As Filed With the Securities and Exchange Commission on January 13, 2000
Securities Act File No. 2-74452
Investment Company Act File No. 811-3290
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM N-1A
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 [X]
Pre-Effective Amendment No. [ ]
Post-Effective Amendment No. 33 [X]
and/or
REGISTRATION STATEMENT UNDER THE
INVESTMENT COMPANY ACT OF 1940 [X]
Amendment No. 34 [X]
(Check appropriate box or boxes)
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Merrill Lynch Variable Series Funds, Inc.
(Exact Name of Registrant as Specified in Charter)
P.O. Box 9011, Princeton, New Jersey 08543-9011
(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code (609) 282-2800
Terry K. Glenn
Merrill Lynch Variable Series Funds, Inc.
800 Scudders Mill Road
Plainsboro, New Jersey 08536
(Name and Address of Agent for Service)
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Copies to:
Michael J. Hennewinkel, Esq. Leonard B. Mackey, Jr., Esq.
Merrill Lynch Clifford Chance Rogers & Wells LLP
Asset Management, L.P. 200 Park Avenue
P.O. Box 9011 New York, New York 10166
Princeton, New Jersey 08543-9011
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It is proposed that this filing will become effective (check appropriate box):
[ ] immediately upon filing pursuant to paragraph (b)
[ ] on (date) pursuant to paragraph (b)
[ ] 60 days after filing pursuant to paragraph (a)(1)
[ ] on (date) pursuant to paragraph (a)(1) of rule 485
[X] 75 days after filing pursuant to paragraph (a)(2)
[ ] on (date) pursuant to paragraph (a)(2) of Rule 485.
If appropriate, check the following box:
[ ] this post-effective amendment designates a new effective date for
a previously filed post-effective amendment.
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<PAGE>
EXPLANATORY NOTE
Merrill Lynch Variable Series Funds, Inc. (the "Company") is an open-ended
management investment company that has a wide range of investment objectives
among its nineteen separate funds (hereinafter referred to as the "Funds" or
individually as a "Fund"). Two separate classes of common stock ("Common
Stock"), Class A Common Stock and Class B Common Stock, are offered for each
Fund. This filing is being made solely for the purpose of registering shares of
a new Fund, the Merrill Lynch Fundamental Growth Focus Fund. Thus, this filing
includes only the prospectus for this Fund and an Appendix for the Class A
Common Stock of the Fund and a separate Appendix for the Class B Common Stock of
the Fund, each of which constitutes a part of the prospectus for either the
Class A Common Stock of the Fund or the Class B Common Stock of the Fund, as
appropriate. A table of contents may be found in the prospectus.
<PAGE>
The information in this prospectus is not complete and may be changed. We may
not use this prospectus to sell securities until the registration statement
containing this prospectus, which has been filed with the Securities and
Exchange Commission, is effective. This prospectus is not an offer to sell these
securities and is not soliciting an offer to buy these securities in any state
where the offer or sale is not permitted.
SUBJECT TO COMPLETION
PRELIMINARY PROSPECTUS DATED JANUARY 13, 2000
[LOGO] Merrill Lynch
Merrill Lynch Variable Series Funds, Inc.
April __, 2000
This Prospectus contains information you should know before investing, including
information about risks. Please read it before you invest and keep it for future
reference.
The Securities and Exchange Commission has not approved or
disapproved these securities or passed upon the adequacy of this Prospectus. Any
representation to the contrary is a criminal offense.
<PAGE>
Table of Contents
Merrill Lynch Fundamental Growth Focus Fund
PAGE
[ICON] KEY FACTS
- --------------------------------------------------------------------------------
Merrill Lynch Fundamental Growth Focus Fund at a Glance ................... 3
Risk/Return Bar Chart ..................................................... 4
[ICON] DETAILS ABOUT THE FUND
- --------------------------------------------------------------------------------
How the Fund Invests ...................................................... 5
Investment Strategies ..................................................... 7
APPENDIX
[ICON] YOUR ACCOUNT
- --------------------------------------------------------------------------------
The Insurance Companies ................................................... A-3
Investment Strategies ..................................................... A-3
Types of Investment Risk .................................................. A-8
How to Buy and Sell Shares ................................................ A-13
[ICON] MANAGEMENT OF THE FUND
- --------------------------------------------------------------------------------
Merrill Lynch Asset Management ............................................ A-15
[ICON] FOR MORE INFORMATION
- --------------------------------------------------------------------------------
Shareholder Reports ................................................. Back Cover
Statement of Additional Information ................................. Back Cover
MERRILL LYNCH FUNDAMENTAL GROWTH FOCUS FUND
<PAGE>
Key Facts [ICON]
In an effort to help you better
understand the many concepts
involved in making an investment
decision, we have defined the
highlighted terms in this prospectus
in the sidebar.
Common Stock -- shares of
ownership of a corporation.
