<PAGE>
PROSPECTUS
JUNE 2, 1995
MERRILL LYNCH VARIABLE SERIES FUNDS, INC.
P.O. BOX 9011
PRINCETON, NEW JERSEY 08543-9011
PHONE NO. (609) 282-2800
------------------------
Merrill Lynch Variable Series Funds, Inc. (the 'Company') is an open-end
management investment company which has a wide range of investment objectives
among its seventeen separate funds. Shares of four of the funds are offered
hereby (hereinafter referred to as the 'Funds' or individually as a 'Fund'). A
separate class of common stock ('Common Stock') is issued for each Fund. The
Company's investment adviser is Merrill Lynch Asset Management, L.P. (the
'Investment Adviser').
The shares of the Funds will be sold to certain insurance companies
('Insurance Companies'), including Insurance Companies owned by Merrill Lynch &
Co., Inc., for certain separate accounts ('Separate Accounts') to fund benefits
under variable life insurance contracts and/or variable annuities contracts
('Contracts') issued by the Insurance Companies. The Insurance Companies will
redeem shares to the extent necessary to provide benefits under the respective
Contracts or for such other purposes as may be consistent with the respective
Contracts. The investment objectives of the Funds, each of whose name is
preceded by 'Merrill Lynch,' are as follows:
BASIC VALUE FOCUS FUND. Capital appreciation and, secondarily, income
by investing in securities, primarily equities that management of the Fund
believes are undervalued and therefore represent basic investment value.
DOMESTIC MONEY MARKET FUND. Preservation of capital, liquidity and the
highest possible current income consistent with the foregoing objectives by
investing in short-term domestic money market securities.
GLOBAL STRATEGY FOCUS FUND. High total investment return by investing
primarily in a portfolio of equity and fixed-income securities of U.S. and
foreign issuers.
HIGH CURRENT INCOME FUND. As high a level of current income as is
consistent with prudent investment management, and capital appreciation to
the extent consistent with the foregoing objective, by investing principally
in fixed-income securities which are rated, in the lower rating categories
of the established rating services or in unrated securities of comparable
quality.
For more information on the Funds' investment objectives and policies,
please see 'Investment Objectives and Policies of the Funds,' page 6.
THE DOMESTIC MONEY MARKET FUND ATTEMPTS TO MAINTAIN A STABLE NET ASSET VALUE
OF $1.00 PER SHARE, BUT THERE CAN BE NO ASSURANCE THAT IT WILL BE ABLE TO DO SO.
AN INVESTMENT IN THE DOMESTIC MONEY MARKET FUND IS NEITHER INSURED NOR
GUARANTEED BY THE U.S. GOVERNMENT. THE HIGH CURRENT INCOME FUND INVESTS OR MAY
INVEST IN HIGH YIELD BONDS (COMMONLY KNOWN AS 'JUNK BONDS'), WHICH INVOLVE
SPECIAL RISKS. SEE 'INVESTMENT OBJECTIVES AND POLICIES OF THE FUNDS--RISKS OF
HIGH YIELD SECURITIES.'
------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
------------------------
THIS PROSPECTUS SETS FORTH IN CONCISE FORM THE INFORMATION ABOUT THE COMPANY
THAT A PROSPECTIVE INVESTOR SHOULD KNOW BEFORE INVESTING IN THE COMPANY.
INVESTORS SHOULD READ AND RETAIN THIS PROSPECTUS FOR FUTURE REFERENCE. A
STATEMENT CONTAINING ADDITIONAL INFORMATION ABOUT THE COMPANY HAS BEEN FILED
WITH THE SECURITIES AND EXCHANGE COMMISSION IN A STATEMENT OF ADDITIONAL
INFORMATION, DATED APRIL 28, 1995, AND IS AVAILABLE ON REQUEST AND WITHOUT
CHARGE BY CALLING OR WRITING THE COMPANY AT THE ADDRESS AND TELEPHONE NUMBER SET
FORTH ABOVE. THE STATEMENT OF ADDITIONAL INFORMATION IS HEREBY INCORPORATED BY
REFERENCE INTO THIS PROSPECTUS.
MERRILL LYNCH ASSET MANAGEMENT--INVESTMENT ADVISER
MERRILL LYNCH FUNDS DISTRIBUTOR, INC.--DISTRIBUTOR
<PAGE>
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS, OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS AND IN THE
STATEMENT OF ADDITIONAL INFORMATION, IN CONNECTION WITH THE OFFER MADE BY THIS
PROSPECTUS, AND, IF GIVEN OR MADE, SUCH OTHER INFORMATION OR REPRESENTATIONS
MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE FUND OR ITS
DISTRIBUTOR. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY BY THE FUND OR BY THE DISTRIBUTOR IN ANY STATE
IN WHICH SUCH OFFER TO SELL OR SOLICITATION OF ANY OFFER TO BUY MAY NOT LAWFULLY
BE MADE.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Financial Highlights........................... 3
The Insurance Companies........................ 6
Domestic Money Market Fund Yield Information... 6
Investment Objectives and Policies of the
Funds........................................ 6
Directors...................................... 16
Investment Adviser............................. 17
Portfolio Transactions and Brokerage........... 18
Purchase of Shares............................. 19
Redemption of Shares........................... 19
Dividends, Distributions and Taxes............. 19
Performance Data............................... 20
Additional Information......................... 21
Appendix A..................................... A-1
</TABLE>
2
<PAGE>
FINANCIAL HIGHLIGHTS
The following table presents supplementary financial information with
respect to each of the Funds. The table has been audited by Deloitte & Touche
LLP, independent auditors, in connection with their annual audits of the
Company's financial statements. Financial statements for the year ended December
31, 1994 and the independent auditors' report thereon appear in the Statement of
Additional Information. The information in the following table should be read in
conjunction with the financial statements.
<TABLE>
<CAPTION>
DOMESTIC MONEY
MARKET FUND
BASIC VALUE ------------------------------------------------
The following per share data and FOCUS FUND FOR THE
ratios have been derived from ---------------------------------------- PERIOD
information provided in the FOR THE YEAR FOR THE PERIOD JULY 1, FOR THE YEAR FOR THE YEAR FEBRUARY 20,
financial statements. ENDED 1993+ TO ENDED ENDED 1992+ TO
INCREASE (DECREASE) IN NET ASSET DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31,
VALUE: 1994 1993 1994 1993 1992
------------ ----------------------- ------------- ------------- ------------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of
period............................ $ 10.95 $ 10.00 $ 1.00 $ 1.00 $ 1.00
------------ ------ ------------- ------------- ------
Investment income--net............. .17 .04 .0386 .0302 .0302
Realized and unrealized gain (loss)
on investments and foreign
currency
transactions--net................. .08 .91 (.0007) .0005 .0013
------------ ------ ------------- ------------- ------
Total from investment operations... .25 .95 .0379 .0307 .0315
------------ ------ ------------- ------------- ------
Less dividends and distributions:
Investment income--net.......... (.10) -- (.0386) (.0302) (.0302)
Realized gain on
investments--net................ -- -- -- (.0005) (.0010)
------------ ------ ------------- ------------- ------
Total dividends and
distributions..................... (.10) -- (.0386) (.0307) (.0312)
------------ ------ ------------- ------------- ------
Net asset value, end of period..... $ 11.10 $ 10.95 $ 1.00 $ 1.00 $ 1.00
------------ ------ ------------- ------------- ------
------------ ------ ------------- ------------- ------
TOTAL INVESTMENT RETURN:**
Based on net asset value per
share............................. 2.36% 9.50%++ 3.94% 3.10% 3.16%++
------------ ------ ------------- ------------- ------
------------ ------ ------------- ------------- ------
RATIOS TO AVERAGE NET ASSETS:
Expenses, net of reimbursement..... .72% .86%* .50% .36% .32%*
------------ ------ ------------- ------------- ------
------------ ------ ------------- ------------- ------
Expenses........................... .72% .86%* .57% .63% .88%*
------------ ------ ------------- ------------- ------
------------ ------ ------------- ------------- ------
Investment income--net............. 2.08% 1.69%* --% --% --%
------------ ------ ------------- ------------- ------
------------ ------ ------------- ------------- ------
Investment income--net, and
realized gain (loss) on
investments--net***............... -- -- 4.02% 3.03% 3.48%*
------------ ------ ------------- ------------- ------
------------ ------ ------------- ------------- ------
SUPPLEMENTAL DATA:
Net assets, end of period (in
thousands)........................ $164,307 $47,207 $ 363,199 $ 170,531 $ 41,128
------------ ------ ------------- ------------- ------
------------ ------ ------------- ------------- ------
Portfolio turnover................. 60.55% 30.86% --% --% --%
------------ ------ ------------- ------------- ------
------------ ------ ------------- ------------- ------
</TABLE>
- ------------------
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
*** Applicable to the Domestic Money Market Fund only.
+ The Basic Value Focus Fund commenced operations on July 1, 1993 and the
Domestic Money Market Fund commenced operations on February 20, 1992.
++ Aggregate total investment return.
Further information about each Fund's performance is contained in the
Company's Annual Report, which can be obtained, without charge, upon request.
3
<PAGE>
FINANCIAL HIGHLIGHTS (CONTINUED)
<TABLE>
<CAPTION>
GLOBAL STRATEGY FOCUS FUND
--------------------------------------
FOR THE
PERIOD
FOR THE YEAR ENDED FEBRUARY 28,
The following per share data and ratios have been derived from information DECEMBER 31, 1992+ TO
provided in the financial statements. --------------------- DECEMBER 31,
INCREASE (DECREASE) IN NET ASSET VALUE: 1994 1993 1992
-------- -------- ------------
<S> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period.............................................. $ 12.17 $ 10.22 $ 10.00
-------- -------- ------
Investment income--net............................................................ .30 .16 .13
Realized and unrealized gain (loss) on investments and foreign currency
transactions--net................................................................ (.48) 1.96 .13
-------- -------- ------
Total from investment operations.................................................. (.18) 2.12 .26
-------- -------- ------
Less dividends and distributions:
Investment income--net......................................................... (.21) (.17) (.04)
Realized gain on investments--net.............................................. (.04) -- --
In excess of realized gain on investments--net................................. (.01) -- --
-------- -------- ------
Total dividends and distributions................................................. (.26) (.17) (.04)
-------- -------- ------
Net asset value, end of period.................................................... $ 11.73 $ 12.17 $ 10.22
-------- -------- ------
-------- -------- ------
TOTAL INVESTMENT RETURN:**
Based on net asset value per share................................................ (1.46)% 21.03% 2.62%++
-------- -------- ------
-------- -------- ------
RATIOS TO AVERAGE NET ASSETS:
Expenses, net of reimbursement.................................................... .77% .88% 1.25%*
-------- -------- ------
-------- -------- ------
Expenses.......................................................................... .77% .88% 1.35%*
-------- -------- ------
-------- -------- ------
Investment income--net............................................................ 2.85% 2.41% 2.66%*
-------- -------- ------
-------- -------- ------
SUPPLEMENTAL DATA:
Net assets, end of period (in thousands).......................................... $515,407% $269,627 $ 15,527
-------- -------- ------
-------- -------- ------
Portfolio turnover................................................................ 21.03% 17.07% 14.47%
-------- -------- ------
-------- -------- ------
</TABLE>
- ------------------
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
+ The Global Strategy Focus Fund commenced operations on February 28, 1992.
++ Aggregate total investment return.
Further information about each Fund's performance is contained in the
Company's Annual Report, which can be obtained, without charge, upon request.
