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STATEMENT OF ADDITIONAL INFORMATION
STRONG ASSET ALLOCATION FUND, INC.
P.O. Box 2936
Milwaukee, Wisconsin 53201
Telephone: 1-414-359-1400
Toll-Free: 1-800-368-3863
This Statement of Additional Information is not a Prospectus and should be
read in conjunction with the Prospectus of Strong Asset Allocation Fund, Inc.
(formerly known as the Strong Investment Fund, Inc.) (the "Fund"), dated May 1,
1995. Requests for copies of the Prospectus should be made by calling one
of the numbers listed above. The financial statements appearing in the Fund's
Annual Report, which accompanies this Statement of Additional Information, are
incorporated herein by reference.
This Statement of Additional Information is dated May 1, 1995, as
supplemented on September 15, 1995.
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STRONG ASSET ALLOCATION FUND, INC.
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INVESTMENT RESTRICTIONS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
INVESTMENT POLICIES AND TECHNIQUES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
High-Yield (High-Risk) Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Derivative Instruments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Variable- or Floating-Rate Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Mortgage- and Asset-Backed Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
When-Issued Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
Foreign Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Sovereign Debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Repurchase Agreements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Illiquid Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Warrants . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
Debt Obligations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
Lending of Portfolio Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
Small Companies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
Borrowing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
Mortgage Dollar Rolls and Reverse Repurchase Agreements . . . . . . . . . . . . . . . . . . . . . . 20
Short Sales Against the Box . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
Depositary Receipts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
Foreign Investment Companies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
DIRECTORS AND OFFICERS OF THE FUND . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
PRINCIPAL SHAREHOLDERS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
INVESTMENT ADVISOR AND DISTRIBUTOR . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
PORTFOLIO TRANSACTIONS AND BROKERAGE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
CUSTODIAN . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26
TRANSFER AGENT AND DIVIDEND-DISBURSING AGENT . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27
TAXES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27
DETERMINATION OF NET ASSET VALUE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29
ADDITIONAL SHAREHOLDER INFORMATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30
FUND ORGANIZATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
SHAREHOLDER MEETINGS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31
PERFORMANCE INFORMATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32
GENERAL INFORMATION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36
PORTFOLIO MANAGEMENT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37
INDEPENDENT ACCOUNTANTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38
LEGAL COUNSEL . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38
FINANCIAL STATEMENTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38
APPENDIX . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A-1
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No person has been authorized to give any information or to make any
representations other than those contained in this Statement of Additional
Information and the Prospectus dated May 1, 1995, and if given or made, such
information or representations may not be relied upon as having been authorized
by the Fund.
This Statement of Additional Information does not
constitute an offer to sell securities.
<PAGE> 3
INVESTMENT RESTRICTIONS
The investment objective of the Fund is to seek high total return
consistent with reasonable risk over the long term. The Fund's investment
objective and policies are described in detail in the Prospectus under the
caption "Investment Objectives and Policies." The following are the Fund's
fundamental investment limitations which cannot be changed without shareholder
approval.
The Fund:
1. May not with respect to 75% of its total assets, purchase the
securities of any issuer (except securities issued or guaranteed by
the U.S. government or its agencies or instrumentalities) if, as a
result, (i) more than 5% of the Fund's total assets would be invested
in the securities of that issuer, or (ii) the Fund would hold more
than 10% of the outstanding voting securities of that issuer.
2. May (i) borrow money from banks and (ii) make other investments or
engage in other transactions permissible under the Investment Company
Act of 1940 (the "1940 Act") which may involve a borrowing, provided
that the combination of (i) and (ii) shall not exceed 33 1/3% of the
value of the Fund's total assets (including the amount borrowed), less
the Fund's liabilities (other than borrowings), except that the Fund
may borrow up to an additional 5% of its total assets (not including
the amount borrowed) from a bank for temporary or emergency purposes
(but not for leverage or the purchase of investments). The Fund may
also borrow money from the other Strong Funds or other persons to the
extent permitted by applicable law.
3. May not issue senior securities, except as permitted under the 1940
Act.
4. May not act as an underwriter of another issuer's securities, except
to the extent that the Fund may be deemed to be an underwriter within
the meaning of the Securities Act of 1933 in connection with the
purchase and sale of portfolio securities.
5. May not purchase or sell physical commodities unless acquired as a
result of ownership of securities or other instruments (but this shall
not prevent the Fund from purchasing or selling options, futures
contracts, or other derivative instruments, or from investing in
securities or other instruments backed by physical commodities).
6. May not make loans if, as a result, more than 33 1/3% of the Fund's
total assets would be lent to other persons, except through (i)
purchases of debt securities or other debt instruments, or (ii)
engaging in repurchase agreements.
7. May not purchase the securities of any issuer if, as a result, more
than 25% of the Fund's total assets would be invested in the
securities of issuers, the principal business activities of which are
in the same industry.
8. May not purchase or sell real estate unless acquired as a result of
ownership of securities or other instruments (but this shall not
prohibit the Fund from purchasing or selling securities or other
instruments backed by real estate or of issuers engaged in real estate
activities).
9. May, notwithstanding any other fundamental investment policy or
restriction, invest all of its assets in the securities of a single
open-end management investment company with substantially the same
fundamental investment objective, policies, and restrictions as the
Fund.
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The following are the Fund's non-fundamental operating policies which
may be changed by the Fund's Board of Directors without shareholder approval.
The Fund may not:
1. Sell securities short, unless the Fund owns or has the right to obtain
securities equivalent in kind and amount to the securities sold short,
or unless it covers such short sale as required by the current rules
and positions of the Securities and Exchange Commission or its staff,
and provided that transactions in options, futures contracts, options
on futures contracts, or other derivative instruments are not deemed
to constitute selling securities short.
2. Purchase securities on margin, except that the Fund may obtain such
short-term credits as are necessary for the clearance of transactions;
and provided that margin deposits in connection with futures
contracts, options on futures contracts, or other derivative
instruments shall not constitute purchasing securities on margin.
3. Invest in illiquid securities if, as a result of such investment, more
than 15% of its net assets would be invested in illiquid securities,
or such other amounts as may be permitted under the 1940 Act.
4. Purchase securities of other investment companies except in compliance
with the 1940 Act and applicable state law.
5. Invest all of its assets in the securities of a single open-end
management investment company with substantially the same fundamental
investment objective, restrictions and policies as the Fund.
6. Purchase the securities of any issuer (other than securities issued or
guaranteed by domestic or foreign governments or political
subdivisions thereof) if, as a result, more than 5% of its total
assets would be invested in the securities of issuers that, including
predecessor or unconditional guarantors, have a record of less than
three years of continuous operation. This policy does not apply to
securities of pooled investment vehicles or mortgage or asset-backed
securities.
7. Invest in direct interests in oil, gas, or other mineral exploration
programs or leases; however, the Fund may invest in the securities of
issuers that engage in these activities.
8. Engage in futures or options on futures transactions which are
impermissible pursuant to Rule 4.5 under the Commodity Exchange Act
and, in accordance with Rule 4.5, will use futures or options on
futures transactions solely for bona fide hedging transactions (within
the meaning of the Commodity Exchange Act), provided, however, that
the Fund may, in addition to bona fide hedging transactions, use
futures and options on futures transactions if the aggregate initial
margin and premiums required to establish such positions, less the
amount by which any such options positions are in the money (within
the meaning of the Commodity Exchange Act), do not exceed 5% of the
Fund's net assets.
In addition, (i) the aggregate value of securities underlying call
options on securities written by the Fund or obligations underlying
put options on securities written by the Fund determined as of the
date the options are written will not exceed 50% of the Fund's net
assets; (ii) the aggregate premiums paid on all options purchased by
the Fund and which are being held will not exceed 20% of the Fund's
net assets; (iii) the Fund will not purchase put or call options,
other than hedging positions, if, as a result thereof, more than 5% of
its total assets would be so invested; and (iv) the aggregate margin
deposits required on all futures and options on futures transactions
being held will not exceed 5% of the Fund's total assets.
9. Pledge, mortgage or hypothecate any assets owned by the Fund except as
may be necessary in connection with permissible borrowings or
investments and then such pledging, mortgaging, or hypothecating may
not exceed 33 1/3% of the Fund's total assets at the time of the
borrowing or investment.
10. Purchase or retain the securities of any issuer if any officer or
director of the Fund or its investment advisor beneficially owns more
than 1/2 of 1% of the securities of such issuer and such officers and
directors together own beneficially more than 5% of the securities of
such issuer.
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11. Purchase warrants, valued at the lower of cost or market value, in
excess of 5% of the Fund's net assets. Included in that amount, but
not to exceed 2% of the Fund's net assets, may be warrants that are
not listed on any stock exchange. Warrants acquired by the Fund in
units or attached to securities are not subject to these restrictions.
12. Borrow money except (i) from banks or (ii) through reverse repurchase
agreements or mortgage dollar rolls, and will not purchase securities
when bank borrowings exceed 5% of its total assets.
13. Make any loans other than loans of portfolio securities, except
through (i) purchases of debt securities or other debt instruments, or
(ii) engaging in repurchase agreements.
Except for the fundamental investment limitations listed above and the
Fund's investment objective, the other investment policies described in the
Prospectus and this Statement of Additional Information are not fundamental and
may be changed with approval of the Fund's Board of Directors.
INVESTMENT POLICIES AND TECHNIQUES
The following information supplements the discussion of the Fund's
investment objective, policies and techniques that are described in detail in
the Prospectus under the captions "Investment Objectives and Policies" and
"Implementation of Policies and Risks."
HIGH-YIELD (HIGH-RISK) SECURITIES
IN GENERAL. The Fund has the authority to invest up to, but not
including, 35% of its assets in non-investment grade debt obligations.
Non-investment grade debt obligations (hereinafter referred to as
"lower-quality securities") include (i) bonds rated as low as C by Moody's
Investors Service, Inc. ("Moody's"), Standard & Poor's Ratings Group ("S&P"),
or Fitch Investors Service, Inc. ("Fitch") or CCC by Duff & Phelps, Inc.
("D&P"); (ii) commercial paper rated as low as C by S&P, Not Prime by Moody's,
or Fitch 4 by Fitch; and (iii) unrated debt obligations of comparable quality.
Lower-quality securities, while generally offering higher yields than
investment-grade securities with similar maturities, involve greater risks,
including the possibility of default or bankruptcy. They are regarded as
predominantly speculative with respect to the issuer's capacity to pay interest
and repay principal. The special risk considerations in connection with such
investments are discussed below. Refer to the Appendix of this Statement of
Additional Information for a discussion of securities ratings.
EFFECT OF INTEREST RATES AND ECONOMIC CHANGES. The lower-quality
securities market is relatively new, and its growth paralleled a long economic
expansion. As a result, it is not clear how this market may withstand a
prolonged recession or economic downturn. Such a prolonged economic downturn
could severely disrupt the market for and adversely affect the value of such
securities.
All interest-bearing securities typically experience appreciation when
interest rates decline and depreciation when interest rates rise. The market
values of lower-quality securities tend to reflect individual corporate
developments to a greater extent than do higher rated securities, which react
primarily to fluctuations in the general level of interest rates.
Lower-quality securities also tend to be more sensitive to economic conditions
than are higher rated securities. As a result, they generally involve more
credit risks than securities in the higher rated categories. During an
economic downturn or a sustained period of rising interest rates, highly
leveraged issuers of lower-quality securities may experience financial stress
and may not have sufficient revenues to meet their payment obligations. The
issuer's ability to service its debt obligations may also be adversely affected
by specific corporate developments, the issuer's inability to meet specific
projected business forecasts, or the unavailability of additional financing.
The risk of loss due to default by an issuer of lower-quality securities is
significantly greater than issuers of higher rated securities because such
securities are generally unsecured and are often subordinated to other
creditors. Further, if the issuer of a lower-quality security defaulted, the
Fund might incur additional expenses to seek recovery. Periods of economic
uncertainty and changes would also generally result in increased volatility in
the market prices of lower-quality securities and thus in the Fund's net asset
value.
As previously stated, the value of such a security will decrease in a
rising interest rate market and accordingly, so will the Fund's net asset
value. If the Fund experiences unexpected net redemptions in such a market, it
may be forced to liquidate a
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portion of its portfolio securities without regard to their investment merits.
Due to the limited liquidity of lower-quality securities (discussed below) the
Fund may be forced to liquidate these securities at a substantial discount. Any
such liquidation would reduce the Fund's asset base over which expenses could
be allocated and could result in a reduced rate of return for the Fund.
PAYMENT EXPECTATIONS. Lower-quality securities typically contain
redemption, call, or prepayment provisions which permit the issuer of such
securities containing such provisions to, at their discretion, redeem the
securities. During periods of falling interest rates, issuers of lower-quality
securities are likely to redeem or prepay the securities and refinance them
with debt securities with a lower interest rate. To the extent an issuer is
able to refinance the securities, or otherwise redeem them, the Fund may have
to replace the securities with a lower yielding security, which would result in
a lower return for the Fund.
CREDIT RATINGS. Credit ratings issued by credit-rating agencies
evaluate the safety of principal and interest payments of rated securities.
They do not, however, evaluate the market value risk of lower rated securities
and, therefore, may not fully reflect the true risks of an investment. In
addition, credit-rating agencies may or may not make timely changes in a rating
to reflect changes in the economy or in the condition of the issuer that affect
the market value of the security. Consequently, credit ratings are used only
as a preliminary indicator of investment quality. Investments in lower rated
obligations will be more dependent on the Advisor's credit analysis than would
be the case with investments in investment grade debt obligations. The Advisor
employs its own credit research and analysis, which includes a study of
existing debt, capital structure, ability to service debt and to pay dividends,
the issuer's sensitivity to economic conditions, its operating history, and the
current trend of earnings. The Advisor continually monitors the investments in
the Fund's portfolio and carefully evaluates whether to dispose of or to retain
lower rated securities whose credit ratings or credit quality may have changed.
LIQUIDITY AND VALUATION. The Fund may have difficulty disposing of
certain lower-quality securities because there may be a thin trading market for
such securities. Because not all dealers maintain markets in all lower-quality
securities, there is no established retail 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. To the extent a
secondary trading market does exist, it is generally not as liquid as the
secondary market for higher rated securities. The lack of a liquid secondary
market may have an adverse impact on the market price of the security. As a
result, the Fund's asset value and the Fund's ability to dispose of particular
securities, when necessary to meet the Fund's liquidity needs or in response to
a specific economic event, may be impacted. The lack of a liquid secondary
market for certain securities may also make it more difficult for the Fund to
obtain accurate market quotations for purposes of valuing the Fund's portfolio.
Market quotations are generally available on many lower-quality securities only
from a limited number of dealers and may not necessarily represent firm bids of
such dealers or prices for actual sales. During periods of thin trading, the
spread between bid and asked prices is likely to increase significantly. In
addition, adverse publicity and investor perceptions, whether or not based on
fundamental analysis, may decrease the values and liquidity of lower rated
securities, especially in a thinly traded market.
RECENT AND PROPOSED LEGISLATION. Recent legislation has been adopted, and
from time to time, proposals have been discussed, regarding new legislation
designed to limit the use of certain lower-quality securities by certain
issuers. An example of legislation is a recent law which requires federally
insured savings and loan associations to divest their investments in these
securities over time. It is not currently possible to determine the impact of
the recent legislation or the proposed legislation on the lower-quality
securities market. However, it is anticipated that if additional legislation
is enacted or proposed, it could have a material affect on the value of these
securities and the existence of a secondary trading market for the securities.
DERIVATIVE INSTRUMENTS
GENERAL DESCRIPTION. As discussed in the Prospectus, the Fund may
use a variety of derivative instruments, including options, futures contracts
(sometimes referred to as "futures"), options on futures contracts, forward
currency contracts and swap agreements for any lawful purpose consistent with
the Fund's investment objective, such as to hedge the Fund's portfolio, manage
risk, or attempt to enhance returns, but not for speculation.
The use of these instruments is subject to applicable regulations of
the Securities and Exchange Commission (the "SEC"), the several options and
futures exchanges upon which they may be traded, the Commodity Futures Trading
Commission
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(the "CFTC") and various state regulatory authorities. In addition, the Fund's
ability to use these instruments will be limited by tax considerations.
In addition to the products, strategies and risks described below and
in the Prospectus, the Advisor may discover additional derivative instruments
and other hedging techniques. These new opportunities may become available as
the Advisor develops new techniques or as regulatory authorities broaden the
range of permitted transactions. The Advisor may utilize these opportunities
to the extent that they are consistent with the Fund's investment objective and
permitted by the Fund's investment limitations and applicable regulatory
authorities.
SPECIAL RISKS OF THESE INSTRUMENTS. The use of derivative instruments
involves special considerations and risks as described below. Risks pertaining
to particular instruments are described in the sections that follow.
(1) Successful use of most of these instruments depends upon the
Advisor's ability to predict movements of the overall securities and currency
markets, which requires different skills than predicting changes in the prices
of individual securities. While the Advisor is experienced in the use of these
instruments, there can be no assurance that any particular strategy adopted
will succeed.
(2) There might be imperfect correlation, or even no correlation,
between price movements of an instrument and price movements of investments
being hedged. For example, if the value of an instrument used in a short hedge
(such as writing a call option, buying a put option, or selling a futures
contract) increased by less than the decline in value of the hedged investment,
the hedge would not be fully successful. Such a lack of correlation might
occur due to factors unrelated to the value of the investments being hedged,
such as speculative or other pressures on the markets in which these
instruments are traded. The effectiveness of hedges using instruments on
indices will depend on the degree of correlation between price movements in the
index and price movements in the investments being hedged.
(3) Hedging strategies, if successful, can reduce risk of loss by
wholly or partially offsetting the negative effect of unfavorable price
movements in the investments being hedged. However, hedging strategies can
also reduce opportunity for gain by offsetting the positive effect of favorable
price movements in the hedged investments. For example, if the Fund entered
into a short hedge because the Advisor projected a decline in the price of a
security in the Fund's portfolio, and the price of that security increased
instead, the gain from that increase might be wholly or partially offset by a
decline in the price of the instrument. Moreover, if the price of the
instrument declined by more than the increase in the price of the security, the
Fund could suffer a loss.
(4) As described below, the Fund might be required to maintain assets
as "cover," maintain segregated accounts, or make margin payments when it takes
positions in these instruments involving obligations to third parties (i.e.,
instruments other than purchased options). If the Fund were unable to close
out its positions in such instruments, it might be required to continue to
maintain such assets or accounts or make such payments until the position
expired or matured. The requirements might impair the Fund's ability to sell a
portfolio security or make an investment at a time when it would otherwise be
favorable to do so, or require that the Fund sell a portfolio security at a
disadvantageous time. The Fund's ability to close out a position in an
instrument prior to expiration or maturity depends on the existence of a liquid
secondary market or, in the absence of such a market, the ability and
willingness of the other party to the transaction ("counter party") to enter
into a transaction closing out the position. Therefore, there is no assurance
that any hedging position can be closed out at a time and price that is
favorable to the Fund.
For a discussion of the federal income tax treatment of the Fund's
derivative instruments, see "Taxes -- Derivative Instruments" below.
GENERAL LIMITATIONS ON CERTAIN DERIVATIVE TRANSACTIONS. The Fund has
filed a notice of eligibility for exclusion from the definition of the term
"commodity pool operator" with the CFTC and the National Futures Association,
which regulate trading in the futures markets. Pursuant to Rule 4.5 of the
regulations under the Commodity Exchange Act (the "CEA"), the notice of
eligibility includes representations that the Fund will use futures contracts
and related options solely for bona fide hedging purposes within the meaning of
CFTC regulations, provided that the Fund may hold other positions in futures
contracts, and related options that do not qualify as a bona fide hedging
position if the aggregate initial margin deposits and premiums required to
establish these positions, less the amount by which any such options positions
are "in the money," do not exceed 5% of the Fund's net assets. Adoption of
these guidelines does not limit the percentage of the Fund's assets at risk to
5%.
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In addition, (i) the aggregate value of securities underlying call
options on securities written by the Fund or obligations underlying put options
on securities written by the Fund determined as of the date the options are
written will not exceed 50% of the Fund's net assets; (ii) the aggregate
premiums paid on all options purchased by the Fund and which are being held
will not exceed 20% of the Fund's net assets; (iii) the Fund will not purchase
put or call options, other than hedging positions, if, as a result thereof,
more than 5% of its total assets would be so invested; and (iv) the aggregate
margin deposits required on all futures and options on futures transactions
being held will not exceed 5% of the Fund's total assets.
The foregoing limitations are not fundamental policies of the Fund and
may be changed by the Fund's Board of Directors without shareholder approval as
regulatory agencies permit.
Transactions using options (other than purchased options), forward
currency contracts, and swaps expose the Fund to counter-party risk. To the
extent required by SEC guidelines, the Fund will not enter into any such
transactions unless it owns either (1) an offsetting ("covered") position in
securities, currencies, or other options, futures, or forward currency
contracts or (2) cash and liquid high grade debt obligations with a value
sufficient at all times to cover its potential obligations to the extent not
covered as provided in (1) above. The Fund will also segregate such assets
with respect to futures contracts and its net obligations under swap
agreements. See "Swap Agreements" below. Assets used as cover or held in a
segregated account cannot be sold while the position in the corresponding
option, futures contract, or forward currency contract is open, unless they are
replaced with similar assets. As a result, the commitment of a large portion
of the Fund's assets to segregated accounts as a cover could impede portfolio
management or the Fund's ability to meet redemption requests or other current
obligations.
