<PAGE>
PROSPECTUS
OCTOBER 30, 1997
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 sixteen separate funds. Those funds offered pursuant to this
Prospectus are 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 is offering shares of its Class A Common Stock pursuant to
this Prospectus.
The shares of the Funds are sold to separate accounts ("Separate Accounts")
of certain insurance companies (the "Insurance Companies") to fund benefits
under variable annuity contracts ("Variable Annuity Contracts") and/or
variable life insurance contracts (together with the Variable Annuity
Contracts, the "Contracts") issued by such 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. Certain Insurance Companies are wholly owned
subsidiaries of Merrill Lynch & Co., Inc., ("ML & Co.") as is the Company's
investment adviser, Merrill Lynch Asset Management, L.P. (the "Investment
Adviser"). The investment objectives and certain investment policies of the
Funds, each of whose name is preceded by "Merrill Lynch," are as follows:
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.
PRIME BOND FUND. As high a level of current income as is consistent with
prudent investment management, and as a secondary objective, capital
appreciation when consistent with the foregoing objective, by investing
primarily in long-term corporate bonds rated A or better by either Moody's
Investors Service, Inc. ("Moody's") or Standard & Poor's Ratings Group
("Standard & Poor's").
HIGH CURRENT INCOME FUND. As high a level of current income as is
consistent with its investment policies and prudent investment management,
and as a secondary objective, capital appreciation when consistent with the
foregoing objective. The Fund invests principally in fixed-income
securities that are rated in the lower rating categories of the established
rating services or in unrated securities of comparable quality.
(continued on next page)
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, DEVELOPING
CAPITAL MARKETS FOCUS FUND, AND INTERNATIONAL EQUITY FOCUS FUND INVEST OR MAY
INVEST IN HIGH YIELD--HIGH RISK SECURITIES INCLUDING 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 NOR HAS THE SECURITIES AND EXCHANGE 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 25, 1997, 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>
(continuation of cover page)
QUALITY EQUITY FUND. Highest total investment return consistent with
prudent risk. The Fund uses a fully managed investment policy utilizing
equity securities, primarily common stocks of large-capitalization
companies, as well as investment grade debt and convertible securities.
SPECIAL VALUE FOCUS FUND (FORMERLY, THE EQUITY GROWTH FUND). Long-term
capital growth by investing primarily in common shares of small companies
and of emerging growth companies regardless of size.
NATURAL RESOURCES FOCUS FUND. Long-term growth of capital and protection
of the purchasing power of shareholders' capital by investing primarily in
equity securities of domestic and foreign companies with substantial
natural resource assets.
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.
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.
GLOBAL UTILITY FOCUS FUND. Capital appreciation and current income
through investment of at least 65% of its total assets in equity and debt
securities issued by domestic and foreign companies which are, in the
opinion of the Investment Adviser, primarily engaged in the ownership or
operation of facilities used to generate, transmit or distribute
electricity, telecommunications, gas or water.
INTERNATIONAL EQUITY FOCUS FUND. Capital appreciation and, secondarily,
income, through investment in securities, principally equities, of issuers
in countries other than the United States.
DEVELOPING CAPITAL MARKETS FOCUS FUND. Long-term capital appreciation by
investing in securities, principally equities, of issuers in countries
having smaller capital markets.
For more information on the Funds' investment objectives and policies,
please see "Investment Objectives and Policies of the Funds," page 13.
2
<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 AN OFFER TO BUY MAY NOT
LAWFULLY BE MADE.
----------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Financial Highlights....................................................... 4
The Insurance Companies.................................................... 13
Domestic Money Market Fund Yield Information............................... 13
Investment Objectives and Policies of the Funds............................ 13
Directors.................................................................. 34
Investment Adviser......................................................... 35
Portfolio Transactions and Brokerage....................................... 37
Purchase of Shares......................................................... 37
Redemption of Shares....................................................... 38
Dividends, Distributions and Taxes......................................... 38
Performance Data........................................................... 39
Additional Information..................................................... 40
Appendix A................................................................. A-1
Appendix B................................................................. B-1
</TABLE>
3
<PAGE>
FINANCIAL HIGHLIGHTS
The financial information in the tables below has been audited in
conjunction with annual audits of the financial statements of each of the
Company's Funds by Deloitte & Touche LLP, independent auditors. Financial
Statements and the independent auditors' report thereon for the fiscal year
ended December 31, 1996 are included in the Statement of Additional
Information. The following per share data and ratios have been derived from
information provided in the Company's audited financial statements. Further
information about the performance of the Company is contained in the Company's
most recent annual report to shareholders which may be obtained, without
charge, by calling or by writing the Company at the telephone number or
address on the front cover of this prospectus.
<TABLE>
<CAPTION>
DEVELOPING CAPITAL MARKETS
BASIC VALUE FOCUS FUND FOCUS FUND
--------------------------------------------- ---------------------------------
FOR THE YEAR FOR THE
FOR THE YEAR ENDED FOR THE PERIOD ENDED PERIOD MAY 2,
DECEMBER 31, JULY 1, 1993+ DECEMBER 31, 1994+ TO
---------------------------- TO DECEMBER 31, ------------------ DECEMBER 31,
1996 1995 1994 1993 1996 1995 1994
-------- -------- -------- --------------- ------- ------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
INCREASE (DECREASE) IN
NET ASSET VALUE:
PER SHARE OPERATING
PERFORMANCE:
Net asset value,
beginning of year...... $ 13.10 $ 11.10 $ 10.95 $ 10.00 $ 9.32 $ 9.51 $ 10.00
-------- -------- -------- ------- ------- ------- -------
Investment income--net.. .17 .18 .17 .04 .20 .20 .09
Realized and unrealized
gain (loss) on
investments and foreign
currency transactions--
net.................... 2.37 2.49 .08 .91 .76 (.30) (.58)
-------- -------- -------- ------- ------- ------- -------
Total from investment
operations............. 2.54 2.67 .25 .95 .96 (.10) (.49)
-------- -------- -------- ------- ------- ------- -------
Less dividends and
distributions:
Investment income--net.. (.18) (.19) (.10) -- (.23) (.09) --
Realized gain on
investments--net....... (.72) (.48) -- -- -- -- --
-------- -------- -------- ------- ------- ------- -------
Total dividends and
distributions.......... (.90) (.67) (.10) -- (.23) (.09) --
-------- -------- -------- ------- ------- ------- -------
Net asset value, end of
year................... $ 14.74 $ 13.10 $ 11.10 $ 10.95 $ 10.05 $ 9.32 $ 9.51
======== ======== ======== ======= ======= ======= =======
TOTAL INVESTMENT
RETURN:**
Based on net asset value
per share.............. 20.69% 25.49% 2.36% 9.50%# 10.59% (1.08)% (4.90)%#
======== ======== ======== ======= ======= ======= =======
RATIOS TO AVERAGE NET
ASSETS:
Expenses, net of
reimbursement.......... .66% .66% .72% .86%* 1.25% 1.25% 1.29%*
======== ======== ======== ======= ======= ======= =======
Expenses................ .66% .66% .72% .86%* 1.31% 1.36% 1.35%*
======== ======== ======== ======= ======= ======= =======
Investment income--net.. 1.37% 1.68% 2.08% 1.69%* 2.42% 2.73% 2.18%*
======== ======== ======== ======= ======= ======= =======
SUPPLEMENTAL DATA:
Net assets, end of year
(in thousands)......... $524,930 $306,463 $164,307 $47,207 $95,599 $55,209 $36,676
======== ======== ======== ======= ======= ======= =======
Portfolio turnover...... 68.41% 74.10% 60.55% 30.86% 87.33% 62.53% 29.79%
======== ======== ======== ======= ======= ======= =======
Average commission rate
paid##................. $ .0549 -- -- -- $ .0003### -- --
======== ======== ======== ======= ======= ======= =======
</TABLE>
- --------
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
+ Commencement of Operations.
# Aggregate total investment return.
## For fiscal years beginning on or after September 1, 1995, the Fund is
required to disclose its average commission rate per share for purchases
and sales of equity securities.
### The "Average Commission Rate Paid" includes commissions paid in foreign
currencies, which have been converted into U.S. dollars using the
prevailing exchange rate on the date of the transaction. Such conversions
may significantly affect the average rate shown.
4
<PAGE>
FINANCIAL HIGHLIGHTS (CONTINUED)
<TABLE>
<CAPTION>
DOMESTIC MONEY MARKET FUND
-------------------------------------------------------
FOR THE PERIOD
FEBRUARY 20,
FOR THE YEAR ENDED DECEMBER 31, 1992+
-------------------------------------- TO DECEMBER 31,
1996 1995 1994 1993 1992
-------- -------- -------- -------- ---------------
<S> <C> <C> <C> <C> <C>
INCREASE (DECREASE) IN
NET ASSET VALUE:
PER SHARE OPERATING
PERFORMANCE:
Net asset value,
beginning of year...... $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
-------- -------- -------- -------- -------
Investment income--net.. .0504 .0547 .0386 .0302 .0302
Realized and unrealized
gain (loss) on
investments--net....... (.0005) .0012 (.0007) .0005 .0013
-------- -------- -------- -------- -------
Total from investment
operations............. .0499 .0559 .0379 .0307 .0315
-------- -------- -------- -------- -------
Less dividends and
distributions:
Investment income--
net.................. (.0504) (.0547) (.0386) (.0302) (.0302)
Realized gain on
investments--net..... (.0001) (.0002) -- (.0005) (.0010)
-------- -------- -------- -------- -------
Total dividends and
distributions.......... (.0505) (.0549) (.0386) (.0307) (.0312)
-------- -------- -------- -------- -------
Net asset value, end of
year................... $ 1.00 $ 1.00 $ 1.00 $ 1.00 $ 1.00
======== ======== ======== ======== =======
TOTAL INVESTMENT
RETURN:**
Based on net asset value
per share.............. 5.13% 5.64% 3.93% 3.10% 3.65%*
======== ======== ======== ======== =======
RATIOS TO AVERAGE NET
ASSETS:
Expenses, net of
reimbursement.......... .54% .55% .50% .36% .32%*
======== ======== ======== ======== =======
Expenses................ .54% .55% .57% .63% .88%*
======== ======== ======== ======== =======
Investment income--net,
and realized gain
(loss) on investments--
net.................... 4.97% 5.50% 4.02% 3.03% 3.48%*
======== ======== ======== ======== =======
SUPPLEMENTAL DATA:
Net assets, end of year
(in thousands)......... $274,756 $303,912 $363,199 $170,531 $41,128
======== ======== ======== ======== =======
</TABLE>
- --------
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
+ Commencement of Operations.
5
<PAGE>
FINANCIAL HIGHLIGHTS (CONTINUED)
<TABLE>
<CAPTION>
SPECIAL VALUE FOCUS FUND#
----------------------------------------------------------------------------------------------
FOR THE YEAR ENDED DECEMBER 31,
----------------------------------------------------------------------------------------------
1996+ 1995+ 1994+ 1993+ 1992+ 1991 1990 1989 1988 1987
-------- -------- -------- ------- ------- ------- ------ ------- ------ ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
INCREASE (DECREASE) IN
NET ASSET VALUE:
PER SHARE OPERATING
PERFORMANCE:
Net asset value,
beginning of year...... $ 27.98 $ 19.26 $ 20.96 $ 17.80 $ 17.96 $ 11.98 $13.70 $ 11.75 $11.47 $18.42
-------- -------- -------- ------- ------- ------- ------ ------- ------ ------
Investment income
(loss)--net............ .13 .17 .05 (.01) .01 .09 .05 (.07) (.10) (.09)
Realized and unrealized
gain (loss) on
investments--net....... 1.84 8.64 (1.56) 3.17 (.10) 5.91 (1.77) 2.02 .60 (4.01)
-------- -------- -------- ------- ------- ------- ------ ------- ------ ------
Total from investment
operations............. 1.97 8.81 (1.51) 3.16 (.09) 6.00 (1.72) 1.95 .50 (4.10)
-------- -------- -------- ------- ------- ------- ------ ------- ------ ------
Less dividends and
distributions:
Investment income--
net................... (.14) (.09) -- --++ (.07) (.02) -- -- -- (.03)
Realized gain on
investments--net...... (3.59) -- (.19) -- -- -- -- -- (.22) (2.82)
-------- -------- -------- ------- ------- ------- ------ ------- ------ ------
Total dividends and
distributions.......... (3.73) (.09) (.19) -- (.07) (.02) -- -- (.22) (2.85)
-------- -------- -------- ------- ------- ------- ------ ------- ------ ------
Net asset value, end of
year................... $ 26.22 $ 27.98 $ 19.26 $ 20.96 $ 17.80 $ 17.96 $11.98 $ 13.70 $11.75 $11.47
======== ======== ======== ======= ======= ======= ====== ======= ====== ======
TOTAL INVESTMENT
RETURN:*
Based on net asset value
per share.............. 8.11% 45.90% (7.27)% 17.78% (.53)% 50.10% (12.55)% 16.60% 4.25% (22.29)%
======== ======== ======== ======= ======= ======= ====== ======= ====== ======
RATIOS TO AVERAGE NET
ASSETS:
Expenses................ .81% .81% .83% .96% 1.18% 1.28% 1.47% 1.53% 1.25% 1.24%
======== ======== ======== ======= ======= ======= ====== ======= ====== ======
Investment income
(loss)--net............ .50% .72% .27% (.05)% .04% .51% .14% (.68)% (.56)% (.60)%
======== ======== ======== ======= ======= ======= ====== ======= ====== ======
SUPPLEMENTAL DATA:
Net assets, end of year
(in thousands)......... $453,029 $339,921 $170,044 $98,976 $23,167 $11,318 $6,851 $ 6,811 $5,521 $6,707
======== ======== ======== ======= ======= ======= ====== ======= ====== ======
Portfolio turnover...... 80.84% 96.79% 88.48% 131.75% 98.64% 79.10% 135.24% 100.49% 68.73% 94.91%
======== ======== ======== ======= ======= ======= ====== ======= ====== ======
Average commission rate
paid##................. $ .0598 -- -- -- -- -- -- -- -- --
======== ======== ======== ======= ======= ======= ====== ======= ====== ======
</TABLE>
- --------
* Total investment returns exclude insurance-related fees and expenses.
+ Based on average shares outstanding during the year.
++ Amount is less than $.01 per share.
# The name of the Equity Growth Fund was changed to the Special Value Focus
Fund.
## For fiscal years beginning on or after September 1, 1995, the Fund is
required to disclose its average commission rate per share for purchases and
sales of equity securities.