4
<PAGE>
FINANCIAL HIGHLIGHTS (CONTINUED)
<TABLE>
<CAPTION>
The following per share data HIGH CURRENT INCOME FUND
and ratios have been derived -----------------------------------------------------------------------------------------------
from information provided in
the financial statements. FOR THE YEAR ENDED DECEMBER 31,
INCREASE (DECREASE) IN NET -----------------------------------------------------------------------------------------------
ASSET VALUE: 1994 1993 1992 1991 1990 1989 1988 1987 1986
-------- -------- ------- ------ ------ ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
PER SHARE OPERATING
PERFORMANCE:
Net asset value, beginning
of year.................... $ 12.06 $ 11.13 $ 10.23 $ 8.14 $10.21 $ 10.85 $ 10.55 $ 11.42 $ 11.39
-------- -------- ------- ------ ------ ------- ------- ------- -------
Investment income--net..... 1.05 .95 1.07 1.19 1.40 1.29 1.21 1.23 1.25
Realized and unrealized
gain (loss) on investments
and foreign currency
transactions--net.......... (1.47) .95 .90 2.10 (2.08) (.64) .20 (.79) .03
-------- -------- ------- ------ ------ ------- ------- ------- -------
Total from investment
operations................. (.42) 1.90 1.97 3.29 (.68) .65 1.41 .44 1.28
-------- -------- ------- ------ ------ ------- ------- ------- -------
Less dividends and
distributions:
Investment income--net..... (1.03) (.97) (1.07) (1.20) (1.39) (1.29) (1.11) (1.23) (1.25)
Realized gain on
investments--net........... -- -- -- -- -- -- -- (.08) --
Total dividends and
distributions................ (1.03) (.97) (1.07) (1.20) (1.39) (1.29) (1.11) (1.31) (1.25)
-------- -------- ------- ------ ------ ------- ------- ------- -------
Net asset value, end of
year......................... $ 10.61 $ 12.06 $ 11.13 $10.23 $ 8.14 $ 10.21 $ 10.85 $ 10.55 $ 11.42
-------- -------- ------- ------ ------ ------- ------- ------- -------
-------- -------- ------- ------ ------ ------- ------- ------- -------
TOTAL INVESTMENT RETURN:**
Based on net asset value
per share.................. (3.59)% 17.84% 20.05% 43.00% (7.63)% 6.14% 13.87% 3.82% 11.74%
-------- -------- ------- ------ ------ ------- ------- ------- -------
-------- -------- ------- ------ ------ ------- ------- ------- -------
RATIOS TO AVERAGE NET ASSETS:
Expenses, net of
reimbursement.............. .61% .72% .89% 1.10% 1.15% 1.22% 1.07% 1.01% 1.12%
-------- -------- ------- ------ ------ ------- ------- ------- -------
-------- -------- ------- ------ ------ ------- ------- ------- -------
Expenses................... .61% .72% .89% 1.10% 1.15% 1.22% 1.07% 1.01% 1.12%
-------- -------- ------- ------ ------ ------- ------- ------- -------
-------- -------- ------- ------ ------ ------- ------- ------- -------
Investment income--net..... 9.73% 8.62% 10.06% 12.49% 14.52% 11.98% 11.22% 10.88% 10.65%
-------- -------- ------- ------ ------ ------- ------- ------- -------
-------- -------- ------- ------ ------ ------- ------- ------- -------
SUPPLEMENTAL DATA:
Net assets, end of year (in
thousands)................. $255,719 $163,428 $26,343 $9,649 $8,106 $12,942 $13,960 $13,075 $12,577
-------- -------- ------- ------ ------ ------- ------- ------- -------
-------- -------- ------- ------ ------ ------- ------- ------- -------
Portfolio turnover......... 51.88% 35.67% 28.21% 51.54% 26.43% 53.52% 33.91% 56.07% 22.44%
-------- -------- ------- ------ ------ ------- ------- ------- -------
-------- -------- ------- ------ ------ ------- ------- ------- -------
<CAPTION>
The following per share data
and ratios have been derived
from information provided in
the financial statements.
INCREASE (DECREASE) IN NET
ASSET VALUE: 1985
------
<S> <C>
PER SHARE OPERATING
PERFORMANCE:
Net asset value, beginning
of year.................... $10.33
------
Investment income--net..... 1.32
Realized and unrealized
gain (loss) on investments
and foreign currency
transactions--net.......... 1.06
------
Total from investment
operations................. 2.38
------
Less dividends and
distributions:
Investment income--net..... (1.32)
Realized gain on
investments--net........... --
Total dividends and
distributions................ (1.32)
------
Net asset value, end of
year......................... $11.39
------
------
TOTAL INVESTMENT RETURN:**
Based on net asset value
per share.................. 24.24%
------
------
RATIOS TO AVERAGE NET ASSETS:
Expenses, net of
reimbursement.............. 1.11%
------
------
Expenses................... 1.54%
------
------
Investment income--net..... 11.87%
------
------
SUPPLEMENTAL DATA:
Net assets, end of year (in
thousands)................. $4,695
------
------
Portfolio turnover......... 33.67%
------
------
</TABLE>
- ------------------
** Total investment returns exclude insurance-related fees and expenses.
Further information about each Fund's performance is contained in the
Company's Annual Report, which can be obtained, without charge, upon request.
5
<PAGE>
THE INSURANCE COMPANIES
The Company was organized to fund benefits under variable annuity and
variable life Contracts issued by the Insurance Companies. Through this
Prospectus, the Company is offering shares in four Funds to certain separate
accounts (the 'Separate Accounts') of certain Insurance Companies to fund
benefits under the Contracts. Those four Funds are: the Basic Value Focus Fund,
Domestic Money Market Fund, Global Strategy Focus Fund, and High Current Income
Fund. Through separate Prospectuses, the Company offers shares in some or all of
its funds to certain other Separate Accounts of other Insurance Companies to
fund benefits under variable life and variable annuity Contracts issued by them.
The rights of the Insurance Companies as shareholders should be
distinguished from the rights of a Contract owner, which are set forth in the
Contract. A Contract owner has no interest in the shares of a Fund, but only in
the Contract. The Contract is described in the Prospectus for each Contract.
That Prospectus describes the relationship between increases or decreases in the
net asset value of shares of a Fund, and any distributions on such shares, and
the benefits provided under a Contract. The Prospectus for the Contracts also
describes various fees payable to the Insurance Companies and charges to the
Separate Accounts made by the Insurance Companies with respect to the Contracts.
Because shares of the Funds will be sold only to the Insurance Companies for the
Separate Accounts, the terms 'shareholder' and 'shareholders' in this Prospectus
refer to the Insurance Companies.
DOMESTIC MONEY MARKET FUND YIELD INFORMATION
Set forth below is yield information for the Domestic Money Market Fund for
the seven-day period ended December 31, 1994, computed to include and exclude
realized and unrealized gains and losses, and information as to the compounded
annualized yield, excluding gains and losses, for the same periods. The yield
quotations may be of limited use for comparative purposes because they do not
reflect charges imposed at the Separate Account level which, if included, would
decrease the yield.
<TABLE>
<CAPTION>
DOMESTIC MONEY
FUND MARKET
--------------
<S> <C>
Annualized Yield:
Including gains and losses.................................................................. 5.17%
Excluding gains and losses.................................................................. 5.17%
Compounded Annualized Yield...................................................................... 5.31%
Average maturity of portfolio at end of period................................................... 35 days
</TABLE>
INVESTMENT OBJECTIVES AND POLICIES OF THE FUNDS
INVESTMENT OBJECTIVES
Each Fund of the Company has a different investment objective which it
pursues through separate investment policies as described below. The differences
in objectives and policies among the Funds can be expected to affect the return
of each Fund and the degree of market and financial risk to which each Fund is
subject. Each Fund is classified as 'diversified,' as defined in the Investment
Company Act of 1940 (the 'Investment Company Act'), except for the Global
Strategy Focus Fund, which is classified as 'non-diversified.' The investment
objectives and classification of each Fund may not be changed without the
approval of the holders of a majority of the outstanding shares of each Fund
affected. The investment objectives and policies of each Fund are discussed
below.
Fixed Income Security Ratings. No Fund other than the High Current Income
Fund invests in fixed-income securities which are rated below investment grade
(i.e., securities rated Ba or below by Moody's Investors Service, Inc.
('Moody's') or BB or below by Standard & Poor's Rating Group ('Standard &
Poor's')). However, securities purchased by a Fund may subsequently be
downgraded. Such securities may continue to be held and will be sold only if, in
the judgment of the Investment Adviser, it is advantageous to do so. Securities
in
6
<PAGE>
the lowest category of investment grade debt securities may have speculative
characteristics which may lead to weakened capacity to pay interest and
principal during periods of adverse economic conditions. See Appendix A for a
fuller description of corporate bond ratings.
BASIC VALUE FOCUS FUND
The investment objective of the Basic Value Focus Fund is to seek capital
appreciation and, secondarily, income by investing in securities, primarily
equities, that management of the Fund believes are undervalued and therefore
represent basic investment value. The Fund seeks special opportunities in
securities that are selling at a discount, either from book value or historical
price-earnings ratios, or seem capable of recovering from temporarily out of
favor considerations. Particular emphasis is placed on securities which provide
an above-average dividend return and sell at a below-average price-earnings
ratio.
The investment policy of the Basic Value Focus Fund is based on the belief
that the pricing mechanism of the securities market lacks total efficiency and
has a tendency to inflate prices of securities in favorable market climates and
depress prices of securities in unfavorable climates. Based on this premise,
management believes that favorable changes in market prices are more likely to
begin when securities are out of favor, earnings are depressed, price-earnings
ratios are relatively low, investment expectations are limited, and there is no
real general interest in the particular security or industry involved. On the
other hand, management believes that negative developments are more likely to
occur when investment expectations are generally high, stock prices are
advancing or have advanced rapidly, price-earnings ratios have been inflated,
and the industry or issue continues to gain new investment acceptance on an
accelerated basis. In other words, management believes that market prices of
securities with relatively high price-earnings ratios are more susceptible to
unexpected adverse developments while securities with relatively low
price-earnings ratios are more favorably positioned to benefit from favorable,
but generally unanticipated, events. This investment policy departs from
traditional philosophy. Management of the Fund believes that the market risk
involved in this policy is moderated somewhat by an emphasis on securities with
above-average dividend returns.
The current institutionally-dominated market tends to ignore, to some
extent, the numerous secondary issues whose market capitalizations are below
those of the relatively few larger size growth companies. It is expected that
the Basic Value Focus Fund's portfolio generally will have significant
representation in this secondary segment of the market. The basic orientation of
the Fund's investment policies is such that at times a large portion of its
common stock holdings may carry less than favorable research ratings from
research analysts.
Investment emphasis is on equities, primarily common stock and, to a lesser
extent, securities convertible into common stocks. The Basic Value Focus Fund
also may invest in preferred stocks and non-convertible debt securities and
utilize covered call options with respect to portfolio securities as described
below and in the Statement of Additional Information. It reserves the right as a
defensive measure to hold other types of securities, including U.S. government
and government agency securities, money market securities or other fixed-income
securities deemed by the Investment Adviser to be consistent with a defensive
posture, or cash, in such proportions as, in the opinion of management,
prevailing market or economic conditions warrant. The Fund may invest up to 10%
of its total assets, taken at market value at the time of acquisition, in the
securities of foreign issuers.
DOMESTIC MONEY MARKET FUND
The investment objectives of the Domestic Money Market Fund are to preserve
shareholder capital, to maintain liquidity and to achieve the highest possible
current income consistent with the foregoing objectives by investing in
short-term domestic money market securities. The Fund will invest in short-term
U.S. Government securities, U.S. Government agency securities, domestic
depository institution money instruments (including certificates of deposit,
bankers' acceptances, time deposits and bank notes), short-term debt securities
(such as commercial paper), variable amount master demand notes and repurchase
and reverse repurchase agreements of U.S. issuers. As a matter of fundamental
policy, which may be changed only with the approval of a majority of the
Domestic Money Market Fund's outstanding voting securities, as defined in the
Investment Company Act,
7
<PAGE>
the Fund may not purchase securities of foreign issuers (including Eurodollar or
Yankeedollar bank obligations). U.S. Government securities may be purchased on a
forward commitment basis. The types of money market securities in which the
Domestic Money Market Fund may invest are described more fully in Appendix A to
this Prospectus. The Domestic Money Market Fund will be subject to portfolio
maturity, quality and diversification restrictions discussed below under 'Money
Market Fund Portfolio Restrictions.'
GLOBAL STRATEGY FOCUS FUND
The investment objective of the Global Strategy Focus Fund is to seek high
total investment return by investing primarily in a portfolio of equity and
fixed income securities, including convertible securities, of U.S. and foreign
issuers. Total investment return consists of interest, dividends, discount
accruals and capital changes, including changes in the value of non-dollar
denominated securities and other assets and liabilities resulting from currency
fluctuations. Investing on an international basis involves special
considerations. See 'Other Portfolio Strategies--Foreign Securities' below.