OPTIONS. The Fund may purchase and write put and call options on
securities, on indices and on foreign currencies and enter into closing
transactions with respect to such options to terminate an existing position.
The purchase of call options serves as a long hedge, and the purchase of put
options serves as a short hedge. Writing put or call options can enable the
Fund to enhance income by reason of the premiums paid by the purchaser of such
options. Writing call options serves as a limited short hedge because declines
in the value of the hedged investment would be offset to the extent of the
premium received for writing the option. However, if the security appreciates
to a price higher than the exercise price of the call option, it can be
expected that the option will be exercised and the Fund will be obligated to
sell the security at less than its market value or will be obligated to
purchase the security at a price greater than that at which the security must
be sold under the option. All or a portion of any assets used as cover for OTC
options written by the Fund would be considered illiquid to the extent
described under "Investment Policies and Techniques--Illiquid Securities."
Writing put options serves as a limited long hedge because increases in the
value of the hedged investment would be offset to the extent of the premium
received for writing the option. However, if the security depreciates to a
price lower than the exercise price of the put option, it can be expected that
the put option will be exercised and the Fund will be obligated to purchase the
security at more than its market value.
The value of an option position will reflect, among other things, the
historical price volatility of the underlying investment, the current market
value of the underlying investment, the time remaining until expiration, the
relationship of the exercise price to the market price of the underlying
investment, and general market conditions. Options used by the Fund may
include European-style options. This means that the option is only exercisable
at its expiration. This is in contrast to American-style options which are
exercisable at any time prior to the expiration date of the option. Options
that expire unexercised have no value.
The Fund may effectively terminate its right or obligation under an
option by entering into a closing transaction. For example, the Fund may
terminate its obligation under a call or put option that it had written by
purchasing an identical call or put option; this is known as a closing purchase
transaction. Conversely, the Fund may terminate a position in a put or call
option it had purchased by writing an identical put or call option; this is
known as a closing sale transaction. Closing transactions permit the Fund to
realize the profit or limit the loss on an option position prior to its
exercise or expiration.
The Fund may purchase or write both exchange-traded and OTC options.
Exchange-traded options are issued by a clearing organization affiliated with
the exchange on which the option is listed that, in effect, guarantees
completion of every exchange-traded option transaction. OTC options are
contracts between the Fund and the other party to the transaction ("counter
party") (usually a securities dealer or a bank) with no clearing organization
guarantee. Thus, when the Fund purchases or writes an OTC option, it relies on
the counter party to make or take delivery of the underlying investment upon
exercise of the option.
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<PAGE> 9
Failure by the counter party to do so would result in the loss of any premium
paid by the Fund as well as the loss of any expected benefit of the
transaction.
The Fund's ability to establish and close out positions in
exchange-listed options depends on the existence of a liquid market. The Fund
intends to purchase or write only those exchange-traded options for which there
appears to be a liquid secondary market. However, there can be no assurance
that such a market will exist at any, particular time. Closing transactions
can be made for OTC options only by negotiating directly with the counter
party, or by a transaction in the secondary market if any such market exists.
Although the Fund will enter into OTC options only with counter parties that
are expected to be capable of entering into closing transactions with the Fund,
there is no assurance that the Fund will in fact be able to close out an OTC
option at a favorable price prior to expiration. In the event of insolvency of
the counter party, the Fund might be unable to close out an OTC option position
at any time prior to its expiration.
If the Fund were unable to effect a closing transaction for an option
it had purchased, it would have to exercise the option to realize any profit.
The inability to enter into a closing purchase transaction for a covered call
option written by the Fund could cause material losses because the Fund would
be unable to sell the investment used as cover for the written option until the
option expires or is exercised.
The Fund may purchase and write put and call options on indices in much
the same manner as the options discussed above, except the index options may
serve as a hedge against overall fluctuations in the securities markets in
general.
The writing and purchasing of options is a highly specialized activity
that involves investment techniques and risks different from those associated
with ordinary portfolio securities transactions. Imperfect correlation between
the options and securities markets may detract from the effectiveness of
attempted hedging.
SPREAD TRANSACTIONS. The Fund may purchase covered spread options from
securities dealers. Such covered spread options are not presently
exchange-listed or exchange-traded. The purchase of a spread option gives the
Fund the right to put, or sell, a security that it owns at a fixed dollar
spread or fixed yield spread in relationship to another security that the Fund
does not own, but which is used as a benchmark. The risk to the Fund in
purchasing covered spread options is the cost of the premium paid for the
spread option and any transaction costs. In addition, there is no assurance
that closing transactions will be available. The purchase of spread options
will be used to protect the Fund against adverse changes in prevailing credit
quality spreads, i.e., the yield spread between high quality and lower quality
securities. Such protection is only provided during the life of the spread
option.
FUTURES CONTRACTS. The Fund may enter into futures contracts,
including interest rate, index, and currency futures. The Fund may also
purchase put and call options, and write covered put and call options, on
futures in which it is allowed to invest. The purchase of futures or call
options thereon can serve as a long hedge, and the sale of futures or the
purchase of put options thereon can serve as a short hedge. Writing covered
call options on futures contracts can serve as a limited short hedge, and
writing covered put options on futures contracts can serve as a limited long
hedge, using a strategy similar to that used for writing covered options in
securities. The Fund's hedging may include purchases of futures as an offset
against the effect of expected increases in currency exchange rates and
securities prices and sales of futures as an offset against the effect of
expected declines in currency exchange rates and securities prices. The Fund's
futures transactions may be entered into for any lawful purpose consistent with
the Fund's investment objective, such as hedging purposes, risk management, or
to enhance returns, but not for speculation. The Fund may also write put
options on futures contracts while at the same time purchasing call options on
the same futures contracts in order to create synthetically a long futures
contract position. Such options would have the same strike prices and
expiration dates. The Fund will engage in this strategy only when the Advisor
believes it is more advantageous to the Fund than is purchasing the futures
contract.
To the extent required by regulatory authorities, the Fund only enters
into futures contracts that are traded on national futures exchanges and are
standardized as to maturity date and underlying financial instrument. Futures
exchanges and trading are regulated under the CEA by the CFTC. Although
techniques other than sales and purchases of futures contracts could be used to
reduce the Fund's exposure to market, currency, or interest rate fluctuations,
the Fund may be able to hedge its exposure more effectively and perhaps at a
lower cost through using futures contracts.
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<PAGE> 10
A futures contract is an agreement pursuant to which the parties agree
to take or make delivery of an amount of cash equal to the difference between
the value of the index at the close of the last trading day of the contract and
the price at which the index futures contract was originally written. An
interest rate futures contract provides for the future sale by one party and
purchase by another party of a specified amount of a specific financial
instrument (e.g., debt security) or currency for a specified price at a
designated date, time, and place. A foreign currency contract is a bilateral
agreement pursuant to which one party agrees to make and the other party agrees
to accept delivery of a specified type of currency at a specified future time
and at a specified price. Transaction costs are incurred when a futures
contract is bought or sold and margin deposits must be maintained. A futures
contract may be satisfied by delivery or purchase, as the case may be, of the
instrument, the currency or by payment of the change in the cash value of the
index. More commonly, futures contracts are closed out prior to delivery by
entering into an offsetting transaction in a matching futures contract.
Although the value of an index might be a function of the value of certain
specified securities, no physical delivery of those securities is made. If the
offsetting purchase price is less than the original sale price, the Fund
realizes a gain; if it is more, the Fund realizes a loss. Conversely, if the
offsetting sale price is more than the original purchase price, the Fund
realizes a gain; if it is less, the Fund realizes a loss. The transaction
costs must also be included in these calculations. There can be no assurance,
however, that the Fund will be able to enter into an offsetting transaction
with respect to a particular futures contract at a particular time. If the
Fund is not able to enter into an offsetting transaction, the Fund will
continue to be required to maintain the margin deposits on the futures
contract.
No price is paid by the Fund upon entering into a futures contract.
Instead, at the inception of a futures contract, the Fund is required to
deposit in a segregated account with its custodian, in the name of the futures
broker through whom the transaction was effected, "initial margin" consisting
of cash, U.S. government securities or other liquid, high grade debt
obligations, in an amount generally equal to 10% or less of the contract value.
High grade securities include securities rated "A" or better by an NRSRO.
Margin must also be deposited when writing a call or put option on a futures
contract, in accordance with applicable exchange rules. Unlike margin in
securities transactions, initial margin on futures contracts does not represent
a borrowing, but rather is in the nature of a performance bond or good-faith
deposit that is returned to the Fund at the termination of the transaction if
all contractual obligations have been satisfied. Under certain circumstances,
such as periods of high volatility, the Fund may be required by an exchange to
increase the level of its initial margin payment, and initial margin
requirements might be increased generally in the future by regulatory action.
Subsequent "variation margin" payments are made to and from the futures
broker daily as the value of the futures position varies, a process known as
"marking to market." Variation margin does not involve borrowing, but rather
represents a daily settlement of the Fund's obligations to or from a futures
broker. When the Fund purchases an option on a future, the premium paid plus
transaction costs is all that is at risk. In contrast, when the Fund purchases
or sells a futures contract or writes a call or put option thereon, it is
subject to daily variation margin calls that could be substantial in the event
of adverse price movements. If the Fund has insufficient cash to meet daily
variation margin requirements, it might need to sell securities at a time when
such sales are disadvantageous. Purchasers and sellers of futures positions
and options on futures can enter into offsetting closing transactions by
selling or purchasing, respectively, an instrument identical to the instrument
held or written. Positions in futures and options on futures may be closed
only on an exchange or board of trade that provides a secondary market. The
Fund intends to enter into futures transactions only on exchanges or boards of
trade where there appears to be a liquid secondary market. However, there can
be no assurance that such a market will exist for a particular contract at a
particular time.
Under certain circumstances, futures exchanges may establish daily
limits on the amount that the price of a future or option on a futures contract
can vary from the previous day's settlement price; once that limit is reached,
no trades may be made that day at a price beyond the limit. Daily price limits
do not limit potential losses because prices could move to the daily limit for
several consecutive days with little or no trading, thereby preventing
liquidation of unfavorable positions.
If the Fund were unable to liquidate a futures or option on a futures
contract position due to the absence of a liquid secondary market or the
imposition of price limits, it could incur substantial losses. The Fund would
continue to be subject to market risk with respect to the position. In
addition, except in the case of purchased options, the Fund would continue to
be required to make daily variation margin payments and might be required to
maintain the position being hedged by the future or option or to maintain cash
or securities in a segregated account.
Certain characteristics of the futures market might increase the risk
that movements in the prices of futures contracts or options on futures
contracts might not correlate perfectly with movements in the prices of the
investments being hedged. For example, all participants in the futures and
options on futures contracts markets are subject to daily variation margin
calls and might be compelled to liquidate futures or options on futures
contracts positions whose prices are moving unfavorably to avoid
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<PAGE> 11
being subject to further calls. These liquidations could increase price
volatility of the instruments and distort the normal price relationship between
the futures or options and the investments being hedged. Also, because initial
margin deposit requirements in the futures markets are less onerous than margin
requirements in the securities markets, there might be increased participation
by speculators in the futures markets. This participation also might cause
temporary price distortions. In addition, activities of large traders in both
the futures and securities markets involving arbitrage, "program trading" and
other investment strategies might result in temporary price distortions.
SWAP AGREEMENTS. The Fund may enter into interest rate, securities
index and currency exchange rate swap agreements for purposes of attempting to
obtain or preserve a particular desired return or spread at a lower cost to the
Fund than if the Fund had invested directly in an instrument that yielded that
desired return or spread. The Fund also may enter into swaps in order to
protect against an increase in the price of, or the currency exchange rate
applicable to, securities that the Fund anticipates purchasing at a later date.
Swap agreements are two-party contracts entered into primarily by
institutional investors for periods ranging from a few weeks to several years.
In a standard "swap" transaction, two parties agree to exchange the returns (or
differentials in rates of return) earned or realized on particular
predetermined investments or instruments. The gross returns to be exchanged or
"swapped" between the parties are calculated with respect to a "notional
amount," i.e., the return on or increase in value of a particular dollar amount
invested at a particular interest rate, in a particular foreign currency, or in
a "basket" of securities representing a particular index. Swap agreements may
include interest rate caps, under which, in return for a premium, one party
agrees to make payments to the other to the extent that interest rates exceed a
specified rate, or "cap," interest rate floors, under which, in return for a
premium, one party agrees to make payments to the other to the extent that
interest rates fall below a specified level, or "floor"; and interest rate
collars, under which a party sells a cap and purchases a floor, or vice versa,
in an attempt to protect itself against interest rate movements exceeding given
minimum or maximum levels.
The "notional amount" of the swap agreement is only the agreed upon
basis for calculating the obligations that the parties to a swap agreement have
agreed to exchange. Under most swap agreements entered into by the Fund, the
obligations of the parties would be exchanged on a "net basis." Consequently,
the Fund's obligations (or rights) under a swap agreement will generally be
equal only to the net amount to be paid or received under the agreement based
on the relative values of the positions held by each party to the agreement
(the "net amount"). The Fund's obligations under a swap agreement will be
accrued daily (offset against amounts owed to the Fund) and any accrued but
unpaid net amounts owed to a swap counter party will be covered by the
maintenance of a segregated account consisting of cash, or liquid high grade
debt obligations.
Whether the Fund's use of swap agreements will be successful in
furthering its investment objective will depend on the Advisor's ability to
predict correctly whether certain types of investments are likely to produce
greater returns than other investments. Swap agreements may be considered to
be illiquid. Moreover, the Fund bears the risk of loss of the amount expected
to be received under a swap agreement in the event of the default or bankruptcy
of a swap agreement counter party. Certain restrictions imposed on the Fund by
the Internal Revenue Code may limit the Fund's ability to use swap agreements.
The swaps market is largely unregulated.
The Fund will enter into swap agreements only with banks and recognized
securities dealers believed by the Advisor to present minimal credit risks in
accordance with guidelines established by the Fund's Board of Directors. If
there is a default by the other party to such a transaction, the Fund will have
to rely on its contractual remedies (which may be limited by bankruptcy,
insolvency or similar laws) pursuant to the agreements related to the
transaction.
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<PAGE> 12
FOREIGN CURRENCY-RELATED DERIVATIVE STRATEGIES-SPECIAL CONSIDERATIONS.
The Fund may purchase and sell foreign currency on a spot basis, and may use
currency-related derivatives instruments such as options on foreign currencies,
futures on foreign currencies, options on futures on foreign currencies and
forward currency contracts (i.e., an obligation to purchase or sell a specific
currency at a specified future date, which may be any fixed number of days from
the contract date agreed upon the parties, at a price set at the time the
contract is entered into). The Fund may use these instruments for hedging or
any other lawful purpose consistent with its investment objective, including
transaction hedging, anticipatory hedging, cross hedging, proxy hedging, and
position hedging. The Fund's use of currency-related derivative instruments
will be directly related to the Fund's current or anticipated portfolio
securities, and the Fund may engage in transactions in currency-related
derivative instruments as a means to protect against some or all of the effects
of adverse changes in foreign currency exchange rates on its portfolio
investments. In general, if the currency in which a portfolio investment 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 portfolio investment expressed
in U.S. dollars.
For example, the Fund might use currency-related derivative instruments
to "lock in" a U.S. dollar price for a portfolio investment, thereby enabling
the Fund to protect itself against a possible loss resulting from an adverse
change in the relationship between the U.S. dollar and the subject foreign
currency during the period between the date the security is purchased or sold
and the date on which payment is made or received. The Fund also might use
currency-related derivative instruments when the Advisor believes that one
currency may experience a substantial movement against another currency,
including the U.S. dollar, and it may use currency-related derivative
instruments to sell or buy the amount of the former foreign currency,
approximating the value of some or all of the Fund's portfolio securities
denominated in such foreign currency. Alternatively, where appropriate, the
Fund may use currency-related derivative instruments to hedge all or part of
its foreign currency exposure through the use of a basket of currencies or a
proxy currency where such currency or currencies act as an effective proxy for
other currencies. The use of this basket hedging technique may be more
efficient and economical than using separate currency-related derivative
instruments for each currency exposure held by the Fund. Furthermore,
currency-related derivative instruments may be used for short hedges -- for
example, the Fund may sell a forward currency contract to lock in the U.S.
dollar equivalent of the proceeds from the anticipated sale of a security
denominated in a foreign currency.
In addition, the Fund may use a currency-related derivative instrument
to shift exposure to foreign currency fluctuations from one foreign country to
another foreign country where the Advisor believes that the foreign currency
exposure purchased will appreciate relative to the U.S. dollar and thus better
protect the Fund against the expected decline in the foreign currency exposure
sold. For example, if the Fund owns securities denominated in a foreign
currency and the Advisor believes that currency will decline, it might enter
into a forward contract to sell an appropriate amount of the first foreign
currency, with payment to be made in a second foreign currency that the Advisor
believes would better protect the Fund against the decline in the first
security than would a U.S. dollar exposure. Hedging transactions that use two
foreign currencies are sometimes referred to as "cross hedges." The effective
use of currency-related derivative instruments by the Fund in a cross hedge is
dependent upon a correlation between price movements of the two currency
instruments and the underlying security involved, and the use of two currencies
magnifies the risk that movements in the price of one instrument may not
correlate or may correlate unfavorably with the foreign currency being hedged.
Such a lack of correlation might occur due to factors unrelated to the value of
the currency instruments used or investments being hedged, such as speculative
or other pressures on the markets in which these instruments are traded.
The Fund also might seek to hedge against changes in the value of a
particular currency when no hedging instruments on that currency are available
or such hedging instruments are more expensive than certain other hedging
instruments. In such cases, the Fund may hedge against price movements in that
currency by entering into transactions using currency-related derivative
instruments on another foreign currency or a basket of currencies, the values
of which the Advisor believes will have a high degree of positive correlation
to the value of the currency being hedged. The risk that movements in the
price of the hedging instrument will not correlate perfectly with movements in
the price of the currency being hedged is magnified when this strategy is used.
The use of currency-related derivative instruments by the Fund
involves a number of risks. The value of currency-related derivative
instruments depends on the value of the underlying currency relative to the
U.S. dollar. Because foreign currency transactions occurring in the interbank
market might involve substantially larger amounts than those involved in the
use of such derivative instruments, the Fund could be disadvantaged by having
to deal in the odd lot market (generally consisting of transactions of less
than $1 million) for the underlying foreign currencies at prices that are less
favorable than for round lots (generally consisting of transactions of greater
than $1 million).
There is no systematic reporting of last sale information for foreign
currencies or any regulatory requirement that quotations available through
dealers or other market sources be firm or revised on a timely basis.
Quotation information generally is representative of very large transactions in
the interbank market and thus might not reflect odd-lot transactions where
rates might be less favorable. The interbank market in foreign currencies is a
global, round-the-clock market. To the extent the U.S. options or futures
markets are closed while the markets for the underlying currencies remain open,
significant price and rate movements might take place in the underlying markets
that cannot be reflected in the markets for the derivative instruments until
they re-open.
Settlement of transactions in currency-related derivative instruments
might be required to take place within the country issuing the underlying
currency. Thus, the Fund might be required to accept or make delivery of the
underlying foreign currency in accordance with any U.S. or foreign regulations
regarding the maintenance of foreign banking arrangements by U.S. residents and
might be required to pay any fees, taxes and charges associated with such
delivery assessed in the issuing country.
When the Fund engages in a transaction in a currency-related derivative
instrument, it relies on the counterparty to make or take delivery of the
underlying currency at the maturity of the contract or otherwise complete the
contract. In other words, the Fund will be subject to the risk that a loss may
be sustained by the Fund as a result of the failure of the counterparty to
comply with the terms of the transaction. The counterparty risk for
exchange-traded instruments is generally less than for privately-negotiated or
OTC currency instruments, since generally a clearing agency, which is the
issuer or counterparty to each instrument, provides a guarantee of performance.
For privately-negotiated instruments, there is no similar clearing agency
guarantee. In all transactions, the Fund will bear the risk that the
counterparty will default, and this could result in a loss of the expected
benefit of the transaction and possibly other losses to the Fund. The Fund
will enter into transactions in currency-related derivative instruments only
with counterparties that the Advisor reasonably believes are capable of
performing under the contract.
Purchasers and sellers of currency-related derivative instruments may
enter into offsetting closing transactions by selling or purchasing,
respectively, an instrument identical to the instrument purchased or sold.
Secondary markets generally do not exist for forward currency contracts, with
the result that closing transactions generally can be made for forward currency
contracts only by negotiating directly with the counterparty. Thus, there can
be no assurance that the Fund will in fact be able to close out a forward
currency contract (or any other currency-related derivative instrument) at a
time and price favorable to the Fund. In addition, in the event of insolvency
of the counterparty, the Fund might be unable to close out a forward currency
contract at any time prior to maturity. In the case of an exchange-traded
instrument, the Fund will be able to close the position out only on an exchange
which provides a market for the instruments. The ability to establish and
close out positions on an exchange is subject to the maintenance of a liquid
market, and there can be no assurance that a liquid market will exist for any
instrument at any specific time. In the case of a privately-negotiated
instrument, the Fund will be able to realize the value of the instrument only
by entering into a closing transaction with the issuer or finding a third party
buyer for the instrument. While the Fund will enter into privately-negotiated
transactions only with entities who are expected to be capable of entering into
a closing transaction, there can be no assurance that the Fund will in fact be
able to enter into such closing transactions.