MERRILL LYNCH FUNDAMENTAL GROWTH FOCUS FUND AT A GLANCE
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What is the Fund's stated investment objective?
The investment objective of the Fundamental Growth Focus Fund is to seek
long-term growth of capital.
What are the Fund's goals?
The Fund tries to choose investments that will increase in value over the long
term. We cannot guarantee that the Fund will achieve its goal.
What are the Fund's main investment strategies?
In trying to meet its goals, the Fund purchases primarily common stocks of U.S.
companies that Fund management believes have shown above-average rates of growth
earnings over the long-term. To a lesser extent, the Fund may also invest in
securities convertible into common stock and rights to subscribe to common stock
of these companies. The Fund may invest up to 10% of its total assets in
securities issued by foreign companies.
What are the main risks of investing in the Fund?
As with any mutual fund, the value of the Fund's investments, and therefore the
value of the Fund's shares, may go up or down. Changes in the value of the
Fund's investments may occur because the stock market is rising or falling or as
the result of specific factors that affect particular investments. If the value
of the Fund's investments goes down, you may lose money.
The Fund can invest a portion of its assets in foreign securities. Since foreign
markets may differ significantly from U.S. markets in terms of both economic
conditions and government regulation, investments in foreign securities involve
special risks.
Who should invest?
The Fund may be an appropriate investment to fund a portion of a variable
annuity or insurance contract for contract owners who:
o are looking for capital appreciation for long-term goals, such as
retirement or funding a child's education
o want a professionally managed and diversified portfolio
o are willing to accept the risk of short-term fluctuations in exchange
for the potential of higher long-term returns
o are not looking for a significant amount of current income.
MERRILL LYNCH FUNDAMENTAL GROWTH FOCUS FUND 3
<PAGE>
[ICON] Key Facts
RISK/RETURN BAR CHART
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Performance information is not available for the Fund because the Fund commenced
operations on April __, 2000.
4 MERRILL LYNCH FUNDAMENTAL GROWTH FOCUS FUND
<PAGE>
DETAILS OF THE FUND [ICON]
Market Capitalization -- the
number of shares of a company's
stock, multiplied by the price per
share of that stock. Market
capitalization is a measure of a
company's size.
HOW THE FUND INVESTS
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The Fund's main goal is long-term growth of capital. The Fund tries to achieve
its goals by investing in a diversified portfolio consisting primarily of common
stocks.
The Fund will generally invest at least 65% of its total assets in the following
equity securities:
o common stock
o convertible preferred stock
o securities convertible into common stock
o rights to subscribe to common stock
Of these securities the Fund will generally invest in common stock.
In selecting securities, Fund management emphasizes common stocks of companies
that have above-average rates of earnings growth. Fund management believes that
the common stocks of companies with above-average rates of earnings growth
frequently have the prospect of having above-average increases in price. On the
other hand, such companies tend to have higher stock market valuations. As a
result, their shares may be more vulnerable to price declines from unexpected
adverse developments. The common stocks of these companies also tend to have
higher prices relative to stocks of companies that do not have above average
rates of earnings growth.
Some, but not all of the factors that may cause a company to have an
above-average rate of earnings growth include:
o above average growth rate in sales
o improvement in its profit margin
o providing proprietary or niche products or services
o leading market share
o strong industry growth
The Fund may invest in companies of any size but emphasizes common stocks of
companies having a medium to large stock market capitalization ($500 million or
more).
The Fund may also invest up to 10% of its total assets in the securities of
foreign companies. Securities of foreign companies may be in the form of
American Depository Receipts ("ADRs"), European Depository Receipts ("EDRs") or
other securities representing interests in securities of foreign companies.
MERRILL LYNCH FUNDAMENTAL GROWTH FOCUS FUND 5
<PAGE>
[ICON] DETAILS OF THE FUND
ABOUT THE PORTFOLIO MANAGER
Lawrence R. Fuller is a Senior Vice
President and the Portfolio
Manager of the Fundamental
Growth Focus Fund. Mr. Fuller has
been a First Vice President of the
Investment Adviser since 1997, a
Vice President from 1992 to 1997,
and is responsible for the day-to-
day management of the Fund's
investment portfolio.
ABOUT THE INVESTMENT ADVISER
The Fund is managed by Merrill
Lynch Asset Management.
The Fund's restriction limiting investments in foreign securities to 10% of
total assets does not include ADRs.
The Fund may also lend its portfolio securities.
The Fund will normally invest a portion of its assets in short-term debt
securities, such as commercial paper. These securities can be sold easily and
have limited risk of loss but earn only limited returns. The Fund may also
invest without limitation in short-term debt securities (including repurchase
agreements), non-convertible preferred stocks and bonds or government and money
market securities when Fund management is unable to find enough attractive
equity investments and to reduce exposure to equities when management believes
it is advisable to do so on a temporary basis. Investment in these securities
may also be used to meet redemptions. Short-term investments and temporary
defensive positions may limit the potential for the Fund to achieve its goal of
long-term growth of capital.
