio
of IAI Investment Funds I, Inc., a Minnesota corporation organized on April 22,
1977, whose shares of common stock are currently issued in two series (Series A
and B). The investment portfolio represented by Series A common shares is
referred to as "IAI Bond Fund." 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.
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. As of November 30, 1999, the Fund had 2,212,907 shares
outstanding.
CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES
As of March 2, 2000, no person was a record holder or, to the knowledge
of Bond Fund, beneficial owner of more than 5% of the outstanding shares of Bond
Fund, except as set forth in the following table.
Name and Address Number Percent
of Shareholder of Shares* of Outstanding Shares
- -------------------- ---------- ---------------------
Charles Schwab & Co., Inc. 310,138 17.68%
SPL Custody A/C for Excl. Bnft. of Cust.
Attn: Mutual Funds Dept. - Bon Rein.
101 Montgomery Street
San Francisco, CA 94104
- -------------------------
* All shares are owned both of record and beneficially.
As of March 2, 2000, 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.
27
<PAGE>
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, Martin Luther King, Jr. Day, Presidents' Day, Good Friday, Memorial
Day, Independence Day, Labor Day, Thanksgiving Day, and Christmas Day.
On November 30, 1999, the net asset value and public offering price per
share of the Fund was calculated as follows:
NAV = Net Assets ($19,082,514)
----------------------------------- = $8.62
Shares Outstanding (2,212,907)
PURCHASES AND REDEMPTIONS OF SHARES
The Fund has authorized one or more brokers to accept on its behalf
purchase and redemption orders and such brokers are authorized to designate
other intermediaries to accept purchase and redemption orders on the Fund's
behalf. The Fund will be deemed to have received a purchase or redemption order
when an authorized broker or, if applicable, a broker's authorized designee,
accepts the order. In such circumstances, customer orders will be priced at the
Fund's NAV next computed after they are accepted by an authorized broker or the
broker's authorized designee.
The Fund has agreed to reduced initial subscription requirements for
employees and directors of the Fund or IAI, their spouses, children and
grandchildren. With respect to such persons, the minimum initial investment in
one or more of the IAI Family of Funds is $500; provided that the minimum amount
that can be allocated to any one of the Funds is $250. Subsequent subscriptions
are limited to a minimum of $100 for each of the Funds.
PURCHASES AND REDEMPTIONS IN KIND
In extraordinary circumstances, Fund shares may be purchased 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. Also in extraordinary circumstances, Fund shares may be redeemed in
exchange for readily marketable securities held by the 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 Fund qualified during its last taxable year, and intends to qualify
during its current taxable year, as a regulated investment company under
Subchapter M of the Internal Revenue Code of 1986, as amended (the "Code"). If
the Fund so qualifies, it will not be subject to federal income tax on income
that it distributes to shareholders.
It is not expected that distributions from the Fund 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.
28
<PAGE>
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 generally 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. If Fund shares are
sold or otherwise disposed of one year or less after the date of acquisition,
the gain or loss will be short-term. Short-term capital gain is taxed at the
same rates as ordinary income.
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 the 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 for distributions
to shareholders.
If the 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 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.
Some of the investment practices that may be employed by the Fund will
be subject to special provisions that, among other things, may defer the use of
certain losses of the Fund, affect the holding period of the securities
29
<PAGE>
held by the Fund and affect the character of the gains or losses realized. These
provisions may also require the Fund to mark-to-market some of the positions in
its portfolio (i.e., treat them as closed out) or to accrue original discount,
both of which may cause such Fund to recognize income without receiving cash
with which to make distributions in amounts necessary to satisfy the
distribution requirements for qualification as a regulated investment company
and for avoiding income and excise taxes. Accordingly, in order to make the
required distributions, the Fund may be required to borrow or liquidate
securities. The Fund will monitor its transactions and may make certain
elections in order to mitigate the effect of these rules and prevent
disqualification of the Fund as a regulated investment company.
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 as applicable to the Fund and its
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 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 Fund
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 recessionary 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.
30
<PAGE>
SHAREHOLDER MEETINGS
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 by written notice of
demand given to the Chief Executive Officer or the Chief Financial Officer of
the Fund. Within thirty days after receipt of the demand by one of those
officers, the Board of Directors shall cause a regular meeting of shareholders
to be called and held no later than ninety days after receipt of the demand, all
at the expense of the Fund. An annual meeting will be held on the removal of a
director or directors of the Fund if requested in writing by holders of not less
than 10% of the outstanding shares of the Fund.
FINANCIAL STATEMENTS
The financial statements included as part of the Fund's Annual Report
to Shareholders for the fiscal year ended November 30, 1999, are incorporated
herein by reference. Such Annual Report may be obtained by shareholders on
request from the Fund at no additional charge.
31
<PAGE>
A-3
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.
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
A-2
<PAGE>
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>
IAI MUTUAL FUNDS
IAI INSTITUTIONAL BOND FUND
PROSPECTUS April 1, 2000
As with all mutual funds, the Securities and Exchange Commission has not
approved or disapproved the shares of this Fund, or determined if the
information in this prospectus is accurate or complete. Any statement to the
contrary is a criminal offense.
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Fund Summary............................................................................................. 3
Objective........................................................................................... 3
Principal Investment Strategies..................................................................... 3
Principal Risks..................................................................................... 3
Fund Performance.................................................................................... 5
Fees and Expenses................................................................................... 6
Buying and Selling Shares................................................................................ 6
How to Buy Shares................................................................................... 6
How to Sell Shares.................................................................................. 8
Exchange Privilege.................................................................................. 10
Authorized Telephone Trading........................................................................ 11
Statements and Confirmations........................................................................ 11
Shareholder Reports................................................................................. 11
Dividend and Capital Gains Distributions................................................................. 11
Taxes.................................................................................................... 12
Taxes on Distributions.............................................................................. 12
Taxes on Transactions............................................................................... 12
Fund Management.......................................................................................... 12
Investment Adviser.................................................................................. 12
Portfolio Manager................................................................................... 13
More Information on Investment Strategies and Risks...................................................... 13
Investment Strategies............................................................................... 13
Effective Duration.................................................................................. 14
Temporary Defensive Investments..................................................................... 15
Portfolio Turnover.................................................................................. 15
Principal Risks..................................................................................... 15
Financial Highlights..................................................................................... 19
</TABLE>
<PAGE>
FUND SUMMARY
This section briefly describes the objective, principal investment strategies
and principal risks of IAI Institutional Bond Fund (the "Fund"). It also
provides you with information on the Fund's performance and expenses. For
further information on the Fund, please read the section entitled "More
Information on Investment Strategies and Risks."
OBJECTIVE
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.
PRINCIPAL INVESTMENT STRATEGIES
The Fund invests primarily in bonds and other debt securities that are rated
investment grade at the time of purchase or that are unrated and judged to be of
comparable quality by the Fund's adviser. At least 65% of the Fund's total
assets will be invested in debt securities. Although the Fund generally does not
purchase common stocks directly, it may invest up to 10% of its net assets in
convertible securities and preferred stock. The Fund's investments may include
foreign securities. However, the Fund does not expect to invest more than 25% of
its total assets in foreign securities, or more than 15% of its total assets in
non-dollar denominated foreign securities.
Although the Fund invests primarily in investment grade securities, it also may
invest up to 15% of its total assets in securities rated lower than investment
grade at the time of purchase, or "junk bonds." However, the Fund will not
invest in junk bonds rated lower than B by Moody's Investors Service, Inc. or
Standard & Poor's Corporation or, if unrated, judged to be of comparable quality
by the Fund's adviser.
The Fund may enter into futures contracts, options on futures contracts and
currency forward contracts. The Fund intends to use these derivative instruments
primarily for hedging purposes, although it may use them for non-hedging
purposes to a limited extent. To generate additional income, the Fund may invest
up to 10% of its net assets in mortgage dollar roll transactions.
The Fund's adviser employs a "top-down" approach in selecting securities for the
Fund. First, the adviser determines its economic outlook and the direction in
which it expects interest rates to move. Based on these factors, the adviser
makes duration and yield curve decisions and determines the Fund's sector
allocation. Selections of individual securities that fall within the appropriate
parameters are based on the adviser's analysis of the individual security and
its relative value compared to other securities in the marketplace. The Fund's
adviser anticipates that the average effective duration for the Fund's portfolio
securities will range from 3 1/2 to 7 1/2 years. This range may change, however,
due to market conditions and other economic factors.
PRINCIPAL RISKS
The principal risks that could adversely affect the Fund's share price and yield
include:
o INTEREST RATE RISK. Prices of the Fund's debt securities will generally
fall when interest rates rise. One measure of interest rate risk is
effective duration, explained under "More Information on Investment
Strategies and Risks -- Investment Strategies." The longer the Fund's
effective duration, the greater its interest rate risk.
o INCOME RISK. The Fund's income could decline due to falling market
interest rates.
3
<PAGE>
o CREDIT RISK. The Fund is subject to the risk that the issuers of debt
securities it holds will not make timely payments of interest or
principal on the securities. Securities rated the lowest investment
grade have speculative characteristics. In adverse economic or other
circumstances, issuers of these lower rated securities are more likely
to have difficulty making principal and interest payments than issuers
of higher rated securities. Non-investment grade securities are subject
to additional risk. See "Risks of Non-Investment Grade Securities"
below.
o RISKS OF NON-INVESTMENT GRADE SECURITIES. Non-investment grade
securities, or "junk bonds," generally have more volatile prices and
carry more risk to principal than investment grade securities.
o CALL RISK. The Fund is subject to the risk that, during periods of
falling interest rates, an issuer of debt securities will "call" -- or
repay -- its high-yielding bonds before their maturity date. The Fund
would then be forced to invest the unanticipated proceeds at lower
interest rates, resulting in a decline in the Fund's income.
o RISKS OF MORTGAGE- AND ASSET-BACKED SECURITIES. Falling interest rates
could cause faster than expected prepayments of the obligations
underlying the Fund's mortgage- and asset-backed securities. These
prepayments pass through to the Fund, which must reinvest them at a
time when interest rates on new investments are falling, reducing the
Fund's income. On the other hand, rising interest rates could cause
prepayments of the obligations to slow, which would lengthen the
duration of the Fund's mortgage- and asset-backed securities and cause
their prices to decline.
o RISKS OF FOREIGN SECURITIES. Investing in foreign securities typically
involves risks not associated with U.S. investing. Risks of foreign
investing include the risk that the Fund may experience a decline in
net asset value resulting from changes in exchange rates between the
U.S. dollar and foreign currencies, the risk of adverse political and
economic developments, and the possibility of expropriation,
nationalization or confiscatory taxation or limitations on the removal
of Fund assets.
o RISKS OF PREFERRED STOCKS AND CONVERTIBLE SECURITIES. The risks
associated with investing in preferred stocks and convertible
securities are similar to the risks of investing in equity securities,
including the risk that the prices of the securities will decline in
response to the activities of the issuing company or in response to
general market and/or economic conditions.
o RISKS OF DERIVATIVE INSTRUMENTS. The use of derivative instruments
exposes the Fund to additional risks and transaction costs. Successful
use of these instruments depends on the adviser's ability to correctly
forecast the direction of market movements. The Fund's performance
could be worse than if the Fund had not used these instruments if the
adviser's judgment proves incorrect. In addition, even if the adviser's
forecast is correct, there may be an imperfect correlation between the
price of derivative instruments and movements in the prices of the
securities, interest rates or currencies being hedged.
o RISKS OF DOLLAR ROLL TRANSACTIONS. The use of mortgage dollar rolls
could increase the volatility of the Fund's share price. It could also
diminish the Fund's investment performance if the adviser does not
predict mortgage prepayments and interest rates correctly.
You can lose money by investing in the Fund. An investment in the Fund is not a
deposit of any bank and is not insured or guaranteed by the Federal Deposit
Insurance Corporation or any other government agency.
4
<PAGE>
FUND PERFORMANCE
The bar chart and table on the left provide you with information on the Fund's
volatility and performance. The bar chart shows how the Fund's performance has
varied from year to year. This information provides some indication of the risks
of investing in the Fund by showing changes in performance from year to year.
The table compares the Fund's average annual returns for the one-year, five-year
and since-inception periods to that of a broad measure of market performance.
The Fund's past performance is not necessarily an indication of how it will
perform in the future.