The precise matching of currency-related derivative instrument amounts
and the value of the portfolio securities involved generally will not be
possible because the value of such securities, measured in the foreign
currency, will change after the currency-related derivative instrument position
has been established. Thus, the Fund might need to purchase or sell foreign
currencies in the spot (cash) market. The projection of short-term currency
market movements is extremely difficult, and the successful execution of a
short-term hedging strategy is highly uncertain.
Permissible foreign currency options will include options traded
primarily in the OTC market. Although options on foreign currencies are traded
primarily in the OTC market, the Fund will normally purchase or sell OTC
options on foreign currency only when the Advisor reasonably believes a liquid
secondary market will exist for a particular option at any specific time.
There will be a cost to the Fund of engaging in transactions in
currency-related derivative instruments that will vary with factors such as the
contract or currency involved, the length of the contract period and the market
conditions then prevailing. The Fund may have to pay a fee or commission or,
in cases where the instruments are entered into on a principal basis, foreign
exchange dealers or other counterparties will realize a profit based on the
difference ("spread") between the prices at which they are buying and selling
various currencies. Thus, for example, a dealer may offer to sell a foreign
currency to the Fund at one rate, while offering a lesser rate of exchange
should the Fund desire to resell that currency to the dealer.
When required by SEC guidelines, the Fund will set aside permissible
liquid assets in segregated accounts or otherwise cover its potential
obligations under currency-related derivatives instruments. To the extent the
Fund's assets are so set aside, they cannot be sold while the corresponding
currency position is open, unless they are replaced with similar assets. As a
result, if a large portion of the Fund's assets are so set aside, this could
impede portfolio management or the Fund's ability to meet redemption requests
or other current obligations.
The Advisor's decision to engage in a transaction in a particular
currency-related derivative instrument will reflect the Advisor's judgment that
the transaction will provide value to the Fund and its shareholders and is
consistent with the Fund's objectives and policies. In making such a judgment,
the Advisor will analyze the benefits and risks of the transaction and weigh
them in the context of the Fund's entire portfolio and objectives. The
effectiveness of any transaction in a currency-related derivative instrument is
dependent on a variety of factors, including the Advisor's skill in analyzing
and predicting currency values and upon a correlation between price movements
of the currency instrument and the underlying security. There might be
imperfect correlation, or even no correlation, between price movements of an
instrument and price movements of investments being hedged. Such a lack of
correlation might occur due to factors unrelated to the value of the
investments being hedged, such as speculative or other pressures on the markets
in which these instruments are traded. In addition, the Fund's use of
currency-related derivative instruments is always subject to the risk that the
currency in question could be devalued by the foreign government. In such
a case, any long currency positions would decline in value and could adversely
affect any hedging position maintained by the Fund.
The Fund's dealing in currency-related derivative instruments will
generally be limited to the transactions described above. However, the Fund
reserves the right to use currency-related derivatives instruments for
different purposes and under different circumstances. Of course, the Fund is
not required to use currency-related derivatives instruments and will not do so
unless deemed appropriate by the Advisor. It also should be realized that use
of these instruments does not eliminate, or protect against, price movements in
the Fund's securities that are attributable to other (i.e., non-currency
related) causes. Moreover, while the use of currency-related derivatives
instruments may reduce the risk of loss due to a decline in the value of a
hedged currency, at the same time the use of these instruments tends to limit
any potential gain which may result from an increase in the value of that
currency.
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VARIABLE- OR FLOATING-RATE SECURITIES
The Fund may invest in securities which offer a variable- or
floating-rate of interest. Variable-rate securities provide for automatic
establishment of a new interest rate at fixed intervals (e.g., daily, monthly,
semi-annually, etc.). Floating-rate securities provide for automatic
adjustment of the interest rate whenever some specified interest rate index
changes. The interest rate on variable- or floating-rate securities is
ordinarily determined by reference to or is a percentage of a bank's prime
rate, the 90-day U.S. Treasury bill rate, the rate of return on commercial
paper, bank certificates of deposit, an index of short-term interest rates, or
some other objective measure.
Variable- or floating-rate securities frequently include a demand
feature entitling the holder to sell the securities to the issuer at par. In
many cases, the demand feature can be exercised at any time on 7 days' notice;
in other cases, the demand feature is exercisable at any time on 30 days'
notice or on similar notice at intervals of not more than one year. Some
securities, which do not have variable or floating interest rates, may be
accompanied by puts producing similar results and price characteristics. When
considering the maturity of any instrument which may be sold or put to the
issuer or a third party, the Fund may consider that instrument's maturity to be
shorter than its stated maturity.
Variable-rate demand notes include master demand notes, which are
obligations that permit the Fund to invest fluctuating amounts that may change
daily without penalty, pursuant to direct arrangements between the Fund, as
lender, and the borrower. The interest rates on these notes fluctuate from
time to time. The issuer of such obligations normally has a corresponding
right, after a given period, to prepay in its discretion the outstanding
principal amount of the obligations plus accrued interest upon a specified
number of days' notice to the holders of such obligations. The interest rate
on a floating-rate demand obligation is based on a known lending rate, such as
a bank's prime rate, and is adjusted automatically each time such rate is
adjusted. The interest rate on a variable-rate demand obligation is adjusted
automatically at specified intervals. Frequently, such obligations are secured
by letters of credit or other credit support arrangements provided by banks.
Because these obligations are direct-lending arrangements between the lender
and borrower, it is not contemplated that such instruments will generally be
traded. There generally is not an established secondary market for these
obligations, although they are redeemable at face value. Accordingly, where
these obligations are not secured by letters of credit or other credit support
arrangements, the Fund's right to redeem is dependent on the ability of the
borrower to pay principal and interest on demand. Such obligations frequently
are not rated by credit rating agencies and, if not so rated, the Fund may
invest in them only if the Fund's Advisor determines that, at the time of
investment, the obligations are of comparable quality to the other obligations
in which the Fund may invest. The Advisor, on behalf of the Fund, will
consider on an ongoing basis the creditworthiness of the issuers of the
floating- and variable-rate demand obligations in the Fund's portfolio.
The Fund will not invest more than 15% of its net assets in variable-
and floating-rate demand obligations that are not readily marketable (a
variable- or floating-rate demand obligation that may be disposed of on not
more than seven days notice will be deemed readily marketable and will not be
subject to this limitation). (See "Illiquid Securities" and "Investment
Restrictions.") In addition, each variable- or floating-rate obligation must
meet the credit quality requirements applicable to all the Fund's
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<PAGE> 14
investments at the time of purchase. When determining whether such an
obligation meets the Fund's credit quality requirements, the Fund may look to
the credit quality of the financial guarantor providing a letter of credit or
other credit support arrangement.
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MORTGAGE- AND ASSET-BACKED SECURITIES
Mortgage-backed securities represent direct or indirect participations
in, or are secured by and payable from, mortgage loans secured by real
property, and include single- and multi-class pass-through securities and
collateralized mortgage obligations. Such securities may be issued or
guaranteed by U.S. government agencies or instrumentalities, such as the
Government National Mortgage Association and the Federal National Mortgage
Association, or by private issuers, generally originators and investors in
mortgage loans, including savings associations, mortgage bankers, commercial
banks, investment bankers, and special purpose entities (collectively, "private
lenders"). Mortgage-backed securities issued by private lenders may be
supported by pools of mortgage loans or other mortgage-backed securities that
are guaranteed, directly or indirectly, by the U.S. government or one of its
agencies or instrumentalities, or they may be issued without any governmental
guarantee of the underlying mortgage assets but with some form of
non-governmental credit enhancement.
Asset-backed securities have structural characteristics similar to
mortgage-backed securities. However, the underlying assets are not first lien
mortgage loans or interests therein, but include assets such as motor vehicle
installment sales contracts, other installment loan contracts, home equity
loans, leases of various types of property, and receivables from credit card or
other revolving credit arrangements. Payments or distributions of principal
and interest on asset-backed securities may be supported by non-governmental
credit enhancements similar to those utilized in connection with
mortgage-backed securities.
The yield characteristics of mortgage- and asset-backed securities
differ from those of traditional debt obligations. Among the principal
differences are that interest and principal payments are made more frequently
on mortgage-and asset-backed securities, usually monthly, and that principal
may be prepaid at any time because the underlying mortgage loans or other
assets generally may be prepaid at any time. As a result, if the Fund
purchases these securities at a premium, a prepayment rate that is faster than
expected will reduce yield to maturity, while a prepayment rate that is slower
than expected will have the opposite effect of increasing the yield to
maturity. Conversely, if the Fund purchases these securities at a discount, a
prepayment rate that is faster than expected will increase yield to maturity,
while a prepayment rate that is slower than expected will reduce yield to
maturity. Amounts available for reinvestment by the Fund are likely to be
greater during a period of declining interest rates and, as a result, are
likely to be reinvested at lower interest rates than during a period of rising
interest rates. Accelerated prepayments on securities purchased by the Fund at
a premium also impose a risk of loss of principal because the premium may not
have been fully amortized at the time the principal is prepaid in full. The
market for privately issued mortgage- and asset-backed securities is smaller
and less liquid than the market for government-sponsored mortgage-backed
securities.
The Fund may invest in stripped mortgage- or asset-backed securities,
which receive differing proportions of the interest and principal payments from
the underlying assets. The market value of such securities generally is more
sensitive to changes in prepayment and interest rates than is the case with
traditional mortgage- and asset-backed securities, and in some cases such
market value may be extremely volatile. With respect to certain stripped
securities, such as interest only and principal only classes, a rate of
prepayment that is faster or slower than anticipated may result in the Fund
failing to recover all or a portion of its investment, even though the
securities are rated investment grade.
WHEN-ISSUED SECURITIES
The Fund may invest without limitation in when-issued and delayed
delivery securities (collectively "When-Issued Securities"). The price of such
securities, which may be expressed in yield terms, is fixed at the time the
commitment to purchase is made, but delivery and payment for the When-Issued
Securities take place at a later date. Normally, the settlement date occurs
within one month of the purchase. During the period between purchase and
settlement, no payment is made by the Fund to the issuer and no interest
accrues to the Fund. Forward commitments involve a risk of loss if the value of
the security to be purchased declines prior to the settlement date, which risk
is in addition to the risk of decline in value of the Fund's other assets.
While When-Issued Securities may be sold prior to the settlement date, the Fund
intends to purchase such securities with the purpose of actually acquiring them
unless a sale appears desirable for investment reasons. At the time the Fund
makes the commitment to purchase a security on a when-issued basis, it will
record the transaction and reflect the value of the security in determining its
net asset value. The Fund does not believe that its net asset value or income
will be adversely affected by its purchases of securities on a when-issued
basis.
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The Fund will maintain cash and marketable securities equal in value to
commitments for When-Issued Securities. Such segregated securities either will
mature or, if necessary, be sold on or before the settlement date. When the
time comes to pay for When-Issued Securities, the Fund will meet its obligation
from then-available cash flow, sale of the securities held in the separate
account, described above, sale of other securities or, although it would not
normally expect to do so, from the sale of the When-Issued Securities
themselves (which may have a market value greater or less than the respective
Fund's payment obligation).
FOREIGN SECURITIES
The Fund may invest without limitation in foreign securities. Many of
the foreign securities held by the Fund will not be registered with the SEC,
nor will the issuers thereof be subject to SEC reporting requirements.
Accordingly, there may be less publicly available information concerning
foreign issuers of securities held by the Fund than is available concerning
U.S. companies. Disclosure and regulatory standards in many respects are less
stringent in emerging market countries than in the U.S. and other major
markets. There also may be a lower level of monitoring and regulation of
emerging markets and the activities of investors in such markets, and
enforcement of existing regulations may be extremely limited. Foreign
companies, and in particular, companies in smaller and emerging capital markets
are not generally subject to uniform accounting, auditing and financial
reporting standards or to other regulatory requirements comparable to those
applicable to U.S. companies. The Fund's net investment income and capital
gains from its foreign investment activities may be subject to non-U.S.
withholding taxes.
The costs attributable to foreign investing that the Fund must bear
frequently are higher than those attributable to domestic investing; this is
particularly true with respect to emerging capital markets. For example, the
cost of maintaining custody of foreign securities exceeds custodian costs for
domestic securities, and transaction and settlement costs of foreign investing
also frequently are higher than those attributable to domestic investing.
Costs associated with the exchange of currencies also make foreign investing
more expensive than domestic investing. Investment income on certain foreign
securities in which the Fund may invest may be subject to foreign withholding
or other government taxes that could reduce the return of these securities.
Tax treaties between the United States and foreign countries, however, may
reduce or eliminate the amount of foreign tax to which the Fund would be
subject.
Foreign markets also have different clearance and settlement
procedures, and in certain markets there have been times when settlements have
failed to keep pace with the volume of securities transactions, making it
difficult to conduct such transactions. Delays in settlement could result in
temporary periods when assets of the Fund are uninvested and no return is
earned thereon. The inability of the Fund to make intended security purchases
due to settlement problems could cause the Fund to miss attractive investment
opportunities. Inability to dispose of a portfolio security due to settlement
problems could result either in losses to the Fund due to subsequent declines
in the value of such portfolio security or, if the Fund has entered into a
contract to sell the security, could result in possible liability to the
purchaser.
SOVEREIGN DEBT
Sovereign debt differs from debt obligations issued by private entities
in that, generally, remedies for defaults must be pursued in the courts of the
defaulting party. Legal recourse is therefore limited. Political conditions,
especially a sovereign entity's willingness to meet the terms of its debt
obligations, are of considerable significance. Also, there can be no assurance
that the holders of commercial bank loans to the same sovereign entity may not
contest payments to the holders of sovereign debt in the event of default under
commercial bank loan agreements.
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. A country whose exports are
concentrated in a few commodities could be vulnerable to a decline in the
international price of such commodities. Increased protectionism on the part
of a country's trading partners, or political changes in those countries, could
also adversely affect its exports. Such events could diminish a country's
trade account surplus, if any, or the credit standing of a particular local
government or agency. Another factor bearing on the ability of a country to
repay sovereign debt is the level of the country's international reserves.
Fluctuations in the level of these reserves can affect the amount of foreign
exchange readily available for external debt payments and, thus, could have a
bearing on the capacity of the country to make payments on its sovereign debt.
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To the extent that a country has a current account deficit (generally
when exports of merchandise and services are less than the country's imports of
merchandise and services plus net transfers (e.g., gifts of currency and goods)
to foreigners), it will need to depend on loans from foreign governments,
multilateral organizations or private commercial banks, aid payments from
foreign governments and inflows of foreign investment. The access of a country
to these forms of external funding may not be certain, and a withdrawal of
external funding could adversely affect the capacity of a government to make
payments on its obligations. In addition, the cost of servicing debt
obligations can be affected by a change in international interest rates since
the majority of these obligations carry interest rates that are adjusted
periodically based upon international rates.
With respect to sovereign debt of emerging market issuers, investors
should be aware that certain emerging market countries are among the largest
debtors to commercial banks and foreign governments. At times certain emerging
market countries have declared moratoria on the payment of principal and
interest on external debt.
Certain emerging market countries have experienced difficulty in
servicing their sovereign debt on a timely basis which led to defaults on
certain obligations and the restructuring of certain indebtedness.
Restructuring arrangements have included, among other things, reducing and
rescheduling interest and principal payments by negotiating new or amended
credit agreements or converting outstanding principal and unpaid interest to
Brady Bonds (discussed below), and obtaining new credit to finance interest
payments. Holders of sovereign debt, including the Fund, may be requested to
participate in the rescheduling of such debt and to extend further loans to
sovereign debtors. The interests of holders of sovereign debt could be
adversely affected in the course of restructuring arrangements or by certain
other factors referred to below. Furthermore, some of the participants in the
secondary market for sovereign debt may also be directly involved in
negotiating the terms of these arrangements and may therefore have access to
information not available to other market participants. Obligations arising
from past restructuring agreements may affect the economic performance and
political and social stability of certain issuers of sovereign debt. There is
no bankruptcy proceeding by which sovereign debt on which a sovereign has
defaulted may be collected in whole or in part.
Foreign investment in certain sovereign debt is restricted or
controlled to varying degrees. These restrictions or controls may at times
limit or preclude foreign investment in such sovereign debt and increase the
costs and expenses of the Fund. Certain countries in which the Fund will
invest require governmental approval prior to investments by foreign persons,
limit the amount of investment by foreign persons in a particular issuer, limit
the investment by foreign persons only to a specific class of securities of an
issuer that may have less advantageous rights than the classes available for
purchase by domiciliaries of the countries, or impose additional taxes on
foreign investors. Certain issuers may require governmental approval for the
repatriation of investment income, capital or the proceeds of sales of
securities by foreign investors. In addition, if a deterioration occurs in a
country's balance of payments, the country could impose temporary restrictions
on foreign capital remittances. The Fund could be adversely affected by delays
in, or a refusal to grant, any required governmental approval for repatriation
of capital, as well as by the application to the Fund of any restrictions on
investments. Investing in local markets may require the Fund to adopt special
procedures, seek local government approvals or take other actions, each of
which may involve additional costs to the Fund.
The sovereign debt in which the Fund may invest includes Brady Bonds,
which are securities issued under the framework of the Brady Plan, an
initiative announced by former U.S. Treasury Secretary Nicholas F. Brady in
1989 as a mechanism for debtor nations to restructure their outstanding
external commercial bank indebtedness. In restructuring its external debt
under the Brady Plan framework, a debtor nation negotiates with its existing
bank lenders as well as multilateral institutions such as the International
Monetary Fund ("IMF"). The Brady Plan framework, as it has developed,
contemplates the exchange of commercial bank debt for newly issued Brady Bonds.
Brady Bonds may also be issued in respect of new money being advanced by
existing lenders in connection with the debt restructuring. The World Bank and
the IMF support the restructuring by providing funds pursuant to loan
agreements or other arrangements which enable the debtor nation to
collateralize the new Brady Bonds or to repurchase outstanding bank debt at a
discount.
There can be no assurance that the circumstances regarding the issuance
of Brady Bonds by these countries will not change. Investors should recognize
that Brady Bonds have been issued only recently, and accordingly do not have a
long payment history. Agreements implemented under the Brady Plan to date are
designed to achieve debt and debt-service reduction through specific options
negotiated by a debtor nation with its creditors. As a result, the financial
packages offered by each country differ. The types of options have included
the exchange of outstanding commercial bank debt for bonds issued at 100% of
face value of such debt, which carry a below-market stated rate of interest
(generally known as par bonds), bonds issued at a discount from the face value
of such debt (generally known as discount bonds), bonds bearing an interest
rate which increases over time, and bonds
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issued in exchange for the advancement of new money by existing lenders.
Regardless of the stated face amount and stated interest rate of the various
types of Brady Bonds, the Fund will purchase Brady Bonds in secondary markets,
as described below, in which the price and yield to the investor reflect market
conditions at the time of purchase.
Certain Brady Bonds have been collateralized as to principal due at
maturity by U.S. Treasury zero coupon bonds with maturities equal to the final
maturity of such Brady Bonds. Collateral purchases are financed by the IMF,
the World Bank, and the debtor nations' reserves. In the event of a default
with respect to collateralized Brady Bonds as a result of which the payment
obligations of the issuer are accelerated, the U.S. Treasury zero coupon
obligations held as collateral for the payment of principal will not be
distributed to investors, nor will such obligations be sold and the proceeds
distributed. The collateral will be held by the collateral agent to the
scheduled maturity of the defaulted Brady Bonds, which will continue to be
outstanding, at which time the face amount of the collateral will equal the
principal payments which would have then been due on the Brady Bonds in the
normal course. In addition, interest payments on certain types of Brady Bonds
may be collateralized by cash or high grade securities in amounts that
typically represent between 12 and 18 months of interest accruals on these
instruments with the balance of the interest accruals being uncollateralized.
Brady Bonds are often viewed as having several valuation components: (1) the
collateralized repayment of principal, if any, at final maturity, (2) the
collateralized interest payments, if any, (3) the uncollateralized interest
payments, and (4) any uncollateralized repayment of principal at maturity
(these uncollateralized amounts constitute the "residual risk"). In light of
the residual risk of Brady Bonds and, among other factors, the history of
defaults with respect to commercial bank loans by public and private entities
of countries issuing Brady Bonds, investments in Brady Bonds are to be viewed
as speculative. The Fund may purchase Brady Bonds with no or limited
collateralization, and will be relying for payment of interest and (except in
the case of principal collateralized Brady Bonds) principal primarily on the
willingness and ability of the foreign government to make payment in accordance
with the terms of the Brady Bonds. Brady Bonds issued to date are purchased
and sold in secondary markets through U.S. securities dealers and other
financial institutions and are generally maintained through European
transnational securities depositories.