6
<PAGE>
FINANCIAL HIGHLIGHTS (CONTINUED)
<TABLE>
<CAPTION>
GLOBAL STRATEGY FOCUS FUND# GLOBAL UTILITY FOCUS FUND
------------------------------------------------------ --------------------------------------------
FOR THE FOR THE
PERIOD PERIOD
FOR THE YEAR ENDED FEBRUARY 28, FOR THE YEAR ENDED JULY 1,
DECEMBER 31, 1992+ TO DECEMBER 31, 1993+ TO
---------------------------------------- DECEMBER 31, ---------------------------- DECEMBER 31,
1996 1995 1994 1993 1992 1996 1995 1994 1993
-------- -------- -------- -------- ------------ -------- -------- -------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
INCREASE (DECREASE) IN
NET ASSET VALUE:
PER SHARE OPERATING
PERFORMANCE:
Net asset value,
beginning of year...... $ 12.55 $ 11.73 $ 12.17 $ 10.22 $ 10.00 $ 11.30 $ 9.45 $ 10.66 $ 10.00
-------- -------- -------- -------- ------- -------- -------- -------- --------
Investment income--net.. .28 .39 .30 .16 .13 .46 .45 .35 .04
Realized and unrealized
gain (loss) on
investments and foreign
currency transactions--
net.................... 1.33 .82 (.48) 1.96 .13 .95 1.79 (1.25) .64
-------- -------- -------- -------- ------- -------- -------- -------- --------
Total from investment
operations............. 1.61 1.21 (.18) 2.12 .26 1.41 2.24 (.90) .68
-------- -------- -------- -------- ------- -------- -------- -------- --------
LESS DIVIDENDS AND
DISTRIBUTIONS:
Investment income--net.. (.29) (.39) (.21) (.17) (.04) (.52) (.39) (.29) (.02)
Realized gain on
investments-- net...... -- -- (.04) -- -- -- -- -- --
In excess of realized
gain on investments--
net.................... -- --++ (.01) -- -- -- -- (.02) --
-------- -------- -------- -------- ------- -------- -------- -------- --------
Total dividends and
distributions.......... (.29) (.39) (.26) (.17) (.04) (.52) (.39) (.31) (.02)
-------- -------- -------- -------- ------- -------- -------- -------- --------
Net asset value, end of
year................... $ 13.87 $ 12.55 $ 11.73 $ 12.17 $ 10.22 $ 12.19 $ 11.30 $ 9.45 $ 10.66
======== ======== ======== ======== ======= ======== ======== ======== ========
TOTAL INVESTMENT
RETURN:**
Based on net asset value
per share.............. 13.17% 10.60% (1.46)% 21.03% 2.62%## 12.96% 24.33% (8.51)% 6.85%##
======== ======== ======== ======== ======= ======== ======== ======== ========
RATIOS TO AVERAGE NET
ASSETS:
Expenses, net of
reimbursement.......... .71% .72% .77% .88% 1.25%* .66% .66% .73% .89%*
======== ======== ======== ======== ======= ======== ======== ======== ========
Expenses................ .71% .72% .77% .88% 1.35%* .66% .66% .73% .89%*
======== ======== ======== ======== ======= ======== ======== ======== ========
Investment income--net.. 2.68% 3.33% 2.85% 2.41% 2.66%* 3.90% 4.44% 3.68% 2.84%*
======== ======== ======== ======== ======= ======== ======== ======== ========
SUPPLEMENTAL DATA:
Net assets, end of year
(in thousands)......... $870,203 $540,242 $515,407 $269,627 $15,527 $142,438 $148,225 $126,243 $104,517
======== ======== ======== ======== ======= ======== ======== ======== ========
Portfolio turnover...... 173.44% 27.23% 21.03% 17.07% 14.47% 11.39% 11.05% 9.52% 1.72%
======== ======== ======== ======== ======= ======== ======== ======== ========
Average commission rate
paid***................ $ .0143 -- -- -- -- $ .0522 -- -- --
======== ======== ======== ======== ======= ======== ======== ======== ========
</TABLE>
- --------
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
*** For fiscal years beginning on or after September 1, 1995, the Fund is
required to disclose its average commission rate per share for purchases
and sales of equity securities. The "Average Commission Rate Paid"
includes commissions paid in foreign currencies, which have been converted
into U.S. dollars using the prevailing exchange rate on the date of the
transaction. Such conversions may significantly affect the average rate
shown.
+ Commencement of Operations.
++ Amount is less than $.01 per share.
# On December 6, 1996, the Global Strategy Focus Fund acquired substantially
all of the assets and assumed substantially all the liabilities of the
Flexible Strategy Fund, a separate Fund of the Company.
## Aggregate total investment return.
7
<PAGE>
FINANCIAL HIGHLIGHTS (CONTINUED)
<TABLE>
<CAPTION>
HIGH CURRENT INCOME FUND
------------------------------------------------------------------------------------------
FOR THE YEAR ENDED DECEMBER 31,
------------------------------------------------------------------------------------------
1996+ 1995 1994 1993 1992 1991 1990 1989 1988 1987
-------- -------- -------- -------- ------- ------ ------ ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
INCREASE (DECREASE) IN
NET ASSET VALUE:
PER SHARE OPERATING
PERFORMANCE:
Net asset value,
beginning of year...... $ 11.25 $ 10.61 $ 12.06 $ 11.13 $ 10.23 $ 8.14 $10.21 $ 10.85 $ 10.55 $ 11.42
-------- -------- -------- -------- ------- ------ ------ ------- ------- -------
Investment income--net.. 1.08 1.09 1.05 .95 1.07 1.19 1.40 1.29 1.21 1.23
Realized and unrealized
gain (loss) on
investments--net....... .12 .65 (1.47) .95 .90 2.10 (2.08) (.64) .20 (.79)
-------- -------- -------- -------- ------- ------ ------ ------- ------- -------
Total from investment
operations............. 1.20 1.74 (.42) 1.90 1.97 3.29 (.68) .65 1.41 .44
-------- -------- -------- -------- ------- ------ ------ ------- ------- -------
Less dividends and
distributions:
Investment income--
net................... (1.06) (1.10) (1.03) (.97) (1.07) (1.20) (1.39) (1.29) (1.11) (1.23)
Realized gain on
investments--net...... -- -- -- -- -- -- -- -- -- (.08)
-------- -------- -------- -------- ------- ------ ------ ------- ------- -------
Total dividends and
distributions.......... (1.06) (1.10) (1.03) (.97) (1.07) (1.20) (1.39) (1.29) (1.11) (1.31)
-------- -------- -------- -------- ------- ------ ------ ------- ------- -------
Net asset value, end of
year................... $ 11.39 $ 11.25 $ 10.61 $ 12.06 $ 11.13 $10.23 $ 8.14 $ 10.21 $ 10.85 $ 10.55
======== ======== ======== ======== ======= ====== ====== ======= ======= =======
TOTAL INVESTMENT RE-
TURN:*
Based on net asset value
per share.............. 11.27% 17.21% (3.59)% 17.84% 20.05% 43.00% (7.63)% 6.14% 13.87% 3.82%
======== ======== ======== ======== ======= ====== ====== ======= ======= =======
RATIOS TO AVERAGE NET
ASSETS:
Expenses................ .54% .55% .61% .72% .89% 1.10% 1.15% 1.22% 1.07% 1.01%
======== ======== ======== ======== ======= ====== ====== ======= ======= =======
Investment income--net.. 9.50% 9.92% 9.73% 8.62% 10.06% 12.49% 14.52% 11.98% 11.22% 10.88%
======== ======== ======== ======== ======= ====== ====== ======= ======= =======
SUPPLEMENTAL DATA:
Net assets, end of year
(in thousands)......... $414,615 $356,352 $255,719 $163,428 $26,343 $9,649 $8,106 $12,942 $13,960 $13,075
======== ======== ======== ======== ======= ====== ====== ======= ======= =======
Portfolio turnover...... 48.92% 41.60% 51.88% 35.67% 28.21% 51.54% 26.43% 53.52% 33.91% 56.07%
======== ======== ======== ======== ======= ====== ====== ======= ======= =======
</TABLE>
- --------
* Total investment returns exclude insurance-related fees and expenses.
+ Based on average shares outstanding during the year.
8
<PAGE>
FINANCIAL HIGHLIGHTS (CONTINUED)
<TABLE>
<CAPTION>
INTERNATIONAL EQUITY FOCUS FUND
------------------------------------------
FOR THE
PERIOD
FOR THE YEAR ENDED JULY 1,
DECEMBER 31, 1993+ TO
---------------------------- DECEMBER 31,
1996++ 1995 1994 1993
-------- -------- -------- ------------
<S> <C> <C> <C> <C>
INCREASE (DECREASE) IN NET ASSET
VALUE:
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of
period............................. $ 11.06 $ 10.90 $ 11.03 $ 10.00
-------- -------- -------- --------
Investment income--net.............. .23 .20 .19 .01
Realized and unrealized gain (loss)
on investments and foreign currency
transactions--net.................. .49 .37 (.13) 1.02
-------- -------- -------- --------
Total from investment operations.... .72 .57 .06 1.03
-------- -------- -------- --------
Less dividends and distributions:
Investment income--net............. (.15) (.01) (.18) --
Realized gain on investments--net.. -- (.17) (.01) --
In excess of realized gain on
investments--net.................. -- (.23) -- --
-------- -------- -------- --------
Total dividends and distributions... (.15) (.41) (.19) --
-------- -------- -------- --------
Net asset value, end of period...... $ 11.63 $ 11.06 $ 10.90 $ 11.03
======== ======== ======== ========
TOTAL INVESTMENT RETURN:**
Based on net asset value per share.. 6.62% 5.48% .55% 10.30%#
======== ======== ======== ========
RATIOS TO AVERAGE NET ASSETS:
Expenses, net of reimbursement...... .89% .89% .97% 1.14%*
======== ======== ======== ========
Expenses............................ .89% .89% .97% 1.14%*
======== ======== ======== ========
Investment income--net.............. 1.96% 1.95% 1.09% .30%*
======== ======== ======== ========
SUPPLEMENTAL DATA:
Net assets, end of period (in
thousands)......................... $349,080 $265,602 $247,884 $ 76,906
======== ======== ======== ========
Portfolio turnover.................. 49.87% 100.02% 58.84% 17.39%
======== ======== ======== ========
Average commission rate paid***..... $ .0004 -- -- --
======== ======== ======== ========
</TABLE>
- --------
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
*** For fiscal years beginning on or after September 1, 1995, the Fund is
required to disclose its average commission rate per share for purchases
and sales of equity securities. The "Average Commission Rate Paid"
includes commissions paid in foreign currencies, which have been converted
into U.S. dollars using the prevailing exchange rate on the date of the
transaction. Such conversions may significantly affect the average rate
shown.
+ Commencement of Operations.
++ Based on average shares outstanding during the period.
# Aggregate total investment return.
9
<PAGE>
FINANCIAL HIGHLIGHTS (CONTINUED)
<TABLE>
<CAPTION>
NATURAL RESOURCES FOCUS FUND
---------------------------------------------------------------------------------
FOR THE
PERIOD
JUNE 1,
FOR THE YEAR ENDED DECEMBER 31, 1988+ TO
------------------------------------------------------------------- DECEMBER 31,
1996 1995 1994 1993 1992 1991 1990 1989 1988
------- ------- ------- ------- ------ ------ ------ ------ ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
INCREASE (DECREASE) IN
NET ASSET VALUE:
PER SHARE OPERATING
PERFORMANCE:
Net asset value,
beginning of period.... $ 11.95 $ 10.82 $ 10.82 $ 9.84 $10.06 $10.17 $11.09 $ 9.58 $10.00
------- ------- ------- ------- ------ ------ ------ ------ ------
Investment income--net.. .18 .20 .17 .11 .18 .25 .22 .24 .12
Realized and unrealized
gain (loss) on
investments and foreign
currency transactions--
net.................... 1.40 1.15 (.02) .92 (.05) (.11) (.90) 1.49 (.54)
------- ------- ------- ------- ------ ------ ------ ------ ------
Total from investment
operations............. 1.58 1.35 .15 1.03 .13 .14 (.68) 1.73 (.42)
------- ------- ------- ------- ------ ------ ------ ------ ------
Less dividends and
distributions:
Investment income--
net................... (.20) (.19) (.15) (.05) (.29) (.25) (.24) (.22) --
Realized gain on
investments--net...... (.21) (.03) -- -- (.06) -- -- -- --
------- ------- ------- ------- ------ ------ ------ ------ ------
Total dividends and
distributions.......... (.41) (.22) (.15) (.05) (.35) (.25) (.24) (.22) --
------- ------- ------- ------- ------ ------ ------ ------ ------
Net asset value, end of
period................. $ 13.12 $ 11.95 $ 10.82 $ 10.82 $ 9.84 $10.06 $10.17 $11.09 $ 9.58
======= ======= ======= ======= ====== ====== ====== ====== ======
TOTAL INVESTMENT
RETURN:**
Based on net asset value
per share.............. 13.52% 12.65% 1.44% 10.47% 1.36% 1.36% (6.21)% 18.23% (4.20)%#
======= ======= ======= ======= ====== ====== ====== ====== ======
RATIOS TO AVERAGE NET
ASSETS:
Expenses, net of
reimbursement.......... .78% .78% .87% 1.13% 1.25% 1.25% 1.25% 1.25% 1.24%*
======= ======= ======= ======= ====== ====== ====== ====== ======
Expenses................ .78% .78% .87% 1.13% 1.27% 1.30% 1.38% 1.74% 1.24%*
======= ======= ======= ======= ====== ====== ====== ====== ======
Investment income--net.. 1.43% 1.75% 1.91% 1.34% 2.00% 2.31% 2.26% 2.26% 2.59%*
======= ======= ======= ======= ====== ====== ====== ====== ======
SUPPLEMENTAL DATA:
Net assets, end of
period (in thousands).. $45,197 $43,102 $39,715 $14,778 $4,144 $3,084 $3,247 $2,704 $2,371
======= ======= ======= ======= ====== ====== ====== ====== ======
Portfolio turnover...... 31.11% 30.15% 10.94% 58.44% 22.88% 31.38% 27.61% 93.97% 16.31%
======= ======= ======= ======= ====== ====== ====== ====== ======
Average commission rate
paid##................. $ .0225 -- -- -- -- -- -- -- --
======= ======= ======= ======= ====== ====== ====== ====== ======
</TABLE>
- --------
* Annualized.
** Total investment returns exclude insurance-related fees and expenses.
+ Commencement of Operations.
# Aggregate total investment return.
## For fiscal years beginning on or after September 1, 1995, the Fund is
required to disclose its average commission rate per share for purchases
and sales of equity securities. The "Average Commission Rate Paid" includes
commissions paid in foreign currencies, which have been converted into U.S.
dollars using the prevailing exchange rate on the date of the transaction.
Such conversions may significantly affect the average rate shown.