6 MERRILL LYNCH FUNDAMENTAL GROWTH FOCUS FUND
<PAGE>
INVESTMENT STRATEGIES
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This table shows the investment strategies that the Fund may use and the
investment limitations, if any, as a percentage of Fund assets. The principal
types of risk associated with each investment strategy are also listed. Numbers
in this table show maximum allowable use only; for actual use, consult the
Fund's annual/semi-annual reports.
The Merrill Lynch Fundamental Growth Focus Fund
Key:
# Maximum % of total assets
- - No restriction on usage
+ Permitted, but used rarely
++ Not Permitted
x Type of risk involved with
investment strategy
<TABLE>
<CAPTION>
Leverage Credit Market Information Valuation Political Currency Liquidity Correlation Selection
risk risk risk risk risk risk risk risk risk risk
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Borrowing 20 x
- -------------------------------------------------------------------------------------------------------------------------------
Short-term Investments/
Repurchase Agreements o x
- -------------------------------------------------------------------------------------------------------------------------------
Securities Lending 20 x x
- -------------------------------------------------------------------------------------------------------------------------------
Short-term Trading o x x
- -------------------------------------------------------------------------------------------------------------------------------
When-issued securities/
forward commitments + x x x
- -------------------------------------------------------------------------------------------------------------------------------
Non-investment grade
securities ++
- -------------------------------------------------------------------------------------------------------------------------------
Foreign Securities 10 x x x x x x x x
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Restricted and Illiquid
Securities 15 x x x x x
- -------------------------------------------------------------------------------------------------------------------------------
Covered call options + x x x x
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Indexed derivative
securities + x x x x x x x x x
- -------------------------------------------------------------------------------------------------------------------------------
Futures and Options + x x x x x x x x
- -------------------------------------------------------------------------------------------------------------------------------
Currency contracts + x x x x x x x x
- -------------------------------------------------------------------------------------------------------------------------------
</TABLE>
Each of these strategies and risks is explained in the Appendix to this
Prospectus.
APPENDIX AND STATEMENT OF ADDITIONAL INFORMATION
- --------------------------------------------------------------------------------
Additional information about this Fund is discussed in the Appendix which is
part of this Prospectus.
If you would like further information about the Fund, including how it invests,
please see the Statement of Additional Information.
MERRILL LYNCH FUNDAMENTAL GROWTH FOCUS FUND 7
<PAGE>
Appendix
Merrill Lynch Variable Series Funds
Class A Shares
PAGE
[ICON] YOUR ACCOUNT
- --------------------------------------------------------------------------------
The Insurance Companies ................................................... A-3
Investment Strategies ..................................................... A-3
Types of Investment Risk .................................................. A-8
How to Buy and Sell Shares ................................................ A-13
[ICON] MANAGEMENT OF THE FUND
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Merrill Lynch Asset Management ............................................ A-15
[ICON] FOR MORE INFORMATION
- --------------------------------------------------------------------------------
Shareholder Reports ................................................. Back Cover
Statement of Additional Information ................................. Back Cover
MERRILL LYNCH VARIABLE SERIES FUNDS
<PAGE>
Your Account [ICON]
THE INSURANCE COMPANIES
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Shares of the Funds are sold to separate accounts of insurance companies (the
"Insurance Companies") to fund certain variable life insurance contracts and/or
variable annuities (the "Contracts") issued by the Insurance Companies. Certain
Insurance Companies may be affiliates of Merrill Lynch Asset Management, L.P.,
the Funds' adviser.
Shares of the Funds are owned by the Insurance Companies, not Contract owners. A
Contract owner has no direct interest in the shares of a Fund, but only in the
Contract. A Contract is described in the prospectus for that Contract. That
prospectus describes the relationship between changes in the value of shares of
a Fund, and the benefits provided under a Contract. The prospectus for a
Contract also describes various fees payable to the Insurance Company and
charges to the separate account made by the Insurance Company with respect to
the Contract. Because shares of the Funds will be sold only to the Insurance
Companies for the separate accounts, the terms "shareholder" and "shareholders"
in this Prospectus refer to the Insurance Companies.
More than one Insurance Company may invest in each Fund. It is possible that a
difference may arise among the interests of Insurance Companies that invest in a
Fund or the holders of different types of Contracts--for example, if applicable
state insurance law or Contract owner instructions prevent an Insurance Company
from continuing to invest in a Fund following a change in the Fund's investment
policies, or if different tax laws apply to variable life insurance contracts
and variable annuities. The Fund and the Insurance Companies will attempt to
monitor events to prevent such differences from arising. If a conflict between
Insurance Companies occurs, or between life insurance policies and annuity
contracts, however, the Fund may be required to take actions that are adverse to
the interests of a particular Insurance Company and its Contract owners, or to
the interests of holders of a particular type of Contract.