REPURCHASE AGREEMENTS
The Fund may invest in repurchase agreements with certain banks or
non-bank dealers. In a repurchase agreement, the Fund buys a security at one
price, and at the time of sale, the seller agrees to repurchase the obligation
at a mutually agreed upon time and price (usually within seven days). The
repurchase agreement, thereby, determines the yield during the purchaser's
holding period, while the seller's obligation to repurchase is secured by the
value of the underlying security. If the value of such securities is less than
the repurchase price, plus any agreed-upon additional amount, the other party
to the agreement will be required to provide additional collateral so that at
all times the collateral is at least equal to the repurchase price, plus any
agreed-upon additional amount. The Advisor will monitor, on an ongoing basis,
the value of the underlying securities to ensure that the value always equals
or exceeds the repurchase price plus accrued interest. Repurchase agreements
could involve certain risks in the event of a default or insolvency of the
other party to the agreement, including possible delays or restrictions upon
the Fund's ability to dispose of the underlying securities. Although no
definitive creditworthiness criteria are used, the Advisor reviews the
creditworthiness of the banks and non-bank dealers with which the Fund enters
into repurchase agreements to evaluate those risks. The Fund may, under certain
circumstances, deem repurchase agreements collateralized by U.S. government
securities to be investments in U.S. government securities.
ILLIQUID SECURITIES
The Fund may invest in illiquid securities (i.e., securities that are
not readily marketable). However, the Fund will not acquire illiquid
securities if, as a result, they would comprise more than 15% of the value of
the Fund's net assets (or such other amounts as may be permitted under the 1940
Act). The Board of Directors or its delegate has the ultimate authority to
determine, to the extent permissible under the federal securities laws, which
securities are illiquid for purposes of this limitation. Certain securities
exempt from registration or issued in transactions exempt from registration
under the Securities Act of 1933, as amended (the "Securities Act"), including
securities that may be resold pursuant to Rule 144A under the Securities Act or
Section 4(2) commercial paper, may be considered liquid. The Board of
Directors has delegated to the Advisor the day-to-day determination of the
liquidity of a security, although it has retained oversight and ultimate
responsibility for such determinations. Although no definitive liquidity
criteria are used, the Fund's Board of Directors has directed the Advisor to
look to such factors as (i) the nature of the market for a security (including
the institutional private resale market), (ii) the terms of certain securities
or other instruments allowing for the disposition to a third party or the
issuer thereof (e.g., certain repurchase obligations and demand
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instruments), (iii) the availability of market quotations (e.g., for securities
quoted in the PORTAL system), and (iv) other permissible relevant factors.
Restricted securities may be sold only in privately negotiated
transactions or in a public offering with respect to which a registration
statement is in effect under the Securities Act. Where registration is
required, the Fund may be obligated to pay all or part of the registration
expenses and a considerable period may elapse between the time of the decision
to sell and the time the Fund may be permitted to sell a security under an
effective registration statement. If, during such a period, adverse market
conditions were to develop, the Fund might obtain a less favorable price than
prevailed when it decided to sell. Restricted securities will be priced at
fair value as determined in good faith by the Fund's Board of Directors. If
through the appreciation of restricted securities or the depreciation of
unrestricted securities, the Fund should be in a position where more than 15%
of the value of its net assets are invested in illiquid securities, including
restricted securities which are not readily marketable, the Fund will take such
steps as are deemed advisable, if any, to protect liquidity.
The Fund may sell OTC options and, in connection therewith, segregate
assets or cover its obligations with respect to OTC options written by the
Fund. The assets used as cover for OTC options written by the Fund will be
considered illiquid unless the OTC options are sold to qualified dealers who
agree that the Fund may repurchase any OTC option it writes at a maximum price
to be calculated by a formula set forth in the option agreement. The cover for
an OTC option written subject to this procedure would be considered illiquid
only to the extent that the maximum repurchase price under the formula exceeds
the intrinsic value of the option.
Notwithstanding the above, the Advisor intends, as a matter of internal
policy, to limit the Fund's investments in illiquid securities to 10% of its
net assets.
WARRANTS
The Fund may acquire warrants. Warrants are securities giving the
holder the right, but not the obligation, to buy the stock of an issuer at a
given price (generally higher than the value of the stock at the time of
issuance) during a specified period or perpetually. Warrants may be acquired
separately or in connection with the acquisition of securities. The Fund will
not purchase warrants, valued at the lower of cost or market value, in excess
of 5% of the Fund's net assets. Included in that amount, but not to exceed 2%
of the Fund's net assets, may be warrants that are not listed on any stock
exchange. Warrants acquired by the Fund in units or attached to securities are
not subject to these restrictions. Warrants do not carry with them the right
to dividends or voting rights with respect to the securities that they entitle
their holder to purchase, and they do not represent any rights in the assets of
the issuer. As a result, warrants may be considered more speculative than
certain other types of investments. In addition, the value of a warrant does
not necessarily change with the value of the underlying securities, and a
warrant ceases to have value if it is not exercised prior to its expiration
date.
DEBT OBLIGATIONS
The Fund may invest a portion of its assets in debt obligations,
including U.S. government securities, commercial paper, banker's acceptances,
certificates of deposit, and time deposits. Issuers of debt obligations have a
contractual obligation to pay interest at a specified rate on specified dates
and to repay principal on a specified maturity date. Certain debt obligations
(usually intermediate- and long-term bonds) have provisions that allow the
issuer to redeem or "call" a bond before its maturity. Issuers are most likely
to call such securities during periods of falling interest rates.
PRICE VOLATILITY. The market value of debt obligations is affected by
changes in prevailing interest rates. The market value of a debt obligation
generally reacts inversely to interest-rate changes, meaning, when prevailing
interest rates decline, an obligation's price usually rises, and when
prevailing interest rates rise, an obligation's price usually declines. A fund
portfolio consisting primarily of debt obligations will react similarly to
changes in interest rates.
MATURITY. In general, the longer the maturity of a debt obligation,
the higher its yield and the greater its sensitivity to changes in interest
rates. Conversely, the shorter the maturity, the lower the yield but the
greater the price stability. Commercial paper is generally considered the
shortest form of debt obligation. The term "bond" generally refers to
securities with maturities longer than two years. Bonds with maturities of
three years or less are considered short-term, bonds with maturities between
three and seven years are considered intermediate-term, and bonds with
maturities greater than seven years are considered long-term.
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CREDIT QUALITY. The values of debt obligations may also be affected by
changes in the credit rating or financial condition of their issuers.
Generally, the lower the quality rating of a security, the higher the degree of
risk as to the payment of interest and return of principal. To compensate
investors for taking on such increased risk, those issuers deemed to be less
creditworthy generally must offer their investors higher interest rates than do
issuers with better credit ratings.
In conducting its credit research and analysis, the Advisor considers
both qualitative and quantitative factors to evaluate the creditworthiness of
individual issuers. The Advisor also relies, in part, on credit ratings
compiled by a number of NRSROs. See the Appendix for additional information.
TEMPORARY DEFENSIVE POSITION. When the Advisor determines that market
conditions warrant a temporary defensive position, the Fund may invest without
limitation in cash and short-term fixed income securities, including U.S.
government securities, commercial paper, banker's acceptances, certificates of
deposit, and time deposits.
LENDING OF PORTFOLIO SECURITIES
The Fund is authorized to lend up to 33 1/3% of the total value of its
portfolio securities to broker-dealers or institutional investors that the
Advisor deems qualified, but only when the borrower maintains with the Fund's
custodian bank collateral either in cash or money market instruments in an
amount at least equal to the market value of the securities loaned, plus
accrued interest and dividends, determined on a daily basis and adjusted
accordingly. However, the Fund does not presently intend to engage in such
lending. In determining whether to lend securities to a particular
broker-dealer or institutional investor, the Advisor will consider, and during
the period of the loan will monitor, all relevant facts and circumstances,
including the creditworthiness of the borrower. The Fund will retain authority
to terminate any loans at any time. The Fund may pay reasonable administrative
and custodial fees in connection with a loan and may pay a negotiated portion
of the interest earned on the cash or money market instruments held as
collateral to the borrower or placing broker. The Fund will receive reasonable
interest on the loan or a flat fee from the borrower and amounts equivalent to
any dividends, interest or other distributions on the securities loaned. The
Fund will retain record ownership of loaned securities to exercise beneficial
rights, such as voting and subscription rights and rights to dividends,
interest or other distributions, when retaining such rights is considered to be
in the Fund's interest.
SMALL COMPANIES
The Fund may, from time to time, invest a substantial portion of its
assets in small companies. While smaller companies generally have the
potential for rapid growth, investments in smaller companies often involve
greater risks than investments in larger, more established companies because
smaller companies may lack the management experience, financial resources,
product diversification, and competitive strengths of larger companies. In
addition, in many instances the securities of smaller companies are traded only
over-the-counter or on a regional securities exchange, and the frequency and
volume of their trading is substantially less than is typical of larger
companies. Therefore, the securities of smaller companies may be subject to
greater and more abrupt price fluctuations. When making large sales, the Fund
may have to sell portfolio holdings at discounts from quoted prices or may have
to make a series of small sales over an extended period of time due to the
trading volume of smaller company securities. Investors should be aware that,
based on the foregoing factors, an investment in the Fund may be subject to
greater price fluctuations than an investment in a fund that invests primarily
in larger, more established companies. The Advisor's research efforts may also
play a greater role in selecting securities for the Fund than in a fund that
invests in larger, more established companies.
BORROWING
The Fund may borrow money from banks, limited by the Fund's fundamental
investment restriction to 33 1/3% of its total assets and may engage in
mortgage dollar roll transactions and reverse repurchase agreements which may
be considered a form of borrowing. (See "Mortgage Dollar Rolls and Reverse
Repurchase Agreements" below.) In addition, the Fund may borrow up to an
additional 5% of its total assets from banks for temporary or emergency
purposes. The Fund will not purchase securities when bank borrowings exceed 5%
of the Fund's total assets.
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MORTGAGE DOLLAR ROLLS AND REVERSE REPURCHASE AGREEMENTS
The Fund may engage in reverse repurchase agreements to facilitate
portfolio liquidity, a practice common in the mutual fund industry, or for
arbitrage transactions discussed below. In a reverse repurchase agreement, the
Fund would sell a security and enter into an agreement to repurchase the
security at a specified future date and price. The Fund generally retains the
right to interest and principal payments on the security. Since the Fund
receives cash upon entering into a reverse repurchase agreement, it may be
considered a borrowing. When required by guidelines of the SEC, the Fund will
set aside permissible liquid assets in a segregated account to secure its
obligation to repurchase the security.
The Fund may also enter into mortgage dollar rolls, in which the Fund
would sell mortgage-backed securities for delivery in the current month and
simultaneously contract to purchase substantially similar securities on a
specified future date. While the Fund would forego principal and interest paid
on the mortgage-backed securities during the roll period, the Fund would be
compensated by the difference between the current sales price and the lower
price for the future purchase as well as by any interest earned on the proceeds
of the initial sale. The Fund also could be compensated through the receipt of
fee income equivalent to a lower forward price. At the time the Fund would
enter into a mortgage dollar roll, it would set aside permissible liquid assets
in a segregated account to secure its obligation for the forward commitment to
buy mortgage-backed securities. Mortgage dollar roll transactions may be
considered a borrowing by the Fund.
The mortgage dollar rolls and reverse repurchase agreements entered
into by the Fund may be used as arbitrage transactions in which the Fund will
maintain an offsetting position in investment-grade securities or repurchase
agreements that mature on or before the settlement date on the related mortgage
dollar roll or reverse repurchase agreement. Since the Fund will receive
interest on the securities or repurchase agreements in which it invests the
transaction proceeds, such transactions may involve leverage. However, since
such securities or repurchase agreements will be high quality and will mature
on or before the settlement date of the mortgage dollar roll or reverse
repurchase agreement, the Advisor believes that such arbitrage transactions do
not present the risks to the Fund that are associated with other types of
leverage.
SHORT SALES AGAINST THE BOX
The Fund may sell securities short against the box to hedge unrealized
gains on portfolio securities. Selling securities short against the box
involves selling a security that the Fund owns or has the right to acquire, for
delivery at a specified date in the future. If the Fund sells securities short
against the box, it may protect unrealized gains, but will lose the opportunity
to profit on such securities if the price rises.
DEPOSITARY RECEIPTS
As indicated in the Prospectus, the Fund may invest in foreign
securities by purchasing depositary receipts, including American Depositary
Receipts ("ADRs") and European Depositary Receipts ("EDRs") or other securities
convertible into securities of issuers based in foreign countries. These
securities may not necessarily be denominated in the same currency as the
securities into which they may be converted. Generally, ADRs, in registered
form, are denominated in U.S. dollars and are designed for use in the U.S.
securities markets, while EDRs, in bearer form, may be denominated in other
currencies and are designed for use in European securities markets. ADRs are
receipts typically issued by a U.S. bank or trust company evidencing ownership
of the underlying securities. EDRs are European receipts evidencing a similar
arrangement. For purposes of the Fund's investment policies, ADRs and EDRs are
deemed to have the same classification as the underlying securities they
represent. Thus, an ADR or EDR representing ownership of common stock will be
treated as common stock.
ADR facilities may be established as either "unsponsored" or
"sponsored." While ADRs issued under these two types of facilities are in some
respects similar, there are distinctions between them relating to the rights
and obligations of ADR holders and the practices of market participants. A
depositary may establish an unsponsored facility without participation by (or
even necessarily the acquiescence of) the issuer of the deposited securities,
although typically the depositary requests a letter of non-objection from such
issuer prior to the establishment of the facility. Holders of unsponsored ADRs
generally bear all the costs of such facilities. The depositary usually
charges fees upon the deposit and withdrawal of the deposited securities, the
conversion of dividends into U.S. dollars, the disposition of non-cash
distributions, and the performance of other services. The depositary of an
unsponsored facility frequently is under no obligation to distribute
shareholder communications received from the issuer of the deposited securities
or to pass through voting rights to ADR holders in respect of the deposited
securities. Sponsored ADR
21
<PAGE> 22
facilities are created in generally the same manner as unsponsored facilities,
except that the issuer of the deposited securities enters into a deposit
agreement with the depositary. The deposit agreement sets out the rights and
responsibilities of the issuer, the depositary and the ADR holders. With
sponsored facilities, the issuer of the deposited securities generally will
bear some of the costs relating to the facility (such as dividend payment fees
of the depositary), although ADR holders continue to bear certain other costs
(such as deposit and withdrawal fees). Under the terms of most sponsored
arrangements, depositories agree to distribute notices of shareholder meetings
and voting instructions, and to provide shareholder communications and other
information to the ADR holders at the request of the issuer of the deposited
securities.
FOREIGN INVESTMENT COMPANIES
Some of the countries in which the Fund invests may not permit direct
investment by outside investors. Investments in such countries may only be
permitted through foreign government-approved or -authorized investment
vehicles, which may include other investment companies. Investing through such
vehicles may involve frequent or layered fees or expenses and may also be
subject to limitation under the 1940 Act. Under the 1940 Act, the Fund may
invest up to 10% of its assets in shares of investment companies and up to 5%
of its assets in any one investment company as long as the investment does not
represent more than 3% of the voting stock of the acquired investment company.
DIRECTORS AND OFFICERS OF THE FUND
Directors and officers of the Fund, together with information as to
their principal business occupations during the last five years, and other
information are shown below. Each director who is deemed an "interested
person," as defined in the 1940 Act, is indicated by an asterisk. Each officer
and director holds the same position with the following registered investment
companies: Strong Advantage Fund, Inc.; Strong American Utilities Fund, Inc.;
Strong Asia Pacific Fund, Inc.; Strong Common Stock Fund, Inc.; Strong
Corporate Bond Fund, Inc.; Strong Discovery Fund, Inc.; Strong Discovery Fund
II, Inc.; Strong Government Securities Fund, Inc.; Strong Growth Fund, Inc.;
Strong High-Yield Municipal Bond Fund, Inc.; Strong Insured Municipal Bond
Fund, Inc.; Strong International Bond Fund, Inc.; Strong International Stock
Fund, Inc.; Strong Money Market Fund, Inc.; Strong Municipal Bond Fund, Inc.;
Strong Municipal Money Market Fund, Inc.; Strong Opportunity Fund, Inc.; Strong
Short-Term Bond Fund, Inc.; Strong Short-Term Global Bond Fund, Inc.; Strong
Short-Term Municipal Bond Fund, Inc.; Strong Special Fund II, Inc.; Strong
Total Return Fund, Inc.; and Strong U.S. Treasury Money Fund, Inc.
(collectively, the "Strong Funds"); and Strong Institutional Funds, Inc.;
Strong Special Fund II, Inc.; and Strong Variable Insurance Funds, Inc.
*Richard S. Strong (DOB 5/12/42), Chairman of the Board and Director of
the Fund.
Prior to August 1985, Mr. Strong was Chief Executive Officer of the
Advisor, which he founded in 1974. Since August 1985, Mr. Strong has been a
Security Analyst and Portfolio Manager of the Advisor. In October 1991, Mr.
Strong also became the Chairman of the Advisor. Mr. Strong is a director of
the Advisor. Since October 1993, Mr. Strong has been Chairman and a director
of Strong Holdings, Inc., a Wisconsin corporation and subsidiary of the Advisor
("Holdings"), and the Fund's underwriter, Strong Funds Distributors, Inc., a
Wisconsin corporation and subsidiary of Holdings ("Distributor"). Since
January 1994, Mr. Strong has been Chairman and a director of Heritage Reserve
Development Corporation, a Wisconsin Corporation and subsidiary of Holdings;
and since February 1994, Mr. Strong has been a member of the Managing Boards of
Fussville Real Estate Holdings L.L.C., a Wisconsin Limited Liability Company
and subsidiary of the Advisor, and Fussville Development L.L.C., a Wisconsin
Limited Liability Company and subsidiary of the Advisor, and a certain of its
subsidiaries. Mr. Strong has served as a director of the Fund since its
inception in 1981 and as Chairman of the Board of the Fund since July 1986.
Mr. Strong has been in the investment management business since 1967.
Marvin E. Nevins (DOB 7/9/18), Director of the Fund.
Private Investor. From 1945 to 1980, Mr. Nevins was Chairman of
Wisconsin Centrifugal Inc., a foundry. From July 1983 to December 1986, he was
Chairman of General Casting Corp., Waukesha, Wisconsin, a foundry. Mr. Nevins
is a former Chairman of the Wisconsin Association of Manufacturers & Commerce.
He was also a regent of the Milwaukee School of Engineering and a member of the
Board of Trustees of the Medical College of Wisconsin. Mr. Nevins has served
as a director of the Fund since the Fund's inception in 1981.
22
<PAGE> 23
Willie D. Davis (DOB 7/24/34), Director of the Fund.
Mr. Davis has been director of Alliance Bank Since 1980, Sara Lee
Corporation (a food/consumer products company) since 1983, KMart Corporation (a
discount consumer products company) since 1985, YMCA Metropolitan - Los Angeles
since 1985, Dow Chemical Company since 1988, MGM Grand, Inc. (an
entertainment/hotel company) since 1990, WICOR, Inc. (a utility company) since
1990, Johnson Controls, Inc. (an industrial company) since 1992, L.A. Gear (a
footwear/sportswear company) since 1992, and Rally's Hamburger, Inc. since
1994. Mr. Davis has been a trustee of the University of Chicago since 1980,
Marquette University since 1988, and Occidental College since 1990. Since
1977, Mr. Davis has been President and Chief Executive Officer of All Pro
Broadcasting, Inc. Mr. Davis was a director of the Fireman's Fund (an
insurance company) from 1975 until 1990. Mr. Davis has served as a director of
the Fund since July 1994.
*John Dragisic (DOB 11/26/40), Vice Chairman of the Fund.
Mr. Dragisic has been Vice Chairman and a director of the Advisor and
director of Holdings and Distributor since July 1994. Mr. Dragisic served as
a director of the Fund from July 1991 until July 1994. Mr. Dragisic was the
President and Chief Executive Officer of Grunau Company, Inc. (a mechanical
contracting and engineering firm), Milwaukee, Wisconsin from 1987 until July
1994. From 1981 to 1987, he was an Executive Vice President with Grunau
Company, Inc. From 1969 until 1973, Mr. Dragisic worked for the Inter American
Development Bank. Mr. Dragisic received his Ph.D. in Economics in 1971 from
the University of Wisconsin-Madison, and his B.A. degree in Economics in 1962
from Lake Forest College. Mr. Dragisic has been Vice Chairman of the Fund
since July 1994.
Stanley Kritzik (DOB 1/9/30), Director of the Fund.
Mr. Kritzik has been a Partner of Metropolitan Associates
since 1962, a Director of Aurora Health Care since 1987, and Health Network
Ventures, Inc. since 1992. He has served as a director of the Fund since April
1995.
William F. Vogt (DOB 7/19/47), Director of the Fund.
Mr. Vogt has been the President of Vogt Management Consulting, Inc.
since 1990. From 1982 until 1990, he served as Executive Director of
University Physicians of the University of Colorado. Mr. Vogt is the Past
President of the Medical Group Management Association, and a Fellow of the
American College of Medical Practice Executives. He has served as a director
of the Fund since April 1995.
Lawrence A. Totsky (DOB 5/6/59), C.P.A., Vice President of the Fund.
Mr. Totsky has been Senior Vice President of the Advisor since December
1994. Mr. Totsky acted as the Advisor's Manager of Shareholder Accounting and
Compliance from June 1987 to June 1991 when he was named Director of Mutual
Fund Administration. Mr. Totsky has been a Vice President of the Fund since May
1993.
Thomas P. Lemke (DOB 7/30/54), Vice President of the Fund.