10
<PAGE>
FINANCIAL HIGHLIGHTS (CONTINUED)
<TABLE>
<CAPTION>
PRIME BOND FUND
---------------------------------------------------------------------------------------------
FOR THE YEAR ENDED DECEMBER 31,
---------------------------------------------------------------------------------------------
1996 1995 1994 1993 1992 1991 1990 1989 1988 1987
-------- -------- -------- -------- ------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
INCREASE (DECREASE) IN
NET ASSET VALUE:
PER SHARE OPERATING
PERFORMANCE:
Net asset value,
beginning of year...... $ 12.45 $ 11.12 $ 12.64 $ 12.04 $ 12.02 $ 11.18 $ 11.29 $ 10.81 $ 10.89 $ 12.04
-------- -------- -------- -------- ------- ------- ------- ------- ------- -------
Investment income--net.. .80 .82 .77 .70 .79 .90 .88 .90 .87 .87
Realized and unrealized
gain (loss) on
investments and foreign
currency transactions--
net.................... (.55) 1.34 (1.36) .71 .04 .84 (.12) .48 (.15) (1.00)
-------- -------- -------- -------- ------- ------- ------- ------- ------- -------
Total from investment
operations............. .25 2.16 (.59) 1.41 .83 1.74 .76 1.38 .72 (.13)
-------- -------- -------- -------- ------- ------- ------- ------- ------- -------
Less dividends and
distributions:
Investment income--
net................... (.79) (.83) (.76) (.70) (.81) (.90) (.87) (.90) (.80) (.87)
Realized gain on
investments--net...... -- -- -- (.11) -- -- -- -- -- (.15)
In excess of realized
gain on investments--
net................... -- -- (.17) -- -- -- -- -- -- --
-------- -------- -------- -------- ------- ------- ------- ------- ------- -------
Total dividends and
distributions.......... (.79) (.83) (.93) (.81) (.81) (.90) (.87) (.90) (.80) (1.02)
-------- -------- -------- -------- ------- ------- ------- ------- ------- -------
Net asset value, end of
year................... $ 11.91 $ 12.45 $ 11.12 $ 12.64 $ 12.04 $ 12.02 $ 11.18 $ 11.29 $ 10.81 $ 10.89
======== ======== ======== ======== ======= ======= ======= ======= ======= =======
TOTAL INVESTMENT
RETURN:*
Based on net asset value
per share.............. 2.21% 20.14% (4.80)% 12.02% 7.27% 16.41% 7.13% 13.29% 6.75% (1.10)%
======== ======== ======== ======== ======= ======= ======= ======= ======= =======
RATIOS TO AVERAGE NET
ASSETS:
Expenses................ .49% .50% .54% .63% .78% .78% 1.06% 1.16% 1.07% 1.07%
======== ======== ======== ======== ======= ======= ======= ======= ======= =======
Investment income--net.. 6.67% 7.00% 6.74% 5.86% 6.76% 7.94% 8.01% 8.12% 8.05% 7.66%
======== ======== ======== ======== ======= ======= ======= ======= ======= =======
SUPPLEMENTAL DATA:
Net assets, end of year
(in thousands)......... $538,394 $489,838 $391,234 $314,091 $84,810 $39,743 $34,655 $29,593 $22,499 $17,385
======== ======== ======== ======== ======= ======= ======= ======= ======= =======
Portfolio turnover...... 91.88% 90.12% 139.89% 115.26% 82.74% 152.18% 155.17% 144.52% 225.81% 129.46%
======== ======== ======== ======== ======= ======= ======= ======= ======= =======
</TABLE>
- --------
*Total investment returns exclude insurance-related fees and expenses.
11
<PAGE>
FINANCIAL HIGHLIGHTS (CONCLUDED)
<TABLE>
<CAPTION>
QUALITY EQUITY FUND
---------------------------------------------------------------------------------------------
FOR THE YEAR ENDED DECEMBER 31,
---------------------------------------------------------------------------------------------
1996+ 1995+ 1994+ 1993 1992 1991 1990 1989 1988 1987
-------- -------- -------- -------- ------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
INCREASE (DECREASE) IN
NET ASSET VALUE:
PER SHARE OPERATING
PERFORMANCE:
Net asset value,
beginning of year...... $ 32.76 $ 27.74 $ 29.02 $ 25.48 $ 26.35 $ 21.72 $ 22.88 $ 17.94 $ 16.00 $ 20.15
-------- -------- -------- -------- ------- ------- ------- ------- ------- -------
Investment income--net.. .58 .58 .38 .24 .34 .43 .47 .50 .43 .42
Realized and unrealized
gain (loss) on
investments and foreign
currency transactions--
net.................... 4.44 5.48 (.74) 3.46 .32 5.75 (.38) 4.96 1.73 (.35)
-------- -------- -------- -------- ------- ------- ------- ------- ------- -------
Total from investment
operations............. 5.02 6.06 (.36) 3.70 .66 6.18 .09 5.46 2.16 .07
-------- -------- -------- -------- ------- ------- ------- ------- ------- -------
Less dividends and
distributions:
Investment income--
net................... (.66) (.45) (.25) (.12) (.58) (.50) (.41) (.52) (.22) (.60)
Realized gain on
investments--net...... (4.29) (.59) (.67) (.04) (.95) (1.05) (.84) -- -- (3.62)
-------- -------- -------- -------- ------- ------- ------- ------- ------- -------
Total dividends and
distributions.......... (4.95) (1.04) (.92) (.16) (1.53) (1.55) (1.25) (.52) (.22) (4.22)
-------- -------- -------- -------- ------- ------- ------- ------- ------- -------
Net asset value, end of
year................... $ 32.83 $ 32.76 $ 27.74 $ 29.02 $ 25.48 $ 26.35 $ 21.72 $ 22.88 $ 17.94 $ 16.00
======== ======== ======== ======== ======= ======= ======= ======= ======= =======
TOTAL INVESTMENT
RETURN:*
Based on net asset value
per share.............. 17.90% 22.61% (1.20)% 14.57% 2.69% 30.18% .66% 30.77% 13.54% (.70)%
======== ======== ======== ======== ======= ======= ======= ======= ======= =======
RATIOS TO AVERAGE NET
ASSETS:
Expenses................ .49% .51% .54% .62% .74% .79% .94% 1.05% 1.02% .93%
======== ======== ======== ======== ======= ======= ======= ======= ======= =======
Investment income--net.. 1.89% 1.94% 1.39% 1.07% 1.54% 1.87% 2.36% 2.58% 2.25% 2.31%
======== ======== ======== ======== ======= ======= ======= ======= ======= =======
SUPPLEMENTAL DATA:
Net assets, end of year
(in thousands)......... $794,275 $644,551 $464,360 $309,420 $87,977 $55,005 $39,470 $31,467 $20,055 $23,986
======== ======== ======== ======== ======= ======= ======= ======= ======= =======
Portfolio turnover...... 88.30% 140.32% 60.57% 88.25% 62.54% 55.83% 69.05% 44.23% 32.53% 65.58%
======== ======== ======== ======== ======= ======= ======= ======= ======= =======
Average commission rate
paid#.................. $ .0615 -- -- -- -- -- -- -- -- --
======== ======== ======== ======== ======= ======= ======= ======= ======= =======
</TABLE>
- --------
+ Based on average shares outstanding during the period.
* Total investment returns exclude insurance-related fees and expenses.
# For fiscal years beginning on or after September 1, 1995, the Fund is
required to disclose its average commission rate per share for purchases and
sales of equity securities.
12
<PAGE>
THE INSURANCE COMPANIES
The Company was organized to fund benefits under the Contracts issued by the
Insurance Companies. Through this Prospectus, the Company is offering shares
in eleven Funds to certain Separate Accounts of certain Insurance Companies to
fund benefits under the Contracts. Those eleven Funds are: the Domestic Money
Market Fund, the Prime Bond Fund, the High Current Income Fund, the Quality
Equity Fund, the Special Value Focus Fund, the Natural Resources Focus Fund,
the Global Strategy Focus Fund, the Basic Value Focus Fund, the Global Utility
Focus Fund, the International Equity Focus Fund, and the Developing Capital
Markets Focus Fund. Through separate Prospectuses, the Company offers shares
in some or all of its funds to certain other separate accounts of the
Insurance Companies to fund benefits under 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. Since 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. Merrill
Lynch Life Insurance Company ("MLLIC") and ML Life Insurance Company of New
York ("ML of New York") are wholly owned subsidiaries of ML & Co., as is the
Investment Adviser.
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, 1996, 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
MARKET FUND
--------------
<S> <C>
Annualized Yield:
Including gains and losses...................................... 5.05%
Excluding gains and losses...................................... 5.05%
Compounded Annualized Yield...................................... 5.18%
Average maturity of portfolio at end of period................... 73 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, as amended (the "Investment
Company Act" or the "Act") except for the Natural Resources Focus Fund, the
Global Strategy Focus Fund, and the Developing Capital Markets Focus Fund,
each of 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. There can
be no assurance that any Fund will achieve its investment objective.
Fixed Income Security Ratings. No Fund other than the High Current Income
Fund, International Equity Focus Fund and Developing Capital Markets Focus
Fund invests in fixed-income securities which are rated
13
<PAGE>
below investment grade (i.e., securities rated Ba or below by Moody's or BB or
below by 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 judgement of the Investment Adviser, it is
advantageous to do so. Securities in 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.
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 insurance
company funding agreements, repurchase and reverse repurchase agreements of
U.S. issuers and other money market instruments. 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, 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."
PRIME BOND FUND
The principal investment objective of the Prime Bond Fund is to provide
shareholders with as high a level of current income as 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 principal objective. There can be no assurance that the Fund's investment
objectives will be achieved.
The Prime Bond Fund invests primarily in securities rated in the top three
rating categories of either Standard & Poor's (AAA, AA and A) or Moody's (Aaa,
Aa and A). Additional information regarding various bond ratings is set forth
in Appendix A to the Prospectus. The financial risk of the Fund should be
minimized by the credit quality of the bonds in which it will invest, but the
long maturities that typically provide the best yield will subject the Fund to
possible substantial price changes resulting from market yield fluctuations.
The market prices of fixed-income securities such as those purchased by the
Fund are 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.
Fund management strategy will attempt to mitigate adverse price changes and
optimize favorable price changes through active trading that shifts the
maturity and/or quality structure of the Fund within the overall investment
guidelines. The Fund's investments will vary from time to time depending upon
the judgement 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. The Fund anticipates that under normal
circumstances more than 90% of the assets of the Fund will be invested in
fixed-income securities, including convertible and non-convertible debt
securities and preferred stock. The Fund does not intend to invest in common
stock, rights or other equity securities. Under unusual market or economic
conditions, the Fund for defensive or other purposes may invest up to 100% of
its assets in U.S. Government or Government agency securities, money market or
other fixed-income securities deemed by the Investment Adviser to be
consistent with the objectives of the Fund, or the Fund may hold its assets in
cash.
HIGH CURRENT INCOME FUND
The primary investment objective of the High Current Income Fund, like the
Prime Bond Fund, is to obtain the highest level of current income that is
consistent with the investment policies of the Fund and with prudent
14
<PAGE>
investment management. As a secondary objective, the Fund seeks capital
appreciation when consistent with its primary objective. There can be no
assurance that the Fund's investment objectives will be achieved.
The High Current Income Fund seeks high current income by investing
principally in fixed-income securities that are rated in the lower rating
categories of the established rating services (Baa or lower by Moody's and BBB
or lower by Standard & Poor's), or in unrated securities of comparable
quality. Securities rated below Baa by Moody's and below BBB by Standard &
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."
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 of 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
& 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 judgement
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 judgement 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-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
15
<PAGE>
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 & Poor's rating category, of the securities held by the High Current
Income Fund during the year ended December 31, 1996.
<TABLE>
<CAPTION>
% MARKET
% VALUE
NET CORPORATE
RATING* ASSETS BONDS
------- ------ ---------
<S> <C> <C>
BBB....................................................... 0.7% 0.8%
BB........................................................ 29.2 33.8
B......................................................... 47.5 55.2
CCC....................................................... 4.2 4.7
NR**...................................................... 5.0 5.5
-----
100.0%
=====
</TABLE>
- --------
* A description of corporate bond ratings of Standard & Poor's is set forth
in Appendix A to the Prospectus.
** Bonds which are not rated by Standard & Poor's. Such bonds may be rated by
nationally recognized statistical rating organizations other than Standard
& Poor's, or may not be rated by any other organizations.
QUALITY EQUITY FUND
The Quality Equity Fund seeks to achieve the highest total investment
return, or the aggregate of income and capital value changes, consistent with
prudent risk. To do this, management will shift the emphasis among investment
alternatives for capital growth, capital stability and income as market trends
change. This "fully managed" investment policy distinguishes the Fund from
investment companies which seek either capital growth or income. The Fund's
investment philosophy is based on management's belief that the structure of
the United States economy and its securities markets will undergo continuous
change. The flexibility of the Fund is designed to reduce overall exposure to
risk by achieving below-average volatility in a falling market and above-
average volatility in a rising market. There can be no assurance that the
Fund's investment objective will be achieved.
The Quality Equity Fund's fully managed investment approach will make use of
equity, debt and convertible securities. The majority of the Fund's equity
portfolio will be in the common stocks of large-capitalization, "quality"
companies. For this purpose, "large capitalization" companies are considered
to be those companies with market capitalizations in excess of $500 million.
Management of the Company believes that a quality company is one which
conforms closely to the following criteria: good financial resources, strong
balance sheet, satisfactory rate of return on capital, good industry position
and superior management skills. The earnings of quality companies generally
tend to grow consistently. Whenever market or financial conditions warrant,
the Fund may, in order to reduce risk and achieve the highest total investment
return, invest in non-convertible, long-term debt securities, including "deep
discount" corporate debt securities of investment grade or issues of fixed-
income convertible securities which give the owner the option of a later
exchange for common stock. The Fund is also permitted to include in its
investments in foreign securities, securities quoted or denominated in
currencies other than the United States dollar, and may employ a variety of
instruments to hedge against currency and market risk, as described in
Appendix B. See "Other Portfolio Strategies--Foreign Securities" for special
considerations concerning investment in non-dollar-denominated securities.
Management expects that over longer periods the larger portion of the Fund's
portfolio will consist of equity securities. During defensive periods, the
Fund may invest in 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.
SPECIAL VALUE FOCUS FUND (FORMERLY, THE EQUITY GROWTH FUND)
The investment objective of the Special Value Focus Fund is to seek long-
term growth of capital by investing in a diversified portfolio of securities,
primarily common stocks, of relatively small companies that
16
<PAGE>
management of the Company believes have special investment value, and of
emerging growth companies regardless of size. There can be no assurance that
the Fund's investment objective will be achieved. Companies are selected by
management on the basis of their long-term potential for expanding their size
and profitability or for gaining increased market recognition for their
securities. Current income is not a factor in the selection of securities. The
Fund is intended to provide an opportunity for Contract Owners who are not
ordinarily in a position to perform the specialized type of research or
analysis of small and emerging growth companies.
Management seeks to identify those small emerging growth companies which can
show significant and sustained increases in earnings over an extended period
of time and are in sound financial condition. Management believes that, while
these companies present above-average risks, properly selected companies of
this type also have the potential to increase their earnings at a rate
substantially in excess of the general growth of the economy. The Fund
attempts to achieve its objective by focusing on the long-range view of a
company's prospects through a fundamental analysis of its management,
financial structure, product development, marketing ability and other relevant
factors. Full development of these companies frequently takes time and, for
this reason, the Fund should be considered as a long-term investment and not
as a vehicle for seeking short-term profits.
Small companies. Management seeks small companies that offer special
investment value in terms of their product or service, research capability, or
other unique attributes, and are relatively undervalued in the marketplace
when compared with similar, but larger, enterprises. These companies typically
have total market capitalizations in the $50-$300 million range and generally
are little known to most individual investors, although some may be dominant
in their respective industries. Underlying this strategy is management's
belief that relatively small companies will continue to have the opportunity
to develop into significant business enterprises. Some such companies may be
in a relatively early stage of development; others may manufacture a new
product or perform a new service. Such companies may not be counted upon to
develop into major industrial companies, but management believes that eventual
recognition of their special value characteristics by the investment community
can provide above-average long-term growth to the portfolio.
Emerging growth companies. In selecting investments for the Special Value
Focus Fund, management also seeks emerging growth companies that either occupy
a dominant position in an emerging industry or subindustry or have a
significant and growing market share in a large, fragmented industry.
Management believes that capable and flexible management is one of the most
important criteria of emerging growth companies and that such companies should
employ sound financial and accounting policies and also demonstrate effective
research, successful product development and marketing, efficient service and
pricing flexibility. Emphasis is given to companies with rapid historical
growth rates, above-average returns on equity and strong current balance
sheets, all of which should enable the company to finance its continued
growth. Management of the Company also analyzes and weighs relevant factors
beyond the company itself, such as the level of competition in the industry,
the extent of governmental regulation, the nature of labor conditions and
other related matters.
