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SBL FUND
Member of the Security Benefit Group of Companies
700 Harrison, Topeka, Kansas 66636-0001
PROSPECTUS
DECEMBER 1, 1997
SBL Fund (the "Fund") is an open-end, diversified management investment
company of the series type offering portfolios with different investment
objectives and strategies.
SERIES C (MONEY MARKET SERIES) seeks as high a level of current income as
is consistent with preservation of capital by investing in money market
securities with varying maturities.
SERIES K (GLOBAL AGGRESSIVE BOND SERIES) seeks high current income and, as
a secondary objective, capital appreciation by investing in a combination of
foreign and domestic high-yield, lower rated debt securities (commonly known as
"junk bonds").
SERIES O (EQUITY INCOME SERIES) seeks to provide substantial dividend
income and also capital appreciation by investing primarily in dividend-paying
common stocks of established companies.
SERIES S (SOCIAL AWARENESS SERIES) seeks capital appreciation by investing
in various types of securities, including common stocks, convertible securities,
preferred stocks and debt securities that meet certain social criteria
established for the Series.
AN INVESTMENT IN THE FUND, INCLUDING AN INVESTMENT IN SERIES C, IS NEITHER
INSURED NOR GUARANTEED BY THE U.S. GOVERNMENT. IN ADDITION TO OTHER RISKS, THE
HIGH YIELD, HIGH RISK BONDS IN WHICH SERIES K AND SERIES O MAY INVEST ARE
SUBJECT TO GREATER FLUCTUATIONS IN VALUE AND RISK OF LOSS OF INCOME AND
PRINCIPAL DUE TO DEFAULT BY THE ISSUER THAN ARE LOWER YIELDING, HIGHER RATED
BONDS.
The Fund's shares are sold to Security Benefit Life Insurance Company
("SBL") for allocation to one or more separate accounts established for funding
variable life insurance policies and variable annuity contracts issued by SBL.
This Prospectus sets forth concisely the information that a prospective
investor should know about SBL Fund. It should be read and retained for future
reference. A Statement of Additional Information about the Fund, dated October
15, 1997, as supplemented December 1, 1997 has been filed with the Securities
and Exchange Commission. The Statement of Additional Information, as it may be
supplemented from time to time, is incorporated by reference in this Prospectus.
It is available at no charge by writing Security Distributors, Inc., 700
Harrison Street, Topeka, Kansas 66636-0001, or by calling (785) 431-3127 or
(800) 888-2461.
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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION, NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
AN INVESTMENT IN THE FUND INVOLVES RISK, INCLUDING LOSS OF PRINCIPAL, AND IS NOT
A DEPOSIT OR OBLIGATION OF, OR GUARANTEED BY ANY BANK. THE FUND IS NOT FEDERALLY
INSURED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION, THE FEDERAL RESERVE BOARD
OR ANY OTHER AGENCY.
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SBL FUND CONTENTS
Page
Financial Highlights...................................................... 3
SBL Fund.................................................................. 4
Investment Objectives and Policies of the Series.......................... 4
Series C (Money Market Series).......................................... 4
Series K (Global Aggressive Bond Series)................................ 5
Series O (Equity Income Series)......................................... 7
Series S (Social Awareness Series)...................................... 8
Investment Methods and Risk Factors....................................... 9
Management of the Fund.................................................... 20
Portfolio Management...................................................... 21
Sale and Redemption of Shares............................................. 22
Distributions and Federal Income Tax Considerations....................... 22
Foreign Taxes............................................................. 22
Determination of Net Asset Value.......................................... 22
Trading Practices and Brokerage........................................... 23
Performance Information................................................... 24
General Information....................................................... 24
Organization............................................................ 24
Custodian, Transfer Agent and Dividend-Paying Agent..................... 24
Contractowner Inquiries................................................. 24
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SBL FUND
FINANCIAL HIGHLIGHTS
The following financial highlights for each of the years presented, except
the six-month period ended June 30, 1997, have been audited by Ernst & Young
LLP. Such information for each of the five years in the period ended December
31, 1996, should be read in conjunction with the financial statements of the
Fund and the report of Ernst & Young LLP, the Fund's independent auditors,
appearing in the December 31, 1996 Annual Report which is incorporated by
reference in this Prospectus. The Fund's Annual Report also contains additional
information about the performance of the Fund and may be obtained without charge
by calling Security Distributors, Inc. at 1-800-888-2461. The information for
each of the years preceding and including the period ended December 31, 1991 and
the six-month period ended June 30, 1997, is not covered by the report of Ernst
& Young LLP.
<TABLE>
<CAPTION>
NET TOTAL
ASSET NET NET GAIN FROM DIVIDENDS DISTRI-
FISCAL VALUE INVEST- (LOSS) ON INVEST- (FROM NET BUTIONS
YEAR BEGIN- MENT SECURITIES MENT INVEST- (FROM RETURN TOTAL
ENDED NING OF INCOME (REALIZED & OPERA- MENT CAPITAL OF DISTRI-
DEC. 31 PERIOD (LOSS) UNREALIZED) TIONS INCOME) GAINS) CAPITAL BUTIONS
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<S> <C> <C> <C> <C> <C> <C> <C> <C>
SERIES C
1987(a) $12.08 $0.76 $ --- $ 0.76 $(1.43) $--- $--- $(1.43)
1988 11.41 0.822 --- 0.822 (0.002) --- --- (0.002)
1989(a) 12.23 1.09 --- 1.09 (0.53) --- --- (0.53)
1990(a) 12.79 1.00 --- 1.00 (1.05) --- --- (1.05)
1991(a) 12.74 0.69 0.01 0.70 (0.92) --- --- (0.92)
1992 12.52 0.43 (0.03) 0.40 (0.71) --- --- (0.71)
1993 12.21 0.29 0.027 0.317 (0.437) --- --- (0.437)
1994 12.09 0.41 0.035 0.445 (0.265) --- --- (0.265)
1995(f) 12.27 0.74 (0.085) 0.655 (0.585) --- --- (0.585)
1996(a)(f) 12.34 0.61 0.01 0.62 (0.40) --- --- (0.40)
1997(h) 12.56 0.316 0.004 0.32 --- --- --- ---
SERIES K
1995(a)(d)(e) $10.00 $0.54 $ 0.22 $ 0.76 $(0.466) $(0.044) $(0.03) $(0.540)
1996(e) 10.22 0.90 0.50 1.40 (0.77) (0.13) --- (0.90)
1997(e)(h) 10.72 0.48 (0.22) 0.26 --- --- --- ---
SERIES O
1995(a)(d) $10.00 $0.166 $ 1.534 $ 1.70 $ --- $ --- $ --- $ ---
1996 11.70 0.169 2.173 2.342 (0.03) (0.002) --- (0.032)
1997(h) 14.01 0.08 1.95 2.03 --- --- --- ---
SERIES S
1991(b) $10.00 $0.05 $ 0.50 $ 0.55 $ --- $ --- $ --- $ ---
1992(a) 10.55 0.03 1.691 1.721 (0.021) --- --- (0.021)
1993 12.25 0.02 1.432 1.452 (0.012) --- --- (0.012)
1994 13.69 0.08 (0.595) (0.515) (0.02) (0.185) --- (0.205)
1995(f) 12.97 0.09 3.507 3.597 (0.077) --- --- (0.077)
1996(f) 16.49 0.03 3.073 3.103 (0.083) (0.43) --- (0.513)
1997(h) 19.08 0.10 2.000 2.100 --- --- --- ---
<CAPTION>
RATIO AVERAGE
NET RATIO OF OF NET COMMISSION
FISCAL ASSET NET ASSETS EXPENSES INCOME PAID PER
YEAR VALUE TOTAL END OF TO (LOSS) TO PORTFOLIO INVESTMENT
ENDED END OF RETURN PERIOD AVERAGE AVERAGE TURNOVER SECURITY
DEC. 31 PERIOD (d) (THOUSANDS) NET ASSETS NET ASSETS RATE TRADED(j)
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<S> <C> <C> <C> <C> <C> <C> <C>
SERIES C
1987(a) $11.41 6.4% $ 44,463 0.66% 6.37% --- $ N/A
1988 12.23 7.2% 82,904 0.65% 7.17% --- N/A
1989(a) 12.79 9.0% 94,560 0.63% 8.58% --- N/A
1990(a) 12.74 8.0% 73,599 0.60% 7.66% --- N/A
1991(a) 12.52 5.6% 86,610 0.61% 5.42% --- N/A
1992 12.21 3.2% 87,246 0.61% 3.19% --- N/A
1993 12.09 2.6% 99,092 0.61% 2.65% --- N/A
1994 12.27 3.7% 118,668 0.61% 3.70% --- N/A
1995(f) 12.34 5.4% 105,436 0.60% 5.27% --- N/A
1996(a)(f) 12.56 5.1% 128,672 0.58% 4.89% --- N/A
1997(h) 12.88 2.5% 138,376 0.58% 5.00% --- N/A
SERIES K
1995(a)(d)(e) $10.22 7.6% $ 5,678 1.63% 11.03% 127% $ N/A
1996(e) 10.72 13.7% 12,720 0.84% 10.79% 86% N/A
1997(e)(h) 10.98 2.4% 15,785 0.60% 9.56% 107% N/A
SERIES O
1995(a)(d) $11.70 17.0% $ 13,528 1.40% 3.0% 3% $ N/A
1996 14.01 20.0% 62,377 1.15% 2.62% 22% 0.0385
1997(h) 16.04 14.5% 105,087 1.09% 2.49% 49% 0.0314
SERIES S
1991(b) $10.55 5.5% $ 2,711 1.00% 1.49% 162% $ N/A
1992(a) 12.25 16.4% 9,653 0.92% 0.24% 110% N/A
1993 13.69 11.9% 19,490 0.90% 0.23% 105% N/A
1994 12.97 (3.7%) 24,539 0.90% 0.75% 67% N/A
1995(f) 16.49 27.7% 36,830 0.86% 0.75% 122% N/A
1996(f) 19.08 18.8% 57,497 0.84% 0.30% 67% 0.0602
1997(h) 21.18 11.0% 74,079 0.82% 0.48% 57% 0.0600
</TABLE>
(a) Net investment income per share has been calculated using the weighted
monthly average number of capital shares outstanding.
(b) The date of inception for Series S was May 1, 1991. On this date the Series
commenced operations with a net asset value of $10 per share. Percentage
amounts for the initial period of the series have been annualized, except
for total return.
(c) Total return information does not take into account (i) any sales charges
paid at the time of purchase, (ii) expenses of the separate account, or
(iii) expenses of the related variable annuity or variable life insurance
contract. Inclusion of these charges would reduce the total return
information for all periods shown.
(d) Series K and O were initially capitalized on June 1, 1995 with net asset
values of $10 per share. Percentage amounts for the period have been
annualized, except for total return.
(e) Fund expenses were reduced by the Investment Manager during the periods,
and expense ratios absent such reimbursement for Series K would have been
2.03% in 1995, 1.59% in 1996 and 1.35% in 1997.
(f) Expense ratios were calculated without the reduction for custodian fees
earnings credits beginning February 1, 1995. Series S expense ratio was
reduced as a result of such credits and would have been 0.84% in 1995 had
such credits been included.
(g) Brokerage commissions paid on portfolio transactions increase the cost of
securities purchased or reduce the proceeds of securities sold and are not
reflected in the Fund's statement of operations. Shares traded on a
principal basis, such as most over-the-counter and fixed-income
transactions, pay a "spread" or "mark-up" rather than a commission and are
therefore excluded from this calculation. Generally, non-U.S. commissions
are lower than U.S. commissions when expressed as cents per share but
higher when expressed as a percentage of transactions because of the lower
per-share prices of many non-U.S. securities. Prior to 1996, average
commission information was not required to be disclosed.
(h) Unaudited figures for the six-month period ended June 30, 1997. Percentage
amounts for the period except total return, have been annualized.
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SBL FUND
SBL Fund (the "Fund"), a Kansas corporation, was organized on May 26, 1977,
to serve as the investment vehicle for certain of Security Benefit Life
Insurance Company's ("SBL") variable annuity and variable life separate
accounts. Shares of the Fund will be sold to SBL for allocation to such separate
accounts established for the purpose of funding variable annuity and variable
life insurance contracts issued by SBL. The Fund reserves the right to expand
the class of persons eligible to purchase shares of any Series of the Fund.
The Fund is subject to certain investment policy limitations which may not
be changed without stockholder approval. Among these limitations, the more
important ones are that the Fund will not, with respect to 75 percent of its
total assets, invest more than 5 percent of the value of its assets in any one
issuer other than the U.S. Government or its agencies or instrumentalities, or
purchase more than 10 percent of the outstanding voting securities of any
issuer. In addition, no Series will invest more than 25 percent of its total
assets in any one industry. The full text of the investment policy limitations
is set forth in the Fund's "Statement of Additional Information."
It is conceivable that in the future it may be disadvantageous for variable
life insurance separate accounts and variable annuity separate accounts to
invest in the Fund simultaneously. Although neither SBL nor SBL Fund currently
foresee any such disadvantages, either to variable life insurance policyowners
or to variable annuity contractowners, the Fund's Board of Directors intends to
monitor events in order to identify any material conflicts between such
policyowners and contractowners resulting from changes in state insurance law,
changes in federal income tax regulation, changes in the investment management
of any portfolio of the underlying fund, and the differences between voting
instructions given by policyowners and contractowners. The Board will determine
what action, if any, should be taken in response to any such conflicts. If the
Board of Directors were to conclude that separate funds should be established
for variable life and variable annuity separate accounts, SBL would bear the
attendant expenses, but variable life insurance policyowners and variable
annuity contractowners would no longer have the economies of scale resulting
from a larger combined fund.