ANNUAL TOTAL RETURNS AS OF 12/31 EACH YEAR
<TABLE>
<S> <C> <C> <C> <C> <C> <C>
20% --
15% --
10% --
5% --
0% --
-5%-- (4.24%) 15.69% 4.62% 8.49% 7.27% (4.02%)
1994 1995 1996 1997 1998 1999
</TABLE>
Best Quarter: Quarter ended March 31, 1995 5.42%
Worst Quarter: Quarter ended March 31, 1994 (3.53)%
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS AS OF 12/31/99
1 YEAR 5 YEARS SINCE INCEPTION (11/1/93)
<S> <C> <C> <C>
INSTITUTIONAL BOND FUND (4.02%) 6.22% 4.13%
LEHMAN BROTHERS AGGREGATE BOND (0.82%) 7.73% 5.66%
INDEX*
</TABLE>
- -----------------------
* Includes U.S. Treasury and government agency securities, mortgage-backed
obligations and corporate bonds rated investment grade or higher. All issues
must have at least one year left to maturity and an outstanding par value of at
least $100 million.
5
<PAGE>
FEES AND EXPENSES
As an investor, you pay certain fees and expenses if you buy and hold shares of
the Fund. Shareholder fees are fees you pay directly when buying or selling
shares. Annual fund operating expenses are deducted from Fund assets. The
figures below are based on expenses during the fiscal year ended November 30,
1999
SHAREHOLDER FEES (FEES PAID DIRECTLY FROM YOUR INVESTMENT)
Maximum Sales Charge (Load) None
Imposed on Purchases
Maximum Deferred Sales Charge None
(Load)
ANNUAL FUND OPERATING EXPENSES (EXPENSES THAT ARE DEDUCTED FROM FUND
ASSETS)(as a % of average net assets)
Management Fees 0.50%
Distribution and Service (12b-1) Fees None
Other Expenses None
Total Annual Fund Operating Expenses 0.50%
EXAMPLE
This example is intended to help you compare the cost of investing in the Fund
with the cost of investing in other mutual funds. It assumes that you invest
$10,000 in the Fund for the time periods indicated, that your investment has a
5% return each year and that the Fund's operating expenses remain the same.
Although your actual costs may be higher or lower, based on these assumptions
your costs would be:
1 year $ 51
3 years $160
5 years $280
10 years $628
BUYING AND SELLING SHARES
HOW TO BUY SHARES
You may purchase Fund shares either directly through the Fund or through certain
securities dealers. These dealers have the responsibility to promptly transmit
orders and may charge a processing fee. The Fund may reject any purchase order
at any time.
MINIMUM INVESTMENTS
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.
DETERMINING YOUR PURCHASE PRICE
Your purchase price will be equal to the Fund's net asset value ("NAV") per
share next calculated after your order is placed in proper form. To make sure
that your order is in proper form, please follow the directions for purchasing
shares given below. No sales load or commission is charged when you purchase
shares. NAV is determined as of the close of regular trading on the New York
Stock Exchange each day the exchange is open.
6
<PAGE>
The Fund's NAV per share 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 values
investments for which market quotations are readily available at market value.
It values short-term investments maturing within 60 days at amortized cost,
which approximates market value. It values all other investments and assets at
their fair value.
The Fund translates prices for its investments quoted in foreign currencies into
U.S. dollars at current exchange rates. As a result, changes in the value of
those currencies in relation to the U.S. dollar will affect the Fund's NAV.
Because foreign markets may be open at different times than the New York Stock
Exchange, the value of the Fund's shares may change on days when shareholders
are not able to buy or sell them. If events materially affecting the values of
the Fund's foreign investments occur between the close of foreign markets and
the close of regular trading on the New York Stock Exchange, these investments
will be valued at their fair value by the Fund's Board of Directors or its
delegates.
INVESTING BY WIRE
If you have an account with a commercial bank that is a member of the Federal
Reserve System, you may purchase shares by requesting your bank to wire funds
to:
Firstar Bank, N.A.
777 E. Wisconsin Ave.
Milwaukee, WI 55302
ABA Number: 075000022
Credit: Firstar Mutual Fund Services, LLC
Account #112-952-137
For further credit to IAI Mutual Funds
(Shareholder Account #, Shareholder Name)
If you are purchasing by wire for a new account, you must do the following
before you wire funds:
o call IAI Shareholder Services at 1-800-945-3863 to advise them
of your investment;
o obtain instructions and an application form; and
o complete the application and send it to:
IAI Mutual Funds
c/o Firstar Mutual Fund Services, LLC
P.O. Box 701
Milwaukee, WI 53201-0701
Your completed application must be received by the Fund before your wire is
sent.
Before initiating any subsequent wires, please call IAI Shareholder Services and
advise them of your name, account number and the name of the bank transmitting
the federal funds.
7
<PAGE>
Wire orders will be accepted only on days when your bank, the Fund, the Fund's
transfer agent and Firstar Bank, N.A. are open for business. A wired purchase
will be considered made when the wired amount is received and the purchase is
accepted by the Fund. The Fund must receive payment before the close of business
for the purchase to be credited to your account on that day. Otherwise, your
purchase will be processed the next business day. The Fund may reject your wire
order if it does not contain the required information stated above. If the Fund
rejects your wire order, your money will be returned promptly, less any costs
incurred by the Fund or the Fund's transfer agent in rejecting the order. You
must pay any charges assessed by your bank for the wire service. 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 Fund's transfer agent.
MAKING ADDITIONAL INVESTMENTS
You can make additional investments to your existing account by mail, by wire or
by exchanging shares of another fund in the IAI Family of Funds for Fund shares.
Additionally, you can make additional investments to your existing account
directly from your bank account by utilizing the Automated Clearing House (ACH)
system. If you did not establish this option when you opened your account, call
IAI Shareholder Services at 1-800-945-3863.
RETIREMENT PLANS
Shares of the Fund may be an appropriate investment for various retirement
plans. If you would like information about establishing an Individual Retirement
Account or other retirement plan, please call IAI Shareholder Services at
1-800-945-3863.
All retirement plans involve a long-term commitment of assets and are subject to
various legal requirements and restrictions. You are urged to consult an
attorney or tax adviser before establishing such a plan.
HOW TO SELL SHARES
You may redeem your shares on any day the New York Stock Exchange is open. Your
redemption price will be the net asset value of your shares next determined
after your redemption request is received in proper form by the Fund. To make
sure that your request is in proper form, please follow the directions for
selling shares given below.
BY MAIL
If you redeem by mail, your redemption price will be equal to the Fund's net
asset value per share next determined following receipt by the Fund of your
written redemption request in the form shown below (and a properly endorsed
stock certificate if one has been issued).
To redeem by mail, send a written request to the Fund at one of the following
addresses:
Regular Mail Overnight Mail
- ------------ --------------
IAI Mutual Funds IAI Mutual Funds
c/o Firstar Mutual Fund Services, LLC c/o Firstar Mutual Fund Services, LLC
P.O. Box 701 615 E Michigan St., Third Floor
Milwaukee, WI 53201-0701 Milwaukee, WI 53202
Your request should include the following information:
o name of the Fund,
o account number,
o dollar amount or number of shares to be redeemed,
8
<PAGE>
o name on the account, and
o signatures of all registered account owners.
If you hold certificates for your shares, they must be included with your
request. They must be endorsed on the back with the signature of the person
whose name appears on the certificate and must be signature guaranteed.
Signatures on your written request must be guaranteed if:
o you would like the proceeds from the sale to be paid to
someone other than the shareholder of record, or
o you have changed your address over the telephone within the
last 15 calendar days.
A signature guarantee assures that a signature is genuine and protects
shareholders from unauthorized account transfers. Banks, savings and loan
associations, trust companies, credit unions, broker-dealers and member firms of
a national securities exchange may guarantee signatures. NOTARIZATION BY A
NOTARY PUBLIC IS NOT ACCEPTED.
If Fund 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 redemption request.
To redeem money from your IRA account, an IRA Distribution Form must be
completed and returned to IAI. To receive a copy of the form, please call IAI
Shareholder Services at 1-800-945-3863.
BY PHONE
You may redeem shares by phone, subject to the following conditions:
o You must have completed the Telephone Options section of the
account application.
o Telephonic redemptions are limited to $50,000.
o Redemption proceeds must be made payable to the owner(s) of
record and delivered to the address of record.
o Telephone redemptions are not permitted for IRAs.
For assistance, please contact IAI Shareholder Services at 1-800-945-3863.
PAYMENT OF REDEMPTION PROCEEDS
BY WIRE. When you redeem by telephone, you may have the proceeds wired
to your bank account if you provided the required information at the time you
opened your account. Wire redemption requests will only be processed on days
your bank, the Fund, the Fund's transfer agent and Firstar Bank, N.A. are open
for business. If you choose to have your redemption proceeds wired to your bank,
please note the following:
o A minimum amount of $1,000 is required to wire redemption
proceeds.
o Proceeds will be wired on the next business day after your
redemption request.
o 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 wire.
9
<PAGE>
To add the ability to receive proceeds by wire to your account, or to change
existing bank account information, please submit a letter of instruction,
including your bank information and a signature guarantee, to:
IAI Mutual Funds
c/o Firstar Mutual Fund Services, LLC
P.O. Box 701
Milwaukee, WI 53201-0701
BY ACH. When you redeem by telephone, you may have the proceeds sent to
your bank account by an Automatic Clearing House Transfer if you provided the
required information at the time you opened your account. Proceeds sent by ACH
transfer should be credited the second day after the redemption. ACH is an
automated method of initializing payments from, and receiving payments in, your
financial institution account. The ACH system is supported by over 20,000 banks,
savings banks and credit unions. For assistance, please contact IAI Shareholder
Services at 1-800-945-3863.
BY CHECK. Normally the Fund will mail payment for shares redeemed on
the business day following the receipt of your redemption request, although
payment may be made as late as seven days after your request. However, the Fund
will not send redemption proceeds until checks (including certified checks,
cashiers checks or automatic investment credits) received in payment for shares
have cleared. This may take up to 15 days from the date of purchase.
INVOLUNTARY REDEMPTIONS
If your account balance falls below $2 million as a result of selling or
exchanging shares, the Fund has the right to redeem your shares and send you the
proceeds. Before redeeming your account, the Fund will mail you a notice of its
intention to redeem, which will give you an opportunity to make an additional
investment. If you do not increase the value of your account to at least $2
million within six months of the date the notice was mailed, the Fund may redeem
your account.
EXCHANGE PRIVILEGE
You may exchange your Fund shares for shares of another fund in the IAI Family
of Funds if you satisfy that fund's purchase requirements. There currently is no
fee to exchange shares.
The Fund generally limits exchanges to four per calendar year. This limit may be
modified for certain retirement plan accounts and for those participating in the
Automatic Exchange Plan described below. The Fund may change or cancel its
exchange privilege at any time.
When you exchange your Fund shares for shares of another fund in the IAI Family
of Funds the exchange is considered a sale of your Fund shares for federal
income tax purposes, and you may have a taxable capital gain or loss.
You may exchange shares by notifying the Fund in writing or, if you have
authorized the Fund to accept telephone instructions, by telephone. See "How to
Sell Shares -- By Telephone."
AUTOMATIC EXCHANGE PLAN
You may arrange to make regular exchanges of $100 or more between any
of the funds in the IAI Family of Funds on a monthly basis. Please note the
following about automatic exchanges:
o If you wish to participate in the Plan, you must complete the
Automatic Exchange Plan portion of your IAI Mutual Fund
application.
10
<PAGE>
o Exchanges will take place at the net asset value determined on
the fifth day of each month (or the next business day).
o If you participate in the Automatic Exchange Plan you will
receive quarterly confirmations of all transactions and
dividends.
o You may not close an account through the Automatic Exchange
Plan.
AUTHORIZED TELEPHONE TRADING
As discussed above, you may exchange and redeem shares by telephone if you have
completed the Telephone Options section of the IAI Mutual Fund application.
Telephone redemptions are not permitted for IRAs.
Address changes may also be made over the telephone. During the 15 calendar days
following an address change by telephone, you may only redeem shares in your
account with a signature guaranteed letter of instruction.
The Fund and its agents will not be responsible for any losses that may result
from acting on telephone instructions that they reasonably believe to be
genuine. The Fund will follow reasonable procedures to confirm that instructions
received by telephone are genuine. These procedures include tape recording all
redemption and exchange requests.