The Global Strategy Focus Fund seeks to achieve its objective by investing
primarily in the securities of issuers located in the United States, Canada,
Western Europe and the Far East. There are no prescribed limits on the
geographical allocation of the Fund among these regions. Such allocation will be
made primarily on the basis of the anticipated total return from investments in
the securities of issuers wherever located, considering such factors as the
condition and growth potential of the various economies and securities markets
and the issuers domiciled therein, anticipated movements in interest rates in
the various capital markets and in the value of foreign currencies relative to
the U.S. dollar, tax considerations and economic, social, financial, national
and political factors which may affect the climate for investing within such
securities markets. When, in the judgment of the Investment Adviser, economic or
market conditions warrant, the Fund reserves the right to concentrate its
investments in one or more capital markets, including the United States. For
additional information, concerning the risks of investing in foreign securities,
see 'Other Portfolio Strategies--Foreign Securities.'
The equity and convertible preferred securities in which the Global
Strategy Focus Fund may invest are primarily securities issued by quality
companies. Generally, the characteristics of such companies include a strong
balance sheet, good financial resources, a satisfactory rate of return on
capital, a good industry position and superior management.
The corporate debt securities, including convertible debt securities, in
which the Fund may invest will be primarily those rated BBB or better by
Standard and Poor's or Baa or better by Moody's or of comparable quality. The
Fund may also invest in debt obligations issued or guaranteed by sovereign
governments, political subdivisions thereof (including states, provinces and
municipalities) or their agencies or instrumentalities or issued or guaranteed
by international organizations designated or supported by governmental entities
to promote economic reconstruction or development ('supranational entities')
such as the International Bank for Reconstruction (the 'World Bank') and the
European Coal and Steel Community. Investments in securities of supranational
entities are subject to the risk that member governments will fail to make
required capital contributions and that a supranational entity will thus be
unable to meet its obligations.
When market or financial considerations warrant, the Global Strategy Focus
Fund may invest as a temporary defensive measure up to 100% of its assets in
U.S. government or government agency securities issued or guaranteed by the
United States Government or its agencies or instrumentalities, money market
securities or other fixed income securities deemed by the Investment Adviser to
be consistent with a defensive posture, or may hold its assets in cash.
The Global Stategy Focus Fund may write covered call options and purchase
put options on its portfolio securities for the purpose of generating
incremental income or hedging its securities against market risk. The Fund may
seek to hedge its non-dollar denominated securities and other assets and
liabilities against adverse currency fluctuations by writing call options and
purchasing put options on currency, purchasing or selling futures contracts and
futures contract options on currency and entering into forward foreign exchange
transactions in currency. See 'Transactions in Options, Futures and Currency.'
8
<PAGE>
HIGH CURRENT INCOME FUND
The primary investment objective of the High Current Income Fund is to
obtain the highest level of current income that is consistent with the
investment policies of the Fund and with prudent investment management. As a
secondary objective, the Fund seeks capital appreciation when consistent with
its primary objective.
The High Current Income Fund seeks high current income by investing
principally in fixed-income securities which are rated in the lower rating
categories of the established rating services (Baa or lower by Moody's and BBB
or lower by Standard and Poor's), or in unrated securities of comparable
quality. Securities rated below Baa by Moody's and below BBB by Standard and
Poor's are commonly known as 'junk bonds.' Additional information regarding
various bond ratings is set forth in Appendix A to the Prospectus. The market
price of fixed-income securities such as those purchased by the Fund is affected
by changes in interest rates generally. As interest rates rise, the market value
of fixed-income securities will fall, adversely affecting the net asset value of
the Fund.
Although they can be expected to provide higher yields, lower-rated
securities such as those purchased by the Fund may be subject to greater market
fluctuations and risks of loss of income and principal than lower-yielding,
higher-rated fixed-income securities. Such securities are generally issued by
corporations which are not as financially secure or as creditworthy as issuers
of higher-rated securities. There is, accordingly, a greater risk that the
issuers of higher-yielding securities will not be able to pay principal and
interest on such securities, especially during periods of adverse economic
conditions. Because investment in such high-yield securities entails relatively
greater risk of loss of income or principal, an investment in the High Current
Income Fund may not be appropriate as the exclusive investment to fund the
Contracts for all Contract Owners. See 'Risks of High Yield Securities' below.
Selection and supervision by the management of the Company of investments
in lower-rated fixed-income securities involves continuous analysis of
individual issuers, general business conditions and other factors which may be
too time consuming or too costly for the average investor. The furnishing of
these services does not, of course, guarantee successful results. The analysis
of issuers may include, among other things, historic and current financial
condition, current and anticipated cash flow and borrowing requirements, value
of assets in relation to historical cost, strength of management, responsiveness
to business conditions, credit standing, and current and anticipated results or
operations. Analysis of general business conditions and other factors may
include anticipated changes in economic activity and interest rates, the
availability of new investment opportunities, and the economic outlook for
specific industries. While the Investment Adviser considers as one factor in its
credit analysis the ratings assigned by the rating services, the Investment
Adviser performs its own independent credit analysis of issuers and
consequently, the Fund may invest, without limit, in unrated securities if such
securities offer, in the opinion of the Investment Adviser, a relatively high
yield without undue risk. As a result, the High Current Income Fund's ability to
achieve its investment objective may depend to a greater extent on the
Investment Adviser's own credit analysis than the Funds which invest in
higher-rated securities. Although the High Current Income Fund will invest
primarily in lower-rated securities, it will not invest in securities rated Ca
or lower by Moody's and CC or lower by Standard and Poor's unless the Investment
Adviser believes that the financial condition of the issuer or the protection
afforded to the particular securities is stronger than would otherwise be
indicated by such low ratings. However, securities purchased by the Fund may
subsequently be downgraded. Such securities may continue to be held and will be
sold only if, in the judgment of the Investment Adviser, it is advantageous to
do so.
When changing economic conditions and other factors cause the yield
difference between lower-rated and higher-rated securities to narrow, the Fund
may purchase higher-rated securities if the Investment Adviser believes that the
risk of loss of income and principal may be substantially reduced with only a
relatively small reduction in yield.
The securities in the Fund will be varied from time to time depending upon
the judgment of management as to prevailing conditions in the economy and the
securities markets and the prospects for interest rate changes among different
categories of fixed-income securities. It is anticipated that under normal
circumstances more than 90% of the Fund's assets will be invested in
fixed-income securities, including convertible and non-
9
<PAGE>
convertible debt securities and preferred stock. Although it is expected that,
in general, the Fund will not invest in common stocks, rights or other equity
securities, it will acquire or hold such securities (if consistent with the
objectives of the Fund) when such securities are acquired in unit offerings with
fixed-income securities or in connection with an actual or proposed conversion
or exchange of fixed-income securities. In addition, under unusual market or
economic conditions, the High Current Income Fund for defensive purposes may
invest up to 100% of its assets in U.S. government or government agency
securities, money market securities or other fixed-income securities deemed by
the Investment Adviser to be consistent with a defensive posture, or may hold
its assets in cash. The yield on such securities may be lower than the yield on
lower-rated fixed-income securities.
The table below shows the average monthly dollar-weighted market value, by
Standard and Poor's rating category, of the securities held by the Fund during
the year ended December 31, 1994.
<TABLE>
<CAPTION>
% MARKET
VALUE
% NET CORPORATE
RATING* ASSETS BONDS
- --------------------------------------------- ----------- -------------
<S> <C> <C>
AAA.......................................... .15% 0.14%
AA........................................... .20 0.20
A............................................ 5.78 5.79
BBB.......................................... .38 0.38
BB........................................... 24.16 24.31
B............................................ 56.20 56.55
CCC.......................................... 3.81 3.85
CC........................................... 0.04 0.04
C............................................ 0.05 0.05
D............................................ 0.03 0.03
NR........................................... 8.62 8.66
-------------
100.00%
</TABLE>
- ------------------
*A description of corporate bond ratings of Standard & Poor's is set forth in
Appendix A to the Prospectus.
NON-DIVERSIFIED FUNDS
The Global Strategy Focus Fund is classified as a non-diversified
investment company under the Investment Company Act. However, the Fund will have
to limit its investments to the extent required by the diversification
requirements applicable to regulated investment companies under the Internal
Revenue Code. To qualify as a regulated investment company, a Fund, at the close
of each fiscal quarter, may not have more than 25% of its total assets invested
in the securities (except obligations of the U.S. Government, its agencies or
instrumentalities) of any one issuer and with respect to 50% of its assets, (i)
may not have more than 5% of its total assets invested in the securities of any
one issuer and (ii) may not own more than 10% of the outstanding voting
securities of any one issuer.
INVESTMENT RESTRICTIONS
The Company has adopted a number of restrictions and policies relating to
the investment of its assets and its activities which are fundamental policies
and may not be changed without the approval of the holders of the Company's
outstanding voting securities (including a majority of the shares of each Fund).
Investors are referred to the Statement of Additional Information for a complete
description of such restrictions and policies.
10
<PAGE>
MONEY MARKET FUND PORTFOLIO RESTRICTIONS
For purposes of the investment policies of the Domestic Money Market Fund,
the Company defines short-term money market securities as securities having a
maturity of no more than 762 days (25 months) in the case of U.S. Government and
agency securities and no more than 397 days (13 months) in the case of all other
securities. Management of the Company expects that substantially all the assets
of the Domestic Money Market Fund will be invested in securities maturing in
less than one year, but at times some portion may have maturities of up to 25
months. For these purposes, the maturity of a variable rate security is deemed
to be the next coupon date on which the interest rate is adjusted. The
dollar-weighted average maturity of the Fund's portfolio assets will not exceed
90 days. During the year ended December 31, 1994, the average maturity of the
Domestic Money Market Fund's assets ranged from 31 days to 78 days.
The Domestic Money Market Fund's investments in short-term debt and
depository institution money instruments will be rated, or will be issued by
issuers who have been rated, in one of the two highest rating categories for
short-term debt obligations by a nationally recognized statistical rating
organization (an 'NRSRO') or, if not rated, will be of comparable quality as
determined by the Directors of the Company. The Fund's investments in corporate
bonds and debentures (which must have maturities at the date of purchase of 397
days (13 months) or less) will be in issuers which have received from an NRSRO a
rating, with respect to a class of short-term debt obligations that is
comparable in priority and security with the investment, in one of the two
highest rating categories for short-term obligations or, if not rated, are of
comparable quality as determined by the Directors of the Company. Currently,
there are six NRSROs: Duff & Phelps Inc., Fitch Investors Services, Inc., IBCA
Limited and its affiliate IBCA Inc., Moody's, Standard & Poor's and Thomson
BankWatch.
A recently adopted regulation of the Securities and Exchange Commission
(the 'SEC') will limit investments by the Domestic Money Market Fund in
securities issued by any one issuer (other than the U.S. Government, its
agencies or instrumentalities) ordinarily to not more than 5% of its total
assets, or in the event that such securities do not have the highest rating, not
more than 1% of its total assets. In addition, this regulation requires that not
more than 5% of the Fund's total assets be invested in securities that have a
rating lower than the highest rating.
OTHER PORTFOLIO STRATEGIES
Restricted Securities. Each of the Funds is subject to limitations on the
amount of illiquid securities they may purchase; however, each Fund may purchase
without regard to that limitation certain securities that are not registered
under the Securities Act of 1933 (the 'Securities Act'), including (a)
commercial paper exempt from registration under Section 4(2) of the Securities
Act, and (b) securities that can be offered and sold to 'qualified institutional
buyers' under Rule 144A under the Securities Act, provided that the Company's
Board of Directors continuously determines, based on the trading markets for the
specific Rule 144A security, that it is liquid. The Board of Directors may adopt
guidelines and delegate to the Investment Adviser the daily function of
determining and monitoring liquidity of restricted securities. The Board has
determined that securities sold under Rule 144A which are freely tradeable in
their primary market offshore should be deemed liquid. The Board, however, will
retain sufficient oversight and be ultimately responsible for the
determinations.
Since it is not possible to predict with assurance exactly how the market
for restricted securities sold and offered under Rule 144A will develop, the
Board of Directors will carefully monitor the Funds' investments in these
securities, focusing on such factors, among others, as valuation, liquidity and
availability of information. This investment practice could have the effect of
increasing the level of illiquidity in a Fund to the extent that qualified
institutional buyers become for a time uninterested in purchasing these
restricted securities.