INVESTMENT OBJECTIVES AND POLICIES OF THE SERIES
The investment objective of each Series is described below. There are risks
inherent in the ownership of any security and there can be no assurance that
such investment objective will be achieved. Some of the risks involved are
described below and in the Statement of Additional Information. The investment
objective and policies of each Series may be modified at any time without
stockholder approval. However, each of the Series is subject to certain
investment policy limitations set forth in the Statement of Additional
Information, which may not be changed without stockholder approval. Each of the
Series may borrow money from banks as a temporary measure for emergency
purposes, to facilitate redemption requests, or for other purposes consistent
with the Series' investment objective and policies. See the discussion of
borrowing under "Investment Methods and Risk Factors." Pending investment in
other securities or to meet potential redemptions or expenses, each Series may
invest in certificates of deposit issued by banks, bank demand accounts,
repurchase agreements and high quality money market instruments.
SERIES C (MONEY MARKET SERIES)
The investment objective of Series C is to seek as high a level of current
income as is consistent with preservation of capital, similar to the objective
associated with a "money market" fund or series. The Series will attempt to
achieve its objective by investing at least 95 percent of its total assets,
measured at the time of investment, in a diversified portfolio of highest
quality money market instruments (e.g., instruments rated Aaa or Prime-1 by
Moody's or AAA or A-1 by S&P or unrated securities that are determined to be of
equivalent quality by the Investment Manager under procedures adopted by the
Fund's Board of Directors). Series C may also invest up to 5 percent of its
total assets, measured at the time of investment, in money market instruments
that are in the second-highest rating category for short-term debt obligations
(e.g., instruments rated Aa or Prime-2 by Moody's or AA or A-2 by S&P). Series C
will purchase only securities that the Investment Manager determines present
minimal credit risk under procedures adopted by the Fund's Board of Directors
and that satisfy the quality requirements of Rule 2a-7 under the Investment
Company Act of 1940 (the "1940 Act"). The Series may invest in money market
instruments with varying maturities (but not longer than thirteen months),
consisting of obligations issued or guaranteed (as to principal or interest) by
the United States Government or its agencies (such as the Federal Housing
Administration and Government National Mortgage Association), or
instrumentalities (such as Federal Home Loan Banks and Federal Land Banks) (see
the Statement of Additional Information for a description of the differing
levels of guarantees associated with these types of securities) and instruments
fully collateralized with such obligations such as repurchase agreements;
obligations of banks or savings and loan associations that are members of the
Federal Deposit Insurance Corporation, and instruments fully collateralized with
such obligations such as repurchase agreements (the additional risks involved in
such agreements are discussed under "Investment Methods and Risk Factors"); or
commercial paper issued by corporations or other corporate debt instruments,
subject to the limitations on investment in instruments in the second-highest
rating category, discussed above. The Statement of Additional Information
contains a description of commercial paper and corporate bond ratings.
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Series C may invest in instruments having rates of interest that are
adjusted periodically according to a specified market rate for such investments
("Variable Rate Instruments"). The interest rate on Variable Rate Instruments is
ordinarily determined by reference to, or is a percentage of, an objective
standard such as a bank's prime rate or the 91-day U.S. Treasury Bill rate.
Generally, the changes in the interest rate on Variable Rate Instruments reduce
the fluctuation in the market value of such securities. Accordingly, as interest
rates decrease or increase, the potential for capital appreciation or
depreciation is less than for fixed-rate obligations. Series C determines the
maturity of Variable Rate Instruments in accordance with Rule 2a-7 under the
1940 Act which allows the Series to consider the maturity date of such
instruments to be the period remaining until the next readjustment of the
interest rate rather than the maturity date on the face of the instrument.
Certain of the securities purchased by Series C may be restricted as to
disposition under the federal securities laws provided that such securities are
eligible for resale to qualified institutional investors pursuant to Rule 144A
under the Securities Act of 1933 and subject to the Series' policy that not more
than 10 percent of total assets will be invested in illiquid securities. See the
description of such securities under "Investment Methods and Risk Factors" --
"Restricted Securities."
Investment in Series C involves minimal market risk and, to reduce the
effect of fluctuating interest rates on the net asset value of its shares,
Series C intends to maintain a dollar weighted average maturity in its portfolio
of not more than 90 days. In addition to general market risks, Series C
investments in non-government obligations are subject to the ability of the
issuer to satisfy its obligations. The Statement of Additional Information
contains a description of the principal types of securities and instruments in
which Series C will invest.
SERIES K (GLOBAL AGGRESSIVE BOND SERIES)
The primary investment objective of Series K is to seek to provide high
current income. Capital appreciation is a secondary objective. As used herein,
the term "bond" is used to describe any type of debt security. Under normal
circumstances, the Series will invest at least 65 percent of its total assets in
bonds as defined herein. The Series under normal circumstances invests
substantially all of its assets in a portfolio of debt securities of issuers in
three separate investment areas: (i) the United States; (ii) developed foreign
countries; and (iii) emerging markets. The Series selects particular debt
securities in each sector based on their relative investment merits. Within each
area, the Series selects debt securities from those issued by governments, their
agencies and instrumentalities; central banks; commercial banks and other
corporate entities. Debt securities in which the Series may invest consist of
bonds, notes, debentures and other similar instruments. The Series may invest up
to 100 percent of its total assets in U.S. and foreign debt securities and other
fixed income securities that, at the time of purchase, are rated below
investment grade ("high yield securities" or "junk bonds"), which involve a high
degree of risk and are predominantly speculative. The Series may also invest in
securities that are in default as to payment of principal and/or interest. See
"Investment Methods and Risk Factors" -- "Risks Associated with Investments in
High-Yield Lower-Rated Debt Securities." Many emerging market debt securities
are not rated by United States rating agencies such as Moody's and S&P. The
Series' ability to achieve its investment objectives is thus more dependent on
the credit analysis of the Series' Sub-Advisers, Lexington Management
Corporation ("Lexington") and MFR Advisors, Inc. ("MFR"), than would be the case
if the Series were to invest in higher quality bonds. Investors should purchase
shares only as a supplement to an overall investment program and only if willing
to undertake the risks involved.
For the year ended December 31, 1996, the dollar weighted average of Series
K's holdings (excluding equities) had the following credit quality
characteristics.
INVESTMENT PERCENT OF NET ASSETS
U.S. Government Securities...................... 5.3%
Cash and other Assets, Less Liabilities......... 0.1%
Rated Fixed Income Securities
AAA........................................... 15.6%
AA............................................ 7.3%
A............................................. 14.9%
Baa/BBB....................................... 21.9%
Ba/BB......................................... 11.9%
B............................................. 23.0%
Caa/CCC....................................... 0%
Unrated Securities Comparable in Quality to
A............................................. 0%
Baa/BBB....................................... 0%
Ba/BB......................................... 0%
B............................................. 0%
Caa/CCC....................................... 0%
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Total........................................... 100.0%
The foregoing table is intended solely to provide disclosure about Series K's
asset composition during the year ended December 31, 1996. The asset composition
after this may or may not be approximately the same as shown above.
"Emerging markets" will consist of all countries determined by the World
Bank or the United Nations to have developing or emerging economies and markets.
Currently, investing in many of the emerging countries and emerging markets is
not feasible or may involve political risks. Accordingly, Lexington currently
intends to consider investments only in those countries in which it believes
investing is feasible. The list of acceptable countries will be reviewed by
Lexington and MFR and approved by the Fund's Board of Directors on a periodic
basis and any additions or deletions with respect to such list will be made in
accordance with changing economic and political circumstances involving such
countries. An issuer in an
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5
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emerging market is an entity: (i) for which the principal securities trading
market is an emerging market, as defined above; (ii) that (alone or on a
consolidated basis) derives 50 percent or more of its total revenue from either
goods produced, sales made or services performed in emerging markets; or (iii)
organized under the laws of, and with a principal office in, an emerging market.
Because of the special risks associated with investing in emerging markets,
an investment in the Series should be considered speculative. Investors are
strongly advised to consider carefully the special risks involved in emerging
markets which are in addition to the usual risks of investing in developed
foreign markets around the world. See the discussion of the risks of investing
in emerging markets under "Investment Methods and Risk Factors" -- "Emerging
Markets Risks."
The Series' investments in emerging market securities consist substantially
of high yield, lower-rated debt securities of foreign corporations, "Brady
Bonds" and other sovereign debt securities issued by emerging market
governments. "Sovereign debt securities" are those issued by emerging market
governments that are traded in the markets of developed countries or groups of
developed countries. The Series may invest in debt securities of emerging market
issuers without regard to ratings. Currently, the substantial majority of
emerging market debt securities are considered to have a credit quality below
investment grade. Series K also may acquire lower quality debt securities during
an initial underwriting or may acquire lower quality debt securities which are
sold without registration under applicable securities laws. Such securities
involve special considerations and risks. The Series may invest in bank loan
participations and assignments, which are fixed and floating rate loans arranged
through private negotiations between foreign entities. For a more detailed
discussion of these instruments and the risks associated with investing therein,
see "Sovereign Debt," "Loan Participations and Assignments" and "Brady Bonds"
under "Investment Methods and Risk Factors."
The Series intends to retain the flexibility to respond promptly to changes
in market and economic conditions. Accordingly, in the interest of preserving
shareholders' capital and consistent with the Series' investment objectives,
Lexington and MFR may employ a temporary defensive investment strategy if they
determine such a strategy to be warranted. Pursuant to such a defensive
strategy, the Series temporarily may hold cash (U.S. dollars, foreign currencies
or multinational currency units) and/or invest up to 100 percent of its assets
in high quality debt securities or money market instruments of U.S. or foreign
issuers, and most or all of the Series' investments may be made in the United
States and denominated in U.S. dollars. For debt obligations other than
commercial paper, this includes securities rated, at the time of purchase, at
least AA by S&P or Aa by Moody's, or if unrated, determined to be of comparable
quality by Lexington or MFR. For commercial paper, this includes securities
rated, at the time of purchase, at least A-2 by S&P or Prime-2 by Moody's, or if
unrated, determined to be of comparable quality by Lexington or MFR. It is
impossible to predict whether, when or for how long the Series will employ
defensive strategies. To the extent the Series adopts a temporary defensive
investment posture, it will not be invested so as to achieve directly its
investment objectives. In addition, pending investment of proceeds from new
sales of Series shares or to meet ordinary daily cash needs, the Series
temporarily may hold cash (U.S. dollars, foreign currencies or multinational
currency units) and may invest any portion of its assets in high quality foreign
or domestic money market instruments.
The Series invests in debt obligations allocated among diverse markets and
denominated in various currencies, including U.S. dollars, or in multinational
currency units such as European Currency Units. The Series may purchase
securities that are issued by the government or a company or financial
institution of one country but denominated in the currency of another country
(or a multinational currency unit). The Series is designed for investors who
wish to accept the risks entailed in such investments, which are different from
those associated with a portfolio consisting entirely of securities of U.S.
issuers denominated in U.S. dollars. See "Investment Methods and Risk Factors"
- -- "Currency Risk" and "Foreign Investment Risks."
Lexington and MFR will seek to allocate the assets of the Series in
securities of issuers in countries and in currency denominations where the
combination of fixed income market returns, the price appreciation potential of
fixed income securities and currency exchange rate movements will present
opportunities primarily for high current income and secondarily for capital
appreciation. In so doing, Lexington and MFR intend to take full advantage of
the different yield, risk and return characteristics that investment in the
fixed income markets of different countries can provide for U.S. investors.
Fundamental economic strength, credit quality and currency and interest rate
trends will be the principal determinants of the emphasis given to various
country, geographic and industry sectors within the Series. Securities held by
the Series may be invested in without limitation as to maturity. Lexington and
MFR evaluate currencies on the basis of fundamental economic criteria (e.g.,
relative inflation and interest rate levels and trends, growth rate forecasts,
balance of payments status and economic policies) as well as technical and
political data. If the currency in which a security is denominated appreciates
against the U.S. dollar, the dollar value of the security will increase.
Conversely, if the exchange rate of the foreign currency declines, the dollar
value of the security will decrease. The Series may seek to protect itself
against such negative currency movements through the use of sophisticated
investment techniques, although the Series is not committed to using such
techniques and may be fully exposed to changes in currency exchange rates.
In seeking to protect against currency exchange rate or interest rate
changes that are adverse to its present or prospective positions, the Series may
employ certain risk
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6
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management practices involving the use of forward currency contracts and options
contracts, futures contracts and options on futures contracts on U.S. and
foreign government securities and currencies. The Series may purchase call and
put options and write such options on a "covered" basis. The Series also may
enter into interest rate currency and index swaps and purchase or sell related
caps, floors and collars and other derivatives. The Series may enter into
derivatives securities transactions without limit. See the discussion of
"Forward Currency Transactions," "Options," "Futures Contracts and Related
Options," and "Swaps, Caps, Floors and Collars" under "Investment Methods and
Risk Factors." There can be no assurance that the Series' risk management
practices will succeed. Only a limited market, if any, currently exists for
forward currency contracts and options and futures instruments relating to
currencies of most emerging markets, to securities denominated in such
currencies or to securities of issuers domiciled or principally engaged in
business in such emerging markets.
The Series may acquire certain securities that are restricted as to
disposition under federal securities laws, including securities eligible for
resale to qualified institutional investors pursuant to Rule 144A under the
Securities Act of 1933, subject to the Series' policy that not more than 15
percent of the Series' net assets will be invested in illiquid assets. See
"Investment Methods and Risk Factors" for a discussion of restricted securities.
The Series may purchase securities on a "when-issued" basis and may
purchase or sell securities on a "forward commitment" basis in order to hedge
against anticipated changes in interest rates and prices. See the discussion of
when-issued and forward commitment securities under "Investment Methods and Risk
Factors." The Series may enter into repurchase agreements, reverse repurchase
agreements and "dollar rolls" which are discussed under "Investment Methods and
Risk Factors." Series K may invest up to 5 percent of its total assets in zero
coupon securities. See "Investment Methods and Risk Factors" for a discussion of
zero coupon securities.