STATEMENTS AND CONFIRMATIONS
Whenever you buy or sell shares of the Fund, IAI will send you a confirmation
statement showing how many shares you bought or sold and at what price. You will
also receive an account statement quarterly and a consolidated transaction
statement annually. Please review carefully all of the information relating to
transactions on your statements and confirmations to ensure that your
instructions were acted on properly. Please notify the Fund immediately in
writing if there is an error. If you do not provide the Fund with notice of an
error within 60 days of non-automatic transactions, or within 60 days of the
date of your consolidated quarterly statement in the case of automatic
transactions, you will be deemed to have ratified the transaction.
SHAREHOLDER REPORTS
Shareholder reports will be sent to you semi-annually. These reports contain
financial information about the Fund, including a list of investment securities
held. To reduce the volume of mail you receive, only one copy of Fund reports
may be mailed to your household (same surname and address). Please call IAI
Shareholder Services at 1-800-945-3863 if you wish to receive additional
shareholder reports.
DIVIDEND AND CAPITAL GAINS DISTRIBUTIONS
The Fund pays dividends from net investment income monthly and distributes
realized capital gains, if any, annually.
When you open an account, you should specify on your application how you want to
receive your distributions. The Fund offers three options:
o full reinvestment -- your dividend and capital gain
distributions are automatically reinvested in additional
shares of the Fund;
o capital gains reinvestment -- your capital gain distributions
will be automatically reinvested, but your income dividend
distributions will be paid in cash; or
o cash-- your income dividends and capital gain distributions
will be paid in cash.
11
<PAGE>
If you elect to receive distributions in cash, they can be sent to you by 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.
If you do not select an option when you open your account, the Fund will
automatically reinvest all distributions in additional Fund shares.
The Fund also has a Directed Dividend service which allows you to invest your
dividends and/or capital gain distributions into another IAI Mutual Fund.
Contact IAI Shareholder Services at 1-800-945-3863 for details.
Prior to purchasing shares of the Fund, you should consider the impact of
dividend or capital gains distributions which are expected to be announced, or
which have been announced but not paid. If you purchase shares shortly before
the record date for such a distribution, you will pay the full price for the
shares and then receive a portion of that price back shortly thereafter as a
taxable distribution.
TAXES
Some of the common tax consequences of investing in the Fund are discussed
below. More information about taxes is in the Statement of Additional
Information. Because everyone's tax situation is unique, be sure to consult with
your tax adviser.
TAXES ON DISTRIBUTIONS
The Fund pays its shareholders distributions from its net investment income and
any net capital gains that it has realized. For most investors, these
distributions will be taxable, whether paid in cash or reinvested (unless your
investment is in an IRA or other tax-advantaged account).
Distributions paid from the Fund's net investment income and short-term capital
gains are taxable as ordinary income. Distributions paid from the Fund's
long-term capital gains are taxable as long-term gains, regardless of how long
you have held your shares. The Fund's distributions are expected to consist
primarily of ordinary income.
TAXES ON TRANSACTIONS
The sale or exchange of Fund shares will be a taxable event for you and may
result in a capital gain or loss. The gain or loss will be considered long-term
if you have held your shares for more than one year. A gain or loss on shares
held for one year or less is considered short-term and is taxed at the same
rates as ordinary income.
Information about the tax status of each year's distributions will be mailed
annually.
FUND MANAGEMENT
INVESTMENT ADVISER
Investment Advisers, Inc. ("IAI") is the Fund's investment adviser. IAI, which
has been in the investment advisory business since 1947, also furnishes
investment advice to other concerns including other investment companies,
pension and profit sharing plans, portfolios of foundations, religious,
educational and charitable institutions, trusts, municipalities and individuals.
IAI is located at 601 Second Avenue South, Suite 3600, Minneapolis, Minnesota
55402.
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<PAGE>
The Fund has entered into a Management Agreement with IAI under which IAI
provides the Fund with investment advisory services and is responsible for
managing the Fund's business affairs, subject to the authority of the Board of
Directors. IAI also is responsible under the Management Agreement for providing
or arranging for the provision of all required administrative, stock transfer,
redemption, dividend disbursing, accounting and shareholder services. IAI may
directly or indirectly pay qualifying broker-dealers, financial institutions and
other entities for providing some of these services to Fund shareholders. The
Management Agreement requires IAI to pay all of the Fund's operating expenses,
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. The Fund pays IAI an annual fee
under the Management Agreement. During its most recent fiscal year, the Fund
paid IAI a management fee equal to 0.50% of the Fund's average daily net assets.
Because IAI is paying the Fund's operating expenses, this fee represents the
Fund's total expenses for the fiscal year.
PORTFOLIO MANAGER
Larry Hill is responsible for the Fund's day-to-day investment decisions. Mr.
Hill is IAI's Chief Fixed Income Officer and has managed the Fund since it
commenced operations in November 1993.
MORE INFORMATION ON INVESTMENT STRATEGIES AND RISKS
INVESTMENT STRATEGIES
The principal investment strategies of the Fund, which are summarized above
under "Fund Summary," are described in more detail below. These are the
strategies that IAI believes are most likely to be important in trying the
achieve the Fund's objective. Of course, there is no guarantee that the Fund
will achieve its objective. Although not considered principal strategies, you
should be aware that the Fund may also use strategies and invest in securities
that are not described in this prospectus, but that are described in the
statement of additional information.
The Fund invests primarily in bonds and other debt securities that are rated
investment grade at the time of purchase or that are unrated and judged by IAI
to be of comparable quality. Investment grade securities are rated within the
four highest grades assigned by Moody's Investors Service, Inc. ("Moody's") or
Standard & Poor's Corporation ("S&P"). Commercial paper in which the Fund
invests must be rated at lease Prime-2 by Moody's or A-2 by S&P or be issued by
companies having an outstanding unsecured debt issue currently rated A or better
by Moody's or S&P.
Debt securities in which the Fund invests may include:
CORPORATE DEBT OBLIGATIONS. These are debt securities such as
bonds, debentures and notes issued by corporations for the
purpose of raising capital by borrowing. These securities
generally represent a promise by the corporation to make
periodic payments of interest and to repay principal on a
specified date.
U.S. GOVERNMENT SECURITIES. The Fund may invest in U.S.
Treasury securities, and in other securities issued or
guaranteed by the U.S. government or its agencies or
instrumentalities.
MORTGAGE-BACKED SECURITIES. The Fund may invest in
mortgage-backed securities issued by government and
non-government entities. These securities are secured by and
payable from pools of mortgage loans. The Fund's investments
in mortgage-backed securities may include collateralized
mortgage obligations (CMOs). These are derivative mortgage
securities secured by pools of mortgage loans or other
mortgage-backed securities.
ASSET-BACKED SECURITIES. Asset-backed securities are bonds or
notes backed by loan paper (such as automobile loans or home
equity loans) or accounts receivable originated by banks,
credit card companies or other providers of credit.
13
<PAGE>
ZERO COUPON SECURITIES. These securities do not pay interest
currently. They are issued at deep discounts from their face
value and mature at their face value.
PAYMENT-IN-KIND BONDS. These securities pay interest through
the issuance of additional securities, rather than paying
cash.
SHORT-TERM DEBT SECURITIES. These investments may include bank
certificates of deposit, bankers' acceptances and commercial
paper.
Although the Fund invests primarily in investment grade securities, it also may
invest up to 15% of its total assets in non-investment grade securities, or
"junk bonds." However, the Fund will not invest in junk bonds rated lower than B
by Moody's or S&P or, if unrated, judged to be of comparable quality by IAI. If
a security is downgraded to a rating below B or, if unrated, is no longer of a
quality comparable to a security rated B, as determined by IAI, the Fund may
retain the security if IAI believes it to be in the Fund's best interest.
The Fund may invest in securities issued by foreign governments, supranational
entities and other foreign issuers, consistent with the rating requirements
discussed above. The Fund does not expect to invest more than 25% of its total
assets in foreign securities, or more than 15% of its total assets in non-dollar
denominated foreign securities.
The Fund may enter into futures contracts on securities, financial indexes and
foreign currencies and options on those contracts, and it may enter into
currency forward contracts. The Fund intends to use these derivative instruments
primarily to hedge the value of its portfolio against potential adverse
movements in securities prices, foreign currency markets or interest rates.
However, the Fund may also use derivative instruments for non-hedging purposes
such as seeking to increase the Fund's income or otherwise seeking to enhance
return, provided that no more than 5% of the Fund's assets will be committed to
initial margin deposits and option premiums on futures and options contracts
entered into for non-hedging purposes (not including any options that are
in-the-money).
To generate additional income, the Fund may invest up to 10% of its net assets
in mortgage dollar roll transactions. In this type of transaction, the Fund
sells mortgage-backed securities for delivery in the current month while
contracting with the same party to repurchase similar securities at a future
date.
EFFECTIVE DURATION
The Fund anticipates that the average effective duration for its portfolio
securities will range from 3 1/2 to 7 1/2 years. Effective duration, one measure
of interest rate risk, measures how much the value of a security is expected to
change with a given change in interest rates. The longer a security's effective
duration, the more sensitive its price to changes in interest rates. For
example, if interest rates were to increase by one percentage point, the market
value of a bond with an effective duration of five years would decrease by 5%,
with all other factors being constant. Effective duration is based on
assumptions and subject to a number of limitations. It is most useful when
interest rate changes are small, rapid and occur equally in short-term and
long-term securities. In addition, it is difficult to calculate precisely for
bonds with prepayment options, such as mortgage-backed securities, because the
calculation requires assumptions about prepayment rates.
14
<PAGE>
TEMPORARY DEFENSIVE INVESTMENTS
In an attempt to respond to adverse market, economic, political or other
conditions, the Fund, as a temporary defensive measure, may hold up to 100% of
its total assets in cash or cash equivalents and short-term securities,
including money market securities. These investments may result in a lower yield
than would be available from longer-term investments and may prevent the Fund
from achieving its investment objective.
PORTFOLIO TURNOVER
Fund managers actively trade portfolio securities, resulting in very high
portfolio turnover rates. Trading of securities may produce capital gains, which
are taxable to shareholders when distributed. Active trading may also increase
the amount of commissions or mark-ups to broker-dealers that the Fund pays when
it buys and sells securities, which could decrease Fund performance. The
"Financial Highlights" section of this prospectus shows the Fund's historical
portfolio turnover rate.
PRINCIPAL RISKS
The principal risks of investing in the Fund are summarized above under "Fund
Summary." More information about Fund risks is presented below.
INTEREST RATE RISK
Debt securities in the Fund's portfolio will fluctuate in value with changes in
interest rates. In general, debt securities will increase in value when interest
rates fall and decrease in value when interest rates rise. Longer-term debt
securities are generally more sensitive to interest rate changes. Securities
which do not pay interest on a current basis, such as zero coupon securities,
may be highly volatile as interest rates rise or fall. Payment-in-kind bonds,
which pay interest in other securities rather than in cash, also may be highly
volatile.
INCOME RISK
The Fund's income could decline due to falling market interest rates. This is
because, in a falling interest rate environment, the Fund generally will have to
invest the proceeds from sales of Fund shares, as well as the proceeds from
maturing portfolio securities (or portfolio securities that have been called,
see "Call Risk," or prepaid, see "Prepayment Risk") in lower-yielding
securities.
CREDIT RISK
The Fund is subject to the risk that the issuers of debt securities it holds
will not make payments on the securities or that the other party to a contract
will default on its obligations. There is also the risk that an issuer could
suffer adverse changes in financial condition that could lower the credit
quality of a security. This could lead to greater volatility in the price of the
security and the shares of the Fund. Also, a change in the credit quality rating
of a bond can affect the bond's liquidity and make it more difficult for the
Fund to sell. Securities rated the lowest investment grade have speculative
characteristics. In adverse economic or other circumstances, issuers of these
lower rated securities are more likely to have difficulty making principal and
interest payments than issuers of higher rated securities. Non-investment grade
securities are subject to additional risk. See "Risks of Non-Investment Grade
Securities" below. When the Fund purchases unrated securities, it will depend on
IAI's analysis of credit risk more heavily than usual.
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<PAGE>
RISKS OF NON-INVESTMENT GRADE SECURITIES
The Fund may invest in non-investment grade debt securities, which are commonly
known as "junk bonds." Although these securities usually offer higher yields
than investment grade securities, they also involve more risk. Junk bonds
generally have more volatile prices and carry more risk to principal than
investment grade securities. Junk bonds may be more susceptible to real or
perceived adverse economic changes (for instance, an economic downturn or
prolonged period of rising interest rates), political changes or adverse
developments specific to the issuer. In addition, the secondary trading market
may be less liquid than the market for investment grade securities. Adverse
publicity and investor perceptions as well as new or proposed laws also may have
a greater negative impact on the market for junk bonds.