Indexed and Inverse Securities. A Fund may invest in securities whose
potential return is based on the change in particular measurements of value or
rate (an 'index'). As an illustration, a Fund may invest in a security that pays
interest and returns principal based on the change in an index of interest rates
or on the value of a precious or industrial metal. Interest and principal
payable on a security may also be based on relative changes
11
<PAGE>
among particular indices. In addition, certain of the Funds may invest in
securities whose potential investment return is inversely based on the change in
particular indices. For example, a Fund may invest in securities that pay a
higher rate of interest and principal when a particular index decreases and pay
a lower rate of interest and principal when the value of the index increases. To
the extent that a Fund invests in such types of securities, it will be subject
to the risks associated with changes in the particular indices, which may
include reduced or eliminated interest payments and losses of invested
principal.
Certain indexed securities, including certain inverse securities, may have
the effect of providing a degree of investment leverage, because they may
increase or decrease in value at a rate that is a multiple of the changes in
applicable indices. As a result, the market value of such securities will
generally be more volatile than the market values of fixed-rate securities. The
Company believes that indexed securities, including inverse securities,
represent flexible portfolio management instruments that may allow a Fund to
seek potential investment rewards, hedge other portfolio positions, or vary the
degree of portfolio leverage relatively efficiently under different market
conditions.
Foreign Securities. The Basic Value Focus, Global Strategy Focus and High
Current Income Funds may invest in securities of foreign issuers. Investments in
foreign securities, particularly those of non-governmental issuers, involve
considerations and risks which are not ordinarily associated with investing in
domestic issuers. These considerations and risks include changes in currency
rates, currency exchange control regulations, the possibility of expropriation,
the unavailability of financial information or the difficulty of interpreting
financial information prepared under foreign accounting standards, less
liquidity and more volatility in foreign securities markets, the impact of
political, social or diplomatic developments, and the difficulty of assessing
economic trends in foreign countries. If it should become necessary, a Fund
could encounter greater difficulties in invoking legal processes abroad than
would be the case in the United States. Transaction costs in foreign securities
may be higher. The operating expense ratio of a Fund investing in foreign
securities can be expected to be higher than that of an investment company
investing exclusively in United States securities because the expenses of the
Fund, such as custodial costs, are higher. In addition, net investment income
earned by a Fund on a foreign security may be subject to withholding and other
taxes imposed by foreign governments which will reduce a Fund's net investment
income. The Investment Adviser will consider these and other factors before
investing in foreign securities, and will not make such investments unless, in
its opinion, such investments will meet the standards and objectives of a
particular Fund. No Fund which may invest in foreign securities will concentrate
its investments in any particular country. The Global Strategy Focus Fund may
from time to time be substantially invested in non-dollar-denominated securities
of foreign issuers. A Fund's return on investments in non-dollar-denominated
securities may be reduced or enhanced as a result of changes in foreign currency
rates during the period in which the Fund holds such investments. Each Fund
other than the Basic Value Focus and Global Strategy Focus Funds will purchase
only securities issued in dollar denominations.
Each of the Funds which is permitted to invest in foreign securities may
from time to time invest in securities of foreign issuers in smaller capital
markets. Foreign investments in smaller capital markets involve risks not
involved in domestic investment, including fluctuations in foreign exchange
rates, future political and economic developments, different legal systems and
the existence or possible imposition of exchange controls or other foreign or
United States governmental laws or restrictions applicable to such investments.
These risks are often heightened for investments in small capital markets.
Because a Fund which invests in foreign securities will invest in securities
denominated or quoted in currencies other than the United States dollar, changes
in foreign currency exchange rates may affect the value of securities in the
portfolio and the unrealized appreciation or depreciation of investments insofar
as United States investors are concerned. Foreign currency exchange rates are
determined by forces of supply and demand in the foreign exchange markets. These
forces are, in turn, affected by international balance of payments and other
economic and financial conditions, government intervention, speculation and
other factors. With respect to certain countries, there may be the possibility
of expropriation of assets, confiscatory taxation, high rates of inflation,
political or social instability or diplomatic developments which could affect
investment in those countries. In addition, certain foreign investments may be
subject to foreign withholding taxes.
12
<PAGE>
There may be less publicly available information about an issuer in a
smaller capital market than would be available about a United States company,
and it may not be subject to accounting, auditing and financial reporting
standards and requirements comparable to those of United States companies. As a
result, traditional investment measurements, such as price/earnings ratios, as
used in the United States, may not be applicable in certain capital markets.
Smaller capital markets, while often growing in trading volume, have
substantially less volume than United States markets, and securities in many
smaller capital markets are less liquid and their prices may be more volatile
than securities of comparable United States companies. Brokerage commissions,
custodial services, and other costs relating to investment in smaller capital
markets are generally more expensive than in the United States. Such markets
have different clearance and settlement procedures, and in certain markets there
have been times when settlements have been unable to keep pace with the volume
of securities transactions, making it difficult to conduct such transactions.
Further, satisfactory custodial services for investment securities may not be
available in some countries having smaller capital markets, which may result in
a Fund which invests in these markets incurring additional costs and delays in
transporting and custodying such securities outside such countries. Delays in
settlement could result in temporary periods when assets of such a Fund are
uninvested and no return is earned thereon. The inability of a 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 value of the portfolio security or, if the Fund
has entered into a contract to sell the security, could result in possible
liability to the purchaser. There is generally less government supervision and
regulation of exchanges, brokers and issuers in countries having smaller capital
markets than there is in the United States.
As a result, management of a Fund which invests in foreign securities may
determine that, notwithstanding otherwise favorable investment criteria, it may
not be practicable or appropriate to invest in a particular country. A Fund may
invest in countries in which foreign investors, including management of the
Fund, have had no or limited prior experience.
Certain of the Funds may invest in debt securities issued by foreign
governments. Investments in foreign government debt securities, particularly
those of emerging market country governments, involve special risks. Certain
emerging market countries have historically experienced, and may continue to
experience, high rates of inflation, high interest rates, exchange rate
fluctuations, large amounts of external debt, balance of payments and trade
difficulties and extreme poverty and unemployment. The issuer or governmental
authority that controls the repayment of an emerging market country's debt may
not be able or willing to repay the principal and/or interest when due in
accordance with the terms of such debt. A debtor's willingness or ability to
repay principal and interest due in a timely manner may be affected by, among
other factors, its cash flow situation, and, in the case of a government debtor,
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 and the political constraints to which a
government debtor may be subject. Government debtors may default on their debt
and may also be dependent on expected disbursements from foreign governments,
multilateral agencies and others abroad to reduce principal and interest
arrearages on their debt. Holders of government debt, including the Fund, may be
requested to participate in the rescheduling of such debt and to extend further
loans to government debtors.
As a result of the foregoing, a government obligor may default on its
obligations. If such an event occurs, a Fund may have limited legal recourse
against the issuer and/or guarantor. Remedies must, in some cases, be pursued in
the courts of the defaulting party itself, and the ability of the holder of
foreign government debt securities to obtain recourse may be subject to the
political climate in the relevant country. Government obligors in developing and
emerging market countries are among the world's largest debtors to commercial
banks, other governments, international financial organizations and other
financial institutions. The issuers of the government debt securities in which a
Fund may invest have in the past experienced substantial difficulties in
servicing their external debt obligations, 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.
13
<PAGE>
Some countries with smaller capital markets prohibit or impose substantial
restrictions on investments in their capital markets, particularly their equity
markets, by foreign entities such as the Fund. As illustrations, certain
countries require governmental approval prior to investments by foreign persons,
or limit the amount of investment by foreign persons in a particular company, or
limit the investment by foreign persons to only a specific class of securities
of a company which may have less advantageous terms than securities of the
company available for purchase by nationals.
In some countries, banks or other financial institutions may constitute a
substantial number of the leading companies or the companies with the most
actively traded securities. Also, the Investment Company Act restricts a Fund's
investments in any equity security of an issuer which, in its most recent fiscal
year, derived more than 15% of its revenues from 'securities related
activities,' as defined by the rules thereunder. These provisions may also
restrict a Fund's investments in certain foreign banks and other financial
institutions.
Lending of Portfolio Securities. Each Fund of the Company may from time to
time lend securities (but not in excess of 20% of its total assets) from its
portfolio to brokers, dealers and financial institutions and receive collateral
in cash or securities issued or guaranteed by the U.S. Government which, while
the loan is outstanding, will be maintained at all times in an amount equal to
at least 100% of the current market value of the loaned securities plus accrued
interest. Such cash collateral will be invested in short-term securities, the
income from which will increase the return to the Fund.
Forward Commitments. Each of the Funds may purchase securities on a
when-issued basis, and they may purchase or sell such securities for delayed
delivery. These transactions occur when securities are purchased or sold by a
Fund with payment and delivery taking place in the future to secure what is
considered an advantageous yield and price to the Fund at the time of entering
into the transaction. The value of the security on the delivery date may be more
or less than its purchase price. A Fund entering into such transactions will
maintain a segregated account with its custodian of cash or liquid, high-grade
debt obligations in an aggregate amount equal to the amount of its commitments
in connection with such delayed delivery and purchase transactions.
Standby Commitment Agreements. The High Current Income Fund may from time
to time enter into standby commitment agreements. Such agreements commit the
Fund, for a stated period of time, to purchase a stated amount of a fixed income
security which may be issued and sold to the Fund at the option of the issuer.
The price and coupon of the security is fixed at the time of the commitment. At
the time of entering into the agreement the Fund is paid a commitment fee which
is typically approximately 0.5% of the aggregate purchase price of the security
which the Fund has committed to purchase. The Fund will at all times maintain a
segregated account with its custodian of cash or liquid, high-grade debt
obligations in an amount equal to the purchase price of the securities
underlying the commitment. There can be no assurance that the securities subject
to a standby commitment will be issued, and the value of the security, if
issued, on the delivery date may be more or less than its purchase price.
TRANSACTIONS IN OPTIONS, FUTURES AND CURRENCY
The Basic Value Focus and Global Strategy Focus Funds may engage in certain
of the options, futures and currency transactions discussed in Appendix A to
this Prospectus. A Fund may engage in transactions in futures contracts, options
on futures contracts, forward foreign exchange contracts, currency options and
options on portfolio securities and on stock indexes only for hedging purposes
and not for speculation. A Fund may write call options on portfolio securities
and on stock indexes for the purpose of achieving, through receipt of premium
income, a greater average total return than it would otherwise realize from
holding portfolio securities alone. There can be no assurance that the
objectives sought to be obtained from the use of these instruments will be
achieved. A Fund's use of such instruments may be limited by certain Internal
Revenue Code requirements for qualification of the Fund for the favorable tax
treatment afforded investment companies. There can be no assurance that a Fund's
hedging transactions will be effective. Furthermore, a Fund will only engage in
hedging activities from time to time and will not necessarily engage in hedging
transactions in all the smaller capital markets in which certain of the Funds
may be invested at any given time.
14
<PAGE>
RISKS OF HIGH YIELD SECURITIES
The High Current Income Fund may invest a substantial portion of its assets
in high yield, high risk securities or junk bonds, which are regarded as being
predominantly speculative as to the issuer's ability to make payments of
principal and interest. Investment in such securities involves substantial risk.
Issuers of junk bonds may be highly leveraged and may not have available to them
more traditional methods of financing. Therefore, the risks associated with
acquiring the securities of such issuers generally are greater than is the case
with higher-rated securities. For example, during an economic downturn or a
sustained period of rising interest rates, issuers of high yield securities may
be more likely to experience financial stress, especially if such issuers are
highly leveraged. During recessionary periods, such issuers may not have
sufficient revenues to meet their interest payment obligations. The issuer's
ability to service its debt obligations also may be adversely affected by
specific issuer developments, or the issuer's inability to meet specific
projected business forecasts, or the unavailability of additional financing. The
risk of loss due to default by the issuer is significantly greater for the
holders of junk bonds because such securities may be unsecured and may be
subordinated to other creditors of the issuer. While the high yield securities
in which the High Current Income Fund may invest normally do not include
securities which, at the time of investment, are in default or the issuers of
which are in bankruptcy, there can be no assurance that such events will not
occur after the Fund purchases a particular security, in which case the Fund may
experience losses and incur costs.
In an effort to minimize the risk of issuer default or bankruptcy, the High
Current Income Fund will diversify its holdings among many issuers. However,
there can be no assurance that diversification will protect the Fund from
widespread defaults brought about by a sustained economic downturn.
High yield securities tend to be more volatile than higher-rated
fixed-income securities, so that adverse economic events may have a greater
impact on their prices and yields than on higher-rated fixed-income securities.