INVESTMENT STRATEGIES
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This section contains a discussion of certain investment strategies that may be
used by the Funds. The forepart of this Prospectus indicates which of the
following strategies may be used by each Fund. The risks associated with each of
these strategies are described in greater detail in the following section of
this Appendix, "Types of Investment Risk". As with any mutual fund, there can be
no guarantee that a Fund will meet its goals or that a Fund's performance will
be positive for any period of time.
MERRILL LYNCH VARIABLE SERIES FUNDS A-3
<PAGE>
[ICON] Your Account
Borrowing and Leverage -- Each Fund may borrow for temporary emergency purposes
including to meet redemptions. Borrowing may exaggerate changes in the net asset
value of Fund shares and in the yield on the Fund's portfolio. Borrowing will
cost the Fund interest expense and other fees. The cost of borrowing may reduce
the Fund's return. Borrowing involves leverage risk.
Short-Term Investments -- Each Fund will normally invest a portion of its assets
in short-term debt securities, such as commercial paper or treasury bills
agreements. As a temporary measure for defensive purposes, each Fund may invest
more heavily in these securities, without limitation. A Fund may also increase
its investment in these securities when Fund management is unable to find enough
attractive long-term investments, to reduce exposure to long-term investments
when management believes it is advisable to do so on a temporary basis, or to
meet redemptions. Investments in short-term debt securities can be sold easily
and have limited risk of loss but earn only limited returns. Short-term
investments may therefore limit the potential for a fund to achieve its
investment objective. Short-term investments involve credit risk.
Repurchase Agreements -- Each Fund may invest in repurchase agreements. A
repurchase agreement involves the purchase of a security together with a
simultaneous agreement to resell the security to the seller at a later date at
approximately the purchase price less an amount that represents interest to the
buyer. Repurchase agreements are considered relatively safe, liquid investments
for short-term cash, but involve the risk that the seller will fail to
repurchase the security and that the Fund will have to attempt to sell the
security in the market for its current value, which may be less than the amount
the Fund paid for the security. Repurchase agreements involve credit risk.
Securities Lending -- Each Fund may lend a portion of its portfolio securities.
A Fund may lend portfolio securities to financial institutions in return for
collateral in the form of government securities or cash. A Fund making a
securities loan will either receive a fee from the borrower or pay the borrower
interest in return for the right to seek to invest cash collateral at a higher
rate. If a borrower fails to return a Fund's security, the Fund will have to
attempt to liquidate the borrower's collateral, which may be worth less than the
Fund's security. Securities loans involve leverage risk and credit risk.
A-4 MERRILL LYNCH VARIABLE SERIES FUNDS
<PAGE>
Short-Term Trading -- Each Fund can buy and sell securities whenever it sees a
market opportunity, and therefore each Fund may engage in short-term trading.
Short-term trading may increase a Fund's expenses and have tax consequences.
Short-term trading involves market risk and selection risk.
When-Issued Securities, Delayed Delivery Securities and Forward Commitments --
When-issued and delayed-delivery securities and forward commitments involve the
risk that the security a Fund buys will lose value prior to its delivery. There
also is the risk that the security will not be issued or that the other party
will not meet its obligation. If this occurs, the Fund both loses the investment
opportunity for the assets it has set aside to pay for the security and any gain
in the security's price. When-issued and delayed delivery securities and forward
commitments involve market risk, selection risk and leverage risk.
Non-Investment Grade Securities -- Non-investment grade securities, otherwise
known as "junk bonds", are debt securities that are rated below investment grade
by the major rating agencies or are unrated securities that Fund management
believes are of comparable quality. Although junk bonds generally pay higher
rates of interest than investment grade bonds, they are high risk investments
that may cause income and principal losses for a Fund. Junk bonds generally are
less liquid and experience more price volatility than higher rated debt
securities. The issuers of junk bonds may have a larger amount of outstanding
debt relative to their assets than issuers of investment grade bonds. In the
event of an issuer bankruptcy, claims of other creditors may have priority over
the claims of junk bond holders, leaving few or no assets available to repay
junk bond holders. Junk bonds involve credit risk, market risk, selection risk,
valuation risk and liquidity risk, and certain junk bonds may also involve
information risk, political risk or currency risk.
Foreign Securities -- Certain Funds may invest in foreign securities. Foreign
investing involves special risks not present in U.S. securities that may
increase the chance a Fund will lose money, including foreign currency risk and
the possibility of substantial volatility due to adverse political, economic or
other developments. Foreign securities may also be less liquid and harder to
value than U.S. securities. These risks are greater for investments in emerging
markets. Foreign investing involves market risk, selection risk and political
risk, and certain foreign investments may also involve credit risk, information
risk, valuation risk, currency risk and liquidity risk.