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, 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. If bonds in the Fund's portfolio were called, the Fund
would most likely be forced to invest the unanticipated proceeds in lower
yielding securities, resulting in a decline in the Fund's income.
PREPAYMENT RISK
Mortgage-backed securities are secured by and payable from pools of mortgage
loans. Similarly, asset-backed securities are supported by obligations such as
automobile loans or home equity loans. These mortgages and other obligations
generally can be prepaid at any time without penalty. As a result, mortgage- and
asset-backed securities are subject to prepayment risk, which is the risk that
falling interest rates could cause prepayments of the securities to occur more
quickly than expected. This occurs because, as interest rates fall, more
homeowners refinance the mortgages underlying mortgage-backed securities or
prepay the debt obligations underlying asset-backed securities. The Fund must
reinvest the prepayments at a time when interest rates on new investments are
falling, reducing the income of the Fund. In addition, when interest rates fall,
prices on mortgage- and asset-backed securities may not rise as much as for
other types of comparable debt securities because investors may anticipate an
increase in prepayments.
EXTENSION RISK
Mortgage- and asset-backed securities also are subject to extension risk, which
is the risk that rising interest rates could cause mortgages and other
obligations underlying the securities to be prepaid more slowly than expected,
resulting in slower prepayments of the securities. This would, in effect,
convert a short or medium duration mortgage- or asset-backed security into a
longer duration security, increasing its sensitivity to interest rate changes
and causing its price to decline.
16
<PAGE>
RISKS OF FOREIGN SECURITIES
Investments in foreign securities involve risks that are different in some
respects from investments in securities of U.S. 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 Fund's 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 that currency and, therefore, will cause an overall decline in
the Fund's net asset value and net investment income and capital gains, if any.
Other risks include 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. 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 OF PREFERRED STOCKS 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 that are convertible into or exchangeable for equity securities or
debt obligations that carry the right to acquire equity securities. The risks
associated with investing in preferred stocks and convertible securities are
different from those traditionally associated with investing in debt securities.
These risks are similar instead to the risks associated with investing in equity
securities, including the risk that the prices of the securities will decline in
response to the activities of the issuing company or in response to general
market and/or economic conditions.
RISKS OF DOLLAR ROLL TRANSACTIONS
In a dollar roll transaction, the Fund sells mortgage-backed securities for
delivery in the current month while contracting with the same party to
repurchase similar securities at a future date. Because the Fund gives up the
right to receive principal and interest paid on the securities sold, a mortgage
dollar roll transaction will diminish the investment performance of the Fund
unless the difference between the price received for the securities sold and the
price to be paid for the securities to be purchased in the future, plus any fee
income received, exceeds any income, principal payments and appreciation on the
securities sold as part of the mortgage dollar roll. Whether mortgage dollar
rolls will benefit the Fund will depend upon IAI's ability to predict mortgage
prepayments and interest rates. In addition, the use of mortgage dollar rolls by
the Fund increases the amount of the Fund's assets that are subject to market
risk, which could increase the volatility of the Fund's share price.
RISKS OF DERIVATIVE INSTRUMENTS
The use of derivative instruments exposes the Fund to additional investment
risks and transaction costs. Risks inherent in the use of derivative instruments
include:
o the risk that interest rates, securities prices and currency markets
will not move in the direction that IAI anticipates;
o an imperfect correlation between the price of derivative instruments
and movements in the prices of the securities, interest rates or
currencies being hedged;
o the inability to close out certain hedged positions to avoid adverse
tax consequences;
17
<PAGE>
o the possible absence of a liquid secondary market for any particular
instrument and possible exchange-imposed price fluctuation limits,
either of which may make it difficult or impossible to close out a
position when desired;
o leverage risk, which is the risk that adverse price movements in an
instrument can result in a loss substantially greater than the Fund's
initial investment in that instrument; and
o particularly in the case of privately negotiated instruments, the risk
that the counterparty will fail to perform its obligations, which could
leave the Fund worse off than if it had not entered into the position.
If the Fund uses derivative instruments and if IAI's judgment proves incorrect,
the Fund's performance could be worse than if it had not used these instruments.
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.
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<PAGE>
FINANCIAL HIGHLIGHTS
The table that follows presents performance information about the Fund. This
information is intended to help you understand the Fund's financial performance
for the past five years. Some of this information reflects financial results for
a single Fund share. The total returns in the table represent the rate that you
would have earned or lost on an investment in the Fund, assuming you reinvested
all of your dividends and distributions. This information has been audited by
KPMG LLP, independent auditors, whose report, along with the Fund's financial
statements, is included in the Fund's annual report, which is available upon
request.
INSTITUTIONAL BOND FUND
<TABLE>
<CAPTION>
YEARS ENDED NOVEMBER 30,
-------------------------------------------------
1999 1998 1997 1996 1995
-------------------------------------------------
<S> <C> <C> <C> <C> <C>
NET ASSET VALUE
Beginning of period $ 9.61 $ 9.49 $ 9.54 $ 9.50 $ 8.85
OPERATIONS
Net investment income .64** .64 .58 .63 .62
Net realized and unrealized gains (losses) (.82) .09 (.04) .04 .66
--------------------------------------------------
TOTAL FROM OPERATIONS (.18) .73 .54 .67 1.28
--------------------------------------------------
DISTRIBUTIONS TO SHAREHOLDERS FROM:
Net investment income (.68) (.61) (.59) (.63) (.63)
Capital gains (.40) - - - -
--------------------------------------------------
TOTAL DISTRIBUTIONS (1.08) (.61) (.59) (.63) (.63)
--------------------------------------------------
NET ASSET VALUE
End of period $ 8.35 $ 9.61 $ 9.49 $ 9.54 $ 9.50
=================================================
Total investment return* (1.97)% 7.92% 5.97% 7.44% 14.95%
Net assets at end of period (000's $ 23,190 $ 49,296 $108,367 $97,085 $101,429
omitted)
RATIOS
Expenses to average daily net assets 0.50% 0.50% 0.50% 0.50% 0.50%
Net investment income to average 7.05% 6.24% 6.19% 6.75% 6.76%
daily net assets
Portfolio turnover rate (excluding 162.1% 333.3% 511.0% 323.0% 358.8%
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.
** Net investment income per share is calculated using the ending balance
prior to consideration of adjustments for permanent book and tax
differences.
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FOR MORE INFORMATION ABOUT IAI INSTITUTIONAL BOND FUND
The Fund's statement of additional information ("SAI") and annual and
semi-annual reports to shareholders include additional information about the
Fund. The SAI provides more details about the Fund and its policies. A current
SAI is on file with the Securities and Exchange Commission (SEC) and is
incorporated into this prospectus by reference (which means that it is legally
considered part of this prospectus). Additional information about the Fund's
investments is available in the Fund's annual and semiannual reports to
shareholders. In the Fund's annual report, you will find a discussion of the
market conditions and investment strategies that significantly affected the
Fund's performance during its last fiscal year. You may obtain free copies of
these materials by calling the Fund toll-free at 1-800-945-3863.
You may also obtain copies by visiting the SEC's Public Reference Room in
Washington, DC or by sending your request and a duplicating fee to the SEC's
Public Reference Section, Washington, DC 20549-6009. For more information, call
1-800-SEC-0330.
Information about the Fund is also available on the Internet. Text-only versions
of Fund documents can be viewed online or downloaded from the SEC's Internet
site at http://www.sec.gov.
SEC file number: 811 - 2747
20
<PAGE>
IAI INSTITUTIONAL BOND FUND
A SERIES OF
IAI INVESTMENT FUNDS I, INC.
STATEMENT OF ADDITIONAL INFORMATION
DATED APRIL 1, 2000
THIS STATEMENT OF ADDITIONAL INFORMATION IS NOT A PROSPECTUS. THIS
STATEMENT OF ADDITIONAL INFORMATION RELATES TO A PROSPECTUS FOR IAI
INSTITUTIONAL BOND FUND (THE "FUND") DATED APRIL 1, 2000, AND SHOULD BE READ IN
CONJUNCTION THEREWITH. THE FINANCIAL STATEMENTS INCLUDED AS PART OF THE FUND'S
ANNUAL REPORT TO SHAREHOLDERS FOR THE FISCAL YEAR ENDED NOVEMBER 30, 1999 ARE
INCORPORATED BY REFERENCE INTO THIS STATEMENT OF ADDITIONAL INFORMATION. COPIES
OF THE FUND'S PROSPECTUS AND/OR ANNUAL REPORT ARE AVAILABLE, WITHOUT CHARGE, BY
WRITING OR CALLING THE FUND'S TRANSFER AGENT, FIRSTAR MUTUAL FUND SERVICES, LLC,
P.O. BOX 701, MILWAUKEE, WISCONSIN 53201-0701 (TELEPHONE NUMBER 1-800-945-3863).
<TABLE>
<CAPTION>
TABLE OF CONTENTS
Page
----
<S> <C>
INVESTMENT OBJECTIVE AND STRATEGIES..................................................................... 2
INVESTMENT RESTRICTIONS................................................................................. 18
INVESTMENT PERFORMANCE.................................................................................. 20
MANAGEMENT.............................................................................................. 22
CUSTODIAN, TRANSFER AGENT AND DIVIDEND DISBURSING AGENT................................................. 25
LEGAL COUNSEL........................................................................................... 25
INDEPENDENT AUDITORS.................................................................................... 25
PORTFOLIO TRANSACTIONS AND ALLOCATION OF BROKERAGE...................................................... 26
CAPITAL STOCK........................................................................................... 27
CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES..................................................... 27
NET ASSET VALUE AND PUBLIC OFFERING PRICE............................................................... 27
PURCHASES AND REDEMPTIONS OF SHARES..................................................................... 28
TAX STATUS.............................................................................................. 28
LIMITATION OF DIRECTOR LIABILITY........................................................................ 30
SHAREHOLDER MEETINGS................................................................................... 30
FINANCIAL STATEMENTS.................................................................................... 30
APPENDIX A - RATINGS OF DEBT SECURITIES................................................................. A-1
</TABLE>
1
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INVESTMENT OBJECTIVE AND STRATEGIES
IAI Institutional Bond Fund (the "Fund") is a diversified series of an
open-end, management investment company. The investment objective and principal
investment strategies of the Fund are discussed in the Prospectus under "Fund
Summary" and "More Information on Investment Strategies and Risks." The Fund's
investment objective may not be changed without shareholder approval.
Investors should understand that all investments are subject to various
risks. 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 strategies
will be successful, or that its investment objective will be attained. Certain
of the Fund's principal investment strategies are discussed in more detail
below. In addition, the Fund may also use strategies and invest in securities
that are not described in the Prospectus, but that are described below.
REPURCHASE AGREEMENTS
The Fund may engage in repurchase agreements relating to the securities
in which it may invest. A repurchase agreement, which is functionally equivalent
to a loan by the Fund, involves the purchase of securities by the Fund 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 engage in reverse repurchase agreements as a form of
borrowing. In a reverse repurchase agreement, the 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 segregate appropriate
liquid assets to cover its obligation under the agreement. 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.
BANK BORROWING
The Fund may borrow from banks 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
currently has a line of credit with a bank at the prime interest rate. To the
extent funds are drawn against the line of credit, securities are held in a
segregated account. No compensating balances or commitment fees are required
under the line of credit. The Fund does not currently intend to borrow (either
from banks or through reverse repurchase agreements) an amount exceeding 5% of
its net assets.
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SECURITIES OF FOREIGN ISSUERS
The Fund may invest in securities of foreign issuers. However, the Fund
does not intend to invest more than 25% of the value of its total assets in
non-dollar denominated securities of foreign issuers. Investing in foreign
securities may result in greater risk than that incurred by investing in
domestic securities. There is generally less publicly available information
about foreign issuers comparable to reports and ratings that are published about
companies in the United States. Also, foreign issuers are not subject to uniform
accounting and auditing and financial reporting standards, practices and
requirements comparable to those applicable to United States companies.
Furthermore, volume and liquidity in most foreign bond markets is less than in
the United States and at times volatility of price can be greater than in the
United States. There is generally less government supervision and regulation of
foreign bond markets, brokers and companies than in the United States.