The Special Value Focus Fund emphasizes investments in companies that do
most of their business in the United States and therefore are free of the
currency exchange problems, foreign tax considerations and potential political
and economic upheavals that many multinational corporations face. Moreover,
the size and kinds of markets that they serve make these companies less
susceptible than larger companies to intervention from the federal government
by means of price controls, regulations or litigation.
While the process of selection and continuous supervision by management does
not, of course, guarantee successful investment results, it does provide
ingredients not available to the average individual due to the time and cost
involved. Careful initial selection is particularly important in this area as
many new enterprises have promise but lack certain of the ingredients
necessary to prosper.
It should be apparent that an investment in a fund such as the Special Value
Focus Fund involves greater risk than is customarily associated with more
established companies. The securities of smaller or emerging growth companies
may be subject to more abrupt or erratic market movements than larger, more
established companies or the market average in general. These companies may
have limited product lines, markets or financial resources, or they may be
dependent upon a limited management group. Because of these factors,
management of the Company believes that shares in the Special Value Focus Fund
are suitable for Contract
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Owners who are in a financial position to assume above-average investment risk
in search of above-average long-term reward. As indicated, the Fund is
designed for Contract Owners whose investment objective is growth rather than
income. It is definitely not intended for exclusive funding of Contracts but
is designed for Contract Owners who are prepared to experience above-average
fluctuations in net asset value.
The securities in which the Special Value Focus Fund invests will often be
traded only in the over-the-counter market or on a regional securities
exchange and may not be traded every day or in the volume typical of trading
on a national securities exchange. As a result, the disposition by the Fund of
portfolio securities to meet redemptions or otherwise may require the Fund to
sell these securities at a discount from market prices or during periods when
in management's judgement such disposition is not desirable or to make many
small sales over a lengthy period of time.
The investment emphasis of the Special Value Focus Fund is on equities,
primarily common stock and, to a lesser extent, securities convertible into
common stocks and rights to subscribe for common stock, and the Fund will
maintain at least 80% of its net assets invested in equity securities of small
or emerging growth companies except during defensive periods. The Fund
reserves the right as a defensive measure and to provide for redemptions to
hold other types of securities, including non-convertible preferred stocks and
debt securities, 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.
NATURAL RESOURCES FOCUS FUND
The investment objectives of the Natural Resources Focus Fund are to achieve
long-term growth of capital and to protect the purchasing power of
shareholders' capital by investing primarily in a portfolio of equity
securities (e.g., common stocks and securities convertible into common stocks)
of domestic and foreign companies with substantial natural resource assets.
This investment objective is a fundamental policy and may not be changed
without a vote of the majority of outstanding shares of the Fund. The Fund
also may invest in debt, preferred or convertible securities, the value of
which is related to the market value of some natural resource asset ("asset-
based securities"). See "Asset-Based Securities" below. Management of the
Company will seek to identify companies or asset-based securities it believes
are attractively priced relative to the intrinsic value of the underlying
natural resource assets or are especially well positioned to benefit during
particular portions of inflationary cycles. There can be no assurance that the
Fund's investment objectives will be achieved.
IN SEEKING TO PROTECT THE PURCHASING POWER OF SHAREHOLDERS' CAPITAL, THE
FUND HAS RESERVED THE RIGHT, WHEN MANAGEMENT OF THE COMPANY ANTICIPATES
SIGNIFICANT ECONOMIC, POLITICAL OR FINANCIAL INSTABILITY, SUCH AS HIGH
INFLATIONARY PRESSURES OR UPHEAVAL IN THE FOREIGN CURRENCY EXCHANGE MARKETS,
TO INVEST A MAJORITY OF ITS ASSETS IN COMPANIES THAT EXPLORE FOR, EXTRACT,
PROCESS OR DEAL IN GOLD OR IN ASSET-BASED SECURITIES INDEXED TO THE VALUE OF
GOLD BULLION. Such a switch in investment strategies could require the Fund to
liquidate portfolio securities and incur transaction costs. The Company has
been advised by counsel that it is uncertain under the current federal tax law
whether the Fund may concentrate its investments in gold and gold-related
securities without adversely affecting the federal tax status of the
Contracts. Accordingly, management of the Company has determined that the Fund
will not concentrate its investments in such securities until counsel has
advised the Company that such uncertainty has been resolved favorably.
Management attempts to achieve the investment objectives of the Fund by
seeking to identify securities of companies which, in its opinion, are
undervalued relative to the value of natural resource holdings of such
companies in light of current and anticipated economic or financial
conditions. Natural resource assets are materials derived from natural sources
which have economic value. Management will consider a company to have
substantial natural resource assets when, in its opinion, the company's
holdings of the assets are of such magnitude, when compared to the
capitalization, revenues or operating profits of the company, that changes in
the economic value of the assets are expected to affect the market price of
the equity securities of such company. Generally, a company has substantial
natural resource assets when at least 50% of the non-current assets,
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capitalization, gross revenues or operating profits of the company in the most
recent or current fiscal year are involved in or result from directly or
indirectly through subsidiaries, exploring, mining, refining, processing,
fabricating, dealing in or owning natural resource assets. Examples of natural
resource assets include precious metals (e.g., gold, silver and platinum),
ferrous and nonferrous metals (e.g., iron, steel, aluminum and copper),
strategic metals (e.g., uranium and titanium), hydrocarbons (e.g., coal, oil
and natural gas), timber land, undeveloped real property and agricultural
commodities. The Fund presently does not intend to invest directly in natural
resource assets or contracts related thereto.
Management of the Company believes that, based upon past performance, the
securities of specific companies that hold different types of substantial
natural resource assets may move relatively independently of one another
during different stages of inflationary cycles due to different degrees of
demand for, or market values of, their respective natural resource holdings
during particular portions of such inflationary cycles. The Fund's fully
managed investment approach enables it to switch its emphasis among various
industry groups depending upon management's outlook with respect to prevailing
trends and developments.
The Natural Resources Focus Fund may use derivatives in connection with
certain trading strategies. See Appendix B.
The Fund at all times, except during defensive periods, will maintain at
least 65% of its total assets invested in companies with substantial natural
resource assets or in asset-based securities. Current income from dividends
and interest will not be a primary consideration in selecting securities. The
Fund reserves the right as a temporary defensive measure and to provide for
redemptions, to hold short-term 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.
Risk Factors. As indicated above, under certain circumstances, the Fund has
reserved the right to invest a majority of its assets in gold-related
companies or securities. Based on historic experience, during periods of
economic or financial instability, the securities of such companies may be
subject to extreme price fluctuations, reflecting the high volatility of gold
prices during such periods. In addition, the instability of gold prices may
result in volatile earnings of gold-related companies which, in turn, may
affect adversely the financial condition of such companies. Gold mining
companies also are subject to the risks generally associated with mining
operations.
The major producers of gold include the Republic of South Africa, Russia,
the United States, Australia, Canada, the People's Republic of China and the
Philippines. Sales of gold by Russia and the People's Republic of China are
largely unpredictable and often relate to political and economic
considerations rather than to market forces. Economic, social and political
developments within Russia, the People's Republic of China and the Republic of
South Africa may affect significantly gold production in those countries.
See "Other Portfolio Strategies--Foreign Securities" for special
considerations concerning investments in foreign securities.
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. There can be no assurance that the Fund's investment
objective will be achieved. Investing on an international basis involves
special considerations. See "Other Portfolio Strategies--Foreign Securities."
The Global Strategy Focus Fund seeks to achieve its objective by investing
in the securities of issuers located in the United States, Canada, Western
Europe, the Far East and Latin America. There are no prescribed limits on the
geographical allocation of the Fund among these regions. Such allocation will
be made primarily
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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 judgement 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 corporate debt securities, including convertible debt securities, in
which the Fund may invest will be rated BBB or better by Standard and Poor's
or Baa or better by Moody's or, in the opinion of the Investment Adviser, 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
and Development (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 conditions 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, 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 Strategy Focus Fund may use derivatives in connection with
certain trading strategies. See "Appendix B."
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. There can be no assurance that the Fund's
investment objectives will be achieved. 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
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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 rated
investment grade and utilize covered call options with respect to portfolio
securities as described in Appendix B. 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.
GLOBAL UTILITY FOCUS FUND
The investment objective of the Global Utility Focus Fund is to seek both
capital appreciation and current income through investment of at least 65% of
its total assets in equity and debt securities issued by domestic and foreign
companies which are, in the opinion of the Investment Adviser, primarily
engaged in the ownership or operation of facilities used to generate, transmit
or distribute electricity, telecommunications, gas or water. There can be no
assurance that the Fund's investment objective will be achieved. The Fund may
employ a variety of instruments and techniques to enhance income and to hedge
against market and currency risk, as described in Appendix B. Investing on an
international basis involves special considerations. See "Other Portfolio
Strategies--Foreign Securities."
The Global Utility Focus Fund at all times, except during temporary
defensive periods, will maintain at least 65% of its total assets invested in
equity and debt securities issued by domestic and foreign companies in the
utilities industries. The Fund reserves the right to hold, as a temporary
defensive measure or as a reserve for redemptions, short-term U.S. Government
securities, money market securities, including repurchase agreements, or cash
in such proportions as, in the opinion of the Investment Adviser, prevailing
market or economic conditions warrant. Except during temporary defensive
periods, such securities or cash will not exceed 20% of its total assets.
Under normal circumstances, the Fund will invest at least 65% of its total
assets in issuers domiciled in at least three countries, one of which may be
the United States, although the Investment Adviser expects the Fund's
portfolio to be more geographically diversified. Under normal conditions, it
is anticipated that the percentage of assets invested in U.S. securities will
be higher than that invested in securities of any other single country. It is
possible that at times the Fund may have 65% or more of its total assets
invested in foreign securities.
The Fund will invest in common stocks (including preferred or debt
securities convertible into common stocks), preferred stocks and debt
securities. The relative weightings among common stocks, debt securities and
preferred stocks will vary from time to time based upon the Investment
Adviser's judgement of the extent to which investments in each category will
contribute to meeting the Fund's investment objective. Fixed income securities
in which the Fund will invest generally will be limited to those rated
investment grade, that is, rated in one of the four highest rating categories
by Standard & Poor's or Moody's (i.e., securities rated at least BBB by
Standard & Poor's or Baa by Moody's), or deemed to be of equivalent quality in
the judgement of the Investment Adviser. Securities rated Baa by Moody's are
described by it as having speculative characteristics and, according to
Standard & Poor's, fixed income securities rated BBB normally exhibit adequate
protection parameters, although adverse economic conditions or changing
circumstances are more likely to lead to a weakened capacity to pay interest
and repay principal. The Fund's commercial paper investments at the time of
purchase will be rated "A-1" or "A-2" by Standard & Poor's or "Prime-1" or
"Prime-2" by Moody's or, if not rated, will be of comparable quality as
determined by the Investment Adviser. The Fund may also invest up to 5% of its
total assets at the time of purchase in fixed income securities having a
minimum rating no lower than Caa by Moody's or CCC by Standard & Poor's. The
Fund may, but need not, dispose of any security if it is subsequently
downgraded. For a description of ratings of debt securities, see Appendix A to
this Prospectus.
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The Fund may invest in the securities of foreign issuers in the form of
American Depository Receipts ("ADRs"), European Depository Receipts ("EDRs")
or other securities convertible into securities of foreign issuers. These
securities may not necessarily be denominated in the same currency as the
securities into which they may be converted. ADRs are receipts typically
issued by an American bank or trust company which evidence ownership of
underlying securities issued by a foreign corporation. EDRs are receipts
issued in Europe which evidence a similar ownership arrangement. Generally,
ADRs, which are issued in registered form, are designated for use in the
United States securities markets, and EDRs, which are issued in bearer form,
are designed for use in European securities markets. The Fund may invest in
ADRs and EDRs through both sponsored and unsponsored arrangements. In a
sponsored ADR or EDR arrangement, the foreign issuer assumes the obligation to
pay some or all of the depository's transaction fees, whereas in an
unsponsored arrangement the foreign issuer assumes no obligations and the
depository's transaction fees are paid by the ADR or EDR holders. Foreign
issuers in respect of whose securities unsponsored ADRs or EDRs have been
issued are not necessarily obligated to disclose material information in the
markets in which the unsponsored ADRs or EDRs are traded and, therefore, there
may not be a correlation between such information and the market value of such
securities.
A change in prevailing interest rates is likely to affect the Fund's net
asset value because prices of debt and equity securities of utility companies
tend to increase when interest rates decline and decrease when interest rates
rise.
Utility Industries--Description and Risks. Under normal circumstances, the
Fund will invest at least 65% of its total assets in common stocks (including
preferred or debt securities convertible into common stocks), debt securities
and preferred stocks of domestic and/or foreign companies in the utility
industries. To meet its objective of current income, the Fund may invest in
domestic utility companies that pay higher than average dividends, but have a
lesser potential for capital appreciation. The average dividend yields of
common stocks issued by domestic utility companies historically have
significantly exceeded those of industrial companies' common stocks, while the
prices of domestic utility stocks have tended to be less volatile than stocks
of industrial companies. The Investment Adviser believes that the average
dividend yields of common stocks issued by foreign utility companies have also
historically exceeded those of foreign industrial companies' common stocks. To
meet its objective of capital appreciation, the Fund may invest in foreign
utility companies which pay lower than average dividends, but have a greater
potential for capital appreciation.
The utility companies in which the Fund will invest include companies which
are, in the opinion of the Investment Adviser, primarily engaged in the
ownership or operation of facilities used to generate, transmit or distribute
electricity, telecommunications, gas or water.
Investments in utility industries bear certain risks, including difficulty
in obtaining an adequate return on invested capital, difficulty in financing
large construction programs during an inflationary period, restrictions on
operations and increased cost and delays attributable to environmental
considerations and regulation, difficulty in raising capital in adequate
amounts on reasonable terms in periods of high inflation and unsettled capital
markets, technological innovations which may render existing plants, equipment
or products obsolete, the potential impact of natural or man-made disasters,
increased costs and reduced availability of certain types of fuel,
occasionally reduced availability and high costs of natural gas for resale,
the effects of energy conservation, the effects of a national energy policy
and lengthy delays and greatly increased costs and other problems associated
with design, construction, licensing, regulation and operation of nuclear
facilities for electric generation, including, among other considerations, the
problems associated with the use of radioactive materials and the disposal of
radioactive wastes. There are substantial differences between the regulatory
practices and policies of various jurisdictions, and any given regulatory
agency may make major shifts in policy from time to time. There is no
assurance that regulatory authorities will, in the future, grant rate
increases or that such increases will be adequate to permit the payment of
dividends on common stocks. Additionally, existing and possible future
regulatory legislation may make it even more difficult for these utilities to
obtain adequate relief. Certain of the issuers of securities in the portfolio
may own or operate nuclear generating facilities. Governmental authorities may
from time to time review existing policies, and impose additional requirements
governing the licensing, construction and operation of nuclear power plants.
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Utility companies in the United States and in foreign countries are
generally subject to regulation. In the United States, most utility companies
are regulated by state and/or federal authorities. Such regulation is intended
to ensure appropriate standards of service and adequate capacity to meet
public demand. Generally, prices are also regulated in the United States and
in foreign countries with the intention of protecting the public while
ensuring that the rate of return earned by utility companies is sufficient to
allow them to attract capital in order to grow and continue to provide
appropriate services. There can be no assurance that such pricing policies or
rates of return will continue in the future.