Restricted and Illiquid Securities -- Each Fund may invest a portion of its
assets in restricted and illiquid securities, which are investments that
MERRILL LYNCH VARIABLE SERIES FUNDS A-5
<PAGE>
[ICON] Your Account
the Fund cannot easily resell within seven days at current value or that have
contractual or legal restrictions on resale. If the Fund buys illiquid
securities it may be unable to quickly resell them or may be able to sell them
only at a price below current value. Restricted and illiquid securities involve
liquidity risk, market risk, selection risk and valuation risk, and may involve
information risk.
Covered Call Options -- Certain Funds can sell covered call options, which are
options that give the purchaser the right to require a Fund to sell a security
owned by the Fund to the purchaser at a specified price within a limited time
period. These Funds may also sell the purchaser a right to require the Fund to
make a payment based on the level of an index that is closely correlated with
some of the Fund's holdings. A Fund will receive a premium (an upfront payment)
for selling a covered call option, and if the option expires unexercised because
the price of the underlying security has gone down the premium received by the
Fund will partially offset any losses on the underlying security. By writing a
covered call option, however, a Fund limits its ability to sell the underlying
security and gives up the opportunity to profit from any increase in the value
of the underlying security beyond the sale price specified in the option.
Covered call options involve market risk, correlation risk, liquidity risk and
selection risk.
Indexed Derivative Securities -- Certain Funds may invest in debt securities the
potential returns of which are directly related to changes in an underlying
index or interest rate, known as indexed securities. The return on indexed
securities will rise when the underlying index or interest rate rises and fall
when the index or interest rate falls. Some funds may also invest in securities
whose return is inversely related to changes in an index or interest rate. In
general, inverse securities change in value in a manner that is opposite to most
securities -- that is, the return of inverse securities will decrease when the
index increases in value and increase in value when the index decreases.
Investments in indexed and inverse securities may subject the Fund to the risks
of reduced or eliminated interest payments and losses of principal. In addition,
certain indexed and inverse securities may increase or decrease in value at a
greater rate than the underlying index, which effectively leverages the Fund's
investment. As a result, the market value of such securities will generally be
more volatile than that of other securities. Indexed and inverse securities
involve credit risk, market risk and selection risk, and may also involve
leverage risk, valuation risk, political risk, currency risk, liquidity risk or
correlation risk.
A-6 MERRILL LYNCH VARIABLE SERIES FUNDS
<PAGE>
Futures and Options -- Certain Funds may use futures and options. Futures are
exchange-traded contracts involving the obligation of the seller to deliver, and
the buyer to receive, certain assets (or a money payment based on the change in
value of certain assets or an index) at a specified time. Futures involve
leverage risk and correlation risk and may involve currency risk and political
risk. Options are exchange-traded or private contracts involving the right of a
holder to deliver (a "put") or receive (a "call") certain assets (or a money
payment based on the change of certain assets or an index) from another party at
a specified price within a specified time period. Options involve leverage risk
and correlation risk. Private options also involve credit risk, valuation risk
and liquidity risk. Options may involve currency risk and political risk.
The Funds will use futures and options primarily for hedging purposes -- that
is, to offset the risk that other holdings may decrease in value or that
potential investment opportunities may increase in value before the Fund can
fully implement its investment strategy. The Funds may use options, however, to
enhance total return as well as for hedging purposes. While hedging can reduce
losses, it can also reduce or eliminate gains if markets move in a different
manner than anticipated by the Fund or if the cost of the future or option
outweighs the benefit of the hedge. Hedging also involves the risk that changes
in the value of the future or option will not match those of the holdings being
hedged as expected by the Fund, in which case losses on the holdings being
hedged may not be reduced.
Currency Contracts -- Certain Funds may buy securities denominated or quoted in
currencies other than the U.S. dollar. Changes in foreign currency exchange
rates will affect the value of the securities of the Fund. In order to seek to
limit such changes, certain Funds may buy or sell contracts relating to foreign
currencies for hedging purposes. Hedging is a strategy in which a currency
contract is used to offset the risk that other Fund holdings may decrease in
U.S. dollar value as the result of changes in exchange rates. Losses on the
other investment may be substantially reduced by gains on a currency contract
that reacts in an opposite manner to market movements. While hedging can reduce
losses, it can also reduce or eliminate gains if exchange rates move in a
different manner than anticipated by the Fund or if the cost of the currency
contract outweighs the benefit of the hedge. Hedging also involves the risk that
changes in the value of the currency contract will not match those of the
holdings being hedged as expected by the Fund, in which case any losses on the
holdings being hedged may not be reduced.
MERRILL LYNCH VARIABLE SERIES FUNDS A-7
<PAGE>
[ICON] Your Account
A Fund may not be able to (or may not try to) hedge all currency risks, and
there is no guaranty that a Fund's currency hedging, if attempted, will be
successful. A Fund may attempt to hedge through several different types of
currency contracts, including currency forwards, currency options and
currency-indexed instruments. Currency contracts involve currency risk, market
risk, political risk and correlation risk and may also involve credit risk,
valuation risk and liquidity risk, leverage risk and liquidity risk.