SERIES O (EQUITY INCOME SERIES)
The investment objective of Series O is to seek to provide substantial
dividend income and also capital appreciation by investing primarily in
dividend-paying common stocks of established companies. In pursuing its
objective, the Series emphasizes companies with favorable prospects for
increasing dividend income, and secondarily, capital appreciation. Over time,
the income component (dividends and interest earned) of the Series' investments
is expected to be a significant contributor to the Series' total return. The
Series' income yield is expected to be significantly above that of the Standard
& Poor's 500 Stock Index ("S&P 500"). Total return will consist primarily of
dividend income and secondarily of capital appreciation (or depreciation).
The investment program of the Series is based on several premises. First,
the Series' Sub-Adviser, T. Rowe Price Associates, Inc. ("T. Rowe Price"),
believes that, over time, dividend income can account for a significant
component of the total return from equity investments. Second, dividends are
normally a more stable and predictable source of return than capital
appreciation. While the price of a company's stock generally increases or
decreases in response to short-term earnings and market fluctuations, its
dividends are generally less volatile. Finally, T. Rowe Price believes that
stocks which distribute a high level of current income tend to have less price
volatility than those which pay below average dividends.
To achieve its objective, the Series, under normal circumstances, will
invest at least 65 percent of its assets in income-producing common stocks,
whose prospects for dividend growth and capital appreciation are considered
favorable by T. Rowe Price. To enhance capital appreciation potential, the
Series also uses a value-oriented approach, which means it invests in stocks it
believes are currently undervalued in the market place. The Series' investments
will generally be made in companies which share some of the following
characteristics: established operating histories; above-average current dividend
yields relative to the S&P 500; low price-earnings ratios relative to the S&P
500; sound balance sheets and other financial characteristics; and low stock
price relative to the company's underlying value as measured by assets,
earnings, cash flow or business franchises.
The Series may also invest its assets in fixed income securities
(corporate, government, and municipal bonds of various maturities). The Series
would invest in municipal bonds when the expected total return from such bonds
appears to exceed the total returns obtainable from corporate or government
bonds of similar credit quality.
Series O may invest in debt securities of any type without regard to
quality or rating. Such securities would be purchased in companies which meet
the investment criteria for the Series. Such securities may include securities
rated below investment grade (e.g., securities rated Ba or lower by Moody's or
BB or lower by S&P). The Series will not purchase such a security (commonly
referred to as a "junk bond") if immediately after such purchase the Series
would have more than 10 percent of its total assets invested in such securities.
See "Investment Methods and Risk Factors" -- "Risks Associated with Investment
in High-Yield Lower-Rated Debt Securities" for a discussion of the risks
associated with investing in such securities.
Although the Series will invest primarily in U.S. common stocks, it may
also purchase other types of securities, for example, foreign securities,
convertible securities, real estate investment trusts (REITs) and warrants, when
considered consistent with the Series' investment objective and program. See the
"Investment Methods and Risk Factors" -- "Real Estate Securities" for a
discussion of the risks of investing in such securities.
The Series' investments in foreign securities include non-dollar
denominated securities traded outside of the U.S. and dollar denominated
securities traded in the U.S. (such
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as ADRs). The Series may invest up to 25 percent of its total assets in foreign
securities. See the discussion of the risks associated with investing in foreign
securities under "Investment Methods and Risk Factors," "American Depositary
Receipts (ADRs)," "Currency Risk" and "Foreign Investment Risks."
The Series may also engage in a variety of investment management practices,
such as buying and selling futures and options. The Series may buy and sell
futures contracts (and options on such contracts) to manage its exposure to
changes in securities prices and foreign currencies and as an efficient means of
adjusting its overall exposure to certain markets. The Series may purchase,
sell, or write call and put options on securities, financial indices, and
foreign currencies. The Series may write call and put options only on a
"covered" basis. It is the Series' operating policy that initial margin deposits
and premiums on options used for non-hedging purposes will not equal more than 5
percent of the Series' net asset value and, with respect to options on
securities, the total market value of securities against which the Series has
written call or put options may not exceed 25 percent of its total assets. The
Series will not commit more than 5 percent of its total assets to premiums when
purchasing call or put options. The Series may also invest up to 10 percent of
its total assets in hybrid instruments which are described under "Investment
Methods and Risk Factors" -- "Hybrid Instruments." Also see the discussion of
"Forward Currency Transactions," "Futures Contracts and Related Options" and
"Options" under "Investment Methods and Risk Factors."
The Series may also invest in restricted securities described under
"Investment Methods and Risk Factors." The Series' investment in such
securities, other than Rule 144A securities, is limited to 5 percent of its net
assets. Series O may invest in securities on a "when issued" or "delayed
delivery basis" as discussed in "Investment Methods and Risk Factors." The
Series may borrow money as described under "Investment Methods and Risk Factors"
- -- "Borrowing." The Series will not purchase securities when borrowings exceed 5
percent of its total assets. The Series may hold a certain portion of its assets
in money market securities, including repurchase agreements, in the two highest
rating categories, maturing in one year or less. For temporary, defensive
purposes, the Series may invest without limitation in such securities. The
Series may lend securities to broker-dealers, other institutions, or other
persons to earn additional income. The value of loaned securities may not exceed
33 1/3 percent of the Series' total assets. See "Investment Methods and Risk
Factors" -- "Lending of Portfolio Securities" for a discussion of the risks
associated with securities lending.
SERIES S (SOCIAL AWARENESS SERIES)
The investment objective of Series S is to seek capital appreciation. In
seeking its objective, Series S will invest in various types of securities which
meet certain social criteria established for the Series. Series S will invest in
a diversified portfolio of common stocks, convertible securities, preferred
stocks and debt securities. From time to time, the Series may purchase
government bonds or commercial notes on a temporary basis for defensive
purposes.
Securities selected for their appreciation possibilities will be primarily
common stocks or other securities having the investment characteristics of
common stocks, such as securities convertible into common stocks. Securities
will be selected on the basis of their appreciation and growth potential.
Securities considered to have capital appreciation and growth potential will
often include securities of smaller and less mature companies. Such companies
may present greater opportunities for capital appreciation because of high
potential earnings growth, but may also involve greater risk. They may have
limited product lines, markets or financial resources, and they may be dependent
on a limited management group. Their securities may trade less frequently and in
limited volume, and only in the over-the-counter market or on smaller securities
exchanges. As a result, the securities of smaller companies may have limited
marketability and may be subject to more abrupt or erratic changes in value than
securities of larger, more established companies. The Series may also invest in
larger companies where opportunities for above-average capital appreciation
appear favorable and the Series' social criteria are satisfied.
Series S may enter into futures contracts (a type of derivative) (or
options thereon) to hedge all or a portion of its portfolio or as an efficient
means of adjusting its exposure to the stock market. The Series will limit its
use of futures contracts so that initial margin deposits or premiums on such
contracts used for non-hedging purposes will not equal more than 5 percent of
the Series' net assets. The Series may also write call and put options on a
covered basis and purchase put and call options on securities and financial
indices. The aggregate market value of the Series' portfolio securities covering
call or put options will not exceed 25 percent of the Series' net assets. See
the discussion of options and futures contracts under "Investment Methods and
Risk Factors."
Series S will seek investments that comply with the Series' social criteria
and that offer investment potential. Because of the limitations on investment
imposed by the social criteria, the availability of investment opportunities for
the Series may be limited as compared to those of similar funds which do not
impose such restrictions on investment.
Series S will not invest in securities of companies that engage in the
production of nuclear energy, alcoholic beverages or tobacco products.
In addition, the Series will not invest in securities of companies that
significantly engage in: (1) the manufacture of weapon systems; (2) practices
that, on balance, have a detrimental effect on the environment; or (3) the
gambling industry. Series S will monitor the activities identified above to
determine whether they are significant to an issuer's business. Significance may
be determined on the basis of the percentage of revenue generated by, or the
size of operations attributable to, such activities. The Series may
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invest in an issuer that engages in the activities set forth above, in a degree
that is not deemed significant by Security Management Company, LLC (the
"Investment Manager"). In addition, the Series will seek out companies that have
contributed substantially to the communities in which they operate, have a
positive record on employment relations, have made substantial progress in the
promotion of women and minorities or in the implementation of benefit policies
that support working parents, or have taken notably positive steps in addressing
environmental challenges.
The Investment Manager will evaluate an issuer's activities to determine
whether it engages in any practices prohibited by the Series' social criteria.
In addition to its own research with respect to an issuer's activities, the
Investment Manager will also rely on other organizations that publish
information for investors concerning the social policy implications of corporate
activities. The Investment Manager may rely upon information provided by
advisory firms that provide social research on U.S. corporations, such as
Kinder, Lydenberg, Domini & Co., Inc., Franklin Insight, Inc. and
Prudential-Bache Capital Funding. Investment selection on the basis of social
attributes is a relatively new practice and the sources for this type of
information are not well established. The Investment Manager will continue to
identify and monitor sources of such information to screen issuers which do not
meet the social investment restrictions of the Series.
If after purchase of an issuer's securities by Series S, it is determined
that such securities do not comply with the Series' social criteria, the
securities will be eliminated from the Series' portfolio within a reasonable
time. This requirement may cause the Series to dispose of a security at a time
when it may be disadvantageous to do so.
INVESTMENT METHODS AND RISK FACTORS
Some of the risk factors related to certain securities, instruments and
techniques that may be used by one or more of the Series are described in the
"Investment Objectives and Policies" section of this Prospectus and in the
Fund's Statement of Additional Information. The following is a description of
certain additional risk factors related to various securities, instruments and
techniques. The risks so described only apply to those Series which may invest
in such securities and instruments or which use such techniques. Also included
is a general description of some of the investment instruments, techniques and
methods which may be used by one or more of the Series. The methods described
only apply to those Series which may use such methods. Although a Series may
employ the techniques, instruments and methods described below, consistent with
its investment objective and policies and any applicable law, no Series will be
required to do so.
INVESTMENT VEHICLES
CONVERTIBLE SECURITIES -- Each of the Series, except Series C, may invest
in convertible securities. A convertible security is a fixed income security or
a preferred stock that may be converted at either a stated price or stated rate
into underlying shares of common stock. Convertible securities have general
characteristics similar to both debt obligations and equity securities. Although
to a lesser extent than with debt obligations generally, the market value of
convertible securities tends to decline as interest rates increase and,
conversely, tends to increase as interest rates decline. In addition, because of
the conversion feature, the market value of convertible securities tends to vary
with fluctuations in the market value of the underlying common stock, and
therefore, also will react to variations in the general market for equity
securities. A unique feature of convertible securities is that as the market
price of the underlying common stock declines, convertible securities tend to
trade increasingly on a yield basis, and so may not experience market value
declines to the same extent as the underlying common stock. When the market
price of the underlying common stock increases, the prices of the convertible
securities tend to rise as a reflection of the value of the underlying common
stock. While no securities investments are without risk, investments in
convertible securities generally entail less risk than investments in common
stock of the same issuer.
As debt obligations, convertible securities are investments that provide
for a stable stream of income with generally higher yields than common stocks.
Of course, like all debt obligations, there can be no assurance of current
income because the issuers of the convertible securities may default on their
obligations. Convertible securities, however, generally offer lower interest or
dividend yields than non-convertible securities of similar quality because of
the potential for capital appreciation. A convertible security, in addition to
providing fixed income, offers the potential for capital appreciation through
the conversion feature, which enables the holder to benefit from increases in
the market price of the underlying common stock. There can be no assurance of
capital appreciation, however, because the market value of securities will
fluctuate.
Convertible securities generally are subordinated to other similar but
non-convertible securities of the same issuer, although convertible bonds, as
corporate debt obligations, enjoy seniority in right of payment to all equity
securities, and convertible preferred stock is senior to common stock of the
same issuer. Because of the subordination feature, however, convertible
securities typically have lower ratings than similar non-convertible securities.
WARRANTS -- Warrants are options to buy a stated number of shares of common
stock at a specified price any time during the life of the warrants (generally
two or more years).
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U.S. GOVERNMENT SECURITIES -- Each Series may invest in U.S. Government
securities which include obligations issued or guaranteed (as to principal and
interest) by the United States Government or its agencies (such as the Small
Business Administration, the Federal Housing Administration, and Government
National Mortgage Association), or instrumentalities (such as Federal Home Loan
Banks and Federal Land Banks), and instruments fully collateralized with such
obligations such as repurchase agreements. Some U.S. Government securities, such
as Treasury bills and bonds, are supported by the full faith and credit of the
U.S. Treasury; others are supported by the right of the issuer to borrow from
the Treasury; others, such as those of the Federal National Mortgage
Association, are supported by the discretionary authority of the U.S. Government
to purchase the agency's obligations; still others, such as those of the Student
Loan Marketing Association, are supported only by the credit of the
instrumentality. Government National Mortgage Association (GNMA) certificates
are mortgage-backed securities representing part ownership of a pool of mortgage
loans on which timely payment of interest and principal is guaranteed by the
full faith and credit of the U.S. Government. Although U.S. Government
securities are guaranteed by the U.S. Government, its agencies or
instrumentalities, shares of the Series are not so guaranteed in any way.
MORTGAGE-BACKED SECURITIES -- Mortgage-backed securities (MBSs), including
mortgage pass-through securities and collateralized mortgage obligations (CMOs),
include certain securities issued or guaranteed by the United States government
or one of its agencies or instrumentalities, such as the Government National
Mortgage Association (GNMA), Federal National Mortgage Association (FNMA), or
Federal Home Loan Mortgage Corporation (FHLMC); securities issued by private
issuers that represent an interest in or are collateralized by mortgage-backed
securities issued or guaranteed by the U.S. government or one of its agencies or
instrumentalities; and securities issued by private issuers that represent an
interest in or are collateralized by mortgage loans. A mortgage pass-through
security is a pro rata interest in a pool of mortgages where the cash flow
generated from the mortgage collateral is passed through to the security holder.
CMOs are obligations fully collateralized by a portfolio of mortgages or
mortgage-related securities. MBSs have been referred to as "derivatives" because
the performance of MBSs is dependent upon and derived from underlying
securities.