Mr. Lemke has been Senior Vice President, Secretary, and General
Counsel of the Advisor since September 1994. For two years prior to joining
the Advisor, Mr. Lemke acted as Resident Counsel for Funds Management at J.P.
Morgan & Co., Inc. From February 1989 until April 1992, Mr. Lemke acted as
Associate General Counsel to Sanford C. Bernstein Co., Inc. For two years
prior to that, Mr. Lemke was Of Counsel at the Washington D.C. law firm of Tew
Jorden & Schulte, a successor of Finley, Kumble Wagner. From August 1979 until
December 1986, Mr. Lemke worked at the Securities and Exchange Commission, most
notably as the Chief Counsel to the Division of Investment Management (November
1984 - December 1986), and as Special Counsel to the Office of Insurance
Products, Division of Investment Management (April 1982 - October 1984). Mr.
Lemke has been a Vice President of the Fund since October 1994.
Ann E. Oglanian (DOB 12/7/61), Secretary of the Fund.
Ms. Oglanian has been an Associate Counsel of the Advisor since January
1992. Ms. Oglanian acted as Associate Counsel for the Chicago-based
investment management firm, Kemper Financial Services, Inc. from June 1988
until December 1991. Ms. Oglanian has been the Secretary of the Fund since May
1994.
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<PAGE> 24
Ronald A. Neville (5/21/47), C.P.A., Treasurer of the Fund.
Mr. Neville has been the Senior Vice President and Chief Financial
Officer of the Advisor since January 1995. For fourteen years prior to that,
Mr. Neville worked at Twentieth Century Companies, Inc., most notably as Senior
Vice President and Chief Financial Officer (1988 until December 1994). Mr.
Neville received his M.B.A. in 1972 from the University of Missouri - Kansas
City and his B.A. degree in Business Administration and Economics in 1969 from
Drury College. Mr. Neville has been the Treasurer of the Fund since April
1995.
Except for Messrs. Nevins, Davis, Kritzik, and Vogt, the address of all
of the above persons is P.O. Box 2936, Milwaukee, Wisconsin 53201. Mr. Nevins'
address is 6075 Pelican Bay Boulevard, Naples, Florida 33962-8172. Mr. Davis'
address is 161 North La Brea, Inglewood, California 90301. Mr. Kritzik's
address is 1123 North Astor Street, P.O. Box 92547, Milwaukee, Wisconsin
53202-0547. Mr. Vogt's address is 3003 East Third Avenue, Denver, Colorado
80206.
The mutual fund complex that is managed by the Advisor, which is
composed of 26 open-end management investment companies consisting of 31 mutual
funds, of which the Fund is a part, in the aggregate, pays each Director who is
not a director, officer, or employee of the Advisor, or any affiliated company
(a "disinterested director") an annual fee of $50,000, plus $100 per Board
meeting for each mutual fund. In addition, each disinterested director is
reimbursed by the mutual funds for travel and other expenses incurred in
connection with attendance at such meetings. Other officers and directors of
the mutual funds receive no compensation or expense reimbursement from the
mutual funds.
As of March 31, 1995, the officers and directors of the Fund in the
aggregate beneficially owned less than 1% of Fund's then outstanding shares.
PRINCIPAL SHAREHOLDERS
As of March 31, 1995, the following persons owned of record or are
known by the Fund to own of record or beneficially, more than 5% of the Fund's
outstanding shares:
<TABLE>
<CAPTION>
NAME AND ADDRESS SHARES PERCENT OF CLASS
---------------- ------ ----------------
<S> <C> <C>
Charles Schwab & Co., Inc. 683,983 5.09%
101 Montgomery Street
San Francisco, California 94104
</TABLE>
INVESTMENT ADVISOR AND DISTRIBUTOR
The Advisor to the Fund is Strong Capital Management, Inc. Mr. Richard
S. Strong controls the Advisor. Mr. Strong is the Chairman and a director of
the Advisor, Mr. Dragisic is the Vice Chairman and a director of the Advisor,
Mr. Totsky is a Senior Vice President of the Advisor, Mr. Lemke is a Senior
Vice President, Secretary and General Counsel of the Advisor, Mr. Neville is a
Senior Vice President and Chief Financial Officer of the Advisor, and Ms.
Oglanian is an Associate Counsel of the Advisor. A brief description of the
Fund's investment advisory agreement is set forth in the Prospectus under
"About the Funds - Management."
The Advisory Agreement, which is dated May 1, 1995 (the "Advisory
Agreement"), was last approved by shareholders at the annual meeting of
shareholders held on April 13, 1995. The Advisory Agreement is required to be
approved annually by the Board of Directors of the Fund or by vote of a
majority of the Fund's outstanding voting securities (as defined in the 1940
Act). In either case, each annual renewal must be approved by the vote of a
majority of the Fund's directors who are not parties to the Advisory Agreement
or interested persons of any such party, cast in person at a meeting called for
the purpose of voting on such approval. The Advisory Agreement is terminable,
without penalty, on 60 days' written notice by the Board of Directors of the
Fund, by vote of a majority of the Fund's outstanding voting securities, or by
the Advisor. In addition, the Advisory Agreement will terminate automatically
in the event of its assignment.
Under the terms of the Advisory Agreement, the Advisor manages the
Fund's investments subject to the supervision of the Fund's Board of Directors.
The Advisor is responsible for investment decisions and supplies investment
research and portfolio management. At its expense, the Advisor provides office
space and all necessary office facilities, equipment, and personnel for
24
<PAGE> 25
servicing the investments of the Fund. The Advisor places all orders for the
purchase and sale of the Fund's portfolio securities at its expense.
Except for expenses assumed by the Advisor as set forth above or as
described below with respect to the distribution of the Fund's shares, the Fund
is responsible for all its other expenses, including, without limitation,
interest charges, taxes, brokerage commissions, and similar expenses; expenses
of issue, sale, repurchase, or redemption of shares; expenses of registering or
qualifying shares for sale; expenses for printing and distribution costs of
Prospectuses and quarterly financial statements mailed to existing
shareholders; and charges of custodians, transfer agent fees (including the
printing and mailing of reports and notices to shareholders), fees of
registrars, fees for auditing and legal services, fees for clerical services
related to recordkeeping and shareholder relations, the cost of stock
certificates, and fees for directors who are not "interested persons" of the
Advisor. The Fund, Advisor, and each of Salomon Brothers Inc. ("Salomon") and
PaineWebber, Incorporated ("PaineWebber") have entered into an agreement
pursuant to which Salomon or PaineWebber pays certain expenses incurred by the
Fund with proceeds from certain brokerage commissions received by Salomon or
PaineWebber. (See "Portfolio Transactions and Brokerage.")
As compensation for its services, the Fund pays to the Advisor a
monthly management fee at the annual rate of .85% of the first $35,000,000 of
the Fund's average daily net asset value and at the annual rate of .80% of the
Fund's average daily net asset value in excess of $35,000,000. (See
"Shareholder Manual - Determining Your Share Price" in the Prospectus.) From
time to time, the Advisor may voluntarily waive all or a portion of its
management fee for the Fund. In 1992, 1993, and 1994 the Fund paid the Advisor
$1,698,048, $1,843,753, and $2,077,850, respectively, in management fees.
The Advisory Agreement requires the Advisor to reimburse the Fund in
the event that the expenses and charges payable by the Fund in any fiscal year,
including the management fee but excluding taxes, interest, brokerage
commissions, and similar fees and to the extent permitted extraordinary
expenses, exceed that percentage of the average net asset value of the Fund for
such year. Such excess is determined by valuations made as of the close of each
business day of the year, which is the most restrictive percentage provided by
the state laws of the various states in which the Fund's common stock is
qualified for sale; or if the states in which the Fund's common stock is
qualified for sale impose no restrictions, then 2%. The most restrictive
percentage limitation currently applicable to the Fund is 2 1/2% of its average
net asset value up to $30,000,000, 2% on the next $70,000,000 of average net
asset value, and 1 1/2% of the average net asset value in excess of
$100,000,000. Reimbursement of expenses in excess of the applicable limitation
will be made on a monthly basis and will be paid to the Fund by reduction of
the Advisor's fee, subject to later adjustment, month by month, for the
remainder of the Fund's fiscal year. The Advisor may from time to time
voluntarily absorb expenses for the Fund in addition to the reimbursement of
expenses in excess of applicable limitations.
On July 12, 1994, the Securities and Exchange Commission (the SEC)
filed an administrative action (Order) against the Advisor, Mr. Strong, and
another employee of the Advisor in connection with conduct that occurred
between 1987 and early 1990. In re Strong/Corneliuson Capital Management, Inc.,
et al. Admin. Proc. File No. 3-8411. The proceeding was settled by consent
without admitting or denying the allegations in the Order. The Order
alleged that the Advisor and Mr. Strong aided and abetted violations of Section
17(a) of the 1940 Act by effecting trades between mutual funds, and between
mutual funds and Harbour Investments Ltd. ("Harbour"), without complying with
the exemptive provisions of SEC Rule 17a-7 or otherwise obtaining an exemption.
It further alleged that the Advisor violated, and Mr. Strong aided and abetted
violations of, the disclosure provisions of the 1940 Act and the Investment
Advisers Act of 1940 by misrepresenting the Advisor's policy on personal
trading and by failing to disclose trading by Harbour, an entity in which
principals of the Advisor owned between 18 and 25 percent of the voting stock.
As part of the settlement, the respondents agreed to a censure and a cease and
desist order and the Advisor agreed to various undertakings, including adoption
of certain procedures and a limitation for six months on accepting certain
types of new advisory clients.
The staff of the U.S. Department of Labor (the "Staff") has contacted
the Advisor regarding alleged cross-trading of securities between 1987 and
early 1990 involving various customer accounts subject to the Employee
Retirement Security Act of 1974 ("ERISA") and managed by the Advisor. The
Advisor has informed the Staff of the basis for its position that the trades
complied with ERISA and that, in any event, any alleged noncompliance was not
the cause of any losses to the accounts. The Staff has stated that it
disagrees with the Advisor's positions, although to date it has not filed any
action against the Advisor. At this time, the Advisor is negotiating with the
Staff regarding a possible resolution of the matter, but it cannot presently
determine whether the matter will be settled or litigated or, if it is settled
or litigated, how it ultimately will be resolved. However, management
presently believes, based on current knowledge and the Advisor's insurance
coverage, that the ultimate resolution of this matter should not have a
material adverse effect on the Advisor's financial position.
25
<PAGE> 26
The Advisor has adopted a Code of Ethics (the "Code") which governs the
personal trading activities of all "Access Persons" of the Advisor. Access
Persons include every director and officer of the Advisor and the investment
companies managed by the Advisor, including the Fund, as well as certain
employees of the Advisor who have access to information relating to the
purchase or sale of securities by the Advisor on behalf of accounts managed by
it. The Code is based upon the principal that such Access Persons have a
fiduciary duty to place the interests of the Advisor's clients ahead of their
own.
The Code requires Access Persons (other than Access Persons who are
independent directors of the investment companies managed by the Advisor,
including the Fund) to, among other things, preclear their securities
transactions (with limited exceptions, such as transactions in shares of mutual
funds, direct obligations of the U.S. government and certain options on
broad-based securities market indexes) and to execute such transactions through
the Advisor's trading department. The Code, which applies to all Access
Persons (other than Access Persons who are independent directors of the
investment companies managed by the Advisor, including the Fund), includes a ban
on acquiring any securities in an initial public offering, other than a new
offering of a registered open-end investment company, and a prohibition from
profiting on short-term trading in securities. In addition, no Access Person
may purchase or sell any security which, at the time, is being purchased or
sold, or to the knowledge of the Access Person, is being considered for
purchase or sale, by the Advisor on behalf of any mutual fund or other account
managed by it. Finally, the Code provides for trading "black out" periods
which prohibit trading by Access Persons who are portfolio managers within
seven calendar days of trading in the same securities by any mutual fund or
other account managed by the portfolio manager.
Under a Distribution Agreement dated December 1, 1993 with the
Fund (the "Distribution Agreement"), Strong Funds Distributors, Inc. acts as
underwriter of the Fund's shares ("Distributor"). The Distribution Agreement
provides that the Distributor will use its best efforts to distribute the
Fund's shares. Since the Fund is a "no-load" fund, no sales commissions are
charged on the purchase of Fund shares. The Distribution Agreement further
provides that the Distributor will bear the costs of printing Prospectuses and
shareholder reports which are used for selling purposes, as well as advertising
and other costs attributable to the distribution of the Fund's shares. The
Distributor is an indirect subsidiary of the Advisor and controlled by the
Advisor and Richard S. Strong. Prior to December 1, 1993, the Advisor acted as
underwriter for the Fund. On December 1, 1993, Distributor succeeded to the
broker-dealer registration of the Advisor and, in connection therewith, the
Distribution Agreement was executed on substantially identical terms as the
former distribution agreement with the Advisor as distributor. The
Distribution Agreement is subject to the same termination and renewal
provisions as are described above with respect to the Advisory Agreement.
From time to time, the Distributor may hold in-house sales incentive
programs for its associated persons under which these persons may receive
non-cash compensation awards in connection with the sale and distribution of
the Fund's shares. These awards may include items such as, but not limited to,
gifts, merchandise, gift certificates, and payment of travel expenses, meals
and lodging. As required by the National Association of Securities Dealers,
Inc. or NASD's proposed rule amendments in this area, any in-house sales
incentive program will be multi-product oriented, i.e., any incentive will be
based on an associated person's gross production of all securities within a
product type and will not be based on the sales of shares of any specifically
designated mutual fund.
PORTFOLIO TRANSACTIONS AND BROKERAGE
The Advisor is responsible for decisions to buy and sell securities for the
Fund and for the placement of its portfolio business and the negotiation of the
commissions to be paid on such transactions. It is the policy of the Advisor
to seek the best execution at the best security price available with respect to
each transaction, in light of the overall quality of brokerage and research
services provided to the Advisor or the Fund. In over-the-counter
transactions, orders are placed directly with a principal market maker unless
it is believed that a better price and execution can be obtained using a
broker. The best price to the Fund means the best net price without regard to
the mix between purchase or sale price and commissions. In selecting
broker-dealers and in negotiating commissions, the Advisor considers a variety
of factors, including best price and execution, the full range of brokerage
services provided by the broker, as well as its capital strength and stability,
and the quality of the research and research services provided by the broker.
Brokerage will not be allocated based on the sale of Fund shares.
Section 28(e) of the Securities Exchange Act of 1934 ("Section 28(e)")
permits an investment advisor, under certain circumstances, to cause an account
to pay a broker or dealer a commission for effecting a transaction in excess of
the amount of commission another broker or dealer would have charged for
effecting the transaction in recognition of the value of the brokerage and
research services provided by the broker or dealer. Brokerage and research
services include (a) furnishing advice as to the value of securities, the
advisability of investing, purchasing or selling securities, and the
availability of securities or purchasers or sellers of securities; (b)
furnishing analyses and reports concerning issuers, industries, securities,
economic factors and trends, portfolio strategy, and the performance of
accounts; and (c) effecting securities transactions and performing functions
incidental thereto (such as clearance, settlement, and custody).
In carrying out the provisions of the Advisory Agreement, the Advisor
may cause the Fund to pay a broker which provides brokerage and research
services to the Advisor a commission for effecting a securities transaction in
excess of the amount another broker would have charged for effecting the
transaction. The Advisor believes it is important to its investment
decision-making process to have access to independent research. The
Advisory Agreement provides that such higher commissions will not be paid by
the Fund unless (a) the Advisor determines in good faith that the amount is
reasonable in relation to the services in terms of the particular transaction
or in terms of the Advisor's overall responsibilities with respect to the
accounts as to which it exercises investment discretion; (b) such payment is
made in compliance with the provisions of Section 28(e), other applicable state
and federal laws, and the Advisory Agreement; and (c) in the opinion of the
Advisor, the total commissions paid by the Fund will be reasonable in relation
to the benefits to the Fund over the long term. The investment management fee
paid by the Fund under the Advisory Agreement is not reduced as a result of the
Advisor's receipt of research services.
26
<PAGE> 27
Generally, research services provided by brokers may include
information on the economy, industries, groups of securities, individual
companies, statistical information, accounting and tax law interpretations,
political developments, legal developments affecting portfolio securities,
technical market action, pricing appraisal services, credit analysis, risk
measurement analysis, performance analysis, and analysis of corporate
responsibility issues. Such research services are received primarily in the
form of written reports, telephone contacts, and personal meetings with
security analysts. In addition, such research services may be provided in the
form of access to various computer-generated data, computer hardware and
software, and meetings arranged with corporate and industry spokespersons,
economists, academicians, and government representatives. In some cases,
research services are generated by third parties but are provided to the
Advisor by or through brokers. Such brokers may pay for all or a portion of
computer hardware and software costs relating to the pricing of securities.
Where the Advisor itself receives both administrative benefits and
research and brokerage services from the services provided by brokers, it makes
a good faith allocation between the administrative benefits and the research
and brokerage services, and will pay for any administrative benefits with cash.
In making good faith allocations of costs between administrative benefits and
research and brokerage services, a conflict of interest may exist by reason of
the Advisor's allocation of the costs of such benefits and services between
those that primarily benefit the Advisor and those that primarily benefit the
Fund and other advisory clients.
From time to time, the Advisor may purchase securities for a Fund in a
fixed price offering. In these situations, the seller may be a member of the
selling group that will, in addition to selling the securities to the Fund and
other advisory clients, provide the Advisor with research. The National
Association of Securities Dealers has adopted rules expressly permitting these
types of arrangements under certain circumstances. Generally, the seller will
provide research "credits" in these situations at a rate that is higher than
that which is available for typical secondary market transactions. These
arrangements may not fall within the safe harbor of Section 28(e).
Each year, the Advisor considers the amount and nature of research and
research services provided by brokers, as well as the extent to which such
services are relied upon, and attempts to allocate a portion of the brokerage
business of the Fund and other advisory clients on the basis of that
consideration. In addition, brokers may suggest a level of business they would
like to receive in order to continue to provide such services. The actual
brokerage business received by a broker may be more or less than the suggested
allocations, depending upon the Advisor's evaluation of all applicable
considerations.
During its last fiscal year, the Advisor had an arrangement with
various brokers whereby, in consideration of the providing of research
services, the Advisor allocated brokerage to those firms, provided that their
brokerage and research services were satisfactory to the Advisor and their
execution capabilities were compatible with the Advisor's policy of seeking
best execution at the best security price available, as discussed above.
The Advisor may direct the purchase of securities on behalf of the
Fund and other advisory clients in secondary market transactions, in public
offerings directly from an underwriter, or in privately negotiated
transactions with an issuer. When the Advisor believes the circumstances so
warrant, securities purchased in public offerings may be resold shortly after
acquisition in the immediate aftermarket for the security in order to take
advantage of price appreciation from the public offering price or for other
reasons. Short-term trading of securities acquired in public offerings, or
otherwise, may result in higher portfolio turnover and associated brokerage
expenses.
The Advisor places portfolio transactions for other advisory accounts,
including other mutual funds managed by the Advisor. Research services
furnished by firms through which the Fund effects its securities transactions
may be used by the Advisor in servicing all of its accounts; not all of such
services may be used by the Advisor in connection with the Fund. In the
opinion of the Advisor, it is not possible to separately measure the benefits
from research services to each of the accounts (including the Fund) managed by
the Advisor. Because the volume and nature of the trading activities of the
accounts are not uniform, the amount of commissions in excess of those charged
by another broker paid by each account for brokerage and research services will
vary. However, in the opinion of the Advisor, such costs to the Fund will not
be disproportionate to the benefits received by the Fund on a continuing basis.
The Advisor seeks to allocate portfolio transactions equitably
whenever concurrent decisions are made to purchase or sell securities by the
Fund and another advisory account. In some cases, this procedure could have an
adverse effect on the price or the amount of securities available to the Fund.
In making such allocations between the Fund and other advisory accounts, the
main factors considered by the Advisor are the respective investment
objectives, the relative size of portfolio holdings of the same or comparable
securities, the availability of cash for investment, the size of investment
commitments generally held, and the opinions of the persons responsible for
recommending the investment.
The Fund has entered into agreements with the Advisor and each of
Salomon and PaineWebber (collectively, the "Brokers"), in which the Brokers
have agreed to pay directly to vendors certain investment management and other
related expenses incurred and otherwise payable by the Fund ("Expense
Agreements"). In accordance with the Expense Agreements, the Advisor directs
the delivery to the Brokers of invoices determined by the Fund to be
appropriate for payment by the Brokers. The Brokers pay the invoices with the
proceeds of certain commissions received from the Fund. The Expense Agreements
provide that a percentage of commissions received from the Fund for completed
agency transactions in certain securities for the Fund, designated by the
Advisor as directed commissions subject to the Expense Agreements, shall be
used by the Brokers to pay the invoices. Investment management and other
related expenses include those payable by the Fund, as described under
"Investment Advisor and Distributor" in this Statement of Additional
Information.
During 1992, 1993, and 1994, the Fund paid approximately $520,000,
$630,000, and $626,000, respectively, in brokerage commissions.
CUSTODIAN
As custodian of the Fund's assets, Firstar Trust Company, P.O. Box
701, Milwaukee, Wisconsin 53201, has custody of all securities and cash of the
Fund, delivers and receives payment for securities sold, receives and pays for
securities purchased, collects income from investments, and performs other
duties, all as directed by officers of the Fund. The custodian is in no way
responsible for any of the investment policies or decisions of the Fund.