TYPES OF INVESTMENT RISK
- --------------------------------------------------------------------------------
This section contains a discussion of various risks that may be associated with
certain investment strategies. The forepart of this Prospectus indicates which
investment strategies may be used by each Fund.
Correlation Risk -- The risk that changes in the value of two investments do not
track or offset each other in the manner anticipated by Fund management.
Correlation risk is associated with hedging transactions, in which a Fund uses a
derivative to offset the risk that other Fund holdings may decrease in value or
that potential investment opportunities may increase in value before the Fund
can fully implement its investment strategy. Correlation risk means that changes
in the value of the derivative may not match those of the holdings being hedged
as expected by the Fund, in which case any losses on the holdings or potential
holdings being hedged may not be reduced.
Credit Risk -- The risk that the issuer of an investment or other party to a
trade will be unable to honor its obligations to a Fund.
Currency Risk -- The risk that changes in the exchange rate between currencies
will adversely affect the value (in U.S. dollar terms) of an investment.
Generally, when the U.S. dollar rises in value against a foreign currency, a
security denominated in that currency loses value to a U.S. investor because the
currency is worth fewer U.S. dollars.
Information Risk -- The risk that important information about a security or
market is inaccurate, unreliable or unavailable.
Leverage Risk -- The risk associated with certain types of investments or
trading strategies (such as borrowing money to increase the amount of
investments) that relatively small market movements may result in large
A-8 MERRILL LYNCH VARIABLE SERIES FUNDS
<PAGE>
changes in value of an investment. Certain investments or trading strategies
that involve leverage can result in losses that greatly exceed the amount
originally invested.
Liquidity Risk -- The risk that certain securities may be difficult or
impossible to sell at the time that a Fund would like or at the price that a
Fund believes the security is currently worth.
Market Risk/Interest Rate Risk -- The risk that the entire market will undergo
an unanticipated change in value, including the possibility that the market will
go down sharply and unpredictably. For fixed-income investments, this includes
the risk that the value of an investment will decrease as a result of changes in
interest rates. Generally, when interest rates increase, fixed-income securities
decrease in value and longer-term fixed-income securities decrease in value more
than short-term fixed-income securities.
Political Risk -- The risk of losses arising from government or legal events,
such as changes in tax or trade laws, imposition of currency controls, adverse
court or administrative rulings, or change of a government or political system.
Selection Risk -- The risk that a specific Fund investment will underperform the
market.
Valuation Risk -- The risk that a Fund has valued an investment at a higher
price than it can actually obtain upon a sale.
SPECIAL RISKS ASSOCIATED WITH FOREIGN INVESTMENTS GENERALLY
- --------------------------------------------------------------------------------
Foreign Market Risk -- Since a Fund may invest in foreign securities, it offers
the potential for more diversification than an investment only in the United
States. This is because stocks traded on foreign markets have often (though not
always) performed differently than stocks in the United States. However, such
investments involve special risks not present in U.S. investments that can
increase the chances that a Fund will lose money. In particular, investment in
foreign securities involves the following risks, which are generally greater for
investments in emerging markets.
MERRILL LYNCH VARIABLE SERIES FUNDS A-9
<PAGE>
[ICON] Your Account
o The economies of some foreign markets often do not compare favorably
with that of the United States in areas such as growth of gross
domestic product, reinvestment of capital, resources and balance of
payments. Some of these economies may rely heavily on particular
industries or foreign capital. They may be more vulnerable to adverse
diplomatic developments, the imposition of economic sanctions against
a particular country or countries, changes in international trading
patterns, trade barriers and other protectionist or retaliatory
measures.
o Investments in foreign markets may be adversely affected by
governmental actions such as the imposition of capital controls,
nationalization of companies or industries, expropriation of assets or
the imposition of punitive taxes.
o The governments of certain countries may prohibit or impose
substantial restrictions on foreign investing in their capital markets
or in certain industries. Any of these actions could severely affect
security prices. They could also impair a Fund's ability to purchase
or sell foreign securities or transfer its assets or income back into
the United States, or otherwise adversely affect the Fund's
operations.
o Other foreign market risks include foreign exchange controls,
difficulties in pricing securities, defaults on foreign government
securities, difficulties in enforcing favorable legal judgments in
foreign courts and political and social instability. Legal remedies
available to investors in some foreign countries may be less extensive
than those available to investors in the United States.
o Because there are generally fewer investors on foreign exchanges and a
smaller number of shares traded each day, it may be difficult for a
Fund to buy and sell securities on those exchanges. In addition,
prices of foreign securities may go up and down more than prices of
securities traded in the United States.