The nature of regulation of the utility industries is evolving both in the
United States and in foreign countries. Changes in regulation in the United
States increasingly allow utility companies to provide services and products
outside their traditional geographic areas and lines of business, creating new
areas of competition within the industries. In some instances, utility
companies are operating on an unregulated basis. Because of trends toward
deregulation and the evolution of independent power producers as well as new
entrants to the field of telecommunications, non-regulated providers of
utility services have become a significant part of their respective
industries. The Investment Adviser believes that the emergence of competition
and deregulation will result in certain utility companies being able to earn
more than their traditional regulated rates of return, while others may be
forced to defend their core businesses from increased competition and may be
less profitable. The Investment Adviser seeks to take advantage of favorable
investment opportunities that are expected to arise from these structural
changes. Of course, there can be no assurance that favorable developments will
occur in the future.
Foreign utility companies are also subject to regulation, although such
regulations may or may not be comparable to that in the United States. Foreign
utility companies may be more heavily regulated by their respective
governments than utilities in the United States and, as in the U.S., generally
are required to seek government approval for rate increases. In addition, many
foreign utilities use fuels that cause more pollution than those used in the
United States, which may require such utilities to invest in pollution control
equipment to meet any proposed pollution restrictions. Foreign regulatory
systems vary from country to country and may evolve in ways different from
regulation in the United States.
The principal sectors of the global utility industries are discussed below.
Electric. The electric utility industry consists of companies that are
engaged principally in the generation, transmission and sale of electric
energy, although many also provide other energy-related services. Domestic
electric utility companies, in general, recently have been favorably affected
by lower fuel and financing costs and the full or near completion of major
construction programs. In addition, certain of these companies generate cash
flows in excess of current operating expenses and construction expenditures,
permitting some degree of diversification into unregulated businesses. Some
electric utilities have also taken advantage of the right to sell power
outside of their traditional geographic areas. Electric utility companies have
historically been subject to the risks associated with increases in fuel and
other operating costs, high interest costs on borrowings needed for capital
construction programs, costs associated with compliance with environmental and
safety regulations and changes in the regulatory climate. As interest rates
have declined, many utilities have refinanced high cost debt and in doing so
have improved their fixed charges coverage. Regulators, however, have lowered
allowed rates of return as interest rates have declined and thereby caused the
benefits of the rate declines to be shared wholly or in part with customers.
In the United States, the construction and operation of nuclear power
facilities is subject to increased scrutiny by, and evolving regulations of,
the Nuclear Regulatory Commission and state agencies having comparable
jurisdiction. Increased scrutiny might result in higher operating costs and
higher capital expenditures, with the risk that the regulators may disallow
inclusion of these costs in rate authorizations or the risk that a company may
not be permitted to operate or complete construction of a facility. In
addition, operators of nuclear power plants may be subject to significant
costs for disposal of nuclear fuel and for decommissioning of such plants.
In October 1993, Standard & Poor's stiffened its debt-ratings formula for
the electric utility industry, stating that the industry is in long-term
decline. In addition, Moody's stated that it expected a drop in the next three
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years in its average credit ratings for the industry. Reasons set forth for
these outlooks included slowing demand and increasing cost pressures as a
result of competition from rival providers.
Telecommunications. The telephone industry is large and highly concentrated.
Companies that distribute telephone services and provide access to the
telephone networks comprise the greatest portion of this segment. Telephone
companies in the United States are still experiencing the effects of the
breakup of American Telephone & Telegraph Company, which occurred in 1984.
Since 1984, companies engaged in telephone communication services have
expanded their non-regulated activities into other businesses, including
cellular telephone services, data processing, equipment retailing, computer
software and hardware services, and financial services. This expansion has
provided significant opportunities for certain telephone companies to increase
their earnings and dividends at faster rates than had been allowed in
traditional regulated businesses. Increasing competition, technological
innovations and other structural changes, however, could adversely affect the
profitability of such utilities. Technological breakthroughs and the merger of
telecommunications with video and entertainment is now associated with the
expansion of the role of cable companies as providers of utility services in
the telecommunications industry and the competitive response of traditional
telephone companies. Given mergers and certain marketing tests currently
underway, it is likely that both traditional telephone companies and cable
companies will soon provide a greatly expanded range of utility services,
including two-way video and informational services.
Gas. Gas transmission companies and gas distribution companies are also
undergoing significant changes. In the United States, interstate transmission
companies are regulated by the Federal Energy Regulatory Commission, which is
reducing its regulation of the industry. Many companies have diversified into
oil and gas exploration and development, making returns more sensitive to
energy prices. In the recent decades, gas utility companies have been
adversely affected by disruptions in the oil industry and have also been
affected by increased concentration and competition.
Water. Water supply utilities are companies that collect, purify, distribute
and sell water. In the United States and around the world, the industry is
highly fragmented because most of the supplies are owned by local authorities.
Companies in this industry are generally mature and are experiencing little or
no per capita volume growth.
Investment Outside the Utility Industries. The Global Utility Focus Fund is
permitted to invest up to 35% of its assets in securities of issuers that are
outside the utility industries. Such investments may include common stocks,
debt securities or preferred stocks and will be selected to meet the Fund's
investment objective of both capital appreciation and current income. These
securities may be issued by either U.S. or non-U.S. companies. Some of these
issuers may be in industries related to utility industries and, therefore, may
be subject to similar risks. Securities that are issued by foreign companies
or are denominated in foreign currencies are subject to certain risks. See
"Other Portfolio Strategies--Foreign Securities."
The Global Utility Focus Fund is also permitted to invest in securities
issued or guaranteed by the U.S. Government, its agencies or instrumentalities
and in securities issued or guaranteed by foreign governments. Foreign
government securities are typically denominated in foreign currencies and are
subject to the currency fluctuation and other risks of foreign securities
investments. The foreign government securities in which the Fund intends to
invest generally will consist of obligations supported by national, state or
local governments or similar political subdivisions. Foreign government
securities also include debt obligations of supranational entities, including
international organizations designated or supported by governmental entities
to promote economic reconstruction or development and international banking
institutions and related government agencies. Examples include the
International Bank for Reconstruction and Development (the "World Bank"), the
European Investment Bank, the Asian Development Bank and the Inter-American
Development Bank.
Foreign government securities also include debt securities of "quasi-
governmental agencies" and debt securities denominated in multinational
currency units. An example of a multinational currency unit is the European
Currency Unit. A European Currency Unit represents specified amounts of the
currencies of certain of the twelve member states of the European Economic
Community. Debt securities of quasi-governmental agencies are issued by
entities owned by either a national or local government or are obligations of
a political unit that is
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not backed by the national government's full faith and credit and general
taxing powers. Foreign government securities will not be considered government
securities for purposes of determining the Fund's compliance with
diversification and concentration policies.
INTERNATIONAL EQUITY FOCUS FUND
The investment objective of the International Equity Focus Fund is to seek
capital appreciation and, secondarily, income by investing in a diversified
portfolio of equity securities of issuers located in countries other than the
United States. Under normal conditions, at least 65% of the Fund's net assets
will be invested in such equity securities and at least 65% of the Fund's
total assets will be invested in the securities of issuers from at least three
different foreign countries. The investment objective of the Fund is a
fundamental policy and may not be changed without approval of a majority of
the Fund's outstanding shares. There can be no assurance that the Fund's
investment objectives will be achieved. The Fund may employ a variety of
investments and techniques to hedge against market and currency risk. See
Appendix B. Investing on an international basis involves special
considerations. Investing in smaller capital markets entails the risk of
significant volatility in the Fund's security prices. See "Other Portfolio
Strategies--Foreign Securities." The Fund is designed for investors seeking to
complement their U.S. holdings through foreign investments. The Fund should be
considered as a long-term investment and a vehicle for diversification and not
as a balanced investment program.
The International Equity Focus Fund will invest in an international
portfolio of securities of foreign companies located throughout the world.
While there are no prescribed limits on the geographic allocation of the
Fund's investments, management of the Fund anticipates that a substantial
portion of its assets will be invested in the developed countries of Europe
and the Far East. For the reasons stated below, management of the Fund will
give special attention to investment opportunities in the developing countries
of the world, including, but not limited to Latin America, the Far East and
Eastern Europe. It is anticipated that a significant portion of the Fund's
assets may be invested in such developing countries.
The allocation of the Fund's assets among the various foreign securities
markets will be determined by the Investment Adviser based primarily on its
assessment of the relative condition and growth potential of the various
economies and securities markets, currency and taxation considerations and
other pertinent financial, social, national and political factors. Within such
allocations, the Investment Adviser will seek to identify equity investments
in each market which are expected to provide a total return which equals or
exceeds the return of such market as a whole.
A significant portion of the Fund's assets may be invested in developing
countries. This allocation of the Fund's assets reflects the belief that
attractive investment opportunities may result from an evolving long-term
international trend favoring more market-oriented economies, a trend that may
especially benefit certain developing countries with smaller capital markets.
This trend may be facilitated by local or international political, economic or
financial developments that could benefit the capital markets of such
countries. Certain such countries, particularly so-called "emerging" countries
(such as Malaysia, Mexico and Thailand), which may be in the process of
developing more market-oriented economies, may experience relatively high
rates of economic growth. Because of the general illiquidity of the capital
markets in certain developing countries, the Fund may invest in a relatively
small number of leading or relatively actively traded companies in the capital
markets of such a country in the expectation that the investment experience of
the securities of such companies will substantially represent the investment
experience of that country's capital markets as a whole.
While the Fund will primarily emphasize investments in common stock, the
Fund may also invest in preferred stocks, convertible debt securities and
other instruments the return on which is linked to the performance of a common
stock or a basket or index of common stocks (collectively, "equity
securities"). The Fund may also invest in non-equity securities, including
debt securities, cash or cash equivalents denominated in U.S. dollars or
foreign currencies and short-term securities, including money market
instruments. Under certain adverse investment conditions, for defensive
purposes, the Fund may restrict the markets in which its assets will be
invested and may increase the proportion of assets invested in short-term
obligations of U.S. issuers. Investments made for defensive purposes will be
maintained only during periods in which the Investment
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Adviser determines that economic or financial conditions are adverse for
holding or being fully invested in equity securities of foreign issuers.
The Fund may invest in the securities of foreign issuers in the form of
American Depositary Receipts ("ADRs"), European Depositary Receipts ("EDRs"),
Global Depositary Receipts ("GDRs") or other securities convertible into
securities of foreign issuers. These securities may not necessarily be
denominated in the same currency as the securities into which they may be
converted. ADRs are receipts, typically issued by an American bank or trust
company, that evidence ownership of underlying securities issued by a foreign
corporation. EDRs are receipts issued in Europe that evidence a similar
ownership arrangement. GDRs are receipts issued throughout the world that
evidence a similar ownership arrangement. Generally, ADRs, in registered form,
are designed for use in the U.S. securities markets, and EDRs, in bearer form,
are designed for use in European securities markets. GDRs are tradeable both
in the U.S. and Europe and are designed for use throughout the world.
The Fund also may invest up to 35% of its net assets in longer-term, non-
convertible debt securities emphasizing debt securities which offer the
opportunity for capital appreciation. Capital appreciation in debt securities
may arise as a result of a favorable change in relative foreign exchange
rates, in relative interest rate levels, or in the creditworthiness of
issuers. In accordance with its investment objective, the Fund will not seek
to benefit from anticipated short-term fluctuations in currency exchange
rates. The Fund may, from time to time, invest in debt securities with
relatively high yields (as compared to other debt securities meeting the
Fund's investment criteria), notwithstanding that the Fund may not anticipate
that such securities will experience substantial capital appreciation. Such
income can be used, however, to offset the operating expenses of the Fund.
The Fund may invest in debt securities issued or guaranteed by foreign
governments (including foreign states, provinces and municipalities) or their
agencies and instrumentalities ("governmental entities"), issued or guaranteed
by international organizations designated or supported by multiple foreign
governmental entities (which are not obligations of foreign governments) to
promote economic reconstruction or development ("supranational entities"), or
issued by foreign corporations or financial institutions.
Supranational entities include international organizations designated or
supported by governmental entities to promote economic reconstruction or
development and international banking institutions and related government
agencies. Examples include the International Bank for Reconstruction and
Development (the "World Bank"), the European Steel and Coal Community, the
Asian Development Bank and the Inter-American Development Bank. The
governmental members, or "stockholders," usually make initial capital
contributions to the supranational entity and in many cases are committed to
make additional capital contributions if the supranational entity is unable to
repay its borrowings.
The Fund has established no rating criteria for the debt securities in which
it may invest, and such securities may not be rated at all for
creditworthiness. Securities rated in the medium to lower rating categories of
nationally recognized statistical rating organizations and unrated securities
of comparable quality are predominantly speculative with respect to the
capacity to pay interest and repay principal in accordance with the terms of
the security and generally involve a greater volatility of price than
securities in higher rating categories. In purchasing such securities, the
Fund will rely on the Investment Adviser's judgement, analysis and experience
in evaluating the creditworthiness of an issuer of such securities. The
Investment Adviser will take into consideration, among other things, the
issuer's financial resources, its sensitivity to economic conditions and
trends, its operating history, the quality of the issuer's management and
regulatory matters. The Fund does not intend to purchase debt securities that
are in default or which the Investment Adviser believes will be in default.
See "Other Portfolio Strategies--Foreign Securities" and "Risks of High Yield
Securities" below.
DEVELOPING CAPITAL MARKETS FOCUS FUND
The investment objective of the Developing Capital Markets Focus Fund is to
seek long-term capital appreciation by investing in securities, principally
equities, of issuers in countries having smaller capital markets. Under normal
conditions, at least 65% of the Fund's net assets will be invested in such
equity securities. The investment objective of the Fund is a fundamental
policy and may not be changed without approval of a majority
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of the Fund's outstanding shares. There can be no assurance that the Fund's
investment objective will be achieved. The Fund may employ a variety of
investments and techniques to hedge against market and currency risk. See
Appendix B. Investing on an international basis involves special
considerations. Investing in smaller capital markets entails the risk of
significant volatility in the Fund's security prices. See "Other Portfolio
Strategies--Foreign Securities." The Fund is designed for investors seeking to
complement their U.S. holdings through foreign investments. The Fund should be
considered as a long-term investment and a vehicle for diversification and not
as a balanced investment program.
For purposes of its investment objective, the Fund considers countries
having smaller capital markets to be all countries other than the four
countries having the largest equity market capitalizations. Currently, these
four countries are Japan, the United Kingdom, the United States and Germany.
At December 31, 1996, those countries' equity market capitalizations totalled
approximately 69.84% of the world's equity market capitalization according to
data provided by Morgan Stanley Capital International. The Fund will at all
times, except during defensive periods, maintain investments in at least three
countries having smaller capital markets.
The Fund seeks to benefit from economic and other developments in smaller
capital markets. The investment objective of the Fund reflects the belief that
investment opportunities may result from an evolving long-term international
trend favoring more market-oriented economies, a trend that may especially
benefit certain countries having smaller capital markets. This trend may be
facilitated by local or international political, economic or financial
developments that could benefit the capital markets of such countries. Certain
such countries, particularly so-called "emerging" countries (such as Malaysia,
Mexico and Thailand) which may be in the process of developing more market-
oriented economies, may experience relatively high rates of economic growth.