With respect to certain foreign countries, there is the possibility of
adverse changes in investment or exchange control regulations, expropriation or
confiscatory taxation, limitations on the removal of funds or other assets of
the Fund, political or social instability, or diplomatic developments which
could affect United States investments in those countries. Moreover, individual
foreign economies may differ favorably or unfavorably from the United States'
economy in such respects as growth of gross national product, rate of inflation,
capital reinvestment, resource self-sufficiency and balance of payments
position.
The Fund is not aware at this time of the existence of any investment
or exchange control regulations which might substantially impair its 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 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. GOVERNMENT SECURITIES
The Fund may invest in securities of, or guaranteed by, the United
States Government, its agencies or instrumentalities. These securities include:
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.
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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 the Fund's shares. In the case of securities in which the 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.
The Fund's investments in U.S. government securities may include U.S.
Treasury inflation-protection securities. Inflation-protection securities are a
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 are auctioned and issued on a quarterly
basis on the 15th of January, April, July, and October. They have been issued as
10-year notes, with other maturities added thereafter. The index used to measure
inflation is the non-seasonally adjusted U.S. City Average All Items Consumer
Price Index for All Urban Consumers ("CPI-U").
The value of the principal is adjusted for inflation, and every six
months the security will pay interest, which is 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 is 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.
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.
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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
(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 Fund has 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
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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
The 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.
WHEN-ISSUED/DELAYED-DELIVERY TRANSACTIONS
The Fund may purchase securities on a delayed-delivery or when-issued
basis and purchase or sell securities on a "forward commitment" 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 set aside appropriate liquid assets in a segregated
custodial account to cover its purchase obligations. When the 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, 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.
No more than 20% of the Fund's net assets may be invested in
when-issued, delayed delivery or forward commitment transactions. Of such 20%,
no more than one-half (i.e., 10% of net assets) may be invested in when-issued,
delayed delivery or forward commitment transactions without the intention of
actually acquiring securities (i.e., dollar roll transactions).
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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
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. 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 appropriate liquid assets 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 invest in mortgage-backed securities that are Agency
Pass-Through Certificates, Private Pass-Throughs or collateralized mortgage
obligations ("CMOs"), as defined and described below.
Agency Pass-Through Certificates are mortgage pass-through certificates
representing undivided interests in pools of residential mortgage loans.
Distribution of principal and interest on the mortgage loans underlying an
Agency Pass-Through Certificate is an obligation of or guaranteed by GNMA, FNMA
or FHLMC. GNMA is a wholly-owned corporate instrumentality of the United States
within the Department of Housing and Urban Development. The guarantee of GNMA
with respect to GNMA certificates is backed by the full faith and credit of the
United States, and GNMA is authorized to borrow from the United States Treasury
in an amount which is at any time sufficient to enable GNMA, with no limitation
as to amount, to perform its guarantee.
FNMA is a federally chartered and privately owned corporation organized
and existing under federal law. Although the Secretary of the Treasury of the
United States has discretionary authority to lend funds to FNMA, neither the
United States nor any agency thereof is obligated to finance FNMA's operations
or to assist FNMA in any other manner.
FHLMC is a federally chartered corporation organized and existing under
federal law, the common stock of which is owned by the Federal Home Loan Banks.
Neither the United States nor any agency thereof is obligated to finance FHLMC's
operations or to assist FHLMC in any other manner.
The mortgage loans underlying GNMA certificates are partially or fully
guaranteed by the Federal Housing Administration or the Veterans Administration,
while the mortgage loans underlying FNMA certificates and FHLMC certificates are
conventional mortgage loans which are, in some cases, insured by private
mortgage insurance companies. Agency Pass-Through Certificates may be issued in
a single class with respect to a given pool of mortgage loans or in multiple
classes.
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The residential mortgage loans evidenced by Agency Pass-Through
Certificates and upon which CMOs are based generally are secured by first
mortgages on one- to four-family residential dwellings. Such mortgage loans
generally have final maturities ranging from 15 to 30 years and provide for
monthly payments in amounts sufficient to amortize their original principal
amounts by the maturity dates. Each monthly payment on such mortgage loans
generally includes both an interest component and a principal component, so that
the holder of the mortgage loans receives both interest and a partial return of
principal in each monthly payment. In general, such mortgage loans can be
prepaid by the borrowers at any time without any prepayment penalty. In
addition, many such mortgage loans contain a "due-on-sale" clause requiring the
loans to be repaid in full upon the sale of the property securing the loans.
Because residential mortgage loans generally provide for monthly amortization
and may be prepaid in full at any time, the weighted average maturity of a pool
of residential mortgage loans is likely to be substantially shorter than its
stated final maturity date. The rate at which a pool of residential mortgage
loans is prepaid may be influenced by many factors and is not predictable with
precision.
Private mortgage pass-through securities ("Private Pass-Throughs") are
structured similarly to GNMA, FNMA and FHLMC mortgage pass-through securities
and are issued by originators of and investors in mortgage loans, including
savings and loan associations, mortgage bankers, commercial banks, investment
banks and special purpose subsidiaries of the foregoing. These securities
usually are backed by a pool of conventional fixed rate or adjustable loans.
Since Private Pass-Throughs typically are not guaranteed by an entity having the
credit status of GNMA, FNMA or FHLMC, such securities generally are structured
with one or more types of credit enhancement. Such credit support falls into two
categories: (i) liquidity protection and (ii) protection against losses
resulting from ultimate default by an obligor on the underlying assets.
Liquidity protection refers to the provisions of advances, generally by the
entity administering the pool of assets, to ensure that the pass-through of
payments due on the underlying pool occurs in a timely fashion. Protection
against losses resulting from ultimate default enhances the likelihood of
ultimate payment of the obligations on at least a portion of the assets in the
pool. Such protection may be provided through guarantees, insurance policies or
letters of credit obtained by the issuer or sponsor from third parties, through
various means of structuring the transaction or through a combination of such
approaches. The Fund will not pay any additional fees for such credit support,
although the existence of credit support may increase the price of a security.
The ratings of securities for which third-party credit enhancement
provides liquidity protection or protection against losses from default are
generally dependent upon the continued creditworthiness of the enhancement
provider. The ratings of such securities could be subject to reduction in the
event of deterioration in the creditworthiness of the credit enhancement
provider even in cases where the delinquency and loss experience on the
underlying pool of assets is better than expected.
The Fund 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.
CMOs are debt obligations typically issued by a private special-purpose
entity and collateralized by residential or commercial mortgage loans or Agency
Pass-Through Certificates. Because CMOs are debt obligations of private
entities, payments on CMOs generally are not obligations of or guaranteed by any
governmental entity, and their ratings and creditworthiness typically depend,
among other factors, on the legal insulation of the issuer and transaction from
the consequences of a sponsoring entity's bankruptcy.
CMOs generally are issued in multiple classes, with holders of each
class entitled to receive specified portions of the principal payments and
prepayments and/or of the interest payments on the underlying mortgage loans.
These entitlements can be specified in a wide variety of ways, so that the
payment characteristics of various classes may differ greatly from one another.
For instance, holders may hold interests in CMO tranches called Z-
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tranches which defer interest and principal payments until one or other classes
of the CMO have been paid in full. In addition, for example:
o In a sequential-pay CMO structure, one class is entitled to
receive all principal payments and prepayments on the
underlying mortgage loans (and interest on unpaid principal)
until the principal of the class is repaid in full, while the
remaining classes receive only interest; when the first class
is repaid in full, a second class becomes entitled to receive
all principal payments and prepayments on the underlying
mortgage loans until the class is repaid in full, and so
forth.
o A planned amortization class ("PAC") of CMOs is entitled to
receive principal on a stated schedule to the extent that it
is available from the underlying mortgage loans, thus
providing a greater (but not absolute) degree of certainty as
to the schedule upon which principal will be repaid.
o An accrual class of CMOs provides for interest to accrue and
be added to principal (but not be paid currently) until
specified payments have been made on prior classes, at which
time the principal of the accrual class (including the accrued
interest which was added to principal) and interest thereon
begins to be paid from payments on the underlying mortgage
loans.
o As discussed above with respect to pass-through
mortgage-backed securities, an interest-only class of CMOs
entitles the holder to receive all of the interest and none of
the principal on the underlying mortgage loans, while a
principal-only class of CMOs entitles the holder to receive
all of the principal payments and prepayments and none of the
interest on the underlying mortgage loans.
o A floating rate class of CMOs entitles the holder to receive
interest at a rate which changes in the same direction and
magnitude as changes in a specified index rate. An inverse
floating rate class of CMOs entitles the holder to receive
interest at a rate which changes in the opposite direction
from, and in the same magnitude as or in a multiple of,
changes in a specified index rate. Floating rate and inverse
floating rate classes also may be subject to "caps" and
"floors" on adjustments to the interest rates which they bear.
o A subordinated class of CMOs is subordinated in right of
payment to one or more other classes. Such a subordinated
class provides some or all of the credit support for the
classes that are senior to it by absorbing losses on the
underlying mortgage loans before the senior classes absorb any
losses. A subordinated class which is subordinated to one or
more classes but senior to one or more other classes is
sometimes referred to as a "mezzanine" class. A subordinated
class generally carries a lower rating than the classes that
are senior to it, but may still carry an investment grade
rating.
It generally is more difficult to predict the effect of changes in
market interest rates on the return on mortgage-backed securities than to
predict the effect of such changes on the return of a conventional fixed-rate
debt instrument, and the magnitude of such effects may be greater in some cases.
The return on interest-only and principal-only mortgage-backed securities is
particularly sensitive to changes in interest rates and prepayment speeds. When
interest rates decline and prepayment speeds increase, the holder of an
interest-only mortgage-backed security may not even recover its initial
investment. Similarly, the return on an inverse floating rate CMO is likely to
decline more sharply in periods of increasing interest rates than that of a
fixed-rate security. For these reasons, interest-only, principal-only and
inverse floating rate mortgage-backed securities generally have greater risk
than more conventional classes of mortgage-backed securities.
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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. Interest and principal payments 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.
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.
ZERO COUPON BONDS
The 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, 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.
PAYMENT-IN-KIND BONDS
The Fund may invest in bonds the interest on which may be paid in other
securities rather than cash (PIKs). Typically, during a specified term prior to
the bond's maturity, the issuer of a PIK may provide for the option or the
obligation to make interest payments in bonds, common stock or other instruments
(i.e., "in kind" rather than in cash). The type of instrument in which interest
may or will be paid would be known by the Fund at the time of investment. While
PIKs generate income for purposes of generally accepted accounting principles,
they do not generate cash flow and thus could cause the Fund to be forced to
liquidate securities at an inopportune time in order to distribute cash, as
required by the Internal Revenue Code.
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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 such Fund's liquidity needs or in
response to a specific economic event such as a deterioration in the
creditworthiness of the issuer.
Adverse publicity and investor perceptions, which may not be based on
fundamental analysis, also may decrease the value and liquidity of high yield
securities, particularly in a thinly traded market. Factors adversely affecting
the market value of high yield securities are likely to adversely affect the
Fund's net asset value. In addition, the Fund may incur additional expenses to
the extent it is required to seek recovery upon a default on a portfolio holding
or participate in the restructuring of the obligation.
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.
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.
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LOANS AND OTHER DIRECT DEBT INSTRUMENTS
The Fund 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 the Fund's policies
regarding the quality of debt securities.
Purchasers of loans and other forms of direct indebtedness depend
primarily upon the creditworthiness of the borrower for payment of principal and
interest. Direct debt instruments may not be rated by any nationally recognized
rating service. If the Fund does not receive scheduled interest or principal
payments on such indebtedness, the Fund's share price and yield could be
adversely affected. Loans that are fully secured offer the Fund more protection
than an unsecured loan in the event of non-payment of scheduled interest or
principal. However, there is no assurance that the liquidation of collateral
from a secured loan would satisfy the borrower's obligation, or that the
collateral can be liquidated. Indebtedness of borrowers whose creditworthiness
is poor involves substantially greater risks, and may be highly speculative.
Borrowers that are in bankruptcy or restructuring may never pay off their
indebtedness, or may pay only a small fraction of the amount owed. Direct
indebtedness of developing countries will also involve a risk that the
governmental entities responsible for the repayment of the debt may be unable,
or unwilling, to pay interest and repay principal when due.