Investment in MBSs poses several risks, including prepayment, market and
credit risks. Prepayment risk reflects the chance that borrowers may prepay
their mortgages faster than expected, thereby affecting the investment's average
life and perhaps its yield. Borrowers are most likely to exercise their
prepayment options at a time when it is least advantageous to investors,
generally prepaying mortgages as interest rates fall, and slowing payments as
interest rates rise. Certain classes of CMOs may have priority over others with
respect to the receipt of prepayments on the mortgages and the Series may invest
in CMOs which are subject to greater risk of prepayment. Market risk reflects
the chance that the price of the security may fluctuate over time. The price of
MBSs may be particularly sensitive to prevailing interest rates, the length of
time the security is expected to be outstanding and the liquidity of the issue.
In a period of unstable interest rates, there may be decreased demand for
certain types of MBSs, and a Series invested in such securities wishing to sell
them may find it difficult to find a buyer, which may in turn decrease the price
at which they may be sold. Certain CMOs, especially those which pay variable
rates of interest which adjust inversely with and more rapidly than short-term
interest rates are very volatile in price and may have lower liquidity than most
mortgage-backed securities. Credit risk reflects the chance that the Fund may
not receive all or part of its principal because the issuer or credit enhancer
has defaulted on its obligations. Obligations issued by U.S. Government-related
entities are guaranteed by the agency or instrumentality, and some, such as GNMA
certificates, are supported by the full faith and credit of the U.S. Treasury;
others are supported by the right of the issuer to borrow from the Treasury;
others, such as those of the FNMA, are supported by the discretionary authority
of the U.S. Government to purchase the agency's obligations; still others, are
supported only by the credit of the instrumentality. Although securities issued
by U.S. Government-related agencies are guaranteed by the U.S. Government, its
agencies or instrumentalities, shares of the Series are not so guaranteed in any
way. The performance of private label MBSs, issued by private institutions, is
based on the financial health of those institutions. There is no guarantee the
Series' investment in MBSs will be successful, and the Series' total return
could be adversely affected as a result.
ASSET-BACKED SECURITIES -- Asset-backed securities represent a
participation in, or are secured by and payable from, a stream of payments
generated by particular assets, for example, automobile, credit card or trade
receivables. Asset-backed commercial paper, one type of asset-backed security,
is issued by a special purpose entity, organized solely to issue the commercial
paper and to purchase interests in the assets. The credit quality of these
securities depends primarily upon the quality of the underlying assets and the
level of credit support and/or enhancement provided.
The underlying assets (e.g., loans) are subject to prepayments which
shorten the securities' weighted average life and may lower their return. If the
credit support or enhancement is exhausted, losses or delays in payment may
result if the required payments of principal and interest are not made. The
value of these securities also may change because of changes in the market's
perception of the creditworthiness of the servicing agent for the pool, the
originator of the pool, or the financial institution providing the credit
support or enhancement.
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REAL ESTATE SECURITIES -- Certain Series may invest in equity securities of
real estate investment trusts ("REITs") and other real estate industry companies
or companies with substantial real estate investments and therefore, such Series
may be subject to certain risks associated with direct ownership of real estate
and with the real estate industry in general. These risks include, among others:
possible declines in the value of real estate; possible lack of availability of
mortgage funds; extended vacancies of properties; risks related to general and
local economic conditions; overbuilding; increases in competition, property
taxes and operating expenses; changes in zoning laws; costs resulting from the
clean-up of, and liability to third parties for damages resulting from,
environmental problems; casualty or condemnation losses; uninsured damages from
floods, earthquakes or other natural disasters; limitations on and variations in
rents; and changes in interest rates.
REITs are pooled investment vehicles which invest primarily in income
producing real estate or real estate related loans or interests. REITs are
generally classified as equity REITs, mortgage REITs or hybrid REITs. Equity
REITs invest the majority of their assets directly in real property and derive
income primarily from the collection of rents. Equity REITs can also realize
capital gains by selling properties that have appreciated in value. Mortgage
REITs invest the majority of their assets in real estate mortgages and derive
income from the collection of interest payments. REITs are not taxed on income
distributed to shareholders provided they comply with several requirement of the
Internal Revenue Code, as amended ( the "Code"). Certain REITs may be
self-liquidating in that a specific term of existence is provided for in the
trust document. Such trusts run the risk of liquidating at an economically
inopportune time.
WHEN-ISSUED AND FORWARD COMMITMENT SECURITIES -- Purchase or sale of
securities on a "forward commitment" basis may be used to hedge against
anticipated changes in interest rates and prices. The price, which is generally
expressed in yield terms, is fixed at the time the commitment is made, but
delivery and payment for the securities take place at a later date. When-issued
securities and forward commitments may be sold prior to the settlement date, but
the Series will enter into when-issued and forward commitments only with the
intention of actually receiving or delivering the securities, as the case may
be; however, a Series may dispose of a commitment prior to settlement if the
Investment Manager or relevant Sub-Adviser deems it appropriate to do so. No
income accrues on securities which have been purchased pursuant to a forward
commitment or on a when-issued basis prior to delivery of the securities. If a
Series disposes of the right to acquire a when-issued security prior to its
acquisition or disposes of its right to deliver or receive against a forward
commitment, it may incur a gain or loss. At the time a Series enters into a
transaction on a when-issued or forward commitment basis, a segregated account
consisting of cash or liquid securities equal to the value of the when-issued or
forward commitment securities will be established and maintained with its
custodian and will be marked to market daily. There is a risk that the
securities may not be delivered and that the Series may incur a loss.
RESTRICTED SECURITIES -- Restricted securities are acquired through private
placement transactions, directly from the issuer or from security holders,
generally at higher yields or on terms more favorable to investors than
comparable publicly traded securities. However, the restrictions on resale of
such securities may make it difficult for a Series to dispose of such securities
at the time considered most advantageous, and/or may involve expenses that would
not be incurred in the sale of securities that were freely marketable.
Restricted securities cannot be sold to the public without registration under
the Securities Act of 1933 ("1933 Act"). Unless registered for sale, restricted
securities can be sold only in privately negotiated transactions or pursuant to
an exemption from registration. Restricted securities are generally considered
illiquid and, therefore, subject to the Series' limitation on illiquid
securities.
Trading restricted securities pursuant to Rule 144A may enable a Series to
dispose of restricted securities at a time considered to be advantageous and/or
at a more favorable price than would be available if such securities were not
traded pursuant to Rule 144A. However, the Rule 144A market is relatively new
and liquidity of a Series' investment in such market could be impaired if
trading does not develop or declines. Risks associated with restricted
securities include the potential obligation to pay all or part of the
registration expenses in order to sell certain restricted securities. A
considerable period of time may elapse between the time of the decision to sell
a security and the time a Series may be permitted to sell it under an effective
registration statement. If, during a period, adverse conditions were to develop,
a Series might obtain a less favorable price than prevailing when it decided to
sell.
Non-publicly traded securities (including Rule 144A Securities) may involve
a high degree of business and financial risk which may result in substantial
losses. The securities may be less liquid than publicly traded securities.
Although these securities may be resold in privately negotiated transactions,
the prices realized from these sales could be less than those originally paid by
the Series. In particular, Rule 144A Securities may be resold only to qualified
institutional buyers in accordance with Rule 144A under the Securities Act of
1933. Unregistered securities may also be sold abroad pursuant to Regulation S
under the 1933 Act. Companies whose securities are not publicly traded are not
subject to the disclosure and other investor protection requirements that would
be applicable if their securities were publicly traded. Acting pursuant to
guidelines established by the Board of Directors, some restricted securities and
Rule 144A Securities may be considered liquid.
The Board of Directors is responsible for developing and establishing
guidelines and procedures for determining the
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liquidity of Rule 144A securities. As permitted by Rule 144A, the Board of
Directors has delegated this responsibility to the Investment Manager or
relevant Sub-Adviser. In making the determination regarding the liquidity of
Rule 144A securities, the Investment Manager or relevant Sub-Adviser will
consider trading markets for the specific security taking into account the
unregistered nature of a Rule 144A security. In addition, the Investment Manager
or relevant Sub-Adviser may consider: (1) the frequency of trades and quotes;
(2) the number of dealers and potential purchasers; (3) dealer undertakings to
make a market; and (4) the nature of the security and of the market place trades
(e.g., the time needed to dispose of the security, the method of soliciting
offers and the mechanics of transfer). Investing in Rule 144A securities could
have the effect of increasing the amount of a Series' assets invested in
illiquid securities to the extent that qualified institutional buyers become
uninterested, for a time, in purchasing these securities.
AMERICAN DEPOSITARY RECEIPTS (ADRS) -- ADRs are dollar-denominated receipts
issued generally by U.S. banks and which represent the deposit with the bank of
a foreign company's securities. ADRs are publicly traded on exchanges or
over-the-counter in the United States. Investors should consider carefully the
substantial risks involved in investing in securities issued by companies of
foreign nations, which are in addition to the usual risks inherent in domestic
investments. See "Foreign Investment Risks," below.
BRADY BONDS -- Certain Series may invest in "Brady Bonds," which are debt
restructurings that provide for the exchange of cash and loans for newly issued
bonds. Brady Bonds are securities created through the exchange of existing
commercial bank loans to public and private entities in certain emerging markets
for new bonds in connection with debt restructuring under a debt restructuring
plan introduced by former U.S. Secretary of the Treasury, Nicholas F. Brady.
Brady Bonds have been issued by the governments of Argentina, Brazil, Bulgaria,
Costa Rica, Dominican Republic, Ecuador, Jordan, Mexico, Nigeria, Panama, Peru,
The Philippines, Poland, Uruguay and Venezuela, and are expected to be issued by
other emerging market countries. Approximately $150 billion in principal amount
of Brady Bonds has been issued to date. Investors should recognize that Brady
Bonds have been issued only recently and, accordingly, do not have a long
payment history. Brady Bonds may be collateralized or uncollateralized, are
issued in various currencies (primarily the U.S. dollar) and are actively traded
in the secondary market for Latin American debt. The Salomon Brothers Brady Bond
Index provides a benchmark that can be used to compare returns of emerging
market Brady Bonds with returns in other bond markets, e.g., the U.S. bond
market.
Series K may invest in either collateralized or uncollateralized Brady
Bonds denominated in various currencies. U.S. dollar-denominated, collateralized
Brady Bonds, which may be fixed rate par bonds or floating rate discount bonds,
are collateralized in full as to principal by U.S. Treasury zero coupon bonds
having the same maturity as the bonds. Interest payments on such bonds generally
are collateralized by cash or securities in an amount that, in the case of fixed
rate bonds, is equal to at least one year of rolling interest payments or, in
the case of floating rate bonds, initially is equal to at least one year's
rolling interest payments based on the applicable interest rate at the time and
is adjusted at regular intervals thereafter.
LOAN PARTICIPATIONS AND ASSIGNMENTS -- Certain Series may invest in fixed
and floating rate loans ("Loans") arranged through private negotiations between
a corporate or foreign entity and one or more financial institutions
("Lenders"). The majority of Series K's investments in Loans in emerging markets
is expected to be in the form of participations in Loans ("Participations") and
assignments of portions of Loans from third parties ("Assignments").
Participations typically will result in a Series having a contractual
relationship only with the Lender, not with the borrower. The Series will have
the right to receive payments of principal, interest and any fees to which it is
entitled only from the Lender selling the Participation and only upon receipt by
the Lender of the payments from the borrower. In connection with purchasing
Participations, the Series generally will have no right to enforce compliance by
the borrower with the terms of the loan agreement relating to the Loan ("Loan
Agreement"), nor any rights of set-off against the borrower, and the Series may
not directly benefit from any collateral supporting the Loan in which it has
purchased the Participation. As a result, the Series will assume the credit risk
of both the borrower and the Lender that is selling the Participation.
In the event of the insolvency of the Lender selling a Participation, the
Series may be treated as a general creditor of the Lender and may not benefit
from any set-off between the Lender and the borrower. The Series will acquire
Participations only if the Lender interpositioned between the Series and the
borrower is determined by the Investment Manager or relevant Sub-Adviser to be
creditworthy. When a Series purchases Assignments from Lenders, the Series will
acquire direct rights against the borrower on the Loan. However, since
Assignments are arranged through private negotiations between potential
assignees and assignors, the rights and obligations acquired by the Series as
the purchaser of an Assignment may differ from, and be more limited than, those
held by the assigning Lender.
A Series may have difficulty disposing of Assignments and Participations.
The liquidity of such securities is limited and the Series anticipates that such
securities could be sold only to a limited number of institutional investors.
The lack of a liquid secondary market could have an adverse impact on the value
of such securities and on the Series' ability to dispose of particular
Assignments or Participations when necessary to meet the Series' liquidity needs
or in response to a specific economic event, such as a deterioration in the
creditworthiness of the borrower. The lack of a liquid secondary market for
Assignments and Participations also
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may make it more difficult for the Series to assign a value to those securities
for purposes of valuing the Series' portfolio and calculating its net asset
value.
ZERO COUPON SECURITIES -- Certain Series may invest in certain zero coupon
securities that are "stripped" U.S. Treasury notes and bonds. Certain Series
also may invest in zero coupon and other deep discount securities issued by
foreign governments and domestic and foreign corporations, including certain
Brady Bonds and other foreign debt and payment-in-kind securities. Zero coupon
securities pay no interest to holders prior to maturity, and payment-in-kind
securities pay interest in the form of additional securities. However, a portion
of the original issue discount on zero coupon securities and the "interest" on
payment-in-kind securities will be included in the investing Series' income.
Accordingly, for a Series to qualify for tax treatment as a regulated investment
company and to avoid certain taxes (see "Distributions and Federal Income Tax
Considerations"), the Series may be required to distribute an amount that is
greater than the total amount of cash it actually receives. These distributions
must be made from the Series' cash assets or, if necessary, from the proceeds of
sales of portfolio securities. A Series will not be able to purchase additional
income-producing securities with cash used to make such distributions and its
current income ultimately may be reduced as a result. Zero coupon and
payment-in-kind securities usually trade at a deep discount from their face or
par value and will be subject to greater fluctuations of market value in
response to changing interest rates than debt obligations of comparable
maturities that make current distributions of interest in cash.