Zero coupon bonds and bonds which pay interest and/or principal in additional
bonds rather than in cash are especially volatile. Like higher-rated
fixed-income securities, junk bonds are generally purchased and sold through
dealers who make a market in such securities for their own accounts. However,
there are fewer dealers in this market, which may be less liquid than the market
for higher-rated fixed-income securities, even under normal economic conditions.
Also, there may be significant disparities in the prices quoted for such bonds
by various dealers. Adverse economic conditions or investor perceptions (whether
or not based on economic fundamentals) may impair the liquidity of this market,
and may cause the prices the High Current Income Fund receives for its junk
bonds to be reduced, or the Fund may experience difficulty in liquidating a
portion of its portfolio when necessary to meet the Fund's liquidity needs or in
response to a specific economic event such as a deterioration in the
creditworthiness of the issuer. Under such conditions, judgment may play a
greater role in valuing certain of the Fund's portfolio securities than in the
case of securities trading in a more liquid market.
Adverse publicity and investor perceptions, which may not be based on
fundamental analysis, also may decrease the value and liquidity of junk bonds,
particularly in a thinly traded market. Factors adversely affecting the market
value of such securities are likely to affect adversely the net asset value of
the High Current Income Fund. In addition, the Fund may incur additional
expenses to the extent that it is required to seek recovery upon a default on a
portfolio holding or to participate in the restructuring of the obligation.
INSURANCE LAW RESTRICTIONS
In order for shares of the Company's Funds to remain eligible investments
for the Separate Accounts, it may be necessary, from time to time, for a Fund to
limit its investments in certain types of securities in accordance with the
insurance laws or regulations of the various states in which the Contracts are
sold.
The New York insurance law requires that investments of each Fund be made
with the degree of care of an 'ordinarily prudent person.' In addition, each
Fund has undertaken, at the request of the State of California Department of
Insurance, to observe certain investment related requirements of the Insurance
Code of the State of
15
<PAGE>
California. The Investment Adviser believes that compliance with these standards
will not have any negative impact on the performance of any of the Funds.
OTHER CONSIDERATIONS
The Investment Adviser will use its best efforts to assure that each Fund
of the Company complies with certain investment limitations of the Internal
Revenue Service to assure favorable income tax treatment for the Contracts. It
is not expected that such investment limitations will materially affect the
ability of any Fund to achieve its investment objective.
DIRECTORS
The Directors of the Company consist of six individuals, five of whom are
not 'interested persons' of the Company as defined in the Investment Company
Act. The Directors of the Company are responsible for the overall supervision of
the operations of the Company and perform the various duties imposed on the
directors of investment companies by the Investment Company Act. The Board of
Directors elects officers of the Company annually.
The Directors of the Company and their principal employment are as follows:
ARTHUR ZEIKEL*--President of the Investment Adviser; Executive Vice
President of Merrill Lynch & Co., Inc. ('ML&Co.'); Executive Vice President
of Merrill Lynch; Director of the Distributor.
WALTER MINTZ--Special Limited Partner of Cumberland Partners
(investment partnership).
MELVIN R. SEIDEN--President of Silbanc Properties, Ltd. (real estate,
consulting and investments).
STEPHEN B. SWENSRUD--Principal of Fernwood Associates (financial
consultants).
JOE GRILLS--Member of the Committee on Investment of Employee Benefits
Assets of the Financial Executives Institute.
HARRY WOOLF--Professor and former Director of the Institute for
Advanced Study (private institution devoted to the encouragement, support
and patronage of learning).
- ---------------
* Interested person, as defined in the Investment Company Act, of the Company.
16
<PAGE>
INVESTMENT ADVISER
Merrill Lynch Asset Management L.P. ('MLAM'), an indirect wholly-owned
subsidiary of Merrill Lynch & Co., Inc., is the investment adviser for the Fund.
The principal address of the Investment Adviser is 800 Scudders Mill Road,
Plainsboro, New Jersey 08536 (mailing address: Box 9011, Princeton, New Jersey
08543-9011). The Investment Adviser or its affiliate, Fund Asset Management,
L.P. ('FAM'), acts as the investment adviser for over 130 other registered
investment companies. MLAM also offers portfolio management and portfolio
analysis services to individuals and institutions. In the aggregate, as of March
31, 1995, MLAM and FAM had a total of approximately $170.3 billion in investment
company and other portfolio assets under management including accounts of
certain affiliates of FAM.
MLAM (the general partner of which is Princeton Services, Inc., a
wholly-owned subsidiary of Merrill Lynch & Co., Inc.) is itself a wholly-owned
affiliate of Merrill Lynch & Co., Inc. and has its principal place of business
at 800 Scudders Mill Road, Plainsboro, New Jersey 08536.
While the Investment Adviser is at all times subject to the direction of
the Board of Directors of the Company, the Investment Advisory Agreements
provide that the Investment Adviser, subject to review by the Board of
Directors, is responsible for the actual management of the Funds and has
responsibility for making decisions to buy, sell or hold any particular
security. The Investment Adviser provides the portfolio managers for the Funds,
who consider information from various sources, make the necessary investment
decisions and effect transactions accordingly. The Investment Adviser is also
obligated to perform certain administrative and management services for the
Company (certain of which it may delegate to third parties) and is obligated to
provide all the office space, facilities, equipment and personnel necessary to
perform its duties under the Agreements. The Investment Adviser has access to
the full range of the securities and economic research facilities of Merrill
Lynch.
During the Company's fiscal year ended December 31, 1994, the advisory fees
expense incurred by the Company totalled $16,313,767 of which $683,107 related
to the Basic Value Focus Fund (representing .60% of its average net assets),
$1,418,479 related to the Domestic Money Market Fund (representing .50% of its
average net assets), $2,818,040 related to the Global Strategy Focus Fund
(representing .65% of its average net assets), $1,176,777 related to the High
Current Income Fund (representing .52% of its average net assets).
During the Company's fiscal year ended December 31, 1994, the total
operating expenses of the Company's Funds (including the advisory fees paid to
the Investment Adviser), before reimbursement of a portion of such expenses,
were as follows: $814,168 related to the Basic Value Focus Fund (representing
.72% of its average net assets), $1,629,682 related to the Domestic Money Market
Fund (representing .57% of its average net assets), $3,336,174 related to the
Global Strategy Focus Fund (representing .77% of its net assets), $1,371,582
related to the High Current Income Fund (representing .61% of its net assets).
The Investment Advisory Agreements require the Investment Adviser to
reimburse the Company's Funds if and to the extent that in any fiscal year the
operating expenses of each Fund exceeds the most restrictive expense limitations
then in effect under any state securities laws or published regulations
thereunder. At present the most restrictive expense limitation requires the
Investment Adviser to reimburse expenses which exceed 2.5% of each Fund's first
$30 million of average daily net assets, 2.0% of its average daily net assets in
excess of $30 million but less than $100 million, and 1.5% of its average daily
net assets in excess of $100 million. Expenses for this purpose include the
Investment Adviser's fee but exclude interest, taxes, brokerage fees and
commissions and extraordinary charges, such as litigation. No fee payments will
be made to the Investment Adviser with respect to any Fund during any fiscal
year which would cause the expenses of such Fund to exceed the pro rata expense
limitation applicable to such Fund at the time of such payment.
The Investment Adviser and Merrill Lynch Life Agency, Inc. ('MLLA') have
entered into two agreements which limit the operating expenses paid by each Fund
in a given year to 1.25% of its average daily net assets (the 'Reimbursement
Agreements'), which is less than the expense limitations imposed by state
securities laws or published regulations thereunder. The reimbursement
agreements, dated April 30, 1985 and February 11, 1992, provide that any
expenses in excess of 1.25% of average daily net assets will be reimbursed to
the Fund by the
17
<PAGE>
Investment Adviser which, in turn, will be reimbursed by MLLA. During the
Company's fiscal year ended December 31, 1994, the Domestic Money Market Fund
was reimbursed for operating expenses. Such reimbursements amounted to $8,915.
See 'Investment Advisory Arrangements' in the Statement of Additional
Information. MLLA sells certain Contracts described in the Prospectus for such
Contracts.
The Investment Adviser has entered into an Administrative Services
Agreement with certain Insurance Companies pursuant to which the Investment
Adviser compensates such companies for administrative responsibilities relating
to the Company which are performed by such Insurance Companies. The Investment
Adviser may enter into similar agreements with other Insurance Companies in the
future.
CODE OF ETHICS
The Board of Directors of the Company has adopted a Code of Ethics under
Rule 17j-1 of the Act which incorporates the Code of Ethics of the Adviser
(together, the 'Codes'). The Codes significantly restrict the personal investing
activities of all employees of the Adviser and, as described below, impose
additional, more onerous, restrictions on fund investment personnel.
The Codes require that all employees of the Adviser preclear any personal
securities investment (with limited exceptions, such as government securities).
The preclearance requirement and associated procedures are designed to identify
any substantive prohibition or limitation applicable to the proposed investment.
The substantive restrictions applicable to all employees of the Adviser include
a ban on acquiring any securities in a 'hot' initial public offering and a
prohibition from profiting on short-term trading in securities. In addition, no
employee may purchase or sell any security which at the time is being purchased
or sold (as the case may be), or to the knowledge of the employee is being
considered for purchase or sale, by any fund advised by the Adviser.
Furthermore, the Codes provide for trading 'blackout periods' which prohibit
trading by investment personnel of the Company within periods of trading by the
Company in the same (or equivalent) security (15 or 30 days depending upon the
transaction).
PORTFOLIO MANAGERS
The following is information with respect to the Portfolio Managers for
each of the Company's Funds.
Kevin Rendino has served as the Basic Value Focus Fund's Portfolio Manager
since July 1993, and is primarily responsible for the Fund's day-to-day
management. He has served as Vice President of MLAM since December 1993; Senior
Research Analyst from 1990 to 1992; Corporate Analyst from 1988 to 1990.
Christopher Ayoub has served as the Domestic Money Market Fund's Portfolio
Manager since June 1992, and is primarily responsible for the Fund's day-to-day
management. He has served as Vice President of MLAM since 1985.
Joel Heymsfeld has served as the Global Strategy Focus Fund's Portfolio
Manager since February 1992, and is primarily responsible for the Fund's
day-to-day management. He has served as Vice President of MLAM since 1978.
Aldona Schwartz has served as the High Current Income Fund's Portfolio
Manager since July 1993, and is primarily responsible for the Fund's day-to-day
management. She has served as Vice President of MLAM since 1991 and an employee
of the Investment Adviser since 1986.
PORTFOLIO TRANSACTIONS AND BROKERAGE
None of the Company's Funds has any obligation to deal with any dealer or
group of dealers in the execution of transactions in portfolio securities.
Subject to policy established by the Board of Directors of the Company, the
Investment Adviser is primarily responsible for the Company's portfolio
decisions and the placing of the Company's portfolio transactions. In placing
orders, it is the policy of each Fund to obtain the most favorable net results,
taking into account various factors, including price, dealer spread or
commission, if any, size of the transactions and difficulty of execution. While
the Investment Adviser generally seeks reasonably
18
<PAGE>
competitive spreads or commissions, the Company will not necessarily be paying
the lowest spread or commission available.
Under the Investment Company Act, persons affiliated with the Company are
prohibited from dealing with the Company as a principal in the purchase and sale
of the Company's portfolio securities unless an exemptive order allowing such
transactions is obtained from the SEC. Affiliated persons of the Company may
serve as its broker in over-the-counter transactions conducted on an agency
basis. The SEC has issued an order permitting the Company to conduct certain
principal transactions with respect to the Domestic Money Market Fund with
Merrill Lynch Government Securities Inc. and Merrill Lynch Money Markets Inc. in
U.S. Government and government agency securities, and certain other money market
securities, subject to certain terms and conditions. During the year ended
December 31, 1994, the Company engaged in 33 transactions pursuant to such order
involving $154.9 million of securities. For the year ended December 31, 1994,
the Company paid brokerage commissions of $3,526,815, of which $219,686 was paid
to Merrill Lynch.
PURCHASE OF SHARES
The Company will offer shares in the Funds, without sales charge, only for
purchase by the Insurance Companies for the Separate Accounts to fund benefits
under the Contracts. Shares of the Basic Value Focus Fund, Domestic Money Market
and Global Strategy Focus Funds are currently sold only to MLLIC and ML of New
York, but may be sold to other Insurance Companies if the Company is granted an
exemptive order by the SEC permitting such sales. The Company continuously
offers shares in each of its Funds to the Insurance Companies at prices equal to
the respective per share net asset value of the Funds. Merrill Lynch Funds
Distributor, Inc., a wholly-owned subsidiary of the Investment Adviser, acts as
the distributor of the shares. Net asset value is determined in the manner set
forth below under 'Additional Information-Determination of Net Asset Value.'