Other countries (such as France, the Netherlands and Spain), although having
relatively mature smaller capital markets, may also be in a position to
benefit from local or international developments encouraging greater market
orientation and diminishing governmental intervention in economic affairs.
Many investors, particularly individuals, lack the information, capability
or inclination to invest in countries having smaller capital markets. It also
may not be permissible for such investors to invest directly in certain such
markets. Unlike many intermediary investment vehicles, such as closed-end
investment companies that invest in a single country, the Fund intends to
diversify investment risk among the capital markets of a number of countries.
The Fund will not necessarily seek to diversify investments on a geographical
basis or on the basis of the level of economic development of any particular
country.
In its investment decision-making, the Investment Adviser will emphasize the
allocation of assets among certain countries' capital markets, rather than the
selection of particular industries or issuers. Because of the general
illiquidity of the capital markets in some countries, the Fund may invest in a
relatively small number of leading or actively traded companies in a country's
capital markets in the expectation that the investment experience of the
securities of such companies will substantially represent the investment
experience of the country's capital markets as a whole.
The Fund also may invest in debt securities of issuers in countries having
smaller capital markets. Capital appreciation in debt securities may arise as
a result of a favorable change in relative foreign exchange rates, in relative
interest rate levels, or in the creditworthiness of issuers. In accordance
with its investment objective, the Fund will not seek to benefit from
anticipated short-term fluctuations in currency exchange rates. The Fund may,
from time to time, invest in debt securities with relatively high yields (as
compared to other debt securities meeting the Fund's investment criteria),
notwithstanding that the Fund may not anticipate that such securities will
experience substantial capital appreciation. See "Risks of High Yield
Securities" below. Such income can be used, however, to offset the operating
expenses of the Fund.
The Fund may invest in debt securities issued or guaranteed by foreign
governments (including foreign states, provinces and municipalities) or their
agencies and instrumentalities ("governmental entities"), issued or guaranteed
by international organizations designated or supported by multiple foreign
governmental entities (which are not obligations of foreign governments) to
promote economic reconstruction or development ("supranational entities"), or
issued by foreign corporations or financial institutions.
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Supranational entities include international organizations designated or
supported by governmental entities to promote economic reconstruction or
development and international banking institutions and related government
agencies. Examples include the World Bank, the European Steel and Coal
Community, the Asian Development Bank and the Inter-American Development Bank.
The governmental members, or "stockholders," usually make initial capital
contributions to the supranational entity and in many cases are committed to
make additional capital contributions if the supranational entity is unable to
repay its borrowings.
The Fund has established no rating criteria for the debt securities in which
it may invest, and such securities may not be rated at all for
creditworthiness. Securities rated in the medium to lower rating categories of
nationally recognized statistical rating organizations and unrated securities
of comparable quality are predominantly speculative with respect to the
capacity to pay interest and repay principal in accordance with the terms of
the security and generally involve a greater volatility of price than
securities in higher rating categories. In purchasing such securities, the
Fund will rely on the Investment Adviser's judgement, analysis and experience
in evaluating the creditworthiness of an issuer of such securities. The
Investment Adviser will take into consideration, among other things, the
issuer's financial resources, its sensitivity to economic conditions and
trends, its operating history, the quality of the issuer's management and
regulatory matters. The Fund does not intend to purchase debt securities that
are in default or which the Investment Adviser believes will be in default.
See "Other Portfolio Strategies--Foreign Securities" and "Risks of High Yield
Securities" below.
For purposes of the Fund's investment objective, an issuer ordinarily will
be considered to be located in the country where the primary trading market of
its securities is located. The Fund, however, may consider a company to be
located in countries having smaller capital markets, without reference to its
domicile or to the primary trading market of its securities, when at least 50%
of its non-current assets, capitalization, gross revenues or profits in any
one of the two most recent fiscal years represents (directly or indirectly
through subsidiaries) assets or activities located in such countries. The Fund
also may consider closed-end investment companies to be located in the country
or countries in which they primarily make their portfolio investments.
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. 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.
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.
The Fund reserves the right, as a temporary defensive measure or to provide
for redemptions or in anticipation of investment in countries having smaller
capital markets, to hold cash or cash equivalents (in U.S. dollars or foreign
currencies) and short-term securities, including money market securities. The
Fund may invest in the securities of foreign issuers in the form of American
Depositary Receipts ("ADRs"), European Depositary Receipts ("EDRs"), Global
Depositary Receipts ("GDRs") or other securities convertible into securities
of foreign issuers. The Fund may invest in unsponsored ADRs. The issuers of
unsponsored ADRs are not obligated to disclose material information in the
United States, and therefore, there may not be a correlation between such
information and the market value of such ADRs.
NON-DIVERSIFIED FUNDS
The Natural Resources Focus, Global Strategy Focus, and Developing Capital
Markets Focus Funds are classified as non-diversified investment companies
under the Investment Company Act. However, each 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,
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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.
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.
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 regulation of the Securities and Exchange Commission limits 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 it may purchase; however, each Fund may purchase
without regard to that limitation certain securities that are not registered
under the Securities Act of 1933, as amended (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.
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Foreign Securities. The Prime Bond, High Current Income, Quality Equity,
Special Value Focus, Natural Resources Focus, Global Strategy Focus, Basic
Value Focus, Global Utility Focus, International Equity Focus and Developing
Capital Markets Focus 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, other than the Natural Resources
Focus and Global Strategy Focus Funds, will concentrate its investments in any
particular country. The Natural Resources Focus, Global Strategy Focus, Global
Utility Focus, International Equity Focus and Developing Capital Markets Focus
Funds may from time to time be substantially invested in non-dollar-
denominated securities of foreign issuers. For a Fund that invests in foreign
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, and 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. 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. Each Fund of the Company other
than the Natural Resources Focus, Global Strategy Focus, Basic Value Focus,
Global Utility Focus, International Equity Focus, Quality Equity and
Developing Capital Markets Focus Funds will purchase only securities issued
only in dollar denominations.
Each of the International Equity Focus Fund and Developing Capital Markets
Focus Fund may invest a significant portion of its assets in securities of
foreign issuers in smaller capital markets, while each of the other Funds
which is permitted to invest in foreign securities may from time to time
invest in securities of such foreign issuers. Foreign investments involve
risks, including fluctuations in foreign exchange rates, future political and
economic developments, different legal systems, the existence or possible
imposition of exchange controls, or other foreign or United States
governmental laws or restrictions, which are often heightened for investments
in smaller capital markets.
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
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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. Due to its emphasis on
securities of issuers located in smaller capital markets, each of the
Developing Capital Markets Focus Fund and the International Equity Focus Fund
should be considered as a vehicle for diversification and not as a balanced
investment program.
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.
The Developing Capital Markets Focus and International Equity Focus Funds
intend to invest in securities of foreign issuers in smaller capital markets.
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.
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A number of countries, such as South Korea, Taiwan and Thailand, have
authorized the formation of closed-end investment companies to facilitate
indirect foreign investment in their capital markets. In accordance with the
Investment Company Act, the Developing Capital Markets Focus and International
Equity Focus Funds each may invest up to 10% of its total assets in securities
of such closed-end investment companies. This restriction on investments in
securities of closed-end investment companies may limit opportunities for the
Fund to invest indirectly in certain smaller capital markets. Shares of
certain closed-end investment companies may at times be acquired only at
market prices representing premiums to their net asset values. If a Fund
acquires shares in closed-end investment companies, shareholders would bear
both their proportionate share of expenses in the Fund (including management
and advisory fees) and, indirectly, the expenses of such closed-end investment
companies. A Fund also may seek, at its own cost, to create its own investment
entities under the laws of certain countries.
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
securities 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, Global Utility Focus
and Developing Capital Markets Focus Funds may from time to time enter into
standby commitment agreements. Such agreements commit the respective 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 securities
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.
Portfolio Strategies Involving Indexed and Inverse Securities, Options,
Futures and Foreign Exchange Transactions. Certain Funds may use derivative
instruments, including indexed and inverse securities, options and futures and
purchase and sell foreign exchange. Transactions involving such instruments
expose these Funds to certain risks. Each Fund's use of these instruments and
the associated risks are described in detail in Appendix B attached to this
Prospectus.
RISKS OF HIGH YIELD SECURITIES
The High Current Income Fund, International Equity Focus Fund and Developing
Capital Markets Focus Fund may invest a substantial portion of their 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.
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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, International Equity Focus Fund or Developing
Capital Markets Focus 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
a Fund purchases a particular security, in which case a Fund may experience
losses and incur costs.
In an effort to minimize the risk of issuer default or bankruptcy, the High
Current Income Fund, International Equity Focus Fund and Developing Capital
Markets Focus Fund each will diversify its holdings among many issuers.
However, there can be no assurance that diversification will protect a 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,
International Equity Focus Fund and Developing Capital Markets Focus Fund
receive for their junk bonds to be reduced, or a 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,
judgement may play a greater role in valuing certain of each 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, International Equity Focus Fund and Developing
Capital Markets Focus Fund. In addition, each 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.
Sovereign Debt. The junk bonds in which the High Current Income Fund,
International Equity Focus Fund and Developing Capital Markets Focus Fund may
invest include junk bonds issued by sovereign entities. Investment in such
sovereign debt involves a high degree of risk. The governmental entity that
controls the repayment of sovereign 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 governmental entity'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, the extent of its foreign reserves, the availability of
sufficient foreign exchange on the date a payment is due, the relative size of
the debt service burden to the economy as a whole, the governmental entity's
policy towards the International Monetary Fund and the political constraints
to which a governmental entity may be subject. Governmental entities may also
be dependent on expected disbursements from foreign governments, multilateral
agencies and others abroad to reduce principal and interest arrearages on
their debt. The commitment on the part of these governments, agencies and
others to make such disbursements may be conditioned on a governmental
entity's implementation of economic reforms and/or economic performance and
the timely service of such debtor's
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obligations. Failure to implement such reforms, achieve such levels of
economic performance or repay principal or interest when due may result in the
cancellation of such third parties' commitments to lend funds to the
governmental entity, which may further impair such debtor's ability or
willingness to timely service its debts. Consequently, governmental entities
may default on their sovereign debt.
Holders of sovereign debt, including the High Current Income Fund,
International Equity Focus Fund and Developing Capital Markets Focus Fund, may
be requested to participate in the rescheduling of such debt and to extend
further loans to governmental entities. In the event of a default by a
governmental entity, there may be few or no effective legal remedies available
to a Fund and there can be no assurance a Fund will be able to collect on
defaulted sovereign debt in whole or in part.
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." The Investment
Adviser believes that compliance with this standard 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 the 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 and its affiliate, Fund
Asset Management, L.P. ("FAM"); President and Director of Princeton Services,
Inc. ("Princeton Services"); Executive Vice President of ML & Co.
Joe Grills--Member of the Committee on Investment of Employee Benefit Assets
of the Financial Executives Institute ("CIEBA"); Member of CIEBA's Executive
Committee; and Member of the Investment Advisory Committee of the State of New
York Common Retirement Fund and the Howard Hughes Medical Institute; Director,
Duke Management Company, LaSalle Street Fund and Kimco Realty Corporation.
Walter Mintz--Special Limited Partner of Cumberland Partners (investment
partnership).
Robert S. Salomon, Jr.--Principal of STI Management (investment adviser).
Melvin R. Seiden--Director of Silbanc Properties, Ltd. (real estate,
consulting and investments).
Stephen R. Swensrud--Chairman of Fernwood Associates (financial
consultants).
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* Interested person, as defined in the Investment Company Act of 1940 as
amended, of the Company.
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INVESTMENT ADVISER
Merrill Lynch Asset Management L.P. ("MLAM"), an indirect wholly owned
subsidiary of ML & Co. is the investment adviser (the "Investment Adviser")
for the Fund. The general partner of the Investment Adviser is Princeton
Services, Inc., a wholly owned subsidiary of ML & Co. Inc. 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, FAM, acts as the investment adviser
for over 130 other registered investment companies. The Investment Adviser
also offers portfolio management and portfolio analysis services to
individuals and institutions. In the aggregate, as of September 30, 1997, MLAM
and FAM had a total of approximately $272.5 billion in investment company and
other portfolio assets under management including assets of certain
affiliates.
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, 1996, the advisory fees
expense incurred by the Company totaled $24,131,430 of which $2,160,063
related to the Prime Bond Fund (representing .44% of its average net assets),
$1,881,541 related to the High Current Income Fund (representing .49% of its
average net assets), $3,136,852 related to the Quality Equity Fund
(representing .44% of its average net assets), $3,010,613 related to the
Special Value Focus Fund (representing .75% of its average net assets),
$297,742 related to the Natural Resources Focus Fund (representing .65% of its
average net assets), $1,386,726 related to the Domestic Money Market Fund
(representing .50% of its average net assets), $3,715,122 related to the
Global Strategy Focus Fund (representing .65% of its average net assets),
$2,414,605 related to the Basic Value Focus Fund (representing .60% of its
average net assets) $880,959 related to the Global Utility Focus Fund
(representing .60% of its average net assets), $2,358,140 related to the
International Equity Focus Fund (representing .75% of its average net assets),
$765,718 related to the Developing Capital Markets Focus Fund (representing
1.00% of its average net assets) of which $52,388 was voluntarily waived by
MLAM.
During the Company's fiscal year ended December 31, 1996, the total
operating expenses of the Company's Funds (including the advisory fees paid to
the Investment Adviser), before any fee waiver or reimbursement of a portion
of such expenses were as follows: $2,418,846 related to the Prime Bond Fund
(representing .49% of its average net assets), $2,096,102 related to the High
Current Income Fund (representing .54% of its average net assets), $3,495,231
related to Quality Equity Fund (representing .49% of its average net assets),
$3,240,858 related to the Special Value Focus Fund (representing .81% of its
average net assets), $358,882 related to the Natural Resources Focus Fund
(representing .78% of its average net assets), $1,507,384 related to the
Domestic Money Market Fund (representing .54% of its average net assets),
$4,077,255 related to the Global Strategy Focus Fund (representing .71% of its
average net assets), $2,657,872 related to the Basic Value Focus Fund
(representing .66% of its average net assets), $970,696 related to the Global
Utility Focus Fund (representing .66% of its average net assets), $2,802,938
related to the International Equity Focus Fund (representing .89% of its
average net assets), $1,009,535 related to the Developing Capital Markets
Focus Fund (representing 1.31% of its average net assets).
The Investment Adviser has entered into a sub-advisory agreement (the "Sub-
Advisory Agreement") with MLAM U.K., an indirect wholly owned subsidiary of ML
& Co., and an affiliate of the Investment Adviser, pursuant to which the
Investment Adviser pays MLAM U.K. a fee for providing investment advisory
services to the Investment Adviser with respect to the Funds in an amount to
be determined from time to time by the
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Investment Adviser and MLAM U.K. but in no event in excess of the amount that
the Investment Adviser actually receives for providing services to the Funds
pursuant to the Investment Advisory Agreement.
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"). 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 Investment
Adviser which, in turn, will be reimbursed by MLLA.
The Investment Adviser has entered into administrative services agreements
with certain Insurance Companies, including MLLIC and ML of New York, pursuant
to which the Investment Adviser compensates such companies for administrative
responsibilities relating to the Company which are performed by such Insurance
Companies.