SOVEREIGN DEBT -- Certain Series may invest in sovereign debt securities of
emerging market governments, including Brady Bonds (described above).
Investments in such securities involve special risks. The issuer of the debt or
the governmental authorities that control the repayment of the debt may be
unable or unwilling to repay principal or interest when due in accordance with
the terms of such debt. Periods of economic uncertainty may result in the
volatility of market prices of sovereign debt, and in turn the Series' net asset
value, to a greater extent than the volatility inherent in domestic fixed income
securities. A sovereign debtor's willingness or ability to repay principal and
pay interest in a timely manner may be affected by, among other factors, its
cash flow situation, the extent of its foreign reserves, the availability of
sufficient foreign exchange on the date a payment is due, the relative size of
the debt service burden to the economy as a whole, the sovereign debtor's policy
toward principal international lenders and the political constraints to which a
sovereign debtor may be subject. Emerging market governments could default on
their sovereign debt. Such sovereign debtors also may be dependent on expected
disbursements from foreign governments, multilateral agencies and other entities
abroad to reduce principal and interest arrearages on their debt. The commitment
on the part of these governments, agencies and others to make such disbursements
may be conditioned on a sovereign debtor's implementation of economic reforms
and/or economic performance and the timely service of such debtor's obligations.
Failure to implement such reforms, achieve such levels of economic performance
or repay principal or interest when due, may result in the cancellation of such
third parties' commitments to lend funds to the sovereign debtor, which may
further impair such debtor's ability or willingness to timely service its debt.
The occurrence of political, social or diplomatic changes in one or more of
the countries issuing sovereign debt could adversely affect the Series'
investments. Emerging markets are faced with social and political issues and
some of them have experienced high rates of inflation in recent years and have
extensive internal debt. Among other effects, high inflation and internal debt
service requirements may adversely affect the cost and availability of future
domestic sovereign borrowing to finance governmental programs, and may have
other adverse social, political and economic consequences. Political changes or
a deterioration of a country's domestic economy or balance of trade may affect
the willingness of countries to service their sovereign debt. Although the
Investment Manager or relevant Sub-Adviser intends to manage the Series in a
manner that will minimize the exposure to such risks, there can be no assurance
that adverse political changes will not cause the Series to suffer a loss of
interest or principal on any of its holdings.
In recent years, some of the emerging market countries in which Series K
expects to invest have encountered difficulties in servicing their sovereign
debt obligations. Some of these countries have withheld payments of interest
and/or principal of sovereign debt. These difficulties have also led to
agreements to restructure external debt obligations--in particular, commercial
bank loans, typically by rescheduling principal payments, reducing interest
rates and extending new credits to finance interest payments on existing debt.
In the future, holders of emerging market sovereign debt securities may be
requested to participate in similar rescheduling of such debt. Certain emerging
market countries are among the largest debtors to commercial banks and foreign
governments. At times certain emerging market countries have declared a
moratorium on the payment of principal and interest on external debt; such a
moratorium is currently in effect in certain emerging market countries. There is
no bankruptcy proceeding by which a creditor may collect in whole or in part
sovereign debt on which an emerging market government has defaulted.
The ability of emerging market governments to make timely payments on their
sovereign debt securities is likely to be influenced strongly by a country's
balance of trade and its access to trade and other international credits. A
country whose exports are concentrated in a few commodities could be vulnerable
to a decline in the international prices of one or more of such commodities.
Increased protectionism on the part of a country's trading partners could also
adversely affect its exports. Such events could diminish a country's trade
account surplus, if any. To the extent that a country receives payment for its
exports in currencies other than
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hard currencies, its ability to make hard currency payment could be affected.
Investors should also be aware that certain sovereign debt instruments in
which the Series may invest involve great risk. As noted above, sovereign debt
obligations issued by emerging market governments generally are deemed to be the
equivalent in terms of quality to securities rated below investment grade by
Moody's and S&P. Such securities are regarded as predominantly speculative with
respect to the issuer's capacity to pay interest and repay principal in
accordance with the terms of the obligations and involve major risk exposure to
adverse conditions. Some of such securities, with respect to which the issuer
currently may not be paying interest or may be in payment default, may be
comparable to securities rated D by S&P or C by Moody's. The Series may have
difficulty disposing of and valuing certain sovereign debt obligations because
there may be a limited trading market for such securities. Because there is no
liquid secondary market for many of these securities, the Fund anticipates that
such securities could be sold only to a limited number of dealers or
institutional investors. Certain sovereign debt securities may be illiquid.
REPURCHASE AGREEMENTS, REVERSE REPURCHASE AGREEMENTS AND ROLL TRANSACTIONS
- -- A repurchase agreement is a contract under which a Series would acquire a
security for a relatively short period (usually not more than 7 days) subject to
the obligation of the seller to repurchase and the Series to resell such
security at a fixed time and price. The resale price is in excess of the
purchase price and reflects an agreed-upon market rate unrelated to the coupon
rate of the purchased security. Repurchase agreements will be fully
collateralized including interest earned thereon during the entire term of the
agreement. If the institution defaults on the repurchase agreement, the Series
will retain possession of the underlying securities. If bankruptcy proceedings
are commenced with respect to the seller, realization on the collateral by the
Series may be delayed or limited and the Series may incur additional costs. In
such case, the Series will be subject to risks associated with changes in market
value of the collateral securities. Each of the Series intends to limit
repurchase agreements to institutions believed by the Investment Manager or
relevant Sub-Adviser to present minimal credit risk.
Certain Series may also enter into reverse repurchase agreements with the
same parties with whom they may enter into repurchase agreements. Under a
reverse repurchase agreement, the Series would sell securities and agree to
repurchase them at a particular price at a future date. Reverse repurchase
agreements involve the risk that the market value of the securities retained in
lieu of sale by the Series may decline below the price of the securities the
Series has sold but is obligated to repurchase. In the event the buyer of
securities under a reverse repurchase agreement files for bankruptcy or becomes
insolvent, such buyer or its trustee or receiver may receive an extension of
time to determine whether to enforce the Series' obligation to repurchase the
securities, and the Series' use of the proceeds of the reverse repurchase
agreement may effectively be restricted pending such decision.
Certain Series also may enter into "dollar rolls," in which the Series
sells fixed income securities for delivery in the current month and
simultaneously contracts to repurchase substantially similar (same type, coupon
and maturity) securities on a specified future date. During the roll period, the
Series would forego principal and interest paid on such securities. The Series
would be compensated by the difference between the current sales price and the
forward price for the future purchase, as well as by the interest earned on the
cash proceeds of the initial sale.
At the time a Series enters into reverse repurchase agreements or dollar
rolls, it will establish and maintain a segregated account with its custodian
containing cash or liquid securities having a value not less than the repurchase
price, including accrued interest. Reverse repurchase agreements and dollar
rolls will be treated as borrowings and will be deducted from a Series' assets
for purposes of calculating compliance with the Series' borrowing limitation.
See "Borrowing," below.
MANAGEMENT PRACTICES
CASH RESERVES -- Each Series may establish and maintain reserves as the
Investment Manager or relevant Sub-Adviser believes is advisable to facilitate
the Series' cash flow needs (e.g., redemptions, expenses and, purchases of
portfolio securities) or for temporary, defensive purposes. Such reserves may be
invested in domestic, and for certain Series, foreign money market instruments
rated within the top two credit categories by a national rating organization, or
if unrated, the Investment Manager or Sub-Adviser equivalent. Series K and O may
invest in shares of other investment companies. A Series' investment in shares
of other investment companies may not exceed immediately after purchase 10
percent of the Series' total assets and no more than 5 percent of its total
assets may be invested in the shares of any one investment company. Investment
in the shares of other investment companies has the effect of requiring
shareholders to pay the operating expenses of two mutual funds.
SHARES OF OTHER INVESTMENT COMPANIES -- Series K and O may invest in shares
of other investment companies. A Series' investment in shares of other
investment companies may not exceed immediately after purchase 10 percent of the
Series' total assets and no more than 5 percent of its total assets may be
invested in the shares of any one investment company. Investment in the shares
of other investment companies has the effect of requiring shareholders to pay
the operating expenses of two mutual funds.
BORROWING -- Each Series may borrow money from banks as a temporary measure
for emergency purposes, to facilitate redemption requests, or for other purposes
consistent with the Series' investment objective and program. Such borrowings
may be collateralized with Series assets. Borrowings will not exceed 5 percent
of the total
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assets of each Series except Series K and O, borrowings of which may not exceed
33 1/3 percent of total assets. To the extent that a Series purchases securities
while it has outstanding borrowings, it is using leverage, i.e., using borrowed
funds for investment. Leveraging will exaggerate the effect on net asset value
of any increase or decrease in the market value of a Series' portfolio. Money
borrowed for leveraging will be subject to interest costs that may or may not be
recovered by appreciation of the securities purchased; in certain cases,
interest costs may exceed the return received on the securities purchased. A
Series also may be required to maintain minimum average balances in connection
with such borrowing or to pay a commitment or other fee to maintain a line of
credit; either of these requirements would increase the cost of borrowing over
the stated interest rate. Series O may not purchase securities when borrowings
exceed 5 percent of its total assets.
LENDING OF PORTFOLIO SECURITIES -- Certain Series may lend securities to
broker-dealers, institutional investors, or other persons to earn additional
income. The principal risk is the potential insolvency of the broker-dealer or
other borrower. In this event, the Series could experience delays in recovering
its securities and possibly capital losses. Any loan will be continuously
secured by collateral at least equal to the value of the security loaned. Such
lending could result in delays in receiving additional collateral or in the
recovery of the securities or possible loss of rights in the collateral should
the borrower fail financially.
FORWARD CURRENCY TRANSACTIONS -- In seeking to protect against currency
exchange rate or interest rate changes that are adverse to their present or
prospective positions, certain Series may employ certain risk management
practices involving the use of forward currency contracts and options contracts,
futures contracts and options on futures contracts on U.S. and foreign
government securities and currencies. Series K also may enter into interest
rate, currency and index swaps and purchase or sell related caps, floors and
collars and other derivatives. See "Swaps, Caps, Floors and Collars" below.
There can be no assurance that such risk management practices will succeed. Only
a limited market, if any, currently exists for forward currency contracts and
options and futures instruments relating to currencies of most emerging markets,
to securities denominated in such currencies or to securities of issuers
domiciled or principally engaged in business in such emerging markets. To the
extent that such a market does not exist, a Sub-Adviser may not be able to
effectively hedge its investment in such emerging markets.
To attempt to hedge against adverse movements in exchange rates between
currencies, certain Series may enter into forward currency contracts for the
purchase or sale of a specified currency at a specified future date. Such
contracts may involve the purchase or sale of a foreign currency against the
U.S. dollar or may involve two foreign currencies. Such Series may enter into
forward currency contracts either with respect to specific transactions or with
respect to the respective Series' portfolio positions. For example, when a
Series anticipates making a purchase or sale of a security, it may enter into a
forward currency contract in order to set the rate (either relative to the U.S.
dollar or another currency) at which a currency exchange transaction related to
the purchase or sale will be made. Further, if the Investment Manager or
relevant Sub-Adviser believes that a particular currency may decline compared to
the U.S. dollar or another currency, certain Series may enter into a forward
contract to sell the currency the Investment Manager or Sub-Adviser expects to
decline in an amount up to the value of the portfolio securities held by the
Fund denominated in a foreign currency.
The Series' use of forward currency contracts or options and futures
transactions involve certain investment risks and transaction costs to which
they might not otherwise be subject. These risks include: dependence on the
Investment Manager or relevant Sub-Adviser's ability to predict movements in
exchange rates; imperfect correlation between movements in exchange rates and
movements in the currency hedged; and the fact that the skills needed to
effectively hedge against the Series' currency risks are different from those
needed to select the securities in which a Series invests. The Series also may
conduct foreign currency exchange transactions on a spot (i.e., cash) basis at
the spot rate prevailing in the foreign currency exchange market.
OPTIONS -- A call option on a security gives the purchaser of the option,
in return for a premium paid to the writer (seller), the right to buy the
underlying security at the exercise price at any time during the option period.
Upon exercise by the purchaser, the writer (seller) of a call option has the
obligation to sell the underlying security at the exercise price. When a Series
purchases a call option, it will pay a premium to the party writing the option
and a commission to the broker selling the option. If the option is exercised by
such Series, the amount of the premium and the commission paid may be greater
than the amount of the brokerage commission that would be charged if the
security were to be purchased directly. By writing a call option, a Series
assumes the risk that it may be required to deliver the security having a market
value higher than its market value at the time the option was written. A Series
will write call options in order to obtain a return on its investments from the
premiums received and will retain the premiums whether or not the options are
exercised. Any decline in the market value of the Series' portfolio securities
will be offset to the extent of the premiums received (net of transaction
costs). If an option is exercised, the premium received on the option will
effectively increase the exercise price.
The Series may write only covered call options. This means that the Series
will own the security or currency subject to the option or an option to purchase
the same underlying security or currency, having an exercise price equal to or
less than the exercise price of the "covered" option, or will establish and
maintain with its custodian for the term of the option, an account consisting of
cash or liquid securities having a value equal to the fluctuating
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market value of the optioned securities or currencies. During the option period
the writer of a call option has given up the opportunity for capital
appreciation above the exercise price should market price of the underlying
security increase, but has retained the risk of loss should the price of the
underlying security decline. Writing call options also involves the risk
relating to the Series' ability to close out options it has written.
A call option on a stock index is similar to a call option on an individual
security, except that the value of the option depends on the weighted value of
the group of securities comprising the index and all settlements are made in
cash. A call option may be terminated by the writer (seller) by entering into a
closing purchase transaction in which it purchases an option of the same series
as the option previously written.