Investments in loans through direct assignment of a financial
institution's interests with respect to a loan may involve additional risks to
the Fund. For example, if a loan is foreclosed, the Fund could become part owner
of any collateral, and would bear the costs and liabilities associated with
owning and disposing of the collateral. In addition, it is conceivable that
under emerging legal theories of lender liability, the Fund could be held liable
as a co-lender. Direct debt instruments may also involve a risk of insolvency of
the lending bank or other intermediaries. Direct debt instruments that are not
in the form of securities may offer less legal protection to the Fund in the
event of fraud or misrepresentation. In the absence of definitive regulatory
guidance, the Fund relies on IAI's research in an attempt to avoid situations
where fraud or misrepresentation could adversely affect the Fund.
A loan is often administered by a bank or other financial institution
that acts as agent for all holders. The agent administers the terms of the loan,
as specified in the loan agreement. Unless, under the terms of the loan or other
indebtedness, the Fund has direct recourse against the borrower, it may have to
rely on the agent to apply appropriate credit remedies against a borrower. If
assets held by the agent for the benefit of the Fund were determined to be
subject to the claims of the agent's general creditors, the Fund might incur
certain costs and delays in rendering payment on the loan or loan participation
and could suffer a loss of principal or interest.
The Fund limits the amount of the assets that it invests in any one
issuer or in issuers within the same industry. For purposes of these
limitations, the Fund generally will treat the borrower as the "issuer" of
indebtedness held by the Fund. In the case of loan participations where a bank
or other lending institution serves as financial intermediary between the Fund
and the borrower, if the participation does not shift to the Fund the direct
debtor/creditor relationship with the borrower, SEC interpretations require the
Fund, in appropriate circumstances, to treat both the lending bank or other
lending institution and the borrower as "issuers" for the purpose of determining
whether the Fund has invested more than 5% of its total assets in a single
issuer. Treating the 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.
MUNICIPAL OBLIGATIONS
The Fund may invest in municipal bonds and other municipal obligations
when these securities appear to offer more attractive returns. These bonds and
other obligations are issued by the states and by their local and
special-purpose political subdivisions. The term "municipal bond" includes
short-term municipal notes issued by the states and their political subdivision.
The two general classifications of municipal bonds are "general
obligation" bonds and "revenue" bonds. General obligation bonds are secured by
the governmental issuer's pledge of its faith, credit and taxing power for the
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payment of principal and interest. They are usually paid from general revenues
of the issuing governmental entity. Revenue bonds, on the other hand, are
usually payable only out of a specific a revenue source rather than from general
revenues. Revenue bonds ordinarily are not backed by the faith, credit or
general taxing power of the issuing governmental entity. The principal and
interest on revenue bonds for private facilities are typically paid out of rents
or other specified payments made to the issuing governmental entity by a private
company which uses or operates the facilities. Examples of these types of
obligations are industrial revenue bond and pollution control revenue bonds.
Industrial revenue bonds are issued by governmental entities to provide
financing aid to community facilities such as hospitals, hotels, business or
residential complexes, convention halls and sport complexes. Pollution control
revenue bonds are issued to finance air, water and solids pollution control
systems for privately operated industrial or commercial facilities.
Revenue bonds for private facilities usually do not represent a pledge
of the credit, general revenues or taxing powers of the issuing governmental
entity. Instead, the private company operating the facility is the sole source
of payment of the obligation. Sometimes, the funds for payment of revenue bonds
come solely from revenue generated by operation of the facility. Revenue bonds
which are not backed by the credit of the issuing governmental entity frequently
provide a higher rate of return than other municipal obligations, but they
entail greater risk than obligations which are guaranteed by a governmental unit
with taxing power. Federal income tax laws place substantial limitations on
industrial revenue bonds, and particularly certain specified private activity
bonds issued after August 1986. In the future, legislation could be introduced
in Congress which could further restrict or eliminate the income tax exemption
for interest on municipal obligations in which the Funds may invest.
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 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
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, consistent with any limitations imposed
by the Commodity Futures Trading Commission. See "Limitations on Futures and
Options Transactions" below. 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 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.
SWAP AGREEMENTS. The 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 the Fund's exposure to
long- or short-term
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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
objective 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.
The Fund will segregate appropriate liquid assets to cover its current
obligations under swap agreements. If the 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 the Fund's accrued obligations under the swap agreement over
the accrued amount the Fund is entitled to receive under the agreement. If the
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 the Fund's accrued obligations
under the agreement.
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.
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The Fund may also use forward contracts to hedge against a decline in
the value of existing investments denominated in a 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 European Currency Units in
return for U.S. dollars. This type of hedge, sometimes referred to as a "proxy
hedge," could offer advantages in terms of cost, yield, or efficiency, but
generally would not hedge currency exposure as effectively as a simple hedge
into U.S. dollars. Proxy hedges may result in losses if the currency used to
hedge does not perform similarly to the currency in which the hedged securities
are denominated.
Under certain conditions, SEC guidelines require mutual funds to set
aside appropriate liquid assets in a segregated custodial account to cover
currency forward contracts. As required by SEC guidelines, the Fund will
segregate assets to cover currency forward contracts, if any, whose purpose is
essentially speculative. The Fund will not segregate assets to cover forward
contracts entered into for hedging purposes, including settlement hedges,
position hedges, and proxy hedges.
Successful use of forward currency contracts will depend on IAI's skill
in analyzing and predicting currency values. Forward contracts may substantially
change the Fund's investment exposure to changes in currency exchange rates, and
could result in losses to the Fund if currencies do not perform as IAI
anticipates. For example, if a currency's value rose at a time when IAI had
hedged the Fund by selling that currency in exchange for dollars, the Fund would
be unable to participate in the currency's appreciation. If IAI hedges currency
exposure through proxy hedges, the Fund could realize currency losses from the
hedge and the security position at the same time if the two currencies do not
move in tandem. Similarly, if IAI increases the Fund's exposure to a foreign
currency, and that currency's value declines, the Fund will realize a loss.
There is no assurance that IAI's use of forward currency contracts will be
advantageous to the Fund or that it will hedge at an appropriate time. The
policies described in this section are non-fundamental policies of the Fund.
FUTURES CONTRACTS. When the Fund purchases a futures contract, it
agrees to purchase a specified underlying instrument at a specified future date.
When the Fund sells a futures contract, it agrees to sell the underlying
instrument at a specified future date. The price at which the purchase and sale
will take place is fixed when the Fund enters into the contract. Some currently
available futures contracts are based on specific securities, such as U.S.
Treasury bonds or notes, and some are based on indexes of securities prices,
such as the Standard & Poor's 500 Composite Stock Price Index (S&P 500). Futures
can be held until their delivery dates, or can be closed out before then if a
liquid secondary market is available.
The value of a futures contract tends to increase and decrease in
tandem with the value of its underlying instrument. Therefore, purchasing
futures contracts will tend to increase the Fund's exposure to positive and
negative price fluctuations in the underlying instrument, much as if it had
purchased the underlying instrument directly. When the Fund sells a futures
contract, by contrast, the value of its futures position will tend to move in a
direction contrary to the market. Selling futures contracts, therefore, will
tend to offset both positive and negative market price changes, much as if the
underlying instrument had been sold.
FUTURES MARGIN PAYMENTS. The purchaser or seller of a futures contract
is not required to deliver or pay for the underlying instrument unless the
contract is held until the delivery date. However, both the purchaser and seller
are required to deposit "initial margin" with a futures broker, known as a
futures commission merchant (FCM), when the contract is entered into. Initial
margin deposits are typically equal to a percentage of the contract's value. If
the value of either party's position declines, that party will be required to
make additional "variation margin" payments to settle the change in value on a
daily basis. The party that has a gain may be entitled to receive all or a
portion of this amount. Initial and variation margin payments do not constitute
purchasing securities on margin for purposes of the Fund's investment
limitations. In the event of the bankruptcy of an FCM that holds margin on
behalf of the Fund, the Fund may be entitled to a return of margin owed to it
only in proportion to the amount received by the FCM's other customers,
potentially resulting in losses to the Fund.
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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 (i.e., sells) a put
option, it takes the opposite side of the transaction from the option's
purchaser. In return for receipt of the premium, the Fund assumes the obligation
to pay the strike price for the option's underlying instrument if the other
party to the option chooses to exercise it. When writing an option on a futures
contract the Fund would be required to make margin payments to an FCM as
described above for futures contracts. The Fund may seek to terminate its
position in a put option it writes before exercise by closing out the option in
the secondary market at its current price. If the secondary market is not liquid
for a put option the Fund has written, however, the Fund must continue to be
prepared to pay the strike price while the option is outstanding, regardless of
price changes, and must continue to set aside assets to cover its position. If
security prices rise, a put writer would generally expect to profit, although
its gain would be limited to the amount of the premium it received.
If security prices remain the same over time, it is likely that the
writer will also profit, because it should be able to close out the option at a
lower price. If security prices fall, the put writer would expect to suffer a
loss. This loss should be less than the loss from purchasing the underlying
instrument directly, however, because the premium received for writing the
option should mitigate the effects of the decline.
Writing a call option obligates the Fund to sell or deliver the
option's underlying instrument, in return for the strike price, upon exercise of
the option. The characteristics of writing call options are similar to those of
writing put options, except that writing calls generally is a profitable
strategy if prices remain the same or fall. 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.
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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. Although the Fund intends
to purchase and sell options and futures only on exchanges or boards of trade
where there appears to be an active secondary market, there is no assurance a
liquid secondary market will exist for any particular options or futures
contract at any particular time. Options may have relatively low trading volume
and liquidity if their strike prices are not close to the underlying
instrument's current price. In addition, exchanges may establish daily price
fluctuation limits for options and futures contracts, and may halt trading if a
contract's price moves upward or downward more than the limit in a given day. On
volatile trading days when the price fluctuation limit is reached or a trading
halt is imposed, it may be impossible for the Fund to enter into new positions
or close out existing positions. If the secondary market for a contract is not
liquid because of price fluctuation limits or otherwise, it could prevent prompt
liquidation of unfavorable positions, and potentially could require the Fund to
continue to hold a position until delivery or expiration regardless of changes
in its value. As a result, the Fund's access to other assets held to cover its
options or futures positions could also be impaired.
OTC OPTIONS. The Fund 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 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. The Fund 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.
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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 segregate appropriate liquid assets in the
amount prescribed. These securities will be marked to market daily to assure
that coverage requirements are met. 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.
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. 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 five percent.
INVESTMENT RESTRICTIONS
The Fund is subject to certain policies and restrictions which, along
with the Fund's investment objective, are "fundamental" and may not be changed
without shareholder approval. Shareholder approval consists of the approval of
the lesser of (i) more than 50% of the outstanding voting securities of the
Fund, or (ii) 67% or more of the voting securities present at a meeting if the
holders of more than 50% of the outstanding voting securities of the Fund are
present or represented by proxy. Limitations 1 through 8 below are deemed
fundamental limitations. The remaining limitations set forth below serve as
operating policies of the Fund and may be changed by the Board of Directors
without shareholder approval.
The Fund may not:
1. Purchase the securities of any issuer if such purchase would cause
the Fund to fail to meet the requirements of a "diversified company" as defined
under the Investment Company Act of 1940, as amended (the "1940 Act").
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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.
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.
19
<PAGE>
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 strategies set forth 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.
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".
INVESTMENT PERFORMANCE
Advertisements and other sales literature for the Fund may refer to
monthly, quarterly, yearly, cumulative and average annual total returns. 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. Monthly,
quarterly and yearly total returns are computed in the same manner as cumulative
total return, as set forth below.
20
<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
The Fund's cumulative total return from the Fund's inception on
November 1, 1993 through November 30, 1999 was 30.53%.
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:
n
P(1+T) = 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 average annual total returns of the Fund for the one year, five
year and since inception periods ended November 30, 1999 were (1.97%), 6.73% and
4.48%, respectively.
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:
6
YIELD = 2[(a-b + 1) -1]
---
cd
Where: a = dividends and interest earned during the
period.
b = expenses accrued for the period (net of
reimbursements).
c = the average daily number of shares
outstanding during the period that were
entitled to receive dividends.
d = the net asset value of the Fund at the end of
the period.
The Fund's yield for the thirty-day period ended November 30, 1999 was
8.06%.
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.
21
<PAGE>
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
Under Minnesota law, the Fund's Board of Directors is generally
responsible for the overall operation and management of the Fund.
The names, addresses, positions and principal occupations of the
directors and executive officers of the Fund are given below.