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 Investment
Adviser (together, the "Codes"). The Codes significantly restrict the personal
investing activities of all employees of the Investment Adviser and, as
described below, impose additional, more onerous, restrictions on fund
investment personnel.
The Codes require that all employees of the Investment 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 Investment 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 Investment 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 Funds.
Thomas R. Robinson has served as the Portfolio Manager of the Global
Strategy Focus Fund and Quality Equity Fund since November 1995, and is
primarily responsible for each such Fund's day-to-day management. He has
served as a Senior Portfolio Manager of MLAM since November 1995. From 1989 to
1995, he served as Manager of International Strategy for ML & Co. Global
Securities Research & Economics Group.
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.
Walter Rogers has served as the Global Utility 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 1987.
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
employee of the Investment Adviser since 1986.
Andrew Bascand has served as the International Equity Focus Fund's Co-
Portfolio Manager since July 1993 and became sole Portfolio Manager in March
1997. He is primarily responsible for the Fund's day-to-day management. He has
been the director of MLAM, U.K. and Vice President of Merrill Lynch Global
Asset Management Limited (MLGAM) since 1993; Chief Economist with A.M.P.
Investment (NZ) in New Zealand
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from 1989 to 1993; Economic Adviser to the Chief Economist of the Reserve Bank
of New Zealand from 1987 to 1989; and Senior Research Officer of the Bank of
England's International Department from 1986 to 1987.
Peter Lehman has served as the Natural Resources Focus Fund's Portfolio
Manager since January 1994, and is primarily responsible for the Fund's day-
to-day management. He has served as Vice President of MLAM since 1994; Senior
Fund Analyst for an international fund managed by the Investment Adviser from
1992 to 1994; Director and Senior Portfolio Manager for Prudential Insurance
Company of America from 1989 to 1991.
Jay Harbeck has served as the Prime Bond Fund's Portfolio Manager since July
1992 and is primarily responsible for the Fund's day-to-day management. He has
served as Vice President of MLAM since 1986.
Jacqueline Rogers has served as the Portfolio Manager of the Domestic Money
Market Fund since October 1996, and is primarily responsible for the Fund's
day-to-day management. She has served as Vice President of MLAM since January
1986.
Grace Pineda has served as the Developing Capital Markets Focus Fund's
Portfolio Manager since May 1994, and is primarily responsible for the Fund's
day-to-day management. She has served as Vice President of MLAM since 1989.
Daniel V. Szemis has served as the Portfolio Manager of the Special Value
Focus Fund (formerly, the Equity Growth Fund) since May 1997 and is primarily
responsible for the fund's day-to-day management. Mr. Szemis has served as
Vice President of MLAM since 1996. From 1990 to 1996, Mr. Szemis was a
Portfolio Manager with Prudential Mutual Fund Investment Management Advisors.
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 competitive spreads or
commissions, the Company will not necessarily be paying the lowest spread or
commission available.
Under the Investment Company Act of 1940, 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 Securities and Exchange
Commission. Affiliated persons of the Company may serve as its broker in over-
the-counter transactions conducted on an agency basis. The Securities and
Exchange Commission 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, 1996, the Company engaged in 16 transactions pursuant
to such order involving approximately $64.9 million of securities. For the
year ended December 31, 1996, the Company paid brokerage commissions of
$6,656,814, of which $266,405 was paid to Merrill Lynch.
PURCHASE OF SHARES
The Company continuously offers shares of Class A Common Stock 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."
The Company and the Distributor reserve the right to suspend the sale of
shares of each Fund in response to conditions in the securities markets or
otherwise.
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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 Company's 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). Net investment income of the Domestic Money Market Fund (from the
time of the immediate preceding determination thereof) consists of (i)
interest accrued and/or discount earned (including both original issue and
market discount), (ii) plus or minus all realized and unrealized gains (other
than realized long-term capital gains) and losses on its portfolio securities,
(iii) less the estimated expenses of the respective Fund (including the fees
payable to the Investment Adviser) applicable to that dividend period.
Dividends on the Domestic Money Market Fund are declared daily and
reinvested monthly in additional full and fractional shares of such Fund.
Dividends from net investment income of the Prime Bond, and High Current
Income, Funds 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 Global Utility Focus Fund are declared and
reinvested quarterly in additional full and fractional shares of the Fund.
Dividends from net investment income of the Quality Equity, Special Value
Focus, National Resources Focus, Global Strategy Focus, International Equity
Focus, Basic Value Focus and Developing Capital Markets 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, other than short-term capital gains of the Domestic Money Market Fund,
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 (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.
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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 Securities and Exchange
Commission.
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, 1996 was 6.23% for the Prime Bond Fund, and 9.30% 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.
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 "S&P 500
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 indicative
of the Fund's relative performance for any future period.
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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. Since the net investment income of the Domestic Money Market
Fund (including realized and unrealized gains and losses on their portfolio
securities) is 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.
Except with respect to securities held by the Domestic Money Market Fund
having a remaining maturity of 60 days or less, securities held by each Fund
will be valued as follows: Portfolio securities that 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
("OTC") market are valued at the last available bid price in the OTC market
prior to the time of valuation. Portfolio securities that are traded both in
the OTC 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 OTC market. When a Fund writes an 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 OTC 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 OTC 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.
The Company has used pricing services, including Merrill Lynch Securities
Pricing(TM) Service ("MLSPS"), to value securities held by the High Current
Income and Prime Bond Funds and to value bonds held by other of the Company's
Funds. The Board of Directors of the Company has examined the methods used by
the pricing services in estimating the value of securities held by the Funds
and believes that such methods will reasonably and fairly approximate the
price at which those securities may be sold and result in a good faith
determination of the fair value of such securities; however, there is no
assurance that securities can be sold at the prices at which they are valued.
During the fiscal year ended December 31, 1996, Global Strategy Focus Fund,
Global Utility Focus Fund, High Current Income Fund, and Prime Bond Fund paid
MLSPS $175, $77, $7,269, and $5,884, respectively.
ORGANIZATION OF THE COMPANY
The Company was incorporated on October 16, 1981. Operations of the Prime
Bond, High Current Income, Quality Equity and Special Value Focus Funds
commenced on April 20, 1982. The Natural Resources Focus Fund commenced
operations on June 1, 1988. The Domestic Money Market Fund and the Global
Strategy Focus Fund commenced operations on February 20 and February 28, 1992,
respectively. The Basic Value Focus, Global Utility Focus and International
Equity Focus Funds commenced operations on July 1, 1993. The Developing
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Capital Markets Focus Fund commenced operations on May 2, 1994. The authorized
capital stock of the Company consists of 3,400,000,000 shares of Class A
Common Stock, par value $0.10 per share, and 3,400,000,000 shares of Class B
Common Stock, par value $0.10 per share. The shares of Class A and Class B
Common Stock are each divided into sixteen 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 Special Value Focus 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 Global Bond 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 Government
Bond Fund Common Stock and Merrill Lynch Index 500 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 Class A shares and 100,000,000 Class B shares
except for Domestic Money Market Fund Common Stock which consists of
1,300,000,000 Class A shares and 1,300,000,000 Class B shares, Reserve Assets
Fund Common Stock which consists of 500,000,000 Class A shares and 500,000,000
Class B shares and Global Bond Focus Fund Common Stock and Global Strategy
Focus Fund Common Stock, each of which consists of 200,000,000 Class A shares
and 200,000,000 Class B 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
of 1940 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 Board of Directors of the Company has authorized the issuance of shares
of Class B Common Stock with respect to each of the Company's Funds, with the
existing shares of Common Stock of each Fund to be designated Class A Common
Stock of such Fund. The Board of Directors have also authorized the Company to
enter into a Distribution Plan with Merrill Lynch Funds Distributor, Inc.
under which the Company would pay distribution fees in respect of the shares
of its Class B Common Stock. The Company commenced issuing shares of Class B
Common Stock in 1997 pursuant to a separate Prospectus.
Family Life Insurance Company ("Family Life") purchased $1,000 worth of
shares of the Natural Resources Focus Fund on April 29, 1988 and $1,999,000
worth of shares of such Fund on May 27, 1988. Family Life also provided the
initial capitalization for each of the Company's other Funds other than the
Funds named below for which MLLIC provided the initial capitalization. MLLIC
purchased $100 worth of shares of each of the Domestic Money Market and Global
Strategy Focus Funds on February 6, 1992, $2,000,000 worth of shares of the
Domestic Money Market Fund on February 20, 1992, $2,000,000 worth of shares of
the Global Strategy Focus Fund on February 28, 1992 and $100 worth of shares
of each of the Basic Value Focus, Global Utility Focus and International
Equity Focus Funds on June 28, 1993. MLLIC purchased, on July 1, 1993,
$8,000,000 worth of shares of the International Equity Focus Fund and
$2,000,000 worth of shares of each of the Basic Value Focus Fund and the
Global Utility Focus Fund. MLLIC purchased, on May 2, 1994, $8,000,000 worth
of shares of the Developing Capital Markets Focus Fund. The organizational
expenses of each of the Company's
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Funds are paid by the Investment Adviser. The Investment Adviser is reimbursed
by MLLIC 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 the Company's assets, except that Brown Brothers
Harriman & Co., 40 Water Street, Boston, Massachusetts 02109, acts as
Custodian for assets of the Company's Developing Capital Markets Focus Fund.
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.
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 Securities and Exchange Commission 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 25, 1997, 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 Securities and Exchange Commission in Washington, D.C.
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APPENDIX A
U.S. GOVERNMENT SECURITIES
The Domestic Money Market Fund (and, for temporary or defensive purposes,
each other Fund) 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
The Domestic Money Market Fund (and, for temporary or defensive purposes,
each other Fund) 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
The Domestic Money Market Fund (and, for temporary or defensive purposes,
each other Fund) 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 Fund's
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 Fund is 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. As a matter of policy, the
Domestic Money Market Fund will invest only in these types of instruments
issued by U.S. issuers.
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 Natural Resources Focus Fund,
Global Strategy Focus Fund, Global Utility Focus Fund, International Equity
Focus Fund, and Developing Capital Markets 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 Funds 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 Funds 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 Funds will limit their
investments in Yankeedollar obligations to obligations issued by banking
institutions with more than $1 billion in assets.
For temporary or defensive purposes, the Natural Resources Focus Fund,
Global Strategy Focus Fund, Global Utility Focus Fund, International Equity
Focus Fund and Developing Capital Markets Focus Fund may also invest in U.S.
dollar-denominated obligations of foreign depository institutions and their
foreign branches
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and subsidiaries, such as certificates of deposit, bankers' acceptances, time
deposits and deposit notes. The obligations of such foreign 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
The Domestic Money Market Fund (and, for temporary or defensive purposes,
each other Fund) may invest in commercial paper (including variable amount
master demand notes and insurance company funding agreements), 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.
The Domestic Money Market Fund may also invest in nonconvertible debt
securities issued by entities or asset-backed nonconvertible debt securities
issued by trusts (e.g., bonds and debentures) with no more than 397 days (13
months) remaining to maturity at date of settlement. Short-term debt
securities with a remaining maturity of less than one year tend to become
extremely liquid and are traded as money market securities. For a discussion
of the ratings requirements of the Fund's portfolio securities, see
"Investment Objectives and Policies of the Funds--Money Market Fund Portfolio
Restrictions" and "Investment Objectives and Policies of the Funds--Domestic
Money Market Fund" in the Prospectus.
For temporary or defensive purposes, the Natural Resources Focus Fund,
Global Strategy Focus Fund, Global Utility Focus Fund, International Equity
Focus Fund and Developing Capital Markets 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
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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. 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 than the Fund had paid to the seller, the Fund would
realize a loss. Repurchase agreements maturing in more than seven days will be
considered "illiquid securities." The Domestic Money Markets Fund will not
enter into repurchase agreements maturing in more than 30 days.
Reverse Repurchase Agreements. The Domestic Money Market Fund may enter into
reverse repurchase agreements, which involve the sale of money market
securities held by the Fund, with an agreement to repurchase the securities at
an agreed upon price, date, and interest payment. The Fund will use the
proceeds of the reverse repurchase agreements to purchase other money market
securities either maturing, or under an agreement to resell, at a date
simultaneous with or prior to the expiration of the reverse repurchase
agreement. The Fund will utilize reverse repurchase agreements when the
interest income to be earned from the investment of the proceeds of the
transaction is greater than the interest expense of the reverse repurchase
transaction. A separate account of the Fund will be established with the
Custodian consisting of cash or liquid securities having a market value at all
times at least equal in value to the proceeds received on any sale subject to
repurchase plus accrued interest.
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.
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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--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.
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APPENDIX B
Certain Funds of the Company are authorized to use derivative instruments,
including indexed and inverse securities, options, and futures, and to
purchase and sell foreign exchange, as described below. Such instruments are
referred to collectively herein as "Strategic Instruments."
INDEXED AND INVERSE SECURITIES
The Domestic Money Market Fund, the Global Strategy Focus Fund, the Global
Utility Focus Fund, the International Equity Focus Fund, the Natural Resources
Focus Fund and the Prime Bond Fund may invest in securities the potential
return of which is based on the change in particular measurements of value or
rate (an "index"). As an illustration, a Fund may invest in a debt security
that pays interest and returns principal based on the change in the value of
an interest rate index (such as the prime rate or federal funds rate), a
securities index (such as the S&P 500 or a more narrowly-focused index such as
the AMEX Oil & Gas Index) or a basket of securities, or based on the relative
changes of two indices. In addition, the Developing Capital Markets Focus
Fund, the Global Strategy Focus Fund, the International Equity Focus Fund and
the Natural Resources Focus Fund may invest in securities the potential return
of which is based inversely on the change in an index. For example, these
Funds may invest in securities that pay a higher rate of interest when a
particular index decreases and pay a lower rate of interest (or do not fully
return principal) when the value of the index increases. If the Fund invests
in such securities, it may be subject to reduced or eliminated interest
payments or loss of principal in the event of an adverse movement in the
relevant index or indices.
Certain indexed and inverse securities may have the effect of providing
investment leverage because the rate of interest or amount of principal
payable increases or decreases at a rate that is a multiple of the changes in
the relevant index. As a consequence, the market value of such securities may
be substantially more volatile than the market values of other debt
securities. The Company believes that indexed and inverse securities may
provide portfolio management flexibility that permits Funds to seek enhanced
returns, hedge other portfolio positions or vary the degree of portfolio
leverage with greater efficiency than would otherwise be possible under
certain market conditions.
OPTIONS ON SECURITIES AND SECURITIES INDICES
Purchasing Options. The Developing Capital Markets Focus Fund, the Global
Strategy Focus Fund, the Global Utility Focus Fund, the International Equity
Focus Fund and the Natural Resources Focus Fund are each authorized to
purchase put options on securities held in its portfolio or securities indices
the performance of which is substantially correlated with securities held in
its portfolio. When a Fund purchases a put option, in consideration for an
upfront payment (the "option premium") the Fund acquires a right to sell to
another party specified securities owned by the Fund at a specified price (the
"exercise price") on or before a specified date (the "expiration date"), in
the case of an option on securities, or to receive from another party a
payment based on the amount a specified securities index declines below a
specified level on or before the expiration date, in the case of an option on
a securities index. The purchase of a put option limits the Fund's risk of
loss in the event of a decline in the market value of the portfolio holdings
underlying the put option prior to the option's expiration date. If the market
value of the portfolio holdings associated with the put option increases
rather than decreases, however, the Fund will lose the option premium and will
consequently realize a lower return on the portfolio holdings than would have
been realized without the purchase of the put.