REDEMPTION OF SHARES
The Company is required to redeem all full and fractional shares of the
Funds for cash. The redemption price is the net asset value per share next
determined after the initial receipt of proper notice of redemption.
DIVIDENDS, DISTRIBUTIONS AND TAXES
It is the Company's intention to distribute substantially all of the net
investment income, if any, of each Fund. For dividend purposes, net investment
income of each Fund, other than the Domestic Money Market Fund, will consist of
all payments of dividends or interest received by such Fund less the estimated
expenses of such Fund (including fees payable to the Investment Adviser).
Dividends from net investment income of the High Current Income Fund are
declared and reinvested monthly in additional full and fractional shares of the
respective Funds at net asset value. Dividends from net investment income of the
Basic Value Focus and Global Strategy Focus Funds are declared and reinvested at
least annually in additional full and fractional shares of the respective Funds.
All net realized long-term or short-term capital gains of the Company, if
any, are declared and distributed annually after the close of the Company's
fiscal year to the shareholders of the Fund or Funds to which such gains are
attributable. Short-term capital gains are taxable as ordinary income.
TAX TREATMENT OF THE COMPANY
Each Fund intends to continue to qualify as a regulated investment company
under certain provisions of the Internal Revenue Code of 1986, as amended (the
'Code'). Under such provisions, a Fund will not be subject to federal income tax
on such part of its net ordinary income and net realized capital gains which it
distributes to shareholders. One of the requirements to qualify for treatment as
a regulated investment company under the Code is that a Fund, among other
things, derive less than 30% of its gross income in each taxable year from gains
19
<PAGE>
(without deduction of losses) from the sale or other disposition of stocks,
securities and certain options, futures or forward contracts held for less than
three months. This requirement may limit the ability of certain Funds to dispose
of certain securities at times when management of the Company might otherwise
deem such disposition appropriate or desirable.
If a Fund earns original issue discount income in a taxable year which is
not represented by correlative cash income, or if a Fund receives property
rather than cash in payment of interest, shareholders will be allocated income
greater than the amount of cash distributed to them. In addition, the Fund may
have to dispose of securities and use the proceeds thereof to make distributions
in amounts necessary to satisfy its distribution requirements under the Code.
TAX TREATMENT OF INSURANCE COMPANIES AS SHAREHOLDERS
Dividends paid by the Company from its ordinary income and distributions of
the Company's net realized capital gains are includable in the respective
Insurance Company's gross income. Distributions of the Company's net realized
long-term capital gains retain their character as long-term capital gains in the
hands of the Insurance Companies if certain requirements are met. The tax
treatment of such dividends and distributions depends on the respective
Insurance Company's tax status. To the extent that income of the Company
represents dividends on common or preferred stock, rather than interest income,
its distributions to the Insurance Companies will be eligible for the present
70% dividends received deduction applicable in the case of a life insurance
company as provided in the Code. See the Prospectus for the Contracts for a
description of the respective Insurance Company's tax status and the charges
which may be made to cover any taxes attributable to the Separate Account. Not
later than 60 days after the end of each calendar year, the Company will send to
the Insurance Companies a written notice required by the Code designating the
amount and character of any distributions made during such year.
PERFORMANCE DATA
From time to time the average annual total return and yield of one or more
of the Company's Funds for various specified time periods may be included in
advertisements or information furnished by the Insurance Companies to present or
prospective Contract owners. Average annual total return and yield are computed
in accordance with formulas specified by the SEC.
Average annual total return quotations for the specified periods will be
computed by finding the average annual compounded rates of return (based on net
investment income and any realized and unrealized capital gains or losses on
portfolio investments over such periods) that would equate the initial amount
invested to the redeemable value of such investment at the end of each period.
Average annual total return will be computed assuming all dividends and
distributions are reinvested and taking into account all applicable recurring
and nonrecurring expenses.
Yield quotations will be computed based on a 30-day period by dividing (a)
the net income based on the yield to maturity of each security earned during the
period by (b) the average daily number of shares outstanding during the period
that were entitled to receive dividends multiplied by the offering price per
share on the last day of the period. The yield for the 30-day period ending
December 31, 1994 was 11.57% for the High Current Income Fund.
Total return and yield figures are based on the Fund's historical
performance and are not intended to indicate future performance. The Fund's
total return and yield will vary depending on market conditions, the securities
comprising the Fund's portfolio, the Fund's operating expenses and the amount of
realized and unrealized net capital gains or losses during the period. The value
of an investment in the Fund will fluctuate and an investor's shares, when
redeemed, may be worth more or less than their original cost. The yield and
total return quotations may be of limited use for comparative purposes because
they do not reflect charges imposed at the Separate Account level which, if
included, would decrease the yield.
20
<PAGE>
On occasion, one or more of the Company's Funds may compare its performance
to that of the Standard & Poor's 500 Composite Stock Price Index, the Value Line
Composite Index, the Dow Jones Industrial Average, or performance data published
by Lipper Analytical Services, Inc., or Variable Annuity Research Data Service
or contained in publications such as Morningstar Publications, Inc., Chase
Investment Performance Digest, Money Magazine, U.S. News & World Report,
Business Week, Financial Services Weekly, Kiplinger Personal Finances, CDA
Investment Technology, Inc., Forbes Magazine, Fortune Magazine, Wall Street
Journal, USA Today, Barrons, Strategic Insight, Donaghues, Investors Business
Daily and Ibbotson Associates. As with other performance data, performance
comparisons should not be considered representative of the Fund's relative
performance for any future period.
ADDITIONAL INFORMATION
DETERMINATION OF NET ASSET VALUE
The net asset value of the shares of each Fund is determined once daily by
the Investment Adviser immediately after the declaration of dividends, if any,
and is determined as of fifteen minutes following the close of trading on each
day the New York Stock Exchange is open for business. The New York Stock
Exchange is open on business days other than national holidays (except for
Martin Luther King Day, when it is open) and Good Friday. The net asset value
per share of each Fund other than the Domestic Money Market Fund is computed by
dividing the sum of the value of the securities held by that Fund plus any cash
or other assets (including interest and dividends accrued) minus all liabilities
(including accrued expenses) by the total number of shares outstanding of that
Fund at such time, rounded to the nearest cent. Expenses, including the
investment advisory fees payable to the Investment Adviser, are accrued daily.
Because the net investment income of the Domestic Money Market Fund (including
realized and unrealized gains and losses on its portfolio securities) are
declared as a dividend each time the net income of the Fund is determined (see
'Dividends, Distributions and Taxes'), the net asset value per share of the Fund
normally remains at $1.00 per share immediately after each such determination
and dividend declaration.
Securities held by each Fund will be valued as follows: Portfolio
securities which are traded on stock exchanges are valued at the last sale price
(regular way) as of the close of business on the day the securities are being
valued, or, lacking any sales, at the last available bid price. Securities
traded in the over-the-counter market are valued at the last available bid price
in the over-the-counter market prior to the time of valuation. Portfolio
securities which are traded both in the over-the-counter market and on a stock
exchange are valued according to the broadest and most representative market,
and it is expected that for debt securities this ordinarily will be the
over-the-counter market. When a Portfolio writes a call option, the amount of
the premium received is recorded on the books as an asset and an equivalent
liability. The amount of the liability is subsequently valued to reflect the
current market value of the option written, based upon the last sale price in
the case of exchange-traded options or, in the case of options being traded in
the over-the-counter market, the last asked price. Options purchased are valued
at their last sale price in the case of exchange-traded options or, in the case
of options traded in the over-the-counter market, the last bid price. Futures
contracts are valued at settlement price at the close of the applicable
exchange. Securities and assets for which market quotations are not readily
available are valued at fair value as determined in good faith by or under the
direction of the Board of Directors of the Company. Any assets or liabilities
initially expressed in terms of non-U.S. dollar currencies are translated into
U.S. dollars at the prevailing market rates as quoted by one or more banks or
dealers on the day of valuation. Securities held by the Domestic Money Market
Fund with a remaining maturity of 60 days or less are valued on an amortized
cost basis, unless particular circumstances dictate otherwise.
ORGANIZATION OF THE COMPANY
The Company was incorporated on October 16, 1981. Operations of the High
Current Income Fund commenced on April 20, 1982. The Domestic Money Market and
Global Strategy Focus Funds commenced operations on February 20 and February 28,
1992, respectively. The Basic Value Focus Fund commenced operations on July 1,
1993. The authorized capital stock of the Company consists of 2,300,000,000
shares of
21
<PAGE>
Common Stock, par value $0.10 per share. The shares of Common Stock are divided
into seventeen classes designated Merrill Lynch Reserve Assets Fund Common
Stock, Merrill Lynch Prime Bond Fund Common Stock, Merrill Lynch High Current
Income Fund Common Stock, Merrill Lynch Quality Equity Fund Common Stock,
Merrill Lynch Equity Growth Fund Common Stock, Merrill Lynch Flexible Strategy
Fund Common Stock, Merrill Lynch Natural Resources Focus Fund Common Stock,
Merrill Lynch American Balanced Fund Common Stock, Merrill Lynch Global Strategy
Focus Fund Common Stock, Merrill Lynch Domestic Money Market Fund Common Stock,
Merrill Lynch Basic Value Focus Fund Common Stock, Merrill Lynch World Income
Focus Fund Common Stock, Merrill Lynch Global Utility Focus Fund Common Stock,
Merrill Lynch International Equity Focus Fund Common Stock, Merrill Lynch
Developing Capital Markets Focus Fund Common Stock, Merrill Lynch International
Bond Fund Common Stock and Merrill Lynch Intermediate Government Bond Fund
Common Stock, respectively. The Company may, from time to time, at the sole
discretion of its Board of Directors and without the need to obtain the approval
of its shareholders or of Contract Owners, offer and sell shares of one or more
of such classes. Each class consists of 100,000,000 shares except for Domestic
Money Market Fund Common Stock which consists of 300,000,000 shares Reserve
Assets Fund Common Stock which consists of 500,000,000 shares. All shares of
Common Stock have equal voting rights, except that only shares of the respective
classes are entitled to vote on matters concerning only that class. Pursuant to
the Investment Company Act and the rules and regulations thereunder, certain
matters approved by a vote of all shareholders of the Company may not be binding
on a class whose shareholders have not approved such matter. Each issued and
outstanding share of a class is entitled to one vote and to participate equally
in dividends and distributions declared with respect to such class and in net
assets of such class upon liquidation or dissolution remaining after
satisfaction of outstanding liabilities. The shares of each class, when issued,
will be fully paid and nonassessable, have no preference, preemptive,
conversion, exchange or similar rights, and will be freely transferable. Holders
of shares of any class are entitled to redeem their shares as set forth under
'Redemption of Shares.' Shares do not have cumulative voting rights and the
holders of more than 50% of the shares of the Company voting for the election of
directors can elect all of the directors of the Company if they choose to do so
and in such event the holders of the remaining shares would not be able to elect
any directors. The Company does not intend to hold meetings of shareholders
unless under the Investment Company Act shareholders are required to act on any
of the following matters: (i) election of directors; (ii) approval of an
investment advisory agreement; (iii) approval of a distribution agreement; and
(iv) ratification of the selection of independent accountants.
The organizational expenses of each of the Company's Funds are paid by the
Investment Adviser. The Investment Adviser is reimbursed by its affiliate,
Merrill Lynch Life Insurance Company, for all such expenses over a five-year
period.
INDEPENDENT AUDITORS
Deloitte & Touche LLP, 117 Campus Drive, Princeton, New Jersey 08540, has
been selected as the independent auditors of the Company. The selection of
independent auditors is subject to annual ratification by the Company's
shareholders.
CUSTODIAN
The Bank of New York ('BONY'), 110 Washington Street, New York, New York
10286, acts as custodian of each of the Funds.
TRANSFER AND DIVIDEND DISBURSING AGENT
Merrill Lynch Financial Data Services, Inc. ('MLFDS'), which is a
wholly-owned subsidiary of Merrill Lynch & Co., Inc., acts as the Company's
transfer agent and is responsible for the issuance, transfer and redemption of
shares and the opening and maintenance of shareholder accounts. MLFDS will
receive an annual fee of $5,000 per Fund and will be entitled to reimbursement
of out-of-pocket expenses. Prior to June 1, 1990, BONY was the Company's
transfer agent.