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<PAGE> 28
TRANSFER AGENT AND DIVIDEND-DISBURSING AGENT
The Advisor acts as transfer agent and dividend-disbursing agent for
the Fund. The Advisor is compensated based on an annual fee per open account
of the Fund of $21.75 plus certain out-of-pocket expenses and a $4.20 charge
per account per annum on all closed accounts, payable monthly. For transfer
agent and dividend-disbursing agent services in 1992, 1993, and 1994, the Fund
paid the Advisor $515,216, $524,693, and $594,683, respectively, in per account
charges and $101,948, $64,072, and $158,509, respectively, for out-of-pocket
expenses. The Advisor also acts as investment advisor to the Fund. The fees
received and the services provided as transfer agent and dividend-disbursing
agent are in addition to the fees received and services provided under the
Advisory Agreement.
In addition to the foregoing services, the Advisor provides certain
printing and mailing services for the Fund, such as printing and mailing of
shareholder account statements, checks, and tax forms. During 1992, 1993, and
1994, the Fund paid the Advisor $11,600, $12,746, and $14,340, respectively,
for printing and mailing services.
From time to time, the Fund, directly or indirectly through
arrangements with the Advisor, may pay amounts to third parties that provide
transfer agent and other administrative services relating to the Fund to
persons who beneficially own interests in the Fund, such as participants in
401(k) plans. These services may include, among other things, sub-accounting
services, answering inquiries relating to the Fund, transmitting, on behalf of
the Fund, proxy statements, annual reports, updated Prospectuses, other
communications regarding the Fund, and related services as the Fund or
beneficial owners may reasonably request. In such cases, the Fund will not pay
fees at a rate that is greater than the rate the Fund is currently paying the
Advisor for providing these services to Fund shareholders.
TAXES
GENERAL
As indicated under "About the Funds -- Distributions and Taxes" in the
Prospectus, the Fund intends to continue to qualify annually for treatment as a
regulated investment company ("RIC") under the Internal Revenue Code of 1986,
as amended (the "Code"). This qualification does not involve government
supervision of the Fund's management practices or policies.
In order to qualify for treatment as a RIC under the Code, the Fund
must distribute to its shareholders for each taxable year at least 90% of its
investment company taxable income (consisting generally of net investment
income, net short-term capital gain, and net gains from certain foreign
currency transactions) ("Distribution Requirement") and must meet several
additional requirements. Among these requirements are the following: (1) the
Fund must derive at least 90% of its gross income each taxable year from
dividends, interest, payments with respect to securities loans, and gains from
the sale or other disposition of securities or foreign currencies, or other
income (including gains from options, futures, or forward contracts) derived
with respect to its business of investing in securities or those currencies
("Income Requirement"); (2) the Fund must derive less than 30% of its gross
income each taxable year from the sale or other disposition of securities, or
any of the following, that were held for less than three months -- options or
futures (other than those on foreign currencies), or foreign currencies (or
options, futures, or forward contracts thereon) that are not directly related
to the Fund's principal business of investing in securities (or options and
futures with respect to securities) ("30% Limitation"); (3) at the close of
each quarter of the Fund's taxable year, at least 50% of the value of its total
assets must be represented by cash and cash items, U.S. government securities,
securities of other RICs, and other securities, with these other securities
limited, in respect of any one issuer, to an amount that does not exceed 5% of
the value of the Fund's total assets and that does not represent more than 10%
of the issuer's outstanding voting securities; and (4) at the close of each
quarter of the Fund's taxable year, not more than 25% of the value of its total
assets may be invested in securities (other than U.S. government securities or
the securities of other RICs) of any one issuer.
If Fund shares are sold at a loss after being held for six months or
less, the loss will be treated as long-term, instead of short-term, capital
loss to the extent of any capital gain distributions received on those shares.
The Fund will be subject to a nondeductible 4% excise tax ("Excise
Tax") to the extent it fails to distribute by the end of any calendar year
substantially all of its ordinary income for that year and capital gain net
income for the one-year period ending on October 31 of that year, plus certain
other amounts.
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<PAGE> 29
FOREIGN TRANSACTIONS
Interest and dividends received by the Fund may be subject to income,
withholding, or other taxes imposed by foreign countries and U.S. possessions
that would reduce the yield on its securities. Tax conventions between certain
countries and the United States may reduce or eliminate these foreign taxes,
however, and many foreign countries do not impose taxes on capital gains in
respect of investments by foreign investors. If more than 50% of the value of
the Fund's total assets at the close of its taxable year consists of securities
of foreign corporations, it will be eligible to, and may, file an election with
the Internal Revenue Service that would enable its shareholders, in effect, to
receive the benefit of the foreign tax credit with respect to any foreign and
U.S. possessions income taxes paid by it. Pursuant to the election, the Fund
would treat those taxes as dividends paid to its shareholders and each
shareholder would be required to (1) include in gross income, and treat as paid
by him, his proportionate share of those taxes, (2) treat his share of those
taxes and of any dividend paid by the Fund that represents income from foreign
or U.S. possessions sources as his own income from those sources, and (3)
either deduct the taxes deemed paid by him in computing his taxable income or,
alternatively, use the foregoing information in calculating the foreign tax
credit against his federal income tax. The Fund will report to its
shareholders shortly after each taxable year their respective shares of its
income from sources within, and taxes paid to, foreign countries and U.S.
possessions if it makes this election.
The Fund maintains its accounts and calculates its income in U.S.
dollars. In general, gain or loss (1) from the disposition of foreign
currencies and forward currency contracts, (2) from the disposition of
foreign-currency-denominated debt securities that are attributable to
fluctuations in exchange rates between the date the securities are acquired and
their disposition date, and (3) attributable to fluctuations in exchange rates
between the time the Fund accrues interest or other receivables or expenses or
other liabilities denominated in a foreign currency and the time the Fund
actually collects those receivables or pays those liabilities, will be treated
as ordinary income or loss. A foreign-currency-denominated debt security
acquired by the Fund may bear interest at a high nominal rate that takes into
account expected decreases in the value of the principal amount of the security
due to anticipated currency devaluations; in that case, the Fund would be
required to include the interest in income as it accrues but generally would
realize a currency loss with respect to the principal only when the principal
was received (through disposition or upon maturity).
The Fund may invest in the stock of "passive foreign investment
companies" ("PFICs"). A PFIC is a foreign corporation that, in general, meets
either of the following tests: (1) at least 75% of its gross income is passive
or (2) an average of at least 50% of its assets produce, or are held for the
production of, passive income. Under certain circumstances, the Fund will be
subject to federal income tax on a portion of any "excess distribution"
received on the stock of a PFIC or of any gain on disposition of the stock
(collectively, "PFIC income"), plus interest thereon, even if the Fund
distributes the PFIC income as a taxable dividend to its shareholders. The
balance of the PFIC income will be included in the Fund's investment company
taxable income and, accordingly, will not be taxable to it to the extent that
income is distributed to its shareholders. If the Fund invests in a PFIC and
elects to treat the PFIC as a "qualified electing fund," then in lieu of the
foregoing tax and interest obligation, the Fund will be required to include in
income each year its pro rata share of the qualified electing fund's annual
ordinary earnings and net capital gain (the excess of net long-term capital
gain over net short-term capital loss) -- which probably would have to be
distributed to its shareholders to satisfy the Distribution Requirement and
avoid imposition of the Excise Tax -- even if those earnings and gain were not
received by the Fund. In most instances it will be very difficult, if not
impossible, to make this election because of certain requirements thereof.
The "Tax Simplification and Technical Corrections Bill of 1993,"
passed in May 1994 by the House of Representatives, would substantially modify
the taxation of U.S. shareholders of foreign corporations, including
eliminating the provisions described above dealing with PFICs and replacing
them (and other provisions) with a regulatory scheme involving entities called
"passive foreign corporations." Three similar bills were passed by Congress in
1991 and 1992 and were vetoed. It is unclear at this time whether, and in what
form, the proposed modifications may be enacted into law.
Pursuant to proposed regulations, open-end RICs such as the Fund would
be entitled to elect to "mark-to-market" their stock in certain PFICs.
"Marking-to-market," in this context, means recognizing as gain for each
taxable year the excess, as of the end of that year, of the fair market value
of each such PFIC's stock over the adjusted basis in that stock (including
mark-to-market gain for each prior year for which an election was in effect).
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<PAGE> 30
DERIVATIVE INSTRUMENTS
The use of derivatives strategies, such as purchasing and selling
(writing) options and futures and entering into forward currency contracts,
involves complex rules that will determine for income tax purposes the
character and timing of recognition of the gains and losses the Fund realizes
in connection therewith. Gains from the disposition of foreign currencies
(except certain gains therefrom that may be excluded by future regulations),
and income from transactions in options, futures, and forward currency
contracts derived by the Fund with respect to its business of investing in
securities or foreign currencies, will qualify as permissible income under the
Income Requirement. However, income from the disposition of options and
futures (other than those on foreign currencies) will be subject to the 30%
Limitation if they are held for less than three months. Income from the
disposition of foreign currencies, and options, futures, and forward contracts
on foreign currencies, that are not directly related to the Fund's principal
business of investing in securities (or options and futures with respect to
securities) also will be subject to the 30% Limitation if they are held for
less than three months.
If the Fund satisfies certain requirements, any increase in value of a
position that is part of a "designated hedge" will be offset by any decrease in
value (whether realized or not) of the offsetting hedging position during the
period of the hedge for purposes of determining whether the Fund satisfies the
30% Limitation. Thus, only the net gain (if any) from the designated hedge
will be included in gross income for purposes of that limitation. The Fund
intends that, when it engages in hedging strategies, the hedging transactions
will qualify for this treatment, but at the present time it is not clear
whether this treatment will be available for all of the Fund's hedging
transactions. To the extent this treatment is not available or is not elected
by the Fund, it may be forced to defer the closing out of certain options,
futures, or forward currency contracts beyond the time when it otherwise would
be advantageous to do so, in order for the Fund to continue to qualify as a
RIC.
For federal income tax purposes, the Fund is required to recognize as
income for each taxable year its net unrealized gains and losses on options,
futures and forward currency contracts that are subject to section 1256 of the
Code ("Section 1256 Contracts") and are held by the Fund as of the end of the
year, as well as gains and losses on Section 1256 Contracts actually realized
during the year. Except for Section 1256 Contracts that are part of a "mixed
straddle" and with respect to which the Fund makes a certain election, any gain
or loss recognized with respect to Section 1256 Contracts is considered to be
60% long-term capital gain or loss and 40% short-term capital gain or loss,
without regard to the holding period of the Section 1256 Contract. Unrealized
gains on Section 1256 Contracts that have been held by the Fund for less than
three months as of the end of its taxable year, and that are recognized for
federal income tax purposes as described above, will not be considered gains on
investments held for less than three months for purposes of the 30% Limitation.
ZERO-COUPON, STEP-COUPON, AND PAY-IN-KIND SECURITIES
The Fund may acquire zero-coupon, step-coupon, or other securities
issued with original issue discount. As a holder of those securities, the Fund
must include in its income the original issue discount that accrues on the
securities during the taxable year, even if the Fund receives no corresponding
payment on the securities during the year. Similarly, the Fund must include in
its income securities it receives as "interest" on pay-in-kind securities.
Because the Fund annually must distribute substantially all of its investment
company taxable income, including any original issue discount and other
non-cash income, to satisfy the Distribution Requirement and avoid imposition
of the Excise Tax, it may be required in a particular year to distribute as a
dividend an amount that is greater than the total amount of cash it actually
receives. Those distributions may be made from the proceeds on sales of
portfolio securities, if necessary. The Fund may realize capital gains or
losses from those sales, which would increase or decrease its investment
company taxable income or net capital gain, or both. In addition, any such
gains may be realized on the disposition of securities held for less than three
months. Because of the 30% Limitation, any such gains would reduce the Fund's
ability to sell other securities, or certain options, futures, or forward
currency contracts, held for less than three months that it might wish to sell
in the ordinary course of its portfolio management.
The foregoing federal tax discussion as well as the tax discussion
contained within the Prospectus under "About the Funds - Distributions and
Taxes" is intended to provide you with an overview of the impact of federal
income tax provisions on the Fund or its shareholders. These tax provisions are
subject to change by legislative or administrative action at the federal,
state, or local level, and any changes may be applied retroactively. Any such
action that limits or restricts the Fund's current ability to pass-through
earnings without taxation at the Fund level, or otherwise materially changes the
Fund's tax treatment, could adversely affect the value of a shareholder's
investment in the Fund. Because the Fund's taxes are a complex matter, you
should consult your tax adviser for more detailed information concerning the
taxation of the Fund and the federal, state, and local tax consequences to
shareholders of an investment in the Fund.
DETERMINATION OF NET ASSET VALUE
As set forth in the Prospectus under the caption "Shareholder Manual -
Determining Your Share Price," the net asset value of the Fund will be
determined as of the close of trading on each day the New York Stock Exchange
(the "NYSE") is open for trading. The NYSE is open for trading Monday through
Friday except New Year's Day, Presidents' Day, Good Friday, Memorial Day,
Independence Day, Labor Day, Thanksgiving Day, and Christmas Day.
Additionally, if any of the
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<PAGE> 31
aforementioned holidays falls on a Saturday, the NYSE will not be open for
trading on the preceding Friday, and when any such holiday falls on a Sunday,
the NYSE will not be open for trading on the succeeding Monday, unless unusual
business conditions exist, such as the ending of a monthly or the yearly
accounting period.
Debt obligations are valued by a pricing service that utilizes
electronic data processing techniques to determine values for normal
institutional-sized trading units of debt obligations without regard to sale or
bid prices when such values are believed to more accurately reflect the fair
market value for such securities. Otherwise, sale or bid prices are used. Any
securities or other assets for which market quotations are not readily
available are valued at fair value as determined in good faith by the Board of
Directors of the Fund. Debt obligations having remaining maturities of 60 days
or less when purchased are valued by the amortized cost method when the Fund's
Board of Directors determines that the fair value of such securities is their
amortized cost. Under this method of valuation, a security is initially valued
at its acquisition cost, and thereafter, amortization of any discount or
premium is assumed each day, regardless of the impact of the fluctuating rates
on the market value of the instrument.
ADDITIONAL SHAREHOLDER INFORMATION
TELEPHONE EXCHANGE AND REDEMPTION PRIVILEGES AND AUTOMATIC EXCHANGE PLAN
Shares of the Fund and any other funds sponsored by the Advisor may be
exchanged for each other at relative net asset values. Exchanges will be
effected by redemption of shares of the Fund held and purchase of shares of the
fund for which Fund shares are being exchanged (the "New Fund"). For federal
income tax purposes, any such exchange constitutes a sale upon which a capital
gain or loss will be realized, depending upon whether the value of the shares
being exchanged is more or less than the shareholder's adjusted cost basis. If
you are interested in exercising any of these exchange privileges, you should
obtain Prospectuses of other funds sponsored by the Advisor from the Advisor.
Upon a telephone exchange, the transfer agent establishes a new account in the
New Fund with the same registration and dividend and capital gains options as
the redeemed account, unless otherwise specified, and confirms the purchase to
you.
The Fund employs reasonable procedures to confirm that instructions
communicated by telephone are genuine. The Fund may not be liable for losses
due to unauthorized or fraudulent instructions. Such procedures include but are
not limited to requiring a form of personal identification prior to acting on
instructions received by telephone, providing written confirmations of such
transactions to the address of record, and tape recording telephone
instructions.
The Telephone Exchange and Redemption Privileges and Automatic
Exchange Plan are available only in states where shares of the New Fund may be
sold, and may be modified or discontinued at any time. Additional information
regarding the Telephone Exchange and Redemption Privileges and Automatic
Exchange Plan is contained in the Fund's Prospectus.
RETIREMENT PLANS
Individual Retirement Account (IRA): Everyone under age 70 1/2 with earned
income may contribute to a tax-deferred IRA. The Strong Funds offer a prototype
plan for you to establish your own IRA. You are allowed to contribute up to the
lesser of $2,000 or 100% of your earned income each year to your IRA. Under
certain circumstances, your contribution will be deductible.
Direct Rollover IRA: To avoid the mandatory 20% federal withholding tax on
distributions, you must transfer the qualified retirement or Code section
403(b) plan distribution directly into an IRA. This tax cannot be avoided if
you receive a distribution and then roll it over into an IRA. The amount of
your Direct Rollover IRA contribution will not be included in your taxable
income for the year.
Simplified Employee Pension Plan (SEP-IRA): A SEP-IRA allows an employer to
make deductible contributions to separate IRA accounts established for each
eligible employee.
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Salary Reduction Simplified Employee Pension Plan (SAR SEP-IRA): A SAR SEP-IRA
is a type of SEP-IRA in which an employer may allow employees to defer part of
their salaries and contribute into an IRA account. These deferrals help lower
the employees' taxable income.
Defined Contribution Plan: A defined contribution plan allows self-employed
individuals, partners, or a corporation to provide retirement benefits for
themselves and their employees. There are three plan types: a profit-sharing
plan, a money purchase pension plan, and a paired plan (a combination of a
profit-sharing plan and a money purchase plan).
401(k) Plan: A 401(k) plan is a type of profit-sharing plan that allows
employees to have part of their salary contributed to a retirement plan which
will earn tax-deferred income. A 401(k) plan is funded by employee
contributions, employer contributions, or a combination of both.
403(b)(7) Plan: A tax-sheltered custodial account designed to qualify under
section 403(b)(7) of the Code is available for use by employees of certain
educational, non-profit, hospital, and charitable organizations.
FUND ORGANIZATION
The Fund is a Wisconsin corporation that is authorized to offer
separate series of shares representing interests in separate portfolios of
securities, each with differing investment objectives. The shares in any one
portfolio may, in turn, be offered in separate classes, each with differing
preferences, limitations or relative rights. However, the Articles of
Incorporation for the Fund provides that if additional classes of shares are
issued by the Fund, such new classes of shares may not affect the preferences,
limitations or relative rights of the Fund's outstanding shares. In addition,
the Board of Directors of the Fund is authorized to allocate assets,
liabilities, income and expenses to each series and class. Classes within a
series may have different expense arrangements than other classes of the same
series and, accordingly, the net asset value of shares within a series may
differ. Finally, all holders of shares of the Fund may vote on each matter
presented to shareholders for action except with respect to any matter which
affects only one or more series or class, in which case only the shares of the
affected series or class are entitled to vote. Fractional shares have the same
rights proportionately as do full shares. Shares of the Fund have no
preemptive, conversion, or subscription rights. The Fund currently has only one
series of Common Stock outstanding. If the Fund issues additional series, the
assets belonging to each series of shares will be held separately by the
custodian, and in effect each series will be a separate fund.
SHAREHOLDER MEETINGS
The Fund is a Wisconsin corporation organized on September 3, 1981 and
currently has 300,000,000 authorized shares of capital stock, $.01 par value.
The Wisconsin Business Corporation Law permits registered investment companies,
such as the Fund, to operate without an annual meeting of shareholders under
specified circumstances if an annual meeting is not required by the 1940 Act.
The Fund has adopted the appropriate provisions in its Bylaws and may, at its
discretion, not hold an annual meeting in any year in which the election of
directors is not required to be acted on by shareholders under the 1940 Act.
The Fund's Bylaws also contain procedures for the removal of directors
by its shareholders. At any meeting of shareholders, duly called and at which
a quorum is present, the shareholders may, by the affirmative vote of the
holders of a majority of the votes entitled to be cast thereon, remove any
director or directors from office and may elect a successor or successors to
fill any resulting vacancies for the unexpired terms of removed directors.
Upon the written request of the holders of shares entitled to not less
than ten percent (10%) of all the votes entitled to be cast at such meeting,
the Secretary of the Fund shall promptly call a special meeting of shareholders
for the purpose of voting upon the question of removal of any director.
Whenever ten or more shareholders of record who have been such for at least six
months preceding the date of application, and who hold in the aggregate either
shares having a net asset value of at least $25,000 or at least one percent
(1%) of the total outstanding shares, whichever is less, shall apply to the
Fund's Secretary in writing, stating that they wish to communicate with other
shareholders with a view to obtaining signatures to a request for a meeting as
described above and accompanied by a form of communication and request which
they wish to transmit, the Secretary shall within five business days after such
application either: (1) afford to such applicants access to a list of the names
and addresses of all
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<PAGE> 33
shareholders as recorded on the books of the Fund; or (2) inform such
applicants as to the approximate number of shareholders of record and the
approximate cost of mailing to them the proposed communication and form of
request.
If the Secretary elects to follow the course specified in clause (2)
of the last sentence of the preceding paragraph, the Secretary, upon the
written request of such applicants, accompanied by a tender of the material to
be mailed and of the reasonable expenses of mailing, shall, with reasonable
promptness, mail such material to all shareholders of record at their addresses
as recorded on the books unless within five business days after such tender the
Secretary shall mail to such applicants and file with the SEC, together with a
copy of the material to be mailed, a written statement signed by at least a
majority of the Board of Directors to the effect that in their opinion either
such material contains untrue statements of fact or omits to state facts
necessary to make the statements contained therein not misleading, or would be
in violation of applicable law, and specifying the basis of such opinion.