The Developing Capital Markets Focus Fund, the Global Strategy Focus Fund,
the International Equity Focus Fund and the Natural Resources Focus Fund are
each authorized to purchase call options on securities it intends to purchase
or securities indices the performance of which are substantially correlated
with the performance of the types of securities it intends to purchase. When a
Fund purchases a call option, in consideration for the option premium the Fund
acquires a right to purchase from another party specified securities at the
exercise price on or before the expiration date, in the case of an option on
securities, or to receive from another party a payment based on the amount a
specified securities index increases beyond a specified level on or before the
expiration date, in the case of an option on a securities index. The purchase
of a call option may
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protect the Fund from having to pay more for a security as a consequence of
increases in the market value for the security during a period when the Fund
is contemplating its purchase, in the case of an option on a security, or
attempting to identify specific securities in which to invest in a market the
Fund believes to be attractive, in the case of an option on an index (an
"anticipatory hedge"). In the event the Fund determines not to purchase a
security underlying a call option, however, the Fund may lose the entire
option premium.
Each Fund is also authorized to purchase put or call options in connection
with closing out put or call options it has previously sold.
Writing Options. The Basic Value Focus Fund, the Developing Capital Markets
Focus Fund, the Special Value Focus Fund, the Global Strategy Focus Fund, the
Global Utility Focus Fund, the International Equity Focus Fund, the Natural
Resources Focus Fund and the Quality Equity Fund are each authorized to write
(i.e., sell) call options on securities held in its portfolio or securities
indices the performance of which is substantially correlated with securities
held in its portfolio. When a Fund writes a call option, in return for an
option premium the Fund gives another party the right to buy specified
securities owned by the Fund at the exercise price on or before the expiration
date, in the case of an option on securities, or agrees to pay to another
party an amount based on any gain in a specified securities index beyond a
specified level on or before the expiration date, in the case of an option on
a securities index. The Fund may write call options to earn income, through
the receipt of option premiums. In the event the party to which the Fund has
written an option fails to exercise its rights under the option because the
value of the underlying securities is less than the exercise price, the Fund
will partially offset any decline in the value of the underlying securities
through the receipt of the option premium. By writing a call option, however,
the Fund limits its ability to sell the underlying securities, and gives up
the opportunity to profit from any increase in the value of the underlying
securities beyond the exercise price, while the option remains outstanding.
The Developing Capital Markets Focus Fund, the Global Strategy Focus Fund,
the Global Utility Focus Fund, the International Equity Focus Fund and the
Natural Resources Focus Fund each may also write put options on securities or
securities indices. When the Fund writes a put option, in return for an option
premium the Fund gives another party the right to sell to the Fund a specified
security at the exercise price on or before the expiration date, in the case
of an option on a security, or agrees to pay to another party an amount based
on any decline in a specified securities index below a specified level on or
before the expiration date, in the case of an option on a securities index.
The Fund may write put options to earn income, through the receipt of option
premiums. In the event the party to which the Fund has written an option fails
to exercise its rights under the option because the value of the underlying
securities is greater than the exercise price, the Fund will profit by the
amount of the option premium. By writing a put option, however, the Fund will
be obligated to purchase the underlying security at a price that may be higher
than the market value of the security at the time of exercise as long as the
put option is outstanding, in the case of an option on a security, or make a
cash payment reflecting any decline in the index, in the case of an option on
an index. Accordingly, when the Fund writes a put option it is exposed to a
risk of loss in the event the value of the underlying securities falls below
the exercise price, which loss potentially may substantially exceed the amount
of option premium received by the Fund for writing the put option. The Fund
will write a put option on a security or a securities index only if the Fund
would be willing to purchase the security at the exercise price for investment
purposes (in the case of an option on a security) or is writing the put in
connection with trading strategies involving combinations of options--for
example, the sale and purchase of options with identical expiration dates on
the same security or index but different exercise prices (a technique called a
"spread").
Each Fund is also authorized to sell call or put options in connection with
closing out call or put options it has previously purchased.
Other than with respect to closing transactions, a Fund will only write call
or put options that are "covered." A call or put option will be considered
covered if the Fund has segregated assets with respect to such option in the
manner described in "Risk Factors in Options, Futures, and Currency
Instruments" below. A call option will also be considered covered if a Fund
owns the securities it would be required to deliver upon exercise of the
option (or, in the case of option on a securities index, securities which are
substantially correlated
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with the performance of such index) or owns a call option, warrant or
convertible instrument which is immediately exercisable for, or convertible
into, such security.
Types of Options. A Fund may engage in transactions in options on securities
or securities indices on exchanges and in the over-the-counter ("OTC")
markets. In general, exchange-traded options have standardized exercise prices
and expiration dates and require the parties to post margin against their
obligations, and the performance of the parties' obligations in connection
with such options is guaranteed by the exchange or a related clearing
corporation. OTC options have more flexible terms negotiated between the buyer
and the seller, but generally do not require the parties to post margin and
are subject to greater risk of counterparty default. See "Additional Risk
Factors of OTC Transactions" below.
FUTURES
The Developing Capital Markets Focus Fund, the Global Strategy Focus Fund,
the Global Utility Focus Fund, the International Equity Focus Fund and the
Natural Resources Focus Fund may each engage in transactions in futures and
options thereon. Futures are standardized, exchange-traded contracts which
obligate a purchaser to take delivery, and a seller to make delivery, of a
specific amount of a commodity at a specified future date at a specified
price. No price is paid upon entering into a futures contract. Rather, upon
purchasing or selling a futures contract the Fund is required to deposit
collateral ("margin") equal to a percentage (generally less than 10%) of the
contract value. Each day thereafter until the futures position is closed, the
Fund will pay additional margin representing any loss experienced as a result
of the futures position the prior day or be entitled to a payment representing
any profit experienced as a result of the futures position the prior day.
The sale of a futures contract limits a Fund's risk of loss through a
decline in the market value of portfolio holdings correlated with the futures
contract prior to the futures contract's expiration date. In the event the
market value of the portfolio holdings correlated with the futures contract
increases rather than decreases, however, the Fund will realize a loss on the
futures position and a lower return on the portfolio holdings than would have
been realized without the purchase of the futures contract.
The purchase of a futures contract may protect a Fund from having to pay
more for securities as a consequence of increases in the market value for such
securities during a period when the Fund was attempting to identify specific
securities in which to invest in a market the Fund believes to be attractive.
In the event that such securities decline in value or the Fund determines not
to complete an anticipatory hedge transaction relating to a futures contract,
however, the Fund may realize a loss relating to the futures position.
A Fund will limit transactions in futures and options on futures to
financial futures contracts (i.e., contracts for which the underlying
commodity is a currency or securities or interest rate index) purchased or
sold for hedging purposes (including anticipatory hedges). Each Fund will
further limit transactions in futures and options on futures to the extent
necessary to prevent the Fund from being deemed a "commodity pool" under
regulations of the Commodity Futures Trading Commission.
FOREIGN EXCHANGE TRANSACTIONS
The Developing Capital Markets Focus Fund, the Global Strategy Focus Fund,
the Global Utility Focus Fund, the International Equity Focus Fund, the
Quality Equity Fund and the Natural Resources Focus Fund may engage in spot
and forward foreign exchange transactions and currency swaps, purchase and
sell options on currencies and purchase and sell currency futures and related
options thereon (collectively, "Currency Instruments") for purposes of hedging
against the decline in the value of currencies in which its portfolio holdings
are denominated against the US dollar.
Forward foreign exchange transactions are OTC contracts to purchase or sell
a specified amount of a specified currency or multinational currency unit at a
price and future date set at the time of the contract. Spot foreign exchange
transactions are similar but require current, rather than future, settlement.
A Fund will enter into foreign exchange transactions only for purposes of
hedging either a specific transaction or a portfolio
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position. A Fund may enter into a foreign exchange transaction for purposes of
hedging a specific transaction by, for example, purchasing a currency needed
to settle a security transaction or selling a currency in which the Fund has
received or anticipates receiving a dividend or distribution. A Fund may enter
into a foreign exchange transaction for purposes of hedging a portfolio
position by selling forward a currency in which a portfolio position of the
Fund is denominated or by purchasing a currency in which the Fund anticipates
acquiring a portfolio position in the near future. A Fund may also hedge
portfolio positions through currency swaps, which are transactions in which
one currency is simultaneously bought for a second currency on a spot basis
and sold for the second currency on a forward basis.
The Funds authorized to engage in Currency Instrument transactions may also
hedge against the decline in the value of a currency against the US dollar
through use of currency futures or options thereon. Currency futures are
similar to forward foreign exchange transactions except that futures are
standardized exchange-traded contracts. See "Futures" above.
The Funds authorized to engage in Currency Instrument transactions may also
hedge against the decline in the value of a currency against the US dollar
through the use of currency options. Currency options are similar to options
on securities, but in consideration for an option premium the writer of a
currency option is obligated to sell (in the case of a call option) or
purchase (in the case of a put option) a specified amount of a specified
currency on or before the expiration date for a specified amount of another
currency. The Fund may engage in transactions in options on currencies either
on exchanges or OTC markets. See "Types of Options" above and "Additional Risk
Factors of OTC Transactions" below.
No Fund will speculate in Currency Instruments. Accordingly, a Fund will not
hedge a currency in excess of the aggregate market value of the securities
which it owns (including receivables for unsettled securities sales), or has
committed to or anticipates purchasing, which are denominated in such
currency. A Fund may, however, hedge a currency by entering into a transaction
in a Currency Instrument denominated in a currency other than the currency
being hedged (a "cross-hedge"). The Fund will only enter into a cross-hedge if
the Investment Adviser believes that (i) there is a demonstrable high
correlation between the currency in which the cross-hedge is denominated and
the currency being hedged, and (ii) executing a cross-hedge through the
currency in which the cross-hedge is denominated will be significantly more
cost-effective or provide substantially greater liquidity than executing a
similar hedging transaction by means of the currency being hedged.
Risk Factors in Hedging Foreign Currency Risks. While a Fund's use of
Currency Instruments to effect hedging strategies is intended to reduce the
volatility of the net asset value of the Fund's shares, the net asset value of
the Fund's shares will fluctuate. Moreover, although Currency Instruments will
be used with the intention of hedging against adverse currency movements,
transactions in Currency Instruments involve the risk that anticipated
currency movements will not be accurately predicted and that the Fund's
hedging strategies will be ineffective. To the extent that a Fund hedges
against anticipated currency movements which do not occur, the Fund may
realize losses, and decrease its total return, as the result of its hedging
transactions. Furthermore, a Fund will only engage in hedging activities from
time to time and may not be engaging in hedging activities when movements in
currency exchange rates occur. It may not be possible for a Fund to hedge
against currency exchange rate movements, even if correctly anticipated, in
the event that (i) the currency exchange rate movement is so generally
anticipated that the Fund is not able to enter into a hedging transaction at
an effective price, or (ii) the currency exchange rate movement relates to a
market with respect to which Currency Instruments are not available (such as
certain developing markets) and it is not possible to engage in effective
foreign currency hedging.
RISK FACTORS IN OPTIONS, FUTURES, AND CURRENCY INSTRUMENTS
Use of Strategic Instruments for hedging purposes involves the risk of
imperfect correlation in movements in the value of the Strategic Instruments
and the value of the instruments being hedged. If the value of the Strategic
Instruments moves more or less than the value of the hedged instruments a Fund
will experience a gain or loss which will not be completely offset by
movements in the value of the hedged instruments.
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Each Fund intends to enter into transactions involving Strategic Instruments
only if there appears to be a liquid secondary market for such instruments or,
in the case of illiquid instruments traded in OTC transactions, such
instruments satisfy the criteria set forth below under "Additional Risk
Factors of OTC Transactions." However, there can be no assurance that, at any
specific time, either a liquid secondary market will exist for a Strategic
Instrument or the Fund will otherwise be able to sell such instrument at an
acceptable price. It may therefore not be possible to close a position in a
Strategic Instrument without incurring substantial losses, if at all.
Certain transactions in Strategic Instruments (e.g., forward foreign
exchange transactions, futures transactions, sales of put options) may expose
a Fund to potential losses which exceed the amount originally invested by the
Fund in such instruments. When a Fund engages in such a transaction, the Fund
will deposit in a segregated account at its custodian liquid securities with a
value at least equal to the Fund's exposure, on a mark-to-market basis, to the
transaction (as calculated pursuant to requirements of the Securities and
Exchange Commission). Such segregation will ensure that the Fund has assets
available to satisfy its obligations with respect to the transaction, but will
not limit the Fund's exposure to loss.
ADDITIONAL RISK FACTORS OF OTC TRANSACTIONS; LIMITATIONS ON THE USE OF OTC
STRATEGIC INSTRUMENTS
Certain Strategic Instruments traded in OTC markets, including indexed
securities and OTC options, may be substantially less liquid than other
instruments in which a Fund may invest. The absence of liquidity may make it
difficult or impossible for the Fund to sell such instruments promptly at an
acceptable price. The absence of liquidity may also make it more difficult for
the Fund to ascertain a market value for such instruments. A Fund will
therefore acquire illiquid OTC instruments (i) if the agreement pursuant to
which the instrument is purchased contains a formula price at which the
instrument may be terminated or sold, or (ii) for which the Investment Adviser
anticipates the Fund can receive on each business day at least two independent
bids or offers, unless a quotation from only one dealer is available, in which
case that dealer's quotation may be used.
The staff of the Securities and Exchange Commission has taken the position
that purchased OTC options and the assets underlying written OTC options are
illiquid securities. Each Fund has therefore adopted an investment policy
pursuant to which it will not purchase or sell OTC options (including OTC
options on futures contracts) if, as a result of such transactions, the sum of
the market value of OTC options currently outstanding which are held by the
Fund, the market value of the securities underlying OTC call options currently
outstanding which have been sold by the Fund and margin deposits on the Fund's
outstanding OTC options exceeds 15% of the total assets of the Fund, taken at
market value, together with all other assets of the Fund which are deemed to
be illiquid or are otherwise not readily marketable. However, if an OTC option
is sold by the Fund to a dealer in U.S. government securities recognized as a
"primary dealer" by the Federal Reserve Bank of New York and the Fund has the
unconditional contractual right to repurchase such OTC option at a
predetermined price, then the Fund will treat as illiquid such amount of the
underlying securities as is equal to the repurchase price less the amount by
which the option is "in-the-money" (i.e., current market value of the
underlying security minus the option's exercise price).
Because Strategic Instruments traded in OTC markets are not guaranteed by an
exchange or clearing corporation and generally do not require payment of
margin to the extent that a Fund has unrealized gains in such instruments or
has deposited collateral with its counterparty, the Fund is at risk that its
counterparty will become bankrupt or otherwise fail to honor its obligations.
A Fund will attempt to minimize the risk that a counterparty will become
bankrupt or otherwise fail to honor its obligations by engaging in
transactions in Strategic Instruments traded in OTC markets only with
financial institutions which have substantial capital or which have provided
the Fund with a third-party guaranty or other credit enhancement.
ADDITIONAL LIMITATIONS ON THE USE OF STRATEGIC INSTRUMENTS
No Fund may use any Strategic Instrument to gain exposure to an asset or
class of assets that it would be prohibited by its investment restrictions
from purchasing directly, except that the Natural Resources Focus Fund may
acquire securities indexed to a precious metal or other natural resource
index.
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