A-10 MERRILL LYNCH VARIABLE SERIES FUNDS
<PAGE>
o Foreign markets may have different clearance and settlement
procedures. In certain markets, settlements may be unable to keep pace
with the volume of securities transactions. If this occurs, settlement
may be delayed and a Fund's assets may be uninvested and not earning
returns. A Fund may miss investment opportunities or be unable to sell
an investment because of these delays
Certain Risks of Holding Fund Assets Outside the United States -- A Fund
generally holds its foreign securities and cash in foreign banks and securities
depositories. Some foreign banks and securities depositories may be recently
organized or new to the foreign custody business. In addition, there may be
limited or no regulatory oversight over their operations. Also, the laws of
certain countries may put limits on a Fund's ability to recover its assets if a
foreign bank, depository or issuer of a security, or any of their agents, goes
bankrupt. In addition, it is often more expensive for a Fund to buy, sell and
hold securities in certain foreign markets than in the United States. The
increased expense of investing in foreign markets reduces the amount a Fund can
earn on its investments and typically results in a higher operating expense
ratio for a Fund than investment companies invested only in the United States.
European Economic and Monetary Union ("EMU") -- A number of European countries
have entered into EMU in an effort to reduce trade barriers between themselves
and eliminate fluctuations in their currencies. EMU establishes a single
European currency (the euro), which was introduced on January 1, 1999 and is
expected to replace the existing national currencies of all initial EMU
participants by July 1, 2002. Certain securities (beginning with government and
corporate bonds) were redenominated in the euro. These securities trade and make
dividend and other payments only in euros. Like other investment companies and
business organizations, including the companies in which a Fund invests, a Fund
could be adversely affected:
o If the transition to euro, or EMU as a whole, does not proceed as
planned.
o If a participating country withdraws from EMU.
o If the computing, accounting and trading systems used by a Fund's
service providers, or by other entities with which a Fund or its
service providers do business, are not capable of recognizing the euro
as a distinct currency.
MERRILL LYNCH VARIABLE SERIES FUNDS A-11
<PAGE>
[ICON] Your Account
Currency Risk -- Securities in which a Fund invests may be denominated or quoted
in currencies other than the U.S. dollar. Changes in foreign currency exchange
rates affect the value of a Fund's portfolio. Generally, when the U.S. dollar
rises in value against a foreign currency, a security denominated in that
currency loses value because the currency is worth fewer U.S. dollars.
Conversely, when the U.S. dollar decreases in value against a foreign currency,
a security denominated in that currency gains value because the currency is
worth more U.S. dollars. This risk, generally known as "currency risk", means
that a stronger U.S. dollar will reduce returns for U.S. investors while a weak
U.S. dollar will increase those returns.
Governmental Supervision and Regulation/Accounting Standard -- Many foreign
governments supervise and regulate stock exchanges, brokers and the sale of
securities less than the United States does. Some countries may not have laws to
protect investors the way that the United States' securities laws do. For
example, some countries may have no laws or rules against insider trading.
Insider trading occurs when a person buys or sells a company's securities based
on non-public information about that company. Accounting standards in other
countries are not necessarily the same as in the United States. If the
accounting standards in another country do not require as much detail as U.S.
accounting standards, it may be harder for Fund Management to completely and
accurately determine a company's financial condition. Also, brokerage
commissions and other costs of buying or selling securities often are higher in
foreign countries than they are in the United States. This reduces the amount a
Fund can earn on investments.
Emerging Market Risks -- The risks of foreign investments are usually much
greater for emerging markets. Investments in emerging markets may be considered
speculative. Emerging markets include those in countries defined as emerging or
developing by the World Bank, the International Finance Corporation, or the
United Nations. Emerging markets are riskier because they develop unevenly and
may never fully develop. They are more likely to experience hyperinflation and
currency devaluations, which adversely affects returns to U.S. investors. In
addition, the securities markets in many of these countries have far lower
trading volumes and less liquidity than developed markets. Since these markets
are so small, they may be more likely to suffer sharp and frequent price changes
or long-term price depression because of adverse publicity, investor
perceptions, or the actions of a few large investors. In addition, traditional
measures of investment value used in the United States, such as price to
earnings ratios, may not apply to certain small markets.
A-12 MERRILL LYNCH VARIABLE SERIES FUNDS
<PAGE>
Net Asset Value -- the market value of a
Fund's total assets after deducting
liabilities divided by the number shares
outstanding.
Many emerging markets have histories of political instability and abrupt changes
in policies. As a result, their governments are more likely to take actions that
are hostile or detrimental to private enterprise or foreign investment than
those of more developed countries. Certain emerging markets may also face other
significant internal or external risks, including the risk of war, and ethnic,
religious, and racial conflicts. In addition, governments in many emerging
market countries participate to a significant degree in their economies and
securities markets, which may impair investment and economic growth.
HOW TO BUY AND SELL SHARES
- --------------------------------------------------------------------------------
The Company is offering through this prospectus Class A shares in each of its
Funds to the Insurance Companies. The price of shares purchased by the Insurance
Companies is based on the next calculation of the per share net asset value of
the Fund after an order is placed.