22
<PAGE>
LEGAL COUNSEL
Rogers & Wells, New York, New York, is counsel for the Company.
REPORTS TO SHAREHOLDERS
The fiscal year of the Company ends on December 31 of each year. The
Company will send to its shareholders at least semi-annually reports showing the
Funds' portfolio securities and other information. An annual report containing
financial statements, audited by independent auditors, will be sent to
shareholders each year.
ADDITIONAL INFORMATION
This Prospectus does not contain all of the information included in the
Registration Statement filed with the SEC under the Securities Act of 1933 and
the Investment Company Act of 1940, with respect to the securities offered
hereby, certain portions of which have been omitted pursuant to the rules and
regulations of the Securities and Exchange Commission.
The Statement of Additional Information, dated April 28, 1995, which forms
a part of the Registration Statement, is incorporated by reference into this
Prospectus. The Statement of Additional Information may be obtained without
charge as provided on the cover page of this Prospectus. The Registration
Statement, including the exhibits filed therewith, may be examined at the office
of the SEC in Washington, D.C.
23
<PAGE>
APPENDIX A
U.S. GOVERNMENT SECURITIES
For temporary or defensive purposes, each of the Funds may invest in the
various types of marketable securities issued by or guaranteed as to principal
and interest by the U.S. Government and supported by the full faith and credit
of the U.S. Treasury. U.S. Treasury obligations differ mainly in the length of
their maturity. Treasury bills, the most frequently issued marketable government
security, have a maturity of up to one year and are issued on a discount basis.
GOVERNMENT AGENCY SECURITIES
For temporary or defensive purposes, each of the Funds may invest in
government agency securities, which are debt securities issued by government
sponsored enterprises, federal agencies and international institutions. Such
securities are not direct obligations of the Treasury but involve government
sponsorship or guarantees by government agencies or enterprises. The Funds may
invest in all types of government agency securities currently outstanding or to
be issued in the future.
DEPOSITORY INSTITUTIONS MONEY INSTRUMENTS
For temporary or defensive purposes, each of the Funds may invest in
depositary institutions money instruments, such as certificates of deposit,
including variable rate certificates of deposit, bankers' acceptances, time
deposits and bank notes. Certificates of deposit are generally short-term,
interest-bearing negotiable certificates issued by commercial banks, savings
banks or savings and loan associations against funds deposited in the issuing
institution. Variable rate certificates of deposit are certificates of deposit
on which the interest rate is periodically adjusted prior to their stated
maturity, usually at 30, 90 or 180 day intervals ('coupon dates'), based upon a
specified market rate. As a result of these adjustments, the interest rate on
these obligations may be increased or decreased periodically. Often, dealers
selling variable rate certificates of deposit to the Funds agree to repurchase
such instruments, at the Funds' option, at par on the coupon dates. The dealers'
obligations to repurchase these instruments are subject to conditions imposed by
the various dealers; such conditions typically are the continued credit standing
of the issuer and the existence of reasonably orderly market conditions. The
Funds are also able to sell variable rate certificates of deposit in the
secondary market. Variable rate certificates of deposit normally carry a higher
interest rate than comparable fixed rate certificates of deposit because
variable rate certificates of deposit generally have a longer stated maturity
than comparable fixed rate certificates of deposit.
A bankers' acceptance is a time draft drawn on a commercial bank by a
borrower usually in connection with an international commercial transaction (to
finance the import, export, transfer or storage of goods). The borrower is
liable for payment as well as the bank, which unconditionally guarantees to pay
the draft at its face amount on the maturity date. Most acceptances have
maturities of six months or less and are traded in secondary markets prior to
maturity.
For temporary or defensive purposes, the Global Strategy Focus Fund may
invest in certificates of deposit and bankers' acceptances issued by foreign
branches or subsidiaries of U.S. banks ('Eurodollar' obligations) or U.S.
branches or subsidiaries of foreign banks ('Yankeedollar' obligations). The Fund
may invest only in Eurodollar obligations which by their terms are general
obligations of the U.S. parent bank and meet the other criteria discussed below.
Yankeedollar obligations in which the Fund may invest must be issued by U.S.
branches or subsidiaries of foreign banks which are subject to state or federal
banking regulations in the U.S. and by their terms must be general obligations
of the foreign parent. In addition, the Fund will limit its investments in
Yankeedollar obligations to obligations issued by banking institutions with more
than $1 billion in assets.
For temporary or defensive purposes, the Global Strategy Focus Fund may
also invest in U.S. dollar-denominated obligations of foreign depository
institutions and their foreign branches and subsidiaries, such as certificates
of deposit, bankers' acceptances, time deposits and deposit notes. The
obligations of such foreign
A-1
<PAGE>
branches and subsidiaries may be the general obligation of the parent bank or
may be limited to the issuing branch or subsidiary by the terms of the specific
obligation or by government regulation.
Except as otherwise provided above with respect to investment in
Yankeedollar and other foreign bank obligations no Fund may invest in any bank
money instrument issued by a commercial bank or a savings and loan association
unless the bank or association is organized and operating in the United States,
has total assets of at least $1 billion and its deposits are insured by the
Federal Deposit Insurance Corporation (the 'FDIC'); provided that this
limitation shall not prohibit the investment of up to 10% of the total assets of
a Fund (taken at market value at the time of each investment) in certificates of
deposit issued by banks and savings and loan associations with assets of less
than $1 billion if the principal amount of each such certificate of deposit is
fully insured by the FDIC.
SHORT-TERM DEBT INSTRUMENTS
For temporary or defensive purposes, each of the Funds may invest in
commercial paper (including variable amount master demand notes), which refers
to short-term, unsecured promissory notes issued by corporations, partnerships,
trusts and other entities to finance short-term credit needs and by trusts
issuing asset-backed commercial paper. Commercial paper is usually sold on a
discount basis and has a maturity at the time of issuance not exceeding nine
months. Variable amount master demand notes are demand obligations that permit
the investment of fluctuating amounts at varying market rates of interest
pursuant to arrangements between the issuer and a commercial bank acting as
agent for the payees of such notes, whereby both parties have the right to vary
the amount of the outstanding indebtedness on the notes. Because variable amount
master notes are direct lending arrangements between the lender and borrower, it
is not generally contemplated that such instruments will be traded and there is
no secondary market for the notes. Typically, agreements relating to such notes
provide that the lender may not sell or otherwise transfer the note without the
borrower's consent. Such notes provide that the interest rate on the amount
outstanding is adjusted periodically, typically on a daily basis, in accordance
with a stated short-term interest rate benchmark. Because the interest rate of a
variable amount master note is adjusted no less often than every 60 days and
since repayment of the note may be demanded at any time, the Investment Adviser
values such a note in accordance with the amortized cost basis described under
'Determination of Net Asset Value' in the Statement of Additional Information.
For temporary or defensive purposes, the Global Strategy Focus Fund may
also invest in U.S. dollar-denominated commercial paper and other short-term
obligations issued by foreign entities. Such investments are subject to quality
standards similar to those applicable to investments in comparable obligations
of domestic issuers. Investments in foreign entities in general involve the same
risks as those described in the Statement of Additional Information in
connection with investments in Eurodollar, Yankeedollar and foreign bank
obligations.
REPURCHASE AGREEMENTS
Repurchase Agreements; Purchase and Sale Contracts. Each Fund may invest
in securities pursuant to repurchase agreements or purchase and sale contracts.
Under a repurchase agreement, the seller agrees, upon entering into the contract
with the Fund, to repurchase a security (typically a security issued or
guaranteed by the U.S. government) at a mutually agreed upon time and price,
thereby determining the yield during the term of the agreement. This results in
a fixed yield for the Fund insulated from fluctuations in the market value of
the underlying security during such period, although, to the extent the
repurchase agreement is not denominated in U.S. dollars, the Fund's return may
be affected by currency fluctuations. Repurchase agreements may be entered into
only with a member bank of the Federal Reserve System, a primary dealer in U.S.
government securities or an affiliate thereof. A purchase and sale contract is
similar to a repurchase agreement, but purchase and sale contracts, unlike
repurchase agreements, allocate interest on the underlying security to the
purchaser during the term of the agreement and generally do not require the
seller to provide additional securities in the event of a decline in the market
value of the purchased security during the term of the agreement. In all
instances, the Fund takes possession of the underlying securities when investing
in repurchase agreements or purchase and sale contracts. Nevertheless, if the
seller were to default on its obligation to repurchase a security under a
repurchase agreement or purchase and sale contract and the market value of the
underlying security at such time was less
A-2
<PAGE>
than the Fund had paid to the seller, the Fund would realize a loss. Repurchase
agreements and purchase and sale contracts maturing in more than seven days will
be considered 'illiquid securities.'
DESCRIPTION OF CORPORATE BOND RATINGS
Moody's Investors Service, Inc.:
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-edge.' Interest payments are protected by a large or
by an exceptionally stable margin and principal is secure. While the
various protective elements are likely to change, such changes as can be
visualized are most unlikely to impair the fundamentally strong position of
such issues.
Aa--Bonds 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 risks 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
sometime in the future.
Baa--Bonds which are rated Baa are considered medium-grade
obligations, i.e., they are neither highly protected nor poorly secured.
Interest payments and principal security appear adequate for the present
but certain protective elements may be lacking or may be characteristically
unreliable over any 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 both during 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 a
desirable investment. Assurance of interest and principal payments or of
maintenance of other terms of the contract over any period of time may be
small.
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 market 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.
Note: Moody's applies numerical modifiers, 1, 2 and 3 in each generic
rating classification from Aa through B in its corporate bond rating system. The
modifier 1 indicates that the security ranks in the higher end of its generic
rating category; the modifier 2 indicates a mid-range ranking; and the modifier
3 indicates that the issue ranks in the lower end of its generic rating
category.
Standard & Poor's Corporation:
AAA--This is the highest rating assigned by Standard & Poor's to a
debt obligation and indicates an extremely strong capacity to pay principal
and interest.
AA--Bonds rated AA also qualify as high-quality debt obligations.
Capacity to pay principal and interest is very strong, and in the majority
of instances they differ from AAA issues only in small degree.
A-3
<PAGE>
A--Bonds rated A have a strong capacity to pay principal and interest,
although they are somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions.
BBB--Bonds rated BBB are regarded as having an adequate capacity to
pay principal and interest. Whereas they normally exhibit adequate
protection parameters, adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity to pay
principal and interest for bonds in this category than for bonds in the A
category.
BB--B--CCC--CC--Bonds rated BB, B, CCC, and CC are regarded, on
balance, as predominantly speculative with respect to the issuer's capacity
to pay interest and repay principal in accordance with the terms of the
obligations. BB indicates the lowest degree of speculation and CC the
highest degree of speculation. While such bonds will likely have some
quality and protective characteristics, these are outweighed by large
uncertainties or major risk exposures to adverse conditions.
NR--Not rated by the indicated rating agency.
Plus (+) or Minus (-): The ratings from 'AA' to 'B' may be modified by
the addition of a plus or minus sign to show relative standing within the
major rating categories.
TRANSACTIONS IN OPTIONS, FUTURES AND CURRENCY
Options on Portfolio Securities. Each of the Basic Value Focus and Global
Strategy Focus Funds may from time to time sell ('write') covered call options
on its portfolio securities in which it may invest and may engage in closing
purchase transactions with respect to such options. A covered call option is an
option where the Fund, in return for a premium, gives another party a right to
buy particular securities held by the Fund at a specified future date and at a
price set at the time of the contract. The principal reason for writing call
options is to attempt to realize, through the receipt of premiums, a greater
return than would be realized on the securities alone. By writing covered call
options, a Fund gives up the opportunity, while the option is in effect, to
profit from any price increase in the underlying security above the option
exercise price. In addition, the Fund's ability to sell the underlying security
will be limited while the option is in effect unless the Fund effects a closing
purchase transaction. A closing purchase transaction cancels out the Fund's
position as the writer of an option by means of an offsetting purchase of an
identical option prior to the expiration of the option it has written. Covered
call options serve as a partial hedge against the price of the underlying
security declining. The Basic Value Focus Fund may not write covered call
options on underlying securities exceeding 15% of the value of its total assets.