<TABLE>
<CAPTION>
Name and Address Age Position Principal Occupation(s) During Past 5 Years
- ---------------- --- -------- -------------------------------------------
<S> <C> <C> <C>
Madeline Betsch 57 Director Currently retired; until April 1994, was Executive
19 South 1st Street Vice President, Director of Client Services, of
Minneapolis, Minnesota 55401 CME-KHBB Advertising since May 1985, and prior
thereto was a Vice President with Campbell-Mithun,
Inc. (advertising agency) since February 1977.
W. William Hodgson 75 Director Currently retired; served as information manager
1698 Dodd Road for the North Central Home Office of the
Mendota Heights, Minnesota 55118 Prudential Insurance Company of America from 1961
until 1984.
George R. Long 69 Director Chairman of Mayfield Corp. (financial consultants
29 Las Brisas Way and venture capitalists) since 1973.
Naples, Florida 33963
22
<PAGE>
J. Peter Thompson 68 Director Grain farmer in southwestern Minnesota since
Route 1 1974. Prior to that, Mr. Thompson was employed by
Mountain Lake, Minnesota 56159 Paine Webber, Jackson & Curtis, Incorporated, (a
diversified financial services concern), most
recently as Senior Vice President and General Partner.
Charles H. Withers 73 Director Currently retired; was Editor of the Rochester
Rochester Post Bulletin Post-Bulletin, Rochester, Minnesota from 1960
P.O. Box 6118 through March 31, 1980.
Rochester, Minnesota 55903
Keith Wirtz 40 President President and Chief Investment Officer of IAI
601 Second Avenue South since 1999. Prior to that time, Mr. Wirtz was the
P.O. Box 357 Chief Investment Strategist for TradeStreet
Minneapolis, Minnesota 55440 Investment Associates, Inc.
David Koehler 62 Vice Independent training and marketing consultant from
601 Second Avenue South President 1993 to current. Prior to that time, Mr. Koehler
P.O. Box 357 was a partner at IAI Venture Capital Group.
Minneapolis, Minnesota 55440
Jill Stevenson 34 Treasurer Associate Vice President and Director of Fund
601 Second Avenue South Administration and Investment Accounting of IAI.
P.O. Box 357 Ms. Stevenson has served IAI in various capacities
Minneapolis, Minnesota 55440 since joining the firm in 1984.
Michael J. Radmer 54 Secretary Partner of Dorsey & Whitney LLP, a Minnesota based
220 South Sixth Street law firm which acts as General Counsel to the Fund.
Minneapolis, Minnesota 55402
</TABLE>
Each of the directors and executive officers of the Fund, other than
Mr. Koehler, also serves in the same capacity for each of the 14 other mutual
funds for which IAI serves as investment adviser (the "IAI Mutual Funds").
23
<PAGE>
No compensation is paid by the Fund to any officer other than David
Koehler. Directors who are not affiliated with IAI receive from the IAI Mutual
Funds a $15,000 annual retainer, $2,500 for each Board meeting attended, $3,600
for each Audit Committee meeting attended (as applicable) and $1,800 for each
Securities Valuation Committee meeting attended. The Fund will pay its pro rata
share of these fees based on its net assets. Such unaffiliated directors also
are reimbursed for expenses incurred in connection with attending meetings.
<TABLE>
<CAPTION>
Aggregate Compensation
Aggregate Compensation from the
Name of Person, Position from Bond Fund* 15 IAI Mutual Funds**
------------------------ --------------- -------------------
<S> <C> <C>
Koehler, David - Vice President $2,234 $35,000
Betsch, Madeline - Director $2,415 $37,200
Hodgson, W. William - Director $2,415 $37,200
Long, George R. - Director $2,329 $37,200
Thompson, J. Peter - Director $2,427 $37,200
Withers, Charles H. - Director $2,571 $37,200
</TABLE>
- -------------------------
* For the fiscal year ended November 30, 1999.
** For the calendar year ended December 31, 1999; excludes expenses incurred
in connection with attending meetings.
The Board of Directors of the Fund 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 Fund's Board of Directors summarizing existing
procedures and changes, identifying material violations and recommending any
changes needed.
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 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.
24
<PAGE>
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.
For the fiscal years ended November 30, 1997, 1998 and 1999, the Fund
paid IAI $437,589, $403,313 and $208,965, respectively, pursuant to the
Investment Advisory and Administrative Services Agreement.
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.
IAI's ultimate corporate parent is 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.
CUSTODIAN, TRANSFER AGENT AND DIVIDEND DISBURSING AGENT
The Fund's custodian is Firstar Bank, N.A., P.O. Box 510, Milwaukee,
Wisconsin 53201-0510.
Firstar Mutual Fund Services, LLC acts as the Fund's transfer agent and
dividend disbursing agent at P.O. Box 701, Milwaukee Wisconsin 53201-0701.
LEGAL COUNSEL
Dorsey & Whitney LLP, 220 South Sixth Street, Minneapolis, Minnesota
55402, acts as General Counsel to the Fund.
INDEPENDENT AUDITORS
KPMG LLP, 90 South Seventh Street, Minneapolis, Minnesota 55402, acts
as the Fund's independent auditors.
25
<PAGE>
PORTFOLIO TRANSACTIONS AND ALLOCATION OF BROKERAGE
IAI selects and (where applicable) negotiates commissions with the
brokers who execute the transactions for the Fund. The primary criteria for the
selection of a broker is the ability of the broker, in the opinion of IAI, to
secure prompt execution of the transactions on favorable terms, including the
reasonableness of the commission and considering the state of the market at the
time. In selecting a broker, IAI may consider whether such broker provides
brokerage and research services (as defined in the Securities Exchange Act of
1934). IAI may direct Fund transactions to brokers who furnish research services
to IAI. Such research services include advice, both directly and in writing, as
to the value of securities, the advisability of investing in, purchasing or
selling securities, and the availability of securities or purchasers or sellers
of securities, as well as analyses and reports concerning issues, industries,
securities, economic factors and trends, portfolio strategy, and the performance
of accounts. By allocating brokerage business in order to obtain research
services for IAI, the Fund enables IAI to supplement its own investment research
activities and allows IAI to obtain the views and information of individuals and
research staffs of many different securities research firms prior to making
investment decisions for the Fund. To the extent such commissions are directed
to brokers who furnish research services to IAI, IAI receives a benefit, not
capable of evaluation in dollar amounts, without providing any direct monetary
benefit to the Fund from these commissions. Generally the Fund pays higher than
the lowest commission rates available.
IAI believes that most research services obtained by it generally
benefit one or more of the investment companies or other accounts which it
manages. Normally research services obtained through commissions paid by a
managed fund or managed account investing in debt securities would primarily
benefit managed funds and accounts investing in debt securities.
There is no formula for the allocation by IAI of the Fund's brokerage
business to any broker-dealers for brokerage and research services. However, IAI
will authorize the Fund to pay an amount of commission for effecting a
securities transaction in excess of the amount of commission another broker
would have charged only if IAI determines in good faith that such amount of
commission is reasonable in relation to the value of the brokerage and research
services provided by such broker viewed in terms of either that particular
transaction or IAI's overall responsibilities with respect to the accounts as to
which it exercises investment discretion.
Although investment decisions for the Fund are made independently from
other accounts as to which IAI gives investment advice, it may occasionally
develop that the same security is suitable for more than one account. If and
when more than one 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 the Fund and such accounts. The
simultaneous purchase or sale of the same securities by the Fund and other
accounts may have detrimental effects on the Fund, as they may affect the price
paid or received by the Fund or the size of the position obtainable by the Fund.
Consistent with the Rules of Fair Conduct 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.
The following table shows brokerage commissions paid by the Fund during
the indicated periods. Brokerage commissions have decreased from year to year as
a result of decreases in the Fund's net assets. During the Fund's most recent
fiscal year, no commissions were paid to brokerage firms that provided research
services to IAI.
Amount of Commissions
- --------------------------------------------------------------------------------
Year Ended Year Ended Year Ended
November 30, November 30, November 30,
1999 1998 1997
---- ---- ----
$ 2,760 $ 13,505 $ 36,039
26
<PAGE>
CAPITAL STOCK
The Fund, which was created on September 27, 1993, is a separate
portfolio of IAI Investment Funds I, Inc., a Minnesota corporation organized on
April 22, 1977, whose shares of common stock are currently issued in two series
(Series A and B). The investment portfolio represented by Series B common shares
is referred to as "IAI Institutional Bond Fund." On June 25, 1993, the Articles
of Incorporation of the corporation were amended and restated to provide that
the registered investment company whose corporate name had been IAI Bond Fund,
Inc., be renamed IAI Investment Funds I, Inc.
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. As of November 30, 1999, the Fund had 2,777,966 shares
outstanding.
CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES
As of March 2, 2000, no person was a record holder or, to the knowledge
of the Fund, beneficial owner of more than 5% of the Fund's outstanding shares,
except as set forth in the following table:
<TABLE>
<CAPTION>
Name and Address Number Percent
of Shareholder of Shares* of Outstanding Shares
-------------- ---------- ---------------------
<S> <C> <C>
Wells Fargo Bank of Texas NA TTEE 143,655 28.97%
The M/A/R/C, Inc. Pen 05-0173-00
Trust and Investment Svcs.
P.O. Box 9800 MAC 9139-027
Calabasas, CA 91302-9800
The Northern Trust Company 320,619 64.66%
HON Industries Master Trust
P.O. Box 92956
Chicago, IL 60675-2956
</TABLE>
- -------------------------
* All shares are owned both of record and beneficially.
In addition, as of March 2, 2000, 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, Martin Luther King, Jr. Day, Presidents' Day, Good Friday, Memorial
Day, Independence Day, Labor Day, Thanksgiving Day, and Christmas Day.
27
<PAGE>
On November 30, 1999, the net asset value and public offering price per
share of the Fund was calculated as follows:
NAV = Net Assets ($23,189,569) = $8.35
----------------------------------
Shares Outstanding (2,777,966)
PURCHASES AND REDEMPTIONS OF SHARES
The Fund has authorized one or more brokers to accept on its behalf
purchase and redemption orders and such brokers are authorized to designate
other intermediaries to accept purchase and redemption orders on the Fund's
behalf. The Fund will be deemed to have received a purchase or redemption order
when an authorized broker or, if applicable, a broker's authorized designee,
accepts the order. In such circumstances, customer orders will be priced at the
Fund's NAV next computed after they are accepted by an authorized broker or the
broker's authorized designee.
PURCHASES AND REDEMPTIONS IN KIND
In extraordinary circumstances, Fund shares may be purchased 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. Also in extraordinary circumstances, Fund shares may be redeemed in
exchange for readily marketable securities held by the 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 Fund qualified during its last taxable year, and intends to qualify
during its current taxable year, as a regulated investment company under
Subchapter M of the Internal Revenue Code of 1986, as amended (the "Code"). If
the Fund so qualifies, it will not be subject to federal income tax on income
that it distributes to shareholders.
It is not expected that distributions from the Fund 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 generally 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. If Fund shares are
sold or otherwise disposed of one year or less after the date of acquisition,
the gain or loss will be short-term. Short-term capital gain is taxed at the
same rates as ordinary income.
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.
28
<PAGE>
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 the 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 for distributions
to shareholders.
If the 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 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.
Some of the investment practices that may be employed by the Fund will
be subject to special provisions that, among other things, may defer the use of
certain losses of the Fund, affect the holding period of the securities held by
the Fund and affect the character of the gains or losses realized. These
provisions may also require the Fund to mark-to-market some of the positions in
its portfolio (i.e., treat them as closed out) or to accrue original discount,
both of which may cause such Fund to recognize income without receiving cash
with which to make distributions in amounts necessary to satisfy the
distribution requirements for qualification as a regulated investment company
and for avoiding income and excise taxes. Accordingly, in order to make the
required distributions, the Fund may be required to borrow or liquidate
securities. The Fund will monitor its transactions and may make certain
elections in order to mitigate the effect of these rules and prevent
disqualification of the Fund as a regulated investment company.
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 as applicable to the Fund and its
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 the Fund.
LIMITATION OF DIRECTOR LIABILITY
29
<PAGE>
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 rescessionary 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.
SHAREHOLDER MEETINGS
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 by
written notice of demand given to the Chief Executive Officer or the Chief
Financial Officer of the Fund. Within thirty days after receipt of the demand by
one of those officers, the Board of Directors shall cause a regular meeting of
shareholders to be called and held no later than ninety days after receipt of
the demand, all at the expense of the Fund. An annual meeting will be held on
the removal of a director or directors of the Fund if requested in writing by
holders of not less than 10% of the outstanding shares of the Fund.