After opportunity for hearing upon the objections specified in the
written statement so filed, the SEC may, and if demanded by the Board of
Directors or by such applicants shall, enter an order either sustaining one or
more of such objections or refusing to sustain any of them. If the SEC shall
enter an order refusing to sustain any of such objections, or if, after the
entry of an order sustaining one or more of such objections, the SEC shall
find, after notice and opportunity for hearing, that all objections so
sustained have been met, and shall enter an order so declaring, the Secretary
shall mail copies of such material to all shareholders with reasonable
promptness after the entry of such order and the renewal of such tender.
PERFORMANCE INFORMATION
As described in the "About the Funds - Performance Information"
section in the Prospectus, the Fund's historical performance or return may be
shown in the form of "average annual total return," "total return," and
"cumulative total return." From time to time, the Advisor agrees to waive or
reduce its management fee and to absorb certain operating expenses for the
Fund. Without these waivers and absorption of expenses, the performance
results for the Fund noted herein would have been lower. All performance and
returns noted herein are historical and do not represent the future performance
of the Fund.
AVERAGE ANNUAL TOTAL RETURN
The Fund's average annual total return quotation is computed in
accordance with a standardized method prescribed by rules of the SEC. The
average annual total return for the Fund for a specific period is found by
first taking a hypothetical $10,000 investment ("initial investment") in the
Fund's shares on the first day of the period and computing the "redeemable
value" of that investment at the end of the period. The redeemable value is
then divided by the initial investment, and this quotient is taken to the Nth
root (N representing the number of years in the period) and 1 is subtracted
from the result, which is then expressed as a percentage. The calculation
assumes that all income and capital gains dividends paid by the Fund have been
reinvested at net asset value on the reinvestment dates during the period.
Average annual total return figures for various periods are set forth in the
table below.
TOTAL RETURN
Calculation of the Fund's total return is not subject to a
standardized formula. Total return performance for a specific period is
calculated by first taking an investment (assumed below to be $10,000)
("initial investment") in the Fund's shares on the first day of the period and
computing the "ending value" of that investment at the end of the period. The
total return percentage is then determined by subtracting the initial
investment from the ending value and dividing the remainder by the initial
investment and expressing the result as a percentage. The calculation assumes
that all income and capital gains dividends paid by the Fund have been
reinvested at net asset value on reinvestment dates during the period. Total
return may also be shown as the increased dollar value of the hypothetical
investment over the period. Total return figures for various periods are set
forth in the table below.
CUMULATIVE TOTAL RETURN
Cumulative total return represents the simple change in value of our
investment over a stated period and may be quoted as a percentage or as a
dollar amount. Total returns and cumulative total returns may be broken down
into their components of
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<PAGE> 34
income and capital (including capital gains and changes in share price) in
order to illustrate the relationship between these factors and their
contributions to total return.
The Fund's performance figures are based upon historical results and
do not represent future performance. The Fund's shares are sold at net asset
value per share. The Fund's returns and net asset value will fluctuate and
shares are redeemable at the then current net asset value of the Fund, which
may be more or less than original cost. Factors affecting the Fund's
performance include general market conditions, operating expenses and
investment management. Any additional fees charged by a dealer or other
financial services firm would reduce the returns described in this section.
The figures below show performance information for various periods
ended December 31, 1994. No adjustment has been made for taxes, if any,
payable on dividends. Securities prices fluctuated during these periods.
Strong Asset Allocation Fund
<TABLE>
<CAPTION>
Average
Annual
Total Total
Return Return
------ ------
Initial
$10,000 Ending Value Percentage Percentage
Investment December 31, 1994 Increase Increase
---------- ----------------- -------- --------
<S> <C> <C> <C> <C>
Life of Fund(1) $10,000 $51,679 416.79% 13.47%
Ten Years 10,000 24,338 143.38 9.30
Five Years 10,000 14,314 43.14 7.44
One Year 10,000 9,849 -1.51 -1.51
</TABLE>
-----------------------------
(1) December 30, 1981
The Fund's total return for the three months ending March 31, 1995 was
3.62%.
COMPARISONS
(1) U.S. TREASURY BILLS, NOTES, OR BONDS
Investors may want to compare the performance of the Fund to that of
U.S. Treasury bills, notes, or bonds, which are issued by the U.S. Government,
because such instruments represent alternative income producing products.
Treasury obligations are issued in selected denominations. Rates of Treasury
obligations are fixed at the time of issuance and payment of principal and
interest is backed by the full faith and credit of the U.S. Treasury. The
market value of such instruments will generally fluctuate inversely with
interest rates prior to maturity and will equal par value at maturity.
Generally, the values of obligations with shorter maturities will fluctuate
less than those with longer maturities.
(2) CERTIFICATES OF DEPOSIT
Investors may want to compare the Fund's performance to that of
certificates of deposit offered by banks and other depositary institutions.
Certificates of deposit represent an alternative income producing product.
Certificates of deposit may offer fixed or variable interest rates and
principal is guaranteed and may be insured. Withdrawal of the deposits prior
to maturity normally will be subject to a penalty. Rates offered by banks and
other depositary institutions are subject to change at any time specified by
the issuing institution.
(3) MONEY MARKET FUNDS
Investors may also want to compare performance of the Fund to that of
money market funds. Money market fund yields will fluctuate and shares are not
insured, but share values usually remain stable.
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(4) LIPPER ANALYTICAL SERVICES, INC. ("LIPPER") AND OTHER INDEPENDENT
RANKING ORGANIZATIONS
From time to time, in marketing and other fund literature, the Fund's
performance may be compared to the performance of other mutual funds in general
or to the performance of particular types of mutual funds, with similar
investment goals, as tracked by independent organizations. Among these
organizations, Lipper, a widely used independent research firm which ranks
mutual funds by overall performance, investment objectives, and assets, may be
cited. Lipper performance figures are based on changes in net asset value,
with all income and capital gain dividends reinvested. Such calculations do
not include the effect of any sales charges imposed by other funds. The Fund
will be compared to Lipper's appropriate fund category, that is, by fund
objective and portfolio holdings.
(5) MORNINGSTAR, INC.
The Fund's performance may also be compared to the performance of other
mutual funds by Morningstar, Inc. which rates funds on the basis of historical
risk and total return. Morningstar's ratings range from five stars (highest)
to one star (lowest) and represent Morningstar's assessment of the historical
risk level and total return of a fund as a weighted average for 3, 5, and 10
year periods. Ratings are not absolute and do not represent future results.
(6) INDEPENDENT SOURCES
Evaluations of Fund performance made by independent sources may also be
used in advertisements concerning the Fund, including reprints of, or
selections from, editorials or articles about the Fund, especially those with
similar objectives. Sources for Fund performance and articles about the Fund
may include publications such as Money, Forbes, Kiplinger's, Smart Money,
Financial World, Business Week, U.S. News and World Report, The Wall Street
Journal, Barron's and a variety of investment newsletters.
(7) INDICES
The Fund may compare its performance to a wide variety of indices
including the following:
(a) The Consumer Price Index
(b) Dow Jones Average of 30 Industrials
(c) Standard & Poor's 500 Stock Index
(d) NASDAQ Over-the-Counter Composite Index
(e) Russell 2000 Small Stock Index
(f) Russell 3000 Stock Index
(g) Salomon Brothers 3-month Treasury Bill Index
(h) Salomon Brothers Broad Investment-Grade Bond Index
(i) Lehman Brothers Aggregate Bond Index
(j) Lehman Brothers Intermediate Government/Corporate Bond
Index
(k) A blended index consisting of: Standard & Poor's 500
Stock Index (40% weighted), Salomon Brothers Broad
Investment Grade Bond Index (40% weighted), and Salomon
Brothers 3-Month Treasury Bill Index (20% weighted).
There are differences and similarities between the investments that the
Fund may purchase and the investments measured by the indices which are noted
herein.
(8) HISTORICAL ASSET CLASS RETURNS
From time to time, marketing materials may portray the historical
returns of various asset classes. Such presentations will typically compare
the average annual rates of return of inflation, U.S. Treasury bills, bonds,
common stocks, and small stocks. There are important differences between each
of these investments that should be considered in viewing any such comparison.
The market value of stocks will fluctuate with market conditions, and
small-stock prices generally will fluctuate more than large-stock prices.
Stocks are generally more volatile than bonds. In return for this volatility,
stocks have generally preformed better than bonds or cash over time. Bond
prices generally will fluctuate inversely with interest rates and other market
conditions, and the prices of bonds with longer maturities generally will
fluctuate more than those of shorter-maturity bonds. Interest rates for bonds
may be fixed at the time of issuance, and payment of principal and interest may
be guaranteed by the issuer and, in the case of U.S. Treasury obligations,
backed by the full faith and credit of the U.S. Treasury.
35
<PAGE> 36
(9) STRONG FAMILY OF FUNDS
The Strong Family of Funds offers a comprehensive range of conservative
to aggressive investment options. All of the members of the Strong Family and
their investment objectives are listed below. The Funds are listed in ascending
order of risk and return, as determined by the Funds' Advisor.
<TABLE>
<CAPTION>
FUND NAME INVESTMENT OBJECTIVE
--------- --------------------
<S> <C>
Strong U.S. Treasury Money Fund Current income, a stable share-price, and daily liquidity.
Strong Money Market Fund Current income, a stable share-price, and daily liquidity.
Strong Heritage Money Fund Current income, a stable share-price, and daily liquidity.
Strong Municipal Money Market Federally tax-exempt current income, a stable share-price, and daily
Fund liquidity.
Strong Advantage Fund Current income with a very low degree of share-price fluctuation.
Strong Short-Term Bond Fund Total return by investing for a high level of current income with a low
degree of share-price fluctuation.
Strong Short-Term Municipal Bond Total return by investing for a high level of federally tax-exempt
Fund current income with a low degree of share-price fluctuation.
Strong Short-Term Global Bond Total return by investing for a high level of income with a low degree
Fund of share-price fluctuation.
Strong Government Securities Total return by investing for a high level of current income with a
Fund moderate degree of share-price fluctuation.
Strong Insured Municipal Bond Total return by investing for a high level of federally tax-exempt
Fund current income with a moderate degree of share-price fluctuation.
Strong Municipal Bond Fund Total return by investing for a high level of federally tax-exempt
current income with a moderate degree of share-price fluctuation.
Strong Corporate Bond Fund Total return by investing for a high level of current income with a
moderate degree of share-price fluctuation.
Strong International Bond Fund High total return by investing for both income and capital appreciation.
Strong High-Yield Municipal Bond Total return by investing for a high level of federally tax-exempt
Fund current income.
Strong Asset Allocation Fund High total return consistent with reasonable risk over the long term.
Strong American Utilities Fund Total return by investing for both income and capital growth.
Strong Total Return Fund High total return by investing for capital growth and income.
Strong Opportunity Fund Capital growth.
Strong Growth Fund Capital growth.
Strong Common Stock Fund* Capital growth.
Strong Discovery Fund Capital growth.
Strong International Stock Fund Capital growth.
Strong Asia Pacific Fund Capital growth.
</TABLE>
* The Strong Common Stock Fund is currently closed to new investors.
The Advisor also serves as Advisor or Subadvisor to several
management investment companies, some of which fund variable annuity
separate accounts of certain insurance companies.
The Fund may from time to time be compared to the other funds in the
Strong Family of Funds based on a risk/reward spectrum. In general, the amount
of risk associated with any investment product is commensurate with that
product's potential level of reward. The Strong Funds risk/reward continuum or
any Fund's position on the continuum may be described or diagrammed in
marketing materials. The Strong Funds risk/reward continuum positions the risk
and reward potential of each Strong Fund relative to the other Strong Funds,
but is not intended to position any Strong Fund relative to other mutual funds
or investment products. Marketing materials may also discuss the relationship
between risk and reward as it relates to an individual investor's portfolio.
36
<PAGE> 37
Financial goals vary from person to person. You may choose one or more
of the Strong Funds to help you reach your financial goals. To help you better
understand the Strong Growth and Income Funds, which consist of the Strong
Total Return Fund, the Strong American Utilities Fund and the Strong Asset
Allocation Fund, and determine which Fund or combination of Funds best meets
your personal investment objectives, they are described in the same Prospectus.
Though they appear in the same Prospectus, each of the Growth and Income Funds
is a separately incorporated investment company. Because the Funds share a
Prospectus, there may be the possibility of cross liability between the Funds.
ADDITIONAL FUND INFORMATION
(1) PORTFOLIO CHARACTERISTICS
In order to present a more complete picture of a Fund's portfolio,
marketing materials may include various actual or estimated portfolio
characteristics, including but not limited to median market capitalizations,
earnings per share, alphas, betas, price/earnings ratios, returns on equity,
dividend yields, capitalization ranges, growth rates, price/book ratios, top
holdings, sector breakdowns, asset allocations, quality breakdowns, and
breakdowns by geographic region.
(2) MEASURES OF VOLATILITY AND RELATIVE PERFORMANCE
Occasionally statistics may be used to specify Fund volatility or risk.
The general premise is that greater volatility connotes greater risk undertaken
in achieving performance. Measures of volatility or risk are generally used to
compare the Fund's net asset value or performance relative to a market index.
One measure of volatility is beta. Beta is the volatility of a fund relative
to the total market as represented by the Standard & Poor's 500 Stock Index. A
beta of more than 1.00 indicates volatility greater than the market, and a beta
of less than 1.00 indicates volatility less than the market. Another measure
of volatility or risk is standard deviation. Standard deviation is a
statistical tool that measures the degree to which a fund's performance has
varied from its average performance during a particular time period.
Standard deviation is calculated using the following formula:
Standard deviation = the square root of (summation symbol)(xi - xm)2
n-1
where (summation symbol) = "the sum of",
xi = each individual return during the time period,
xm = the average return over the time period, and
n = the number of individual returns during the time period.
Statistics may also be used to discuss a Fund's relative performance.
One such measure is alpha. Alpha measures the actual return of a fund compared
to the expected return of a fund given its risk (as measured by beta). The
expected return is based on how the market as a whole performed, and how the
particular fund has historically performed against the market. Specifically,
alpha is the actual return less the expected return. The expected return is
computed by multiplying the advance or decline in a market representation by
the fund's beta. A positive alpha quantifies the value that the fund manager
has added, and a negative alpha quantifies the value that the fund manager has
lost.
Other measures of volatility and relative performance may be used as
appropriate. However, all such measures will fluctuate and do not represent
future results.
GENERAL INFORMATION
BUSINESS PHILOSOPHY
The Advisor is an independent, Midwestern-based investment advisor,
owned by professionals active in its management. Recognizing that investors are
the focus of its business, the Advisor strives for excellence both in
investment management and in the service provided to investors. This commitment
affects many aspects of the business, including professional staffing, product
development, investment management, and service delivery. Through its
commitment to excellence, the Advisor intends to benefit investors and to
encourage them to think of Strong Funds as their mutual fund family.
37
<PAGE> 38
The increasing complexity of the capital markets requires specialized
skills and processes for each asset class and style. Therefore, the Advisor
believes that active management should produce greater returns than a passively
managed index. The Advisor has brought together a group of top-flight
investment professionals with diverse product expertise, and each concentrates
on their investment specialty. The Advisor believes that people are the firm's
most important asset. For this reason, continuity of professionals is critical
to the firm's long-term success.
INVESTMENT ENVIRONMENT
Discussions of economic, social, and political conditions and their
impact on the Fund may be used in advertisements and sales materials. Such
factors that may impact the Fund include, but are not limited to, changes in
interest rates, political developments, the competitive environment, consumer
behavior, industry trends, technological advances, macroeconomic trends, and
the supply and demand of various financial instruments. In addition, marketing
materials may cite the portfolio management's views or interpretations of such
factors.
EIGHT BASIC PRINCIPLES FOR SUCCESSFUL MUTUAL FUND INVESTING
These common sense rules are followed by many successful investors.
They make sense for beginners, too. If you have a question on these
principles, or would like to discuss them with us, please contact us at
1-800-368-3863.
1. Have a plan - even a simple plan can help you take control of your
financial future. Review your plan once a year, or if your
circumstances change.
2. Start investing as soon as possible. Make time a valuable ally. Let it
put the power of compounding to work for you, while helping to reduce
your potential investment risk.
3. Diversify your portfolio. By investing in different asset classes -
stocks, bonds, and cash - you help protect against poor performance
in one type of investment while including investments most likely to
help you achieve your important goals.
4. Invest regularly. Investing is a process, not a one-time event. Make
a habit of investing regularly. This popular strategy not only helps
you manage investment risk, it ensures you "pay yourself first" on a
regular basis.
5. Maintain a long-term perspective. For most individuals, the best
discipline is staying invested as market conditions change. Reactive,
emotional investment decisions are all too often a source of regret -
and principal loss.
6. Consider stocks to help achieve major long-term goals. Over time,
stocks have provided the more powerful returns needed to help the
value of your investments stay well ahead of inflation.
7. Keep a comfortable amount of cash in your portfolio. To meet current
needs, including emergencies, use a money market fund or a bank
account - not your long-term investment assets.
8. Know what you're buying. Make sure you understand the potential risks
and rewards associated with each of your investments. Ask questions...
request information...make up your own mind. And choose a fund company
that helps you make informed investment decisions.
STRONG RETIREMENT PLAN SERVICES
Strong Retirement Plan Services offers a full menu of high quality,
affordable retirement plan options, including traditional money purchase
pension and profit sharing plans, 401(k) plans, simplified employee pension
plans, salary reduction plans, Keoghs, and 403(b) plans. Retirement plan
specialists are available to help companies determine which type of retirement
plan may be appropriate for their particular situation.
Markets:
The retirement plan services provided by the Advisor focus on four
distinct markets, based on the belief that a retirement plan should fit the
customer's needs, not the other way around.
1. Small company plans. Small company plans are designed for companies with
1-50 plan participants. The objective is to incorporate the features and
benefits typically reserved for large companies, such as sophisticated
recordkeeping systems, outstanding service, and investment expertise, into
a small company plan without administrative hassles or undue expense.
Small company plan sponsors receive a comprehensive plan administration
manual as well as toll-free telephone support.
2. Large company plans. Large company plans are designed for companies with
between 51 and 1,000 plan participants. Each large company plan is
assigned a team of professionals consisting of an account manager, who is
typically an attorney, CPA, or holds a graduate degree in business, a
conversion specialist (if applicable), an accounting manager, a legal/
technical manager, and an education/communications educator.
3. Women-owned businesses.
4. Non-profit and educational organizations (the 403(b) market).
Turnkey approach:
The retirement plans offered by the Advisor are designed to be
streamlined and simple to administer. To this end, the Advisor has invested
heavily in the equipment, systems, and people necessary to adopt or convert a
plan, and to keep it running smoothly. The Advisor provides all aspects of the
plan, including plan design, administration, recordkeeping, and investment
management. To streamline plan design, the Advisor provides customizable IRS-
approved prototype documents. The Advisor's services also include annual
government reporting and testing as well as daily valuation of each
participant's account. This structure is intended to eliminate the confusion
and complication often associated with dealing with multiple vendors. It is
also designed to save plan sponsors time and expense.
The Advisor strives to provide one-stop retirement savings programs
that combine the advantages of proven investment management, flexible plan
design and a wide range of investment options. The open architecture design of
the plans allow for the use of the family of mutual funds managed by the
Advisor as well as a stable asset value option. Large company plans may
supplement these options with their company stock (if publicly traded) or funds
from other well-known mutual fund families.
Education:
Participant education and communication is key to the success of any
retirement program, and therefore is one of the most important services that
the Advisor provides. The Advisor's goal is twofold: to make sure that plan
participants fully understand their options and to educate them about the
lifelong investment process. To this end, the Advisor provides attractive,
readable print materials that are supplemented with audio and video tapes and
retirement education programs.
Service:
The Advisor's goal is to provide a world class level of service. One
aspect of that service is an experienced, knowledgeable team that provides
ongoing support for plan sponsors, both at adoption or conversion and
throughout the life of a plan. The Advisor is committed to delivering accurate
and timely information, evidenced by straightforward, complete, and
understandable reports, participant account statements and plan summaries.
The Advisor has designed both "high-tech" and "high-touch" systems,
providing an automated telephone system as well as personal contact.
Participants can access daily account information, conduct transactions, or
have questions answered in the way that is most comfortable for them.
STRONG FINANCIAL ADVISORS GROUP
The Strong Financial Advisors Group is dedicated to helping financial
advisors better serve their clients. Financial advisors receive regular
updates on the mutual funds managed by the Advisor, access to portfolio
managers through special conference calls, consolidated mailings of duplicate
confirmation statements, access to the Advisor's network of regional
representatives, and other specialized services. For more information on the
Strong Financial Advisors Group, call 1-800-368-1683.
PORTFOLIO MANAGEMENT
The Advisor believes that active management is the best way to achieve
the Fund's objective. This policy is based on the fundamental belief that
economic and financial conditions create favorable and unfavorable investment
periods (or seasons) and that these different seasons require different
investment approaches. During favorable investment periods, the Fund seeks to
generate real (inflation plus) growth, and its portfolio may be more heavily
weighted in equities. During uncertain periods, income and capital
preservation may be emphasized, and the Fund's portfolio may be more heavily
weighted in bonds or short-term securities. Through their understanding and
willingness to change with investment cycles or periods, the co-managers of the
Fund seek to achieve the Fund's objectives throughout the seasons of
investment.