A put option on a security gives the purchaser of the option, in return for
premium paid to the writer (seller), the right to sell the underlying security
at the exercise price at any time during the option period. Upon exercise by the
purchaser, the writer of a put option has the obligation to purchase the
underlying security at the exercise price. The Series may write only covered put
options, which means that the Series will maintain in a segregated account cash
or liquid securities in an amount not less than the exercise price or the Series
will own an option to sell the underlying security or currency subject to the
option having an exercise price equal to or greater than the exercise price of
the "covered" option at all times which the put option is outstanding. By
writing a put option, the Series assumes the risk that it may be required to
purchase the underlying security at a price in excess of its current market
value.
A put option on a stock index is similar to a put option on an individual
security, except that the value of the option depends on the weighted value of
the group of securities comprising the index and all settlements are made in
cash.
A Series may sell a call option or a put option which it has previously
purchased prior to purchase (in the case of a call) or the sale (in the case of
a put) of the underlying security. Any such sale would result in a net gain or
loss depending on whether the amount received on the sale is more or less than
the premium and other transaction costs paid on the call or put which is sold.
FUTURES CONTRACTS AND RELATED OPTIONS -- Certain Series may buy and sell
futures contracts (and options on such contracts) to manage exposure to changes
in securities prices and foreign currencies and as an efficient means of
adjusting overall exposure to certain markets. A financial futures contract
calls for delivery of a particular security at a certain time in the future. The
seller of the contract agrees to make delivery of the type of security called
for in the contract and the buyer agrees to take delivery at a specified future
time. A Series may also write call options and purchase put options on financial
futures contracts as a hedge to attempt to protect the Series' securities from a
decrease in value. When a Series writes a call option on a futures contract, it
is undertaking the obligation of selling a futures contract at a fixed price at
any time during a specified period if the option is exercised. Conversely, the
purchaser of a put option on a futures contract is entitled (but not obligated)
to sell a futures contract at a fixed price during the life of the option.
Financial futures contracts include interest rate futures contracts and
stock index futures contracts. An interest rate futures contract obligates the
seller of the contract to deliver, and the purchaser to take delivery of,
interest rate securities called for in a contract at a specified future time at
a specified price. A stock index assigns relative values to common stocks
included in the index and the index fluctuates with changes in the market values
of the common stocks included. A stock index futures contract is a bilateral
contract pursuant to which two parties agree to take or make delivery of an
amount of cash equal to a specified dollar amount times the difference between
the stock index value at the close of the last trading day of the contract and
the price at which the futures contract is originally struck. An option on a
financial futures contract gives the purchaser the right to assume a position in
the contract (a long position if the option is a call and a short position if
the option is a put) at a specified exercise price at any time during the period
of the option.
REGULATORY MATTERS RELATED TO FUTURES AND OPTIONS -- In connection with its
proposed futures and options transactions, the Fund filed for the Series with
the CFTC a notice of eligibility for exemption from the definition of (and
therefore from CFTC regulation as) a "commodity pool operator" under the
Commodity Exchange Act. The Fund represents in its notice of eligibility that:
(i) it will not purchase or sell futures or options on futures contracts or
stock indices if as a result the sum of the initial margin deposits on its
existing futures contracts and related options positions and premiums paid for
options on futures contracts or stock indices would exceed 5 percent of each
Series' assets; and (ii) with respect to each futures contract purchased or long
position in an option contract, each Series will set aside in a segregated
account cash or liquid securities in an amount equal to the market value of such
contract less the initial margin deposit.
The Staff of the Securities and Exchange Commission ("SEC") has taken the
position that the purchase and sale of futures contracts and the writing of
related options may involve senior securities for purposes of the restrictions
contained in Section 18 of the Investment Company Act of 1940 on investment
companies' issuing senior securities. However, the Staff has issued letters
declaring that it will not recommend enforcement action under Section 18 if an
investment company: (i) sells futures contracts to offset expected declines in
the value of the investment company's securities, provided the value of such
futures contracts does not exceed the total market value of those securities
(plus such additional amount as may be necessary because of differences in the
volatility factor of the securities vis-a-vis the futures contracts); (ii)
writes call options on futures contracts, stock indexes or other securities,
provided that
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such options are covered by the investment company's holding of a corresponding
long futures position, by its ownership of securities which correlate with the
underlying stock index, or otherwise; (iii) purchases futures contracts,
provided the investment company establishes a segregated account consisting of
cash or liquid securities in an amount equal to the total market value of such
futures contracts less the initial margin deposited therefor; and (iv) writes
put options on futures contracts, stock indexes or other securities, provided
that such options are covered by the investment company's holding of a
corresponding short futures position, by establishing a cash segregated account
in an amount equal to the value of its obligation under the option, or
otherwise.
Each Series will conduct its purchases and sales of any futures contracts
and writing of related options transactions in accordance with the foregoing.
SWAPS, CAPS, FLOORS AND COLLARS -- Series K may enter into interest rate,
currency and index swaps, the purchase or sale of related caps, floors and
collars and other derivative instruments. The Series expects to enter into these
transactions primarily to preserve a return or spread on a particular investment
or portion of its portfolio, to protect against currency fluctuations, as a
technique for managing the portfolio's duration (i.e., the price sensitivity to
changes in interest rates) or to protect against any increase in the price of
securities the Series anticipates purchasing at a later date. The Series intends
to use these transactions as hedges and not as speculative investments, and will
not sell interest rate caps or floors if it does not own securities or other
instruments providing the income the Series may be obligated to pay at a later
date.
Interest rate swaps involve the exchange by the Series with another party
of their respective commitments to pay or receive interest (for example, an
exchange of floating rate payments for fixed rate payments) with respect to a
notional amount of principal. A currency swap is an agreement to exchange cash
flows on a notional amount based on changes in the values of the reference
indices.
The purchase of a cap entitles the purchaser to receive payments on a
notional principal amount from the party selling the cap to the extent that a
specified index exceeds a predetermined interest rate. The purchase of an
interest rate floor entitles the purchaser to receive payments on a notional
principal amount from the party selling the floor to the extent that a specified
index falls below a predetermined interest rate or amount. A collar is a
combination of a cap and a floor that preserves a certain return within a
predetermined range of interest rates or values.
HYBRID INSTRUMENTS -- These instruments (which are derivatives) can combine
the characteristics of securities, futures and options. For example, the
principal amount, redemption or conservation terms of a security could be
related to the market price of some commodity, currency or securities index. The
risks of such investments would reflect the risks of investing in futures,
options and securities, including volatility and illiquidity. Such securities
may bear interest or pay dividends at below market (or even relatively nominal)
rates. Under certain conditions, the redemption value of such an investment
could be zero. Hybrids can have volatile prices and limited liquidity and their
use by the Series may not be successful.
RISK FACTORS
GENERAL -- Each Series' net asset value will fluctuate, reflecting
fluctuations in the market value of its portfolio positions and, if applicable,
its net currency exposure. The value of fixed income securities generally
fluctuates inversely with interest rate movements. Longer term bonds held by a
Series are subject to greater interest rate risk. There is no assurance that any
Series will achieve its investment objective.
FUTURES AND OPTIONS RISK -- Futures contracts and options can be highly
volatile and could result in reduction of a Series' total return, and a Series'
attempt to use such investments for hedging purposes may not be successful.
Successful futures strategies require the ability to predict future movements in
securities prices, interest rates and other economic factors. Losses from
options and futures could be significant if a Series is unable to close out its
position due to distortions in the market or lack of liquidity. A Series' risk
of loss from the use of futures extends beyond its initial investment and could
potentially be unlimited.
The use of futures, options and forward contracts involves investment risks
and transaction costs to which a Series would not be subject absent the use of
these strategies. If the Investment Manager or relevant Sub-Adviser seeks to
protect a Series against potential adverse movements in the securities, foreign
currency or interest rate markets using these instruments, and such markets do
not move in a direction adverse to such Series, such Series could be left in a
less favorable position than if such strategies had not been used. Risks
inherent in the use of futures, options and forward contracts include: (a) the
risk that interest rates, securities prices and currency markets will not move
in the directions anticipated; (b) imperfect correlation between the price of
futures, options and forward contracts and movements in the prices of the
securities or currencies being hedged; (c) the fact that skills needed to use
these strategies are different from those needed to select portfolio securities;
(d) the possible absence of a liquid secondary market for any particular
instrument at any time; and (e) the possible need to defer closing out certain
hedged positions to avoid adverse tax consequences. A Series' ability to
terminate option positions established in the over-the-counter market may be
more limited than in the case of exchange-traded options and may also involve
the risk that securities dealers participating in such transactions would fail
to meet their obligations to such Series.
The use of options and futures involves the risk of imperfect correlation
between movements in options and futures prices and movements in the price of
securities which are the subject of a hedge. Such correlation,
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particularly with respect to options on stock indices and stock index futures,
is imperfect, and such risk increases as the composition of the Series diverges
from the composition of the relevant index. The successful use of these
strategies also depends on the ability of the Investment Manager or relevant
Sub-Adviser to correctly forecast interest rate movements and general stock
market price movements.
FOREIGN INVESTMENT RISKS -- Investment in foreign securities involves risks
and considerations not present in domestic investments. Foreign companies
generally are not subject to uniform accounting, auditing and financial
reporting standards, practices and requirements comparable to those applicable
to U.S. companies. The securities of non-U.S. issuers generally are not
registered with the SEC, nor are the issuers thereof usually subject to the
SEC's reporting requirements. Accordingly, there may be less publicly available
information about foreign securities and issuers than is available with respect
to U.S. securities and issuers.
Foreign securities markets, while growing in volume, have for the most part
substantially less volume than United States securities markets and securities
for foreign companies are generally less liquid and at times their prices may be
more volatile than prices of comparable United States companies. Foreign stock
exchanges, brokers and listed companies generally are subject to less government
supervision and regulation than in the United States. The customary settlement
time for foreign securities may be longer than the customary settlement time for
United States securities.
A Series' income and gains from foreign issuers may be subject to non-U.S.
withholding or other taxes, thereby reducing its income and gains. In addition,
with respect to some foreign countries, there is the increased possibility of
expropriation or confiscatory taxation, limitations on the removal of funds or
other assets of the Series, political or social instability, or diplomatic
developments which could affect the investments of the Series in those
countries. Moreover, individual foreign economies may differ favorably or
unfavorably from the U.S. economy in such respects as growth of gross national
product, rate of inflation, rate of savings and capital reinvestment, resource
self-sufficiency and balance of payments positions.
CURRENCY RISK -- Series that invest in securities denominated in currencies
other than the U.S. dollar, will be affected favorably or unfavorably by
exchange control regulations or changes in the exchange rates between such
currencies and the U.S. dollar. Changes in currency exchange rates will
influence the value of a Series' shares, and also may affect the value of
dividends and interest earned by the Series and gains and losses realized by the
Series. In addition, the Series may incur costs in connection with the
conversion or transfer of foreign currencies. Currencies generally are evaluated
on the basis of fundamental economic criteria (e.g., relative inflation and
interest rate levels and trends, growth rate forecasts, balance of payments
status and economic policies) as well as technical and political data. The
exchange rates between the U.S. dollar and other currencies are determined by
supply and demand in the currency exchange markets, the international balance of
payments, governmental intervention, speculation and other economic and
political conditions. If the currency in which a security is denominated
appreciates against the U.S. dollar, the dollar value of the security will
increase. Conversely, a decline in the exchange rate of the currency would
adversely affect the value of the security expressed in U.S. dollars.
EMERGING MARKETS RISKS -- Because of the special risks associated with
investing in emerging markets, an investment in a Series investing in such
markets should be considered speculative. Investors are strongly advised to
consider carefully the special risks involved in emerging markets, which are in
addition to the usual risks of investing in developed foreign markets around the
world. Investing in emerging markets involves risks relating to potential
political and economic instability within such markets and the risks of
expropriation, nationalization, confiscation of assets and property or the
imposition of restrictions on foreign investment and on repatriation of capital
invested. In the event of such expropriation, nationalization or other
confiscation in any emerging market, the Series could lose its entire investment
in that market. Many emerging market countries have experienced substantial, and
in some periods extremely high, rates of inflation for many years. Inflation and
rapid fluctuations in inflation rates have had and may continue to have negative
effects on the economies and securities markets of certain emerging market
countries. Economies in emerging markets generally are dependent heavily upon
international trade and, accordingly, have been and may continue to be affected
adversely by trade barriers, exchange controls, managed adjustments in relative
currency values and other protectionist measures imposed or negotiated by the
countries with which they trade. These economies also have been and may continue
to be affected adversely by economic conditions in the countries with which they
trade.
The securities markets of emerging countries are substantially smaller,
less developed, less liquid and more volatile than the securities markets of the
United States and other more developed countries. Disclosure and regulatory
standards in many respects are less stringent than in the United States and
other major markets. There also may be a lower level of monitoring and
regulation of emerging securities markets and the activities of investors in
such markets, and enforcement of existing regulations has been extremely
limited. Emerging markets may include former communist countries. There is a
possibility that these countries may revert back to communism. In addition,
brokerage commissions, custodial services and other costs relating to investment
in foreign markets generally are more expensive than in the United States,
particularly with respect to emerging markets. Such markets have different
settlement and clearance procedures. In certain markets there have been times
when settlements have been unable to keep pace with the volume of securities
transactions, making it difficult
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to conduct such transactions. The inability of the Series to make intended
securities purchases due to settlement problems could cause the Series to forego
attractive investment opportunities. Inability to dispose of a portfolio
security caused by settlement problems could result either in losses to the
Series due to subsequent declines in value of the portfolio security or, if the
Series has entered into a contract to sell the security, could result in
possible liability to the purchaser.