FINANCIAL STATEMENTS
The financial statements included as part of the Fund's Annual Report
to Shareholders for the fiscal year ended November 30, 1999, are incorporated
herein by reference. Such Annual Report may be obtained by shareholders on
request from the Fund 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.
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.
A-1
<PAGE>
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.
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
A-2
<PAGE>
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>
PART C
IAI Bond Fund and IAI Institutional Bond Fund
series of
IAI Investment Funds I, Inc.
OTHER INFORMATION
Item 23. Exhibits
The Funds are filing or incorporating by reference the following
exhibits:
<TABLE>
<S> <C>
(a).1 Amended and Restated Articles of Incorporation Dated 9/16/93 (1)
(a).2 Certificate of Designation of Series B dated 9/16/93 (1)
(b) Amended and Restated Bylaws as of 8/18/93 (1)
(c) Instruments Defining Rights of Security Holders - not applicable
(d).1 Management Agreement (Series A) dated 4/1/96 (1)
(d).2 Investment Advisory and Administrative Services Agreement (Series B) (1)
(e).1 Underwriting and Distribution Agreement - not applicable
(e).2 Dealer Sales Agreement (2)
(e).3 Shareholder Services Agreement (2)
(f) Bonus or Profit Sharing Contracts - not applicable
(g) Custody Agreement dated 8/18/93 (1)
(h) Other Material Contracts - not applicable
(i) Legal Opinion of Dorsey & Whitney LLP*
(j) Consent of KPMG Peat Marwick LLP*
(k) Omitted Financial Statements - not applicable
(l) Initial Capital Agreements - not applicable
(m) Rule 12b-1 Plan - not applicable
(n) Financial Data Schedule - not applicable
(o) Rule 18f-3 Plan - not applicable
</TABLE>
- -------------
(1) Incorporated by reference to Post-Effective Amendment No. 40 to the
Registrant's Registration Statement on Form N-1A filed with the
Commission on April 1, 1999.
(2) Incorporated by reference to Post-Effective Amendment No. 36 to the
Registrant's Registration Statement on Form N-1A filed with the
Commission on January 31, 1996. * Filed herewith.
Item 24. Persons Controlled by or Under Common Control with the Fund
- ---------------------------------------------------------------------
THE FOLLOWING IS A LIST OF ALL PERSONS DIRECTLY OR INDIRECTLY
CONTROLLED BY OR UNDER COMMON CONTROL WITH THE FUND:
See the section of the Prospectus entitled "Fund Management" and the
section of the Statement of Additional Information entitled "Management" filed
as part of this Registration Statement.
C-1
<PAGE>
Item 25. Indemnification
STATE THE GENERAL EFFECT OF ANY CONTRACT, ARRANGEMENT OR STATUTE UNDER
WHICH ANY DIRECTOR, OFFICER, UNDERWRITER OR AFFILIATED PERSON OF THE FUND IS
INSURED OR INDEMNIFIED AGAINST ANY LIABILITY INCURRED IN THEIR OFFICIAL
CAPACITY, OTHER THAN INSURANCE PROVIDED BY ANY DIRECTOR, OFFICER, AFFILIATED
PERSON OR UNDERWRITER FOR THEIR PROTECTION.
Incorporated by reference to Post-Effective Amendment to Registrant's
Registration Statement on Form N-1A filed on January 31, 1997.
Item 26. Business and Other Connections of the Investment Adviser
DESCRIBE ANY OTHER BUSINESS, PROFESSION, VOCATION OR EMPLOYMENT OF A
SUBSTANTIAL NATURE THAT EACH INVESTMENT ADVISER, AND EACH DIRECTOR, OFFICER OR
PARTNER OF THE ADVISER, IS OR HAS BEEN ENGAGED WITHIN THE LAST TWO FISCAL YEARS
FOR HIS OR HER OWN ACCOUNT OR IN THE CAPACITY OF DIRECTOR, OFFICER, EMPLOYEE,
PARTNER OR TRUSTEE.
Information on the business of Investment Advisers, Inc. ("IAI") is
described in the Prospectus section "Fund Management" and in Part B of this
Registration Statement in the section "Management."
The following senior officers and directors of IAI are not listed in
the Statement of Additional Information:
<TABLE>
<CAPTION>
Other Business/Employment
Name Position with Adviser During Past Two Years
---- --------------------- ---------------------
<S> <C> <C>
Iain D. Cheyne Chairman/Director None
John Alexander Executive Vice President None
Larry Ray Hill Executive Vice President None
James Beloff Senior Vice President None
Stephen C. Coleman Senior Vice President None
Lindsay Johnston Senior Vice President None
Steve Lentz Senior Vice President None
Curt McLeod Senior Vice President None
Deb Ratelle Senior Vice President None
John Caravello Director None
Kevin McKendry Director None
Peter Phillips Director None
</TABLE>
Certain of the officers and directors of IAI also serve as officers and
directors of IAI International Ltd. The address of IAI International is 10 Fleet
Street, London, EC4M 7RH, England. Both IAI and IAI International's ultimate
corporate parent is Lloyds TSB Group plc, a publicly-held financial services
organization based in London, England. The senior officers and directors of IAI
International are Peter Norton, Senior Vice President, International Equity
Investments, and Iain D. Cheyne, Director.
C-2
<PAGE>
Certain of the officers and directors of IAI also serve as officers and
directors of IAI Trust Company, a wholly-owned subsidiary of IAI. The address of
IAI Trust Company is 3600 U.S. Bank Place, Minneapolis, Minnesota 55402. John A.
Alexander is the President and a Director of IAI Trust Company.
Item 27. Principal Underwriters
(a) STATE THE NAME OF EACH INVESTMENT COMPANY (OTHER THAN THE FUND) FOR WHICH
EACH PRINCIPAL UNDERWRITER CURRENTLY DISTRIBUTING THE FUND'S SECURITIES ALSO
ACTS AS A PRINCIPAL UNDERWRITER, DEPOSITOR OR INVESTMENT ADVISER.
Not applicable.
(b) PROVIDE THE INFORMATION REQUIRED BY THE FOLLOWING TABLE FOR EACH DIRECTOR,
OFFICER OR PARTNER OF EACH PRINCIPAL UNDERWRITER NAMED IN RESPONSE TO ITEM 20.
Not applicable.
(c) PROVIDE THE INFORMATION REQUIRED BY THE FOLLOWING TABLE FOR ALL COMMISSIONS
AND OTHER COMPENSATION RECEIVED, DIRECTLY OR INDIRECTLY, FROM THE FUND DURING
THE LAST FISCAL YEAR BY EACH PRINCIPAL UNDERWRITER WHO IS NOT AN AFFILIATED
PERSON OF THE FUND OR ANY AFFILIATED PERSON OF AN AFFILIATED PERSON.
Not applicable.
Item 28. Location of Accounts and Records
STATE THE NAME AND ADDRESS OF EACH PERSON MAINTAINING PHYSICAL
POSSESSION OF EACH ACCOUNT, BOOK OR OTHER DOCUMENT REQUIRED TO BE MAINTAINED BY
SECTION 31(a) AND THE RULES UNDER THAT SECTION.
The Custodian for Registrant is Firstar Bank, N.A., P.O. Box 510,
Milwaukee, WI 53201- 0510. The Custodian maintains records of all cash
transactions of Registrant. All other books and records of Registrant's
investment portfolios are maintained by IAI. Firstar Mutual Fund Services, LLP,
P.O. Box 701, Milwaukee, WI 53201-0701, acts as Registrant's transfer agent and
dividend disbursing agent.
Item 29. Management Services
PROVIDE A SUMMARY OF THE SUBSTANTIVE PROVISIONS OF ANY
MANAGEMENT-RELATED SERVICE CONTRACT NOT DISCUSSED IN PART A OR B, DISCLOSING THE
PARTIES TO THE CONTRACT AND THE TOTAL AMOUNT PAID AND BY WHOM FOR THE FUND FOR
THE LAST THREE FISCAL YEARS.
Not applicable.
C-3
<PAGE>
Item 30. Undertakings
IN INITIAL REGISTRATION STATEMENTS FILED UNDER THE SECURITIES ACT,
PROVIDE AN UNDERTAKING TO FILE AN AMENDMENT TO THE REGISTRATION STATEMENT WITH
CERTIFIED FINANCIAL STATEMENTS SHOWING THE INITIAL CAPITAL RECEIVED BEFORE
ACCEPTING SUBSCRIPTIONS FROM MORE THAN 25 PERSONS IF THE FUND INTENDS TO RAISE
ITS INITIAL CAPITAL UNDER SECTION 14(a)(3).
Not applicable.
C-4
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the
Investment Company Act of 1940, the Registrant certifies that it meets all of
the requirements for effectiveness of this Registration Statement on Form N-1A
pursuant to Rule 485(b) under the Securities Act of 1933 and has duly caused
this Registration Statement to be signed on its behalf by the undersigned,
thereunto duly authorized, in the City of Minneapolis and State of Minnesota on
the 30th day of March, 2000.
IAI INVESTMENT FUNDS I, INC.
(Registrant)
By: /s/ Keith Wiltz
----------------------
Keith Wiltz, President
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed below by the following persons in the
capacities and on the dates indicated.
<TABLE>
<S> <C> <C>
/s/ Keith Wiltz President (principal executive March 30, 2000
- ---------------------------------------------- officer)
Keith Wiltz
/s/ Jill Stevenson Treasurer (principal financial and March 30, 2000
- --------------------------------------------- accounting officer)
Jill Stevenson
Madeline Betsch* Director
W. William Hodgson* Director
George R. Long* Director
J. Peter Thompson* Director
Charles H. Withers* Director
*By: /s/ William C. Joas March 30, 2000
-----------------------------------------------
William C. Joas, Attorney-in-Fact
</TABLE>
* Registrant's directors executing Powers of Attorney dated August 18, 1993,
filed with the Commission on June 28, 1994.
EXHIBIT (I)
DORSEY & WHITNEY LLP
PILLSBURY CENTER SOUTH
220 SOUTH SIXTH STREET
MINNEAPOLIS, MINNESOTA 55402
March 30, 2000
IAI Investment Funds I, Inc.
3700 U.S. Bank Place
P.O. Box 357
Minneapolis, Minnesota 55440
Ladies and Gentlemen:
We have acted as counsel to IAI Investment Funds I, Inc., a Minnesota
corporation (the "Fund"), in connection with a Registration Statement on Form
N-1A (File No. 002-59115) (the "Registration Statement") relating to the sale by
the Fund of an indefinite number of shares of the Fund's Series A and Series B
common stock, each with a par value of $.01 per share (the "Shares").
We have examined such documents and have reviewed such questions of law
as we have considered necessary and appropriate for the purposes of our opinions
set forth below. In rendering our opinions set forth below, we have assumed the
authenticity of all documents submitted to us as originals, the genuineness of
all signatures and the conformity to authentic originals of all documents
submitted to us as copies. We have also assumed the legal capacity for all
purposes relevant hereto of all natural persons and, with respect to all parties
to agreements or instruments relevant hereto other than the Fund, that such
parties had the requisite power and authority (corporate or otherwise) to
execute, deliver and perform such agreements or instruments, that such
agreements or instruments have been duly authorized by all requisite action
(corporate or otherwise), executed and delivered by such parties and that such
agreements or instruments are the valid, binding and enforceable obligations of
such parties. As to questions of fact material to our opinions, we have relied
upon certificates of officers of the Fund and of public officials. We have also
assumed that the Shares will be issued and sold as described in the Registration
Statement.
Based on the foregoing, we are of the opinion that the Shares have been
duly authorized by all requisite corporate action and, upon issuance, delivery
and payment therefore as described in the Registration Statement, will be
validly issued, fully paid and nonassessable.
Our opinions expressed above are limited to the laws of the State of
Minnesota.
<PAGE>
We hereby consent to the filing of this opinion as an exhibit to the
Registration Statement, and to the reference to our firm under the caption
"Legal Counsel" in the Statement of Additional Information constituting part of
the Registration Statement.
Very truly yours,
/s/ DORSEY & WHITNEY LLP
KLP
EXHIBIT (J)
Independent Auditors' Consent
The Board of Directors
IAI Investment Funds I, Inc.:
We consent to the use of our report incorporated herein by reference and to the
references to our Firm under the heading "Financial Highlights" in Part A and
"Independent Auditors" in Part B of the Registration Statement.
KPMG LLP
Minneapolis, Minnesota
March 30, 2000