The Fund's co-managers intend to employ an investment strategy which
will permit it to participate in a rising market in equities with less risk and
volatility and more income than a fund which concentrates its investments in
stocks. On the other hand, since the Fund's portfolio will generally have
significant holdings in equities, it will be subject to greater volatility and
produce less income than a fund which concentrates its investments solely in
bonds or money market instruments.
In allocating the Fund's assets among equities, bonds, and short-term
securities, the team's lead portfolio manager will employ top-down fundamental
analysis in evaluating the attractiveness of the three asset components on the
basis of economic trends such as inflation, growth of corporate profits and
Federal Reserve Board policies in conjunction with measures of market valuation
such as price-earnings ratios, dividend yields and real interest rates. The
relative weights of the Fund's three asset components are adjusted gradually,
perhaps as often as several times a year, rather than making dramatic
reallocations in anticipation of a major shift in the attractiveness of one
asset category over another. Therefore, the Fund should be viewed as a
long-term investment suitable for investors with an investment horizon of five
years or more. In light of the nature of the Fund and its long-term investment
horizon, it may be most appropriate for persons attempting to achieve long-term
goals such as accumulating funds for retirement, college tuition or a better
life for one's family.
Each portfolio manager works with a team of analysts, traders, and
administrative personnel. From time to time, marketing materials may discuss
various members of the team, including their education, investment experience,
and other credentials.
38
<PAGE> 39
INDEPENDENT ACCOUNTANTS
Coopers & Lybrand L.L.P., 411 East Wisconsin Avenue, Milwaukee,
Wisconsin 53202, are the independent accountants for the Fund, providing audit
services and assistance and consultation with respect to the preparation of
filings with the SEC.
LEGAL COUNSEL
Godfrey & Kahn, S.C., 780 North Water Street, Milwaukee, Wisconsin
53202, acts as outside legal counsel for the Fund.
FINANCIAL STATEMENTS
The Annual Report that is attached hereto contains the following
audited financial information for the Fund:
(a) Schedule of Investments in Securities.
(b) Statement of Operations.
(c) Statement of Assets and Liabilities.
(d) Statement of Changes in Net Assets.
(e) Notes to Financial Statements.
(f) Financial Highlights.
(g) Report of Independent Accountants.
39
<PAGE> 40
APPENDIX
BOND RATINGS
STANDARD & POOR'S DEBT RATINGS
A Standard & Poor's corporate or municipal debt rating is a current
assessment of the creditworthiness of an obligor with respect to a specific
obligation. This assessment may take into consideration obligors such as
guarantors, insurers, or lessees.
The debt rating is not a recommendation to purchase, sell, or hold a
security, inasmuch as it does not comment as to market price or suitability for
a particular investor.
The ratings are based on current information furnished by the issuer or
obtained by S&P from other sources it considers reliable. S&P does not perform
an audit in connection with any rating and may, on occasion, rely on unaudited
financial information. The ratings may be changed, suspended, or withdrawn as
a result of changes in, or unavailability of, such information, or for other
circumstances.
The ratings are based, in varying degrees, on the following
considerations:
1. Likelihood of default -- capacity and willingness of the
obligor as to the timely payment of interest and repayment
of principal in accordance with the terms of the
obligation.
2. Nature of and provisions of the obligation.
3. Protection afforded by, and relative position of, the
obligation in the event of bankruptcy, reorganization, or
other arrangement under the laws of bankruptcy and other
laws affecting creditors' rights.
INVESTMENT GRADE
AAA Debt rated 'AAA' has the highest rating assigned by Standard &
Poor's. Capacity to pay interest and repay principal is extremely strong.
AA Debt rated 'AA' has a very strong capacity to pay interest and repay
principal and differs from the highest rated issues only in small degree.
A Debt rated 'A' has a strong capacity to pay interest and repay
principal although it is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than debt in higher rated
categories.
BBB Debt rated 'BBB' is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than in higher rated categories.
SPECULATIVE GRADE
Debt rated 'BB', 'B', 'CCC', 'CC' and 'C' is regarded as having
predominantly speculative characteristics with respect to capacity to pay
interest and repay principal. 'BB' indicates the least degree of speculation
and 'C' the highest. While such debt will likely have some quality and
protective characteristics, these are outweighed by large uncertainties or
major risk exposures to adverse conditions.
BB Debt rated 'BB' has less near-term vulnerability to default than
other speculative issues. However, it faces major ongoing uncertainties or
exposure to adverse business, financial, or economic conditions which could
lead to inadequate capacity to meet timely interest and principal payments.
The 'BB' rating category is also used for debt subordinated to senior debt that
is assigned an actual or implied 'BBB-' rating.
A-1
<PAGE> 41
B Debt rated 'B' has a greater vulnerability to default but currently
has the capacity to meet interest payments and principal repayments. Adverse
business, financial, or economic conditions will likely impair capacity or
willingness to pay interest and repay principal. The 'B' rating category is
also used for debt subordinated to senior debt that is assigned an actual or
implied 'BB' or 'BB-' rating.
CCC Debt rated 'CCC' has a currently identifiable vulnerability to
default, and is dependent upon favorable business, financial, and economic
conditions to meet timely payment of interest and repayment of principal. In
the event of adverse business, financial, or economic conditions, it is not
likely to have the capacity to pay interest and repay principal. The 'CCC'
rating category is also used for debt subordinated to senior debt that is
assigned an actual or implied 'B' or 'B-' rating.
CC Debt rated 'CC' typically is applied to debt subordinated to senior
debt that is assigned an actual or implied 'CCC' rating.
C Debt rated 'C' typically is applied to debt subordinated to senior
debt which is assigned an actual or implied 'CCC-' debt rating. The 'C' rating
may be used to cover a situation where a bankruptcy petition has been filed,
but debt service payments are continued.
CI The rating 'CI' is reserved for income bonds on which no interest is
being paid.
D Debt rated 'D' is in payment default. The 'D' rating category is
used when interest payments or principal payments are not made on the date due
even if the applicable grace period has not expired, unless S&P believes that
such payments will be made during such grade period. The 'D' rating also will
be used upon the filing of a bankruptcy petition if debt service payments are
jeopardized.
MOODY'S LONG-TERM DEBT RATINGS
Aaa - Bonds which are rated Aaa are judged to be of the best quality.
They carry the smallest degree of investment risk and are generally referred to
as "gilt edged". Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized are
most unlikely to impair the fundamentally strong position of such issues.
Aa - Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known
as high grade bonds. They are rated lower than the best bonds because margins
of protection may not be as large as in Aaa securities or fluctuation of
protective elements may be of greater amplitude or there may be other elements
present which make the long-term risk appear somewhat larger than in Aaa
securities.
A - Bonds which are rated A possess many favorable investment
attributes and are to be considered as upper-medium grade obligations. Factors
giving security to principal and interest are considered adequate, but elements
may be present which suggest a susceptibility to impairment some time in the
future.
Baa - Bonds which are rated Baa are considered as medium-grade
obligations (i.e., they are neither highly protected nor poorly secured).
Interest payments and principal security appear adequate for the present but
certain protective elements may be lacking or may be characteristically
unreliable over any great length of time. Such Bonds lack outstanding
investment characteristics and in fact have speculative characteristics as
well.
Ba - Bonds which are rated Ba are judged to have speculative elements;
their future cannot be considered as well-assured. Often the protection of
interest and principal payments may be very moderate, and thereby not well
safeguarded during both good and bad times over the future. Uncertainty of
position characterizes Bonds in this class.
B - Bonds which are rated B generally lack characteristics of the
desirable investment. Assurance of interest and principal payments or of
maintenance of other terms of the contract over any long period of time may be
small.
A-2
<PAGE> 42
Caa - Bonds which are rated Caa are of poor standing. Such issues may
be in default or there may be present elements of danger with respect to
principal or interest.
Ca - Bonds which are rated Ca represent obligations which are
speculative in a high degree. Such issues are often in default or have other
marked shortcomings.
C - Bonds which are rated C are the lowest rated class of bonds, and
issues so rated can be regarded as having extremely poor prospects of ever
attaining any real investment standing.
FITCH INVESTORS SERVICE, INC. BOND RATINGS
Fitch investment grade bond ratings provide a guide to investors in
determining the credit risk associated with a particular security. The ratings
represent Fitch's assessment of the issuer's ability to meet the obligations of
a specific debt issue or class of debt in a timely manner.
The rating takes into consideration special features of the issue, its
relationship to other obligations of the issuer, the current and prospective
financial condition and operating performance of the issuer and any guarantor,
as well as the economic and political environment that might affect the
issuer's future financial strength and credit quality.
Fitch ratings do not reflect any credit enhancement that may be
provided by insurance policies or financial guaranties unless otherwise
indicated.
Bonds that have the same rating are of similar but not necessarily
identical credit quality since the rating categories do not fully reflect small
differences in the degrees of credit risk.
Fitch ratings are not recommendations to buy, sell, or hold any
security. Ratings do not comment on the adequacy of market price, the
suitability of any security for a particular investor, or the tax-exempt nature
or taxability of payments made in respect of any security.
Fitch ratings are based on information obtained from issuers, other
obligors, underwriters, their experts, and other sources Fitch believes to be
reliable. Fitch does not audit or verify the truth or accuracy of such
information. Ratings may be changed, suspended, or withdrawn as a result of
changes in, or the unavailability of, information or for other reasons.
AAA Bonds considered to be investment grade and of the highest credit
quality. The obligor has an exceptionally strong ability to pay
interest and repay principal, which is unlikely to be affected by
reasonably foreseeable events.
AA Bonds considered to be investment grade and of very high credit
quality. The obligor's ability to pay interest and repay
principal is very strong, although not quite as strong as bonds
rated 'AAA'. Because bonds rated in the 'AAA' and 'AA'
categories are not significantly vulnerable to foreseeable future
developments, short-term debt of the issuers is generally rated
'F-1+'.
A Bonds considered to be investment grade and of high credit
quality. The obligor's ability to pay interest and repay
principal is considered to be strong, but may be more vulnerable
to adverse changes in economic conditions and circumstances than
bonds with higher ratings.
BBB Bonds considered to be investment grade and of satisfactory credit
quality. The obligor's ability to pay interest and repay
principal is considered to be adequate. Adverse changes in
economic conditions and circumstances, however, are more likely to
have adverse impact on these bonds, and therefore impair timely
payment. The likelihood that the ratings of these bonds will fall
below investment grade is higher than for bonds with higher
ratings.
A-3
<PAGE> 43
Fitch speculative grade bond ratings provide a guide to investors in
determining the credit risk associated with a particular security. The ratings
('BB' to 'C') represent Fitch's assessment of the likelihood of timely payment
of principal and interest in accordance with the terms of obligation for bond
issues not in default. For defaulted bonds, the rating ('DDD' to 'D') is an
assessment of the ultimate recovery value through reorganization or
liquidation.
The rating takes into consideration special features of the issue, its
relationship to other obligations of the issuer, the current and prospective
financial condition and operating performance of the issuer and any guarantor,
as well as the economic and political environment that might affect the
issuer's future financial strength.
Bonds that have the same rating are of similar but not necessarily
identical credit quality since the rating categories cannot fully reflect the
differences in the degrees of credit risk. Moreover, the character of the risk
factor varies from industry to industry and between corporate, health care and
municipal obligations.
BB Bonds are considered speculative. The obligor's ability to pay
interest and repay principal may be affected over time by adverse
economic changes. However, business and financial alternatives
can be identified which could assist the obligor in satisfying its
debt service requirements.
B Bonds are considered highly speculative. While bonds in this
class are currently meeting debt service requirements, the
probability of continued timely payment of principal and interest
reflects the obligor's limited margin of safety and the need for
reasonable business and economic activity throughout the life of
the issue.
CCC Bonds have certain identifiable characteristics which, if not
remedied, may lead to default. The ability to meet obligations
requires an advantageous business and economic environment.
CC Bonds are minimally protected. Default in payment of interest
and/or principal seems probable over time.
C Bonds are in imminent default in payment of interest or principal.
DDD, DD
and D Bonds are in default on interest and/or principal payments. Such
bonds are extremely speculative and should be valued on the basis
of their ultimate recovery value in liquidation or reorganization
of the obligor. 'DDD' represents the highest potential for
recovery of these bonds, and 'D' represents the lowest potential
for recovery.
A-4
<PAGE> 44
DUFF & PHELPS, INC. LONG-TERM DEBT RATINGS
These ratings represent a summary opinion of the issuer's long-term
fundamental quality. Rating determination is based on qualitative and
quantitative factors which may vary according to the basic economic and
financial characteristics of each industry and each issuer. Important
considerations are vulnerability to economic cycles as well as risks related to
such factors as competition, government action, regulation, technological
obsolescence, demand shifts, cost structure, and management depth and
expertise. The projected viability of the obligor at the trough of the cycle
is a critical determination.
Each rating also takes into account the legal form of the security,
(e.g., first mortgage bonds, subordinated debt, preferred stock, etc.). The
extent of rating dispersion among the various classes of securities is
determined by several factors including relative weightings of the different
security classes in the capital structure, the overall credit strength of the
issuer, and the nature of covenant protection. Review of indenture
restrictions is important to the analysis of a company's operating and
financial constraints.
The Credit Rating Committee formally reviews all ratings once per
quarter (more frequently, if necessary). Ratings of 'BBB-' and higher fall
within the definition of investment grade securities, as defined by bank and
insurance supervisory authorities.
<TABLE>
<CAPTION>
RATING SCALE DEFINITION
<S> <C>
AAA Highest credit quality. The risk factors are negligible, being only slightly
more than for risk-free U.S. Treasury debt.
AA+ High credit quality. Protection factors are strong. Risk is modest, but may
AA vary slightly from time to time because of economic conditions.
AA-
A+ Protection factors are average but adequate. However, risk factors are more
A variable and greater in periods of economic stress.
A-
BBB+ Below average protection factors but still considered sufficient for prudent
BBB investment. Considerable variability in risk during economic cycles.
BBB-
BB+ Below investment grade but deemed likely to meet obligations when due.
BB Present or prospective financial protection factors fluctuate according to
BB- industry conditions or company fortunes. Overall quality may move up or
down frequently within this category.
B+ Below investment grade and possessing risk that obligations will not be met
B when due. Financial protection factors will fluctuate widely according to
B- economic cycles, industry conditions and/or company fortunes. Potential exists
for frequent changes in the rating within this category or into a higher or
lower rating grade.
</TABLE>
A-5
<PAGE> 45
<TABLE>
<S> <C>
CCC Well below investment grade securities. Considerable uncertainty exists as
to timely payment of principal, interest or preferred dividends. Protection factors
are narrow and risk can be substantial with unfavorable economic/industry
conditions, and/or with unfavorable company developments.
DD Defaulted debt obligations. Issuer failed to meet scheduled principal and/or interest payments.
DP Preferred stock with dividend arrearages.
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SHORT-TERM RATINGS
STANDARD & POOR'S COMMERCIAL PAPER RATINGS
A Standard & Poor's commercial paper rating is a current assessment of
the likelihood of timely payment of debt considered short-term in the relevant
market.
Ratings graded into several categories, ranging from 'A-1' for the
highest quality obligations to 'D' for the lowest. These categories are as
follows:
A-1 This highest category indicates that the degree of safety regarding
timely payment is strong. Those issues determined to possess extremely strong
safety characteristics are denoted with a plus sign (+) designation.
A-2 Capacity for timely payment on issues with this designation is
satisfactory. However, the relative degree of safety is not as high as for
issues designated 'A-1'.
A-3 Issues carrying this designation have adequate capacity for timely
payment. They are, however, more vulnerable to the adverse effects of changes
in circumstances than obligations carrying the higher designations.
B Issues rated 'B' are regarded as having only speculative capacity for
timely payment.
C This rating is assigned to short-term debt obligations with doubtful
capacity for payment.
D Debt rated 'D' is in payment default. The 'D' rating category is
used when interest payments or principal payments are not made on the date due,
even if the applicable grace period has not expired, unless S&P believes that
such payments will be made during such grace period.
MOODY'S COMMERCIAL PAPER RATINGS
The term "commercial paper" as used by Moody's means promissory
obligations not having an original maturity in excess of nine months. Moody's
makes no representation as to whether such commercial paper is by any other
definition "commercial paper" or is exempt from registration under the
Securities Act of 1933, as amended.
Moody's commercial paper ratings are opinions of the ability of issuers
to repay punctually promissory obligations not having an original maturity in
excess of nine months. Moody's makes no representation that such obligations
are exempt from registration under the Securities Act of 1933, nor does it
represent that any specific note is a valid obligation of a rated issuer or
issued in conformity with any applicable law. Moody's employs the following
three designations, all judged to be investment grade, to indicate the relative
repayment capacity of rated issuers:
A-6
<PAGE> 46
Issuers rated PRIME-1 (or related supporting institutions) have a
superior capacity for repayment of short-term promissory obligations. Prime-1
repayment capacity will normally be evidenced by the following characteristics:
(i) leading market positions in well established industries, (ii) high rates of
return on funds employed, (iii) conservative capitalization structures with
moderate reliance on debt and ample asset protection, (iv) broad margins in
earnings coverage of fixed financial charges and high internal cash generation,
and (v) well established access to a range of financial markets and assured
sources of alternate liquidity.
Issuers rated PRIME-2 (or related supporting institutions) have a
strong capacity for repayment of short-term promissory obligations. This will
normally be evidenced by many of the characteristics cited above, but to a
lesser degree. Earnings trends and coverage ratios, while sound, will be more
subject to variation. Capitalization characteristics, while still appropriate,
may be more affected by external conditions. Ample alternate liquidity is
maintained.
Issuers rated PRIME-3 (or related supporting institutions) have an
acceptable capacity for repayment of short-term promissory obligations. The
effect of industry characteristics and market composition may be more
pronounced. Variability in earnings and profitability may result in changes in
the level of debt protection measurements and the requirement for relatively
high financial leverage. Adequate alternate liquidity is maintained.
Issuers rated NOT PRIME do not fall within any of the Prime rating
categories.
FITCH INVESTORS SERVICE, INC. SHORT-TERM RATINGS
Fitch's short-term ratings apply to debt obligations that are payable
on demand or have original maturities of generally up to three years, including
commercial paper, certificates of deposit, medium-term notes, and municipal and
investment notes.
The short-term rating places greater emphasis than a long-term rating
on the existence of liquidity necessary to meet the issuer's obligations in a
timely manner.
F-1+ (Exceptionally Strong Credit Quality) Issues assigned this
rating are regarded as having the strongest degree of
assurance for timely payment.
F-1 (Very Strong Credit Quality) Issues assigned this rating
reflect an assurance of timely payment only slightly less
in degree than issues rated 'F-1+'.
F-2 (Good Credit Quality) Issues assigned this rating have a
satisfactory degree of assurance for timely payment but
the margin of safety is not as great as for issues
assigned 'F-1+' and 'F-1' ratings.
F-3 (Fair Credit Quality) Issues assigned this rating have
characteristics suggesting that the degree of assurance
for timely payment is adequate, however, near-term adverse
changes could cause these securities to be rated below
investment grade.
F-S (Weak Credit Quality) Issues assigned this rating have
characteristics suggesting a minimal degree of assurance
for timely payment and are vulnerable to near-term adverse
changes in financial and economic conditions.
D (Default) Issues assigned this rating are in actual or
imminent payment default.
LOC The symbol LOC indicates that the rating is based on a
letter of credit issued by a commercial bank.
A-7
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DUFF & PHELPS, INC. SHORT-TERM DEBT RATINGS
Duff & Phelps' short-term ratings are consistent with the rating
criteria utilized by money market participants. The ratings apply to all
obligations with maturities of under one year, including commercial paper, the
uninsured portion of certificates of deposit, unsecured bank loans, master
notes, bankers acceptances, irrevocable letters of credit, and current
maturities of long-term debt. Asset-backed commercial paper is also rated
according to this scale.
Emphasis is placed on liquidity which is defined as not only cash from
operations, but also access to alternative sources of funds including trade
credit, bank lines, and the capital markets. An important consideration is the
level of an obligor's reliance on short-term funds on an ongoing basis.
Rating Scale: Definition
Duff 1+ Highest certainty of timely payment. Short-term
liquidity, including internal operating factors
and/or access to alternative sources of funds, is
outstanding, and safety is just below risk-free U.S.
Treasury short-term obligations.
Duff 1 Very high certainty of timely payment. Liquidity
factors are excellent and supported by good
fundamental protection factors. Risk factors are
minor.
Duff 1- High certainty of timely payment. Liquidity factors
are strong and supported by good fundamental
protection factors. Risk factors are very small.
Good Grade
Duff 2 Good certainty of timely payment. Liquidity factors
and company fundamentals are sound. Although ongoing
funding needs may enlarge total financing
requirements, access to capital markets is good.
Risk factors are small.
Satisfactory Grade
Duff 3 Satisfactory liquidity and other protection factors
qualify issue as to investment grade. Risk factors
are larger and subject to more variation.
Nevertheless, timely payment is expected.
Non-investment Grade
Duff 4 Speculative investment characteristics. Liquidity is
not sufficient to insure against disruption in debt
service. Operating factors and market access may be
subject to a high degree of variation.
Default
Duff 5 Issuer failed to meet scheduled principal and/or
interest payments.
A-8