The risk also exists that an emergency situation may arise in one or more
emerging markets as a result of which trading of securities may cease or may be
substantially curtailed and prices for the Series' portfolio securities in such
markets may not be readily available. Section 22(e) of the 1940 Act permits a
registered investment company to suspend redemption of its shares for any period
during which an emergency exists, as determined by the SEC. Accordingly, when
the Fund believes that appropriate circumstances warrant, it will promptly apply
to the SEC for a determination that an emergency exists within the meaning of
Section 22(e) of the 1940 Act. During the period commencing from the Fund's
identification of such conditions until the date of SEC action, the portfolio
securities of the Series in the affected markets will be valued at fair value as
determined in good faith by or under the direction of the Fund's Board of
Directors.
RISKS ASSOCIATED WITH INVESTMENTS IN HIGH-YIELD LOWER-RATED DEBT SECURITIES
- -- Investment in debt securities rated below investment grade involves a high
degree of risk. Debt securities rated BB, B, CCC, CC and C by S&P and Ba, B Caa,
Ca and C by Moody's, are regarded, on balance, as predominantly speculative with
respect to the issuer's capacity to pay interest and repay principal in
accordance with the terms of the obligation. For S&P, BB indicates the lowest
degree of speculation and C the highest degree of speculation. For Moody's, Ba
indicates the lowest degree of speculation and C the highest degree of
speculation. While such debt will likely have some quality and protective
characteristics, these are outweighed by large uncertainties or major risk
exposures to adverse conditions. Similarly, debt rated Ba or BB and below is
regarded by the relevant rating agency as speculative. Debt rated C by Moody's
or S&P is the lowest quality debt that is not in default as to principal or
interest and such issues so rated can be regarded as having extremely poor
prospects of ever attaining any real investment standing. Such securities are
also generally considered to be subject to greater risk than higher quality
securities with regard to a deterioration of general economic conditions. These
securities are the equivalent of high yield, high risk bonds. As noted above,
certain Series may invest in debt securities rated below C, which are in default
as to principal and/or interest. Ratings of debt securities represent the rating
agency's opinion regarding their quality and are not a guarantee of quality.
Rating agencies attempt to evaluate the safety of principal and interest
payments and do not evaluate the risks of fluctuations in market value. Also,
rating agencies may fail to make timely changes in credit quality in response to
subsequent events, so that an issuer's current financial condition may be better
or worse than a rating indicates.
DESCRIPTION OF CORPORATE BOND RATINGS
MOODY'S STANDARD &
INVESTORS POOR'S
SERVICE, INC. CORPORATION DEFINITION
-------------------------------------------------------
Aaa AAA Highest quality
Aa AA High quality
A A Upper medium grade
Baa BBB Medium grade
Ba BB Lower medium grade/
speculative elements
B B Speculative
Caa CCC More speculative/
Ca CC possibly in or high
C C risk of default
--- D In default
Not rated Not rated Not rated
For a more complete description of the corporate bond ratings, see the
Appendix to the Fund's Statement of Additional Information.
The market value of lower quality debt securities tends to reflect
individual developments of the issuer to a greater extent than do higher quality
securities, which react primarily to fluctuations in the general level of
interest rates. In addition, lower quality debt securities tend to be more
sensitive to economic conditions and generally have more volatile prices than
higher quality securities. Issuers of lower quality securities are often highly
leveraged and may not have available to them more traditional methods of
financing. For example, during an economic downturn or a sustained period of
rising interest rates, highly leveraged issuers of lower quality securities may
experience financial stress. 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 may also be adversely affected by
specific developments affecting the issuer, such as the issuer's inability to
meet specific projected business forecasts or the unavailability of additional
financing. Similarly, certain emerging market governments that issue lower
quality debt securities are among the largest debtors to commercial banks,
foreign governments and supranational organizations such as the World Bank and
may not be able or willing to make principal and/or interest repayments as they
come due. The risk of loss due to default by the issuer is significantly greater
for the holders of lower quality securities because such securities are
generally unsecured and are often subordinated to other creditors of the issuer.
Adverse publicity and investor perceptions, whether or not based on fundamental
analysis, may also decrease the values and liquidity of lower quality
securities, especially in a thinly traded market.
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Lower quality debt securities of corporate issuers frequently have call or
buy-back features which would permit an issuer to call or repurchase the
security from the Series. If an issuer exercises these provisions in a declining
interest rate market, the Series may have to replace the security with a lower
yielding security, resulting in a decreased return for investors. In addition,
the Series may have difficulty disposing of lower quality securities because
there may be a thin trading market for such securities. There may be no
established retail secondary market for many of these securities, and the Series
anticipates that such securities could be sold only to a limited number of
dealers or institutional investors. The lack of a liquid secondary market also
may have an adverse impact on market prices of such instruments and may make it
more difficult for the Series to obtain accurate market quotations for purposes
of valuing the securities in the portfolio of the Series.
Factors having an adverse effect on the market value of lower rated
securities or their equivalents purchased by the Series will adversely impact
net asset value of the Series. See "Investment Methods and Risk Factors" in the
Statement of Additional Information. In addition to the foregoing, such factors
may include: (i) potential adverse publicity; (ii) heightened sensitivity to
general economic or political conditions; and (iii) the likely adverse impact of
a major economic recession. A Series also may incur additional expenses to the
extent it is required to seek recovery upon a default in the payment of
principal or interest on its portfolio holdings, and the Series may have limited
legal recourse in the event of a default. Debt securities issued by governments
in emerging markets can differ from debt obligations issued by private entities
in that remedies from defaults generally must be pursued in the courts of the
defaulting government, and legal recourse is therefore somewhat diminished.
Political conditions, in terms of a government's willingness to meet the terms
of its debt obligations, also are of considerable significance. There can be no
assurance that the holders of commercial bank debt may not contest payments to
the holders of debt securities issued by governments in emerging markets in the
event of default by the governments under commercial bank loan agreements.
MANAGEMENT OF THE FUND
The management of the Fund's business and affairs is the responsibility of
the Fund's Board of Directors. Security Management Company, LLC (the "Investment
Manager"), 700 SW Harrison, Topeka, Kansas 66636-0001, is responsible for
selection and management of the Fund's portfolio investments. The Investment
Manager is a limited liability company, which is ultimately controlled by
Security Benefit Life Insurance Company, a mutual life insurance company. The
Investment Manager also acts as investment adviser to Security Growth and Income
Fund, Security Ultra Fund, Security Income Fund, Security Cash Fund, Security
Equity Fund, and Security Tax-Exempt Fund. The Investment Manager currently
manages $3.5 billion in assets.
The Investment Manager has engaged Lexington Management Corporation
("Lexington"), Park 80 West, Plaza Two, Saddle Brook, New Jersey 07663, to
provide investment advisory services to Series K of the Fund. Pursuant to the
agreement, Lexington furnishes investment advisory, statistical and research
facilities, supervises and arranges for the purchase and sale of securities on
behalf of Series K and provides for the compilation and maintenance of records
pertaining to such investment advisory services, subject to the control and
supervision of the Board of Directors of the Fund and the Investment Manager.
Lexington is a wholly-owned subsidiary of Lexington Global Asset Managers, Inc.,
a Delaware corporation with offices at Park 80 West, Plaza Two, Saddle Brook,
New Jersey 07663. Descendants of Lunsford Richardson, Sr., their spouses, trusts
and other related entities have a majority voting control of the outstanding
shares of Lexington Global Asset Managers, Inc. Lexington which was established
in 1938 currently serves as an investment adviser, Sub-adviser and/or sponsor to
21 investment companies with varying objectives and manages over $3.8 billion in
assets.
Lexington has entered into a sub-advisory contract with MFR Advisors, Inc.
("MFR"), One Liberty Plaza, New York, New York 10006, under which MFR will
provide Series K with investment and economic research services. MFR has been an
investment adviser since 1992 and currently acts as investment adviser to Global
High Yield Fund, Global Asset Allocation Fund and Emerging Markets Total Return
Fund, a sub-adviser to the Lexington Ramirez Global Income Fund and also serves
as an institutional manager for private clients. MFR is a subsidiary of Maria
Fiorini Ramirez, Inc. ("Ramirez"), which was established in August of 1992 to
provide global economic consulting services. Ramirez owns 80 percent of the
outstanding common stock of MFR. Maria Fiorini Ramirez owns 100 percent of the
outstanding capital stock of Ramirez, and Freedom Securities Corporation owns
preferred securities which would under certain circumstances be convertible to
20 percent of Ramirez's common stock. Security Benefit Life Insurance Company
("SBL") owns the remaining 20 percent of the outstanding common stock of MFR and
has stock rights that would enable SBL in the future to acquire up to 100
percent of the ownership in MFR.
The Investment Manager has engaged T. Rowe Price Associates, Inc. ("T. Rowe
Price"), 100 East Pratt Street, Baltimore, Maryland 21202, organized in 1937
under the laws of the state of Maryland by the late Thomas Rowe Price, Jr., to
provide certain investment advisory services to Series O. Pursuant to the
agreement, T. Rowe Price furnishes investment advisory services, supervises and
arranges for the purchase and sale of securities on behalf of Series O and
provides for the compilation and maintenance of records pertaining to such
investment advisory services, subject to the control and supervision of the
Board of Directors of the Fund and the Investment Manager. T. Rowe Price is a
publicly held company, which with its affiliates manages
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over $95 billion in assets for over 4.5 million individual and institutional
investor accounts.
Subject to the supervision and direction of the Fund's Board of Directors,
the Investment Manager manages the Fund's portfolios in accordance with each
Series' stated investment objective and policies and makes all investment
decisions, except that the Investment Manager supervises such management of
Series K by Lexington and Series O by T. Rowe Price. As compensation for its
management services, the Investment Manager receives on an annual basis, an
amount equal to .75 percent of the average net assets of Series S and K; .50
percent of the average net assets of Series C; and 1.00 percent of the average
net assets of Series O, computed on a daily basis and payable monthly.
The Investment Manager pays Lexington an annual fee equal to .35 percent of
the average net assets of Series K for management services provided to Series K.
For the services provided to Lexington by MFR, MFR, receives from Lexington, on
an annual basis, a fee equal to .15 percent of the average net assets of Series
K, calculated daily and payable monthly.
The Investment Manager pays T. Rowe Price an annual fee equal to .50
percent of the first $20,000,000 of average net assets of Series O and .40
percent of such assets in excess of $20,000,000 for management services provided
to Series O. For any month in which the average daily net assets of Series O
exceeds $50,000,000, T. Rowe Price will waive .10 percent of its investment
management fee on the first $20,000,000 of average net assets of the Series.
Such fee is calculated daily and payable monthly.
The Investment Manager also acts as administrative agent for each Series of
the Fund, and as such performs administrative functions, bookkeeping, accounting
and pricing functions for the Fund. For providing these services, the Investment
Manager receives on an annual basis a fee of .045 percent of the average daily
net assets of the Fund. For these services, the Investment Manager also
receives, with respect to Series K, an annual fee equal to the greater of .10
percent of the Series average net assets or $60,000.
The expense ratio of each Series for the fiscal year ended December 31,
1996, was as follows: Series C - .58 percent; Series K - .84 percent; Series O -
1.15 percent; and Series S - .84 percent. During the fiscal year ended December
31, 1996, the Investment Manager waived the management fee of Series K, and
during the fiscal year ending December 31, 1997, the Investment Manager will
waive the management fee of Series K. In the absence of such waiver, the expense
ratio for Series K would have been higher.
PORTFOLIO MANAGEMENT
SERIES K (GLOBAL AGGRESSIVE BOND SERIES) is managed by an investment
management team of Lexington and MFR. Denis P. Jamison and Maria Fiorini Ramirez
have day-to-day responsibility for managing Series K and have managed the Series
since its inception in 1995. SERIES O (EQUITY INCOME SERIES) is managed by an
Investment Advisory Committee of T. Rowe Price consisting of Brian C. Rogers,
Chairman, Thomas H. Broadus, Jr., Richard P. Howard and William J. Stromberg.
Mr. Rogers has had day-to-day responsibility for managing the Series since its
inception in 1995. SERIES S (SOCIAL AWARENESS SERIES) is managed by the
Investment Manager's Social Responsibility Team, which consists of John Cleland,
Chief Investment Strategist, Cindy Shields, Larry Valencia and Frank Whitsell.
The Social Responsibility Team is responsible for determining general investment
strategy and monitoring portfolio guidelines. Cindy Shields, Portfolio Manager,
has day-to-day responsibility for managing Series S and has managed the Series
since 1994.
John D. Cleland has been involved in the securities industry for more than
30 years. Before joining the Investment Manager in 1968, he was involved in the
investment business in securities and residential and commercial real estate for
approximately ten years. Mr. Cleland earned a Bachelor of Science degree from
the University of Kansas and an M.B.A. from Wharton School of Finance,
University of Pennsylvania.
Denis P. Jamison, C.F.A., Senior Vice President, Director Fixed Income
Strategy, is responsible for fixed-income portfolio management for Lexington. He
is a member of the New York Society of Security Analysts. Mr. Jamison has more
than 20 years investment experience. Prior to joining Lexington in 1981, Mr.
Jamison had spent nine years at Arnold Bernhard & Company, an investment
counseling and financial services organization. At Bernhard, he was a Vice
President supervising the security analyst staff and managing investment
portfolios. He is a specialist in government, corporate and municipal bonds. Mr.
Jamison is a graduate of the City College of New York with a B.A. in Economics.
Maria Fiorini Ramirez, President and Chief Executive Officer of MFR, began
her career as a credit analyst with American Express International Banking
Corporation in 1968. In 1972, she moved to Banco Nazionale De Lavoro in New
York. The following year, she started a ten year association with Merrill Lynch,
serving as Vice President and Senior Money Market Economist. She joined Becker
Paribas in 1984 as Vice President and Senior Money Market Economist before
joining Drexel Burnham Lambert that same year as First Vice President and Money
Market Economist. She was promoted to Managing Director of Drexel in 1986. From
April 1990 to August 1992, Ms. Ramirez was the President and Chief Executive
Officer of Maria Ramirez Capital Consultants, Inc., a subsidiary of John Hancock
Freedom Securities Corporation. Ms. Ramirez established MFR in August, 1992. She
is known in international financial, banking and economic circles for her
assessment of the interaction between global economic policy and political
trends and their effect on investments. Ms. Ramirez holds a B.A. in Business
Administration/ Economics from Pace University.