The Global Strategy Focus Fund also may write put options, which give the
holder of the option the right to sell the underlying security to the Fund at
the stated exercise price. The Fund will receive a premium for writing a put
option which increases the Fund's return. The Fund will write only covered put
options which means that so long as the Fund is obligated as the writer of the
option, it will, through its custodian, have deposited and maintained cash, cash
equivalents, U.S. Government securities or other high grade liquid debt or
equity securities denominated in U.S. dollars or non-U.S. currencies with a
securities depository with a value equal to or greater than the exercise price
of the underlying securities. By writing a put, the Fund will be obligated to
purchase the underlying security at a price that may be higher than the market
value of that security at the time of exercise for as long as the option is
outstanding. The Fund may engage in closing transactions in order to terminate
put options that it has written.
The Global Strategy Focus Fund may purchase put options on portfolio
securities. In return for payment of a premium, the purchase of a put option
gives the holder thereof the right to sell the security underlying the option to
another party at a specified price until the put option is closed out, expires
or is exercised. The Fund will only purchase put options to seek to reduce the
risk of a decline in value of the underlying security. The total return on the
security may be reduced by the amount of the premium paid for the option by the
Fund. Prior to its expiration, a put option may be sold in a closing sale
transaction and profit or loss from the sale will depend on whether the amount
received is more or less than the premium paid for the put option plus the
related transaction costs. A closing sale transaction cancels out the Fund's
position as the purchaser of an option by means of an offsetting sale of an
identical option prior to the expiration of the option it has purchased.
A-4
<PAGE>
In certain circumstances, a Fund may purchase call options on securities
held in its portfolio on which it has written call options or on securities
which it intends to purchase. The Fund will not purchase options on securities
if as a result of such purchase, the aggregate cost of all outstanding options
on securities held by the Fund would exceed 5% of the market value of the Fund's
total assets.
Each of the Funds may engage in options transactions on exchanges and in
the over-the-counter ('OTC') markets. In general, exchange traded contracts are
third-party contracts (i.e., performance of the parties' obligations is
guaranteed by an exchange or clearing corporation) with standardized strike
prices and expiration dates. OTC options transactions are two-party contracts
with terms negotiated by the buyer and seller. See 'Over-the-Counter Options'
below for information as to restrictions on the use of OTC options.
Options on Stock Indices. The Global Strategy Focus Fund may purchase and
write call options and put options on stock indices traded on a national
securities exchange to seek to reduce the general market risk of their
securities or specific industry sectors which the Fund invests in. Options on
indices are similar to options on securities except that, on exercise or
assignment, the parties to the contract pay or receive an amount of cash equal
to the difference between the closing value of the index and the exercise price
of the option times a specified multiple. The Fund may invest in index options
based on a broad market index, e.g., the S&P 500, or on a narrow index
representing an industry or market segment, e.g., the Amex Oil & Gas Index. The
effectiveness of a hedge employing stock index options will depend primarily on
the degree of correlation between movements in the value of the index underlying
the option and in the portion of the portfolio being hedged. For further
discussion concerning such options, see 'Risk Factors in Options, Futures and
Currency Transactions' below and the Company's Statement of Additional
Information.
Stock Index and Financial Futures Contracts. The Global Strategy Focus
Fund may purchase and sell stock index futures contracts and financial futures
contracts to hedge its portfolio. The Fund may sell stock index futures
contracts and financial futures contracts in anticipation of or during a market
decline to attempt to offset the decrease in market value of the Fund's
securities portfolio that might otherwise result. When the Fund is not fully
invested in the securities market and anticipate a significant market advance,
it may purchase stock index or financial futures in order to gain rapid market
exposure that may in part or entirely offset increases in the cost of securities
that the Fund intends to purchase. A stock index or financial futures contract
is a bilateral agreement pursuant to which the Fund will agree to buy or deliver
at settlement an amount of cash equal to a dollar multiplied by the difference
between the value of a stock index or financial instrument at the close of the
last trading day of the contract and the price at which the futures contract is
originally entered into. The Fund may engage in transactions in stock index
futures contracts based on broad market indexes or on indexes on industry or
market segments. The Fund may effect transactions in stock index futures
contracts in connection with the equity securities in which it invests and in
financial futures contracts in connection with the debt securities in which it
invests. As with stock index options, the effectiveness of the Fund's hedging
strategies depend primarily upon the degree of correlation between movements in
the value of the securities subject to the hedge and the index or securities
underlying the futures contract. See 'Risk Factors in Options, Futures and
Currency Transactions' below.
Hedging Foreign Currency Risks. The Global Strategy Focus Fund is
authorized to deal in forward foreign exchange contracts between currencies of
the different countries in which they will invest, including multi-national
currency units, as a hedge against possible variations in the foreign exchange
rate between these currencies. This is accomplished through contractual
agreements to purchase or sell a specified currency at a specified future date
(up to one year) and price at the time of the contract. The dealings of the Fund
in forward foreign exchange will be limited to hedging involving either specific
transactions or portfolio positions. Transaction hedging is the purchase or sale
of forward foreign currency with respect to specific receivables or payables of
the Fund accruing in connection with the purchase and sale of their portfolio
securities, the sale and redemption of shares of the Fund or the payment of
dividends and distributions by the Fund. Position hedging is the sale of forward
foreign currency with respect to portfolio security positions denominated or
quoted in such foreign currency. The Funds will not speculate in forward foreign
exchange. Hedging against a decline in the value of a currency does not
eliminate fluctuations in the prices of portfolio securities or prevent losses
if the prices of such securities decline. Such transactions also preclude the
opportunity for gain if the value of the
A-5
<PAGE>
hedged currency should rise. Moreover, it may not be possible for the Fund to
hedge against a devaluation that is so generally anticipated that the Fund is
not able to contract to sell the currency at a price above the devaluation level
they anticipate.
The Fund is also authorized to purchase or sell listed foreign currency
options and foreign currency futures contracts as a hedge against possible
adverse variations in foreign exchange rates. Foreign currency options provide
the holder thereof the right to buy or to sell a currency at a fixed price on or
before a future date. A futures contract on a foreign currency is an agreement
between two parties to buy and sell a specified amount of a currency for a set
price on a future date. Such transactions may be effected with respect to hedges
on non-U.S. dollar-denominated securities (including securities denominated in
multi-national currency units) owned by the Fund, sold by the Fund but not yet
delivered, or committed or anticipated to be purchased by the Fund. As an
illustration, the Fund may use such techniques to hedge the stated value in
United States dollars of an investment in a Japanese yen-denominated security.
In such circumstances, for example, the Fund may purchase a foreign currency put
option enabling them to sell a specified amount of yen for dollars at a
specified price by a future date. To the extent the hedge is successful, a loss
in the value of the yen relative to the dollar will tend to be offset by an
increase in the value of the put option. To offset, in whole or in part, the
cost of acquiring such a put option, the Fund may also sell a call option which,
if exercised, requires it to sell a specified amount of yen for dollars at a
specified price by a future date (a technique called a 'straddle'). By selling
such call option in this illustration, the Fund gives up the opportunity to
profit without limit from increases in the relative value of the yen to the
dollar.
The Fund will not speculate in foreign currency options or futures.
Accordingly, the Fund will not hedge a currency substantially in excess of the
market value of the securities denominated in such currency which they own, the
expected acquisition price of securities which they have committed or anticipate
to purchase which are denominated in such currency, and, in the case of
securities which have been sold by the Fund but not yet delivered, the proceeds
thereof in its denominated currency. Further, if a security with respect to
which a currency hedging transaction has been executed should subsequently
decrease in value, the Fund will direct its custodian to segregate liquid,
high-grade debt securities having a market value equal to such decrease in
value, less any initial or variation margin held in the account of their broker.
As in the case of forward foreign exchange contracts, employing currency
futures and options in hedging transactions does not eliminate fluctuations in
the market price of a security and such transactions preclude or reduce the
opportunity for gain if the hedged currency should move in a favorable
direction.
Options on Futures Contracts. The Global Strategy Focus Fund may also
purchase and write call and put options on futures contracts in connection with
its hedging activities. Generally, these strategies are utilized under the same
market conditions (i.e., conditions relating to specific types of investments)
in which the Fund enters into futures transactions. The Fund may purchase put
options or write call options on futures contracts rather than selling the
underlying futures contract in anticipation of a decline in the equities markets
or in the value of a foreign currency. Similarly, the Fund may purchase call
options, or write put options on futures contracts, as a substitute for the
purchase of such futures to hedge against the increased cost resulting from
appreciation of equity securities or in the currency in which securities which
the Fund intends to purchase are denominated. Limitations on transactions in
options on futures contracts are described below.
Over-the-Counter Options. The Global Strategy Focus Fund may engage in
options transactions in the over-the-counter markets. In general,
over-the-counter ('OTC') options are two-party contracts with price and terms
negotiated by the buyer and seller, whereas exchange-traded options are
third-party contracts (i.e., performance of the parties' obligations is
guaranteed by an exchange or clearing corporation) with standardized strike
prices and expiration dates. OTC options include put and call options on
individual securities, cash settlement options on groups of securities, and
options on currency. The Fund may engage in an OTC options transaction only if
they are permitted to enter into transactions in exchange-traded options of the
same general type. The Fund will engage in OTC options only with member banks of
the Federal Reserve System and primary dealers in U.S. Government securities or
their affiliates which have a capital of at least $50 million or whose
obligations are guaranteed by an entity having capital of at least $50 million.
A-6
<PAGE>
Restrictions on Use of Futures Transactions. Regulations of the Commodity
Futures Trading Commission applicable to the Company require that the Global
Strategy Focus Fund's futures transactions constitute bona fide hedging
transactions or, with respect to non-hedging transactions, that the Fund not
enter into such transactions, if, immediately thereafter, the sum of the amount
of initial margin deposits on the Fund's existing non-hedging futures positions
and premiums paid for related options would exceed 5% of the market value of the
Fund's total assets.
When the Fund purchases a futures contract, a call option thereon or writes
a put option, an amount of cash and cash equivalents will be deposited in a
segregated account with the Company's custodian so that the amount so
segregated, plus the amount of initial and variation margin held in the account
of its broker, equals the market value of the futures contract, thereby insuring
that the use of such futures is unleveraged.
An order has been obtained from the Securities and Exchange Commission
which exempts the Company from certain provisions of the Investment Company Act
of 1940 in connection with transactions involving futures contracts and options
thereon.
Risk Factors in Options, Futures and Currency Transactions. A Fund's
ability to effectively hedge all or a portion of its portfolio of securities
through transactions in options on stock indexes, stock index futures and
financial futures depends on the degree to which price movements in the index
underlying the hedging instrument correlates with price movements in the
relevant portion of the securities portfolio. The securities portfolio will not
duplicate the components of the index. As a result, the correlation will not be
perfect. Consequently, a Fund bears the risk that the price of the portfolio
securities being hedged will not move in the same amount or direction as the
underlying index or securities and that the Fund would experience a loss on one
position which is not completely offset by a gain on the other position. It is
also possible that there may be a negative correlation between the index or
securities underlying an option or futures contract in which a Fund has a
position and the portfolio securities the Fund is attempting to hedge, which
could result in a loss on both the securities and the hedging instrument. A Fund
will invest in a hedging instrument only if, in the judgment of the Investment
Adviser, there is expected to be a sufficient degree of correlation between
movements in the value of the instrument and movements in the value of the
relevant portion of the portfolio of securities for such hedge to be effective.
There can be no assurance that the judgment will be accurate.
Investment in stock index and currency futures, financial futures and
options thereon entail the additional risk of imperfect correlation between
movements in the futures price and the price of the underlying index or
currency. The anticipated spread between the prices may be distorted due to
differences in the nature of the markets, such as differences in margin and
maintenance requirements, the liquidity of such markets and the participation of
speculators in the futures market. However, the risk of imperfect correlation
generally tends to diminish as the maturity date of the futures contract or
termination date of the option approaches.
The Funds intend to enter into exchange-traded options and futures
transactions only if there appears to be a liquid secondary market for such
options or futures. However, there can be no assurance that a liquid secondary
market will exist at any specific time. Thus, it may not be possible to close an
options or futures transaction. The inability to close options and futures
positions could have an adverse impact on a Fund's ability to effectively hedge
its portfolio. There is also the risk of loss by a Fund of margin deposits or
collateral in the event of bankruptcy of a broker with whom a Fund has an open
position in an option or futures contract.
A-7