Brian C. Rogers joined T. Rowe Price in 1982 and has been managing
investments since 1983.
Cindy L. Shields, Portfolio Manager of the Investment Manager, has eight
years experience in the securities field.
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Ms. Shields has been a portfolio manager since 1994, and prior to that time, she
served as a research analyst for the Investment Manager. She is a Chartered
Financial Analyst. Ms. Shields graduated from Washburn University with a
Bachelor of Business Administration degree, majoring in finance and economics.
She joined the Investment Manager in 1989.
SALE AND REDEMPTION OF SHARES
Shares of the Fund will be sold to SBL for allocation to variable annuity
or variable life separate accounts. Shares are sold and redeemed at their net
asset value next determined after receipt of a purchase or redemption order. No
sales or redemption charge is made. The value of shares redeemed may be more or
less than the stockholder's cost, depending upon the market value of the
portfolio securities at the time of redemption. Payment for shares redeemed will
be made as soon as practicable after receipt, but in no event later than seven
days after tender, except that the Fund may suspend the right of redemption
during any period when trading on the New York Stock Exchange is restricted or
such Exchange is closed for other than weekends or holidays, or any emergency is
deemed to exist by the Securities and Exchange Commission.
DISTRIBUTIONS AND FEDERAL INCOME TAX CONSIDERATIONS
Each Series intends to separately qualify and elects to be treated each
year as a "regulated investment company" under Subchapter M of the Internal
Revenue Code (the "Code") and, therefore, generally will not be liable for
federal income taxes to the extent its net investment income and capital gains
are distributed. The Fund expects to distribute, at least once a year,
substantially all of each Series' net investment income and net realized capital
gains. Such distributions will be reinvested on the payable date in additional
shares of the respective Series at the net asset value thereof as of the record
date (reduced by an amount equal to the amount of the distribution), unless the
shareholder elects to receive cash. Each Series will be treated separately in
determining the amounts of income and capital gains distributions to the
variable life insurance accounts and the variable annuity accounts. For this
purpose, each Series will reflect only the income and gains, net of losses, of
that Series.
To comply with regulations under Code section 817(h), each Series is
required to diversify its investments. Generally, a Series will be required to
diversify its investments so that on the last day of each quarter of the
calendar year no more than 55 percent of the value of the total assets is
represented by any one investment, no more than 70 percent is represented by any
two investments, no more than 80 percent is represented by any three
investments, and no more than 90 percent is represented by any four investments.
If a Series fails to meet the diversification requirements under Code section
817(h), income with respect to life insurance policies and annuity contracts
invested in the Series at any time during the calendar quarter in which the
failure occurred could become currently taxable to the owners of such policies
and contracts and income for prior periods with respect to the policies and
contracts also could be taxable, most likely in the year of the failure to
achieve the required diversification. Other adverse tax consequences could also
ensue. If a Series fails to qualify as a regulated investment company, the
results would be substantially the same as a failure to meet the diversification
requirements under Code section 817(h).
Certain requirements relating to the qualification of a Series as a
regulated investment company and to the satisfaction of the Code section 817(h)
diversification requirements may limit the extent to which a Series will be able
to engage in certain investment practices, including transactions in options,
futures contracts, forwards, swaps and other types of derivative securities
transactions. In addition, if a Series were unable to dispose of portfolio
securities due to settlement problems relating to foreign investments or due to
the holding of illiquid securities, the Series' ability to qualify as a
regulated investment company and to satisfy the Code section 817(h)
diversification requirements might be affected.
See "Distributions and Federal Income Tax Considerations" in the Statement
of Additional Information for more information on taxes, including information
on the taxation of distributions from a Series. The federal tax consequences to
purchasers of SBL's variable annuity contracts and variable life insurance
policies registered under the Securities Act of 1933 are described in the
prospectus applicable to such contracts and such policies, respectively.
FOREIGN TAXES
Investment income and gains received from sources within foreign countries
may be subject to foreign income and other taxes. In this regard, withholding
tax rates in countries with which the United States does not have a tax treaty
are often as high as 30 percent or more. The United States has entered into tax
treaties with many foreign countries which entitle certain investors to a
reduced tax rate (generally 10 to 15 percent) or to certain exemptions from tax.
The Fund intends to operate so as to qualify for such reduced tax rates or tax
exemptions whenever possible. While policyholders and contractowners will
indirectly bear the cost of any foreign tax withholding, they will not be able
to claim foreign tax credit or deduction for taxes paid by the Fund.
DETERMINATION OF NET ASSET VALUE
The net asset value per share of each Series is determined as of the close
of regular trading hours on the New York Stock Exchange on each day that the
Exchange is open for trading (normally 3:00 p.m. Central time). The
determination is made by dividing the value of the portfolio securities of each
Series, plus any cash or other assets, less all liabilities, by the number of
shares of each Series
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outstanding. Securities listed or traded on a recognized securities exchange
will be valued on the basis of the last sales price. If there are no sales on a
particular day, then the securities are valued at the last bid price. If a
security is traded on multiple exchanges, its value will be based on prices from
the principal exchange where it is traded. All other securities for which market
quotations are available are valued on the basis of the last current bid price.
If there is no bid price or if the bid price is deemed unsatisfactory by the
Board of Directors or by the Investment Manager, then the securities are valued
in good faith by such method as the Board of Directors determines will reflect
the fair market value.
The Fund will generally value short-term securities at prices based on
market quotations for securities of similar type, yield, quality and duration,
except that securities with 60 days or less to maturity may be valued on the
basis of the amortized cost valuation technique. The amortized cost valuation
technique involves valuing an instrument at its cost and thereafter assuming a
constant amortization to maturity of any discount or premium, regardless of the
impact of fluctuating interest rates on the market value of the instrument.
A similar procedure may be used for portfolio instruments when they reach
60 days to maturity, with the value of the instrument on the 61st day being used
rather than cost. While this method provides certainty in valuation, it may
result in periods during which value (as determined by amortized cost) is higher
or lower than the price the Fund would receive if the security were sold.
Generally, trading in foreign securities markets is substantially completed
each day at various times prior to the close of the New York Stock Exchange. The
values of foreign securities used in computing the net asset value of the shares
of Series investing in foreign securities generally are determined as of the
close of such foreign markets or the close of the New York Stock Exchange if
earlier. Foreign currency exchange rates are generally determined prior to the
close of the New York Stock Exchange. Trading on foreign exchanges and in
foreign currencies may not take place on every day the New York Stock Exchange
is open. Conversely trading in various foreign markets may take place on days
when the New York Stock Exchange is not open and on other days when the Fund's
net asset values are not calculated. Consequently, the calculation of the net
asset value may not occur contemporaneously with the determination of the most
current market prices for the securities included in such calculation, and
events affecting the value of such securities and such exchange rates that occur
between the times at which they are determined and the close of the New York
Stock Exchange will not be reflected in the computation of net asset value. If
during such periods, events occur that materially affect the value of such
securities, the securities will be valued at their fair market value as
determined in good faith by the Board of Directors.
For purposes of determining the net asset value per share of the Fund, all
assets and liabilities initially expressed in foreign currencies will be
converted into United States dollars at the mean between the bid and offer
prices of such currencies against United States dollars quoted by any major U.S.
bank.
TRADING PRACTICES AND BROKERAGE
The annual portfolio turnover rate of Series S may exceed 100 percent, and
at times may exceed 150 percent. The annual turnover rate of Series K may exceed
100 percent. The annual turnover rate of Series O generally will not exceed 100
percent. Since Series C's investment policies require a maturity shorter than
thirteen months, its portfolio turnover rate will generally be 0 percent,
although the portfolio will turn over many times during a year as a result of
security maturities.
The portfolio turnover rates of the Series for the fiscal year ended
December 31, 1996 were as follows: Series K - 86 percent; Series O - 22 percent;
and Series S - 67 percent. The portfolio turnover rate for Series S for the
fiscal year ended December 31, 1995 was 122 percent. The annualized portfolio
turnover rates for Series K and O for the period June 1, 1995 (date of
inception) to December 31, 1995 were 127 percent and 3 percent, respectively.
Higher portfolio turnover subjects the Series to increased brokerage costs and
may in some cases, have adverse tax effects on the Series or its stockholders.
The rates of portfolio turnover may be substantially higher during any
period when changing market or economic conditions suggest a shift in portfolio
emphasis. Thus, a portfolio turnover rate in excess of 100 percent will not
necessarily indicate a variation from the stated investment policy.
Transactions in portfolio securities are effected in the manner deemed to
be in the best interest of the Series. In selecting a broker to execute a
specific transaction, all relevant factors will be considered such as the
broker's ability to obtain the best execution of a particular transaction.
Portfolio transactions may be directed to brokers who furnish investment
information or research services to the Investment Manager or who sell shares of
the Series. Although the Investment Manager may consider sales of shares of the
Series in the selection of a broker, this will not be a qualifying or
disqualifying factor.
Securities held by the Fund may also be held by other investment advisory
clients of the Investment Manager, including other investment companies, and by
Security Benefit Life Insurance Company ("SBL"). Purchases or sales of the same
security occurring on the same day (which may include orders from SBL) may be
aggregated and executed as a single transaction, subject to the Investment
Manager's obligation to seek best execution. Aggregated purchases or sales are
generally effected at an average price and on a pro rata basis (transaction
costs will also be shared on a pro rata basis) in proportion to the amounts
desired to be purchased or sold. See the Fund's Statement of Additional
Information
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for a more detailed description of aggregated transactions and allocation of
portfolio brokerage.
PERFORMANCE INFORMATION
The Fund may, from time to time, include the average annual total return
and total return of all Series in advertisements or reports to stockholders or
prospective investors. Quotations of average annual total return for any Series
will be expressed in terms of the average annual compounded rate of return on a
hypothetical investment in the Series over a period of 1, 5, and 10 years (up to
the life of the Series), and will assume that all dividends and distributions
are reinvested when paid.
Quotations of total return for any Series will be based on a hypothetical
investment in the Series for a certain period, and will assume that all
dividends and distributions are reinvested when paid. The net increase or
decrease in the value of the investment over the period will be divided by its
beginning value to arrive at total return for the period. Total return
calculated in this manner will differ from the average annual total return in
that it is not expressed in terms of an average rate of return.
Performance information for a Series may be compared, in reports and
promotional literature, to: (i) The Standard & Poor's 500 Stock Index ("S&P
500"), Dow Jones Industrial Average ("DJIA"), or other unmanaged indices so that
investors may compare a Series' results with those of a group of unmanaged
securities widely regarded by investors as representative of the securities
markets in general; (ii) other groups of mutual funds tracked by Lipper
Analytical Services, a widely used independent research firm which ranks mutual
funds by overall performance, investment objectives, and assets, or tracked by
other services, companies, publications, or persons who rank mutual funds on
overall performance or other criteria; and (iii) the Consumer Price Index
(measure for inflation) to assess the real rate of return from an investment in
the Series. Unmanaged indices may assume the reinvestment of dividends but
generally do not reflect deductions for administrative and management costs and
expenses.
Quotations of average annual total return or total return for the Fund will
not take into account charges or deductions against the Separate Accounts to
which the Fund shares are sold or charges and deductions against the Contracts
issued by Security Benefit Life Insurance Company. Performance information for
any Series reflects only the performance of a hypothetical investment in the
Series during a particular time period on which the calculations are based.
Performance information should be considered in light of the Series' investment
objectives and policies, characteristics and quality of the portfolios, and the
market conditions during the given time period, and should not be considered as
a representation of what may be achieved in the future. For a description of the
methods used to determine average annual total return and total return for the
Series, see the Statement of Additional Information.
GENERAL INFORMATION
ORGANIZATION
SBL Fund has authorized the issuance of an indefinite number of shares of
capital stock of $1.00 par value. The Fund's shares are currently issued in
fourteen Series, A, B, C, D, E, J, K, M, N, O, P, S, V and X. The shares of each
Series represent a pro rata beneficial interest in that Series' net assets and
in the earnings and profits or losses derived from the investment of such
assets.
Upon issuance and sale, such shares will be fully paid, nonassessable and
redeemable. These shares have no preemptive rights, but the shareholders of each
Series are entitled to receive dividends as declared for that Series by the
Board of Directors of the Fund.
The shares of each Series have cumulative voting rights for the election of
directors. On matters affecting a particular Series, each share of that Series
has equal voting rights with each other share and there are no preferences as to
conversion, exchange, retirement or liquidation. On other matters, all shares
(irrespective of Series) are entitled to one vote each. Pursuant to the rules
and regulations of the Securities and Exchange Commission, in certain instances
a vote of the outstanding shares of the combined Series may not modify the
rights of holders of a particular Series without the approval of a majority of
the shares of that Series.
The Fund does not generally hold annual meetings of stockholders and will
do so only when required by law. Stockholders may remove directors from office
by votes cast in person or by proxy at a meeting of stockholders. Such a meeting
will be called at the written request of the holders of 10 percent of the Fund's
outstanding shares.
CUSTODIAN, TRANSFER AGENT AND DIVIDEND-PAYING AGENT
UMB Bank, N.A., 928 Grand Avenue, Kansas City, Missouri, acts as the
custodian for the portfolio securities of Series C and S. The Chase Manhattan
Bank, 4 Chase MetroTech Center, Brooklyn, New York 11245 acts as custodian for
the portfolio securities of Series K and O, including those held by foreign
banks and foreign securities depositories which qualify as eligible foreign
custodians under rules adopted by the Securities and Exchange Commission.
Security Management Company, LLC acts as the Fund's transfer and dividend-paying
agent.
CONTRACTOWNER INQUIRIES
Contractowners who have questions concerning the Fund or wish to obtain
additional information, may write to SBL Fund at 700 SW Harrison St., Topeka,
Kansas 66636-0001, or call (785) 431-3127 or 1-800-888-2461, extension 3127.
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