The Company may reject any order to buy shares and may suspend the sale of
shares at any time.
The Company will redeem all full and fractional shares of the Funds for cash.
The price of redeemed shares is based on the next calculation of net asset value
after a redemption order is placed.
HOW SHARES ARE PRICED
- --------------------------------------------------------------------------------
When an Insurance Company purchases shares, the Insurance Company pays the net
asset value. This is the offering price. Shares are also redeemed at their net
asset value. Each Fund calculates its net asset value (generally by using market
quotations) each day the New York Stock Exchange is open, fifteen minutes after
the close of business on the Exchange (the Exchange generally closes at 4:00
p.m. Eastern time). Securities held by the Domestic Money Market and Reserve
Assets Funds with a remaining maturity of 60 days or less are generally valued
on an amortized cost basis. Under this method of valuation, a security is
initially valued at cost on the date of
MERRILL LYNCH VARIABLE SERIES FUNDS A-13
<PAGE>
[ICON] Your Account
Dividends -- ordinary income and capital
gains paid to shareholders. Dividends
will be reinvested in additional Fund
shares as they are paid.
purchase, and then the Domestic Money Market and Reserve Assets Fund amortize
the value of the security at a constant rate until the maturity of the security,
regardless of the impact of fluctuating interest rates on the market value of
the security. The net asset value used in determining the price for the purchase
or redemption of shares is the next one calculated after the purchase or
redemption order is placed. Foreign securities owned by a Fund may trade on
weekends or other days when a Fund does not price its shares. As a result, the
Fund's net asset value may change on days when an Insurance Company will not be
able to purchase or redeem the Fund's shares. The Domestic Money Market Fund and
the Reserve Assets Fund will seek to maintain a net asset value of $1.00 per
Share.
DIVIDENDS AND TAXES
- --------------------------------------------------------------------------------
The Domestic Money Market and Reserve Assets Funds will declare dividends daily
and will reinvest dividends monthly in additional full and fractional shares of
those Funds. The Global Bond Focus, Government Bond, High Current Income and
Prime Bond Funds will declare dividends monthly and reinvest dividends monthly
in additional shares of those Funds. The Global Utility Fund will declare
dividends quarterly and will reinvest dividends quarterly in additional shares
of the Fund. The American Balanced, Basic Value Focus, Capital Focus, Developing
Capital Markets Focus, Fundamental Growth Focus, Global Growth Focus, Global
Strategy Focus, Index 500, International Equity Focus, Natural Resources Focus,
Quality Equity and Special Value Focus Funds will declare dividends at least
annually and will reinvest dividends at least annually in additional shares of
the respective Funds.
Dividends paid by the Company may be included in a Insurance Company's gross
income. The tax treatment of these dividends depends on the Insurance Company's
tax status. A description of an Insurance Company's tax status is contained in
the prospectus for the Contract.
A-14 MERRILL LYNCH VARIABLE SERIES FUNDS
<PAGE>
Management of the Fund [ICON]
MERRILL LYNCH ASSET MANAGEMENT
- --------------------------------------------------------------------------------
Merrill Lynch Asset Management, the Company's Investment Adviser, manages the
Company's investments and its business operations under the overall supervision
of the Company's Board of Directors. The Investment Adviser has the
responsibility for making all investment decisions for the Company. The
Investment Adviser has a sub-advisory agreement with Merrill Lynch Asset
Management U.K. Limited, an affiliate, under which the Investment Adviser may
pay a fee for services it receives.
Management
Fee for
Year Ended % of Its
Fund Name December 31, 1998 Avg Net Assets
- --------------------------------------------------------------------------------
American Balance Fund $1,043,157 0.55%
- --------------------------------------------------------------------------------
Basic Value Focus Fund $4,516,100 0.60%
- --------------------------------------------------------------------------------
Capital Focus Fund $ 61,312 0.60%
- --------------------------------------------------------------------------------
Developing Capital Markets Focus Fund $1,126,826 1.00%
- --------------------------------------------------------------------------------
Domestic Money Market Fund $1,765,415 0.50%
- --------------------------------------------------------------------------------
Fundamental Growth Focus Fund* N/A N/A
- --------------------------------------------------------------------------------
Global Bond Focus Fund $ 430,336 0.60%
- --------------------------------------------------------------------------------
Global Growth Focus Fund $ 49,823 0.75%
- --------------------------------------------------------------------------------
Global Strategy Focus Fund $5,364,685 0.65%
- --------------------------------------------------------------------------------
Global Utility Focus Fund $ 829,080 0.60%
- --------------------------------------------------------------------------------
Government Bond Fund $1,195,999 0.50%
- --------------------------------------------------------------------------------
High Current Income Fund $2,630,447 0.47%
- --------------------------------------------------------------------------------
Index 500 Fund $ 965,368 0.30%
- --------------------------------------------------------------------------------
International Equity Focus Fund $2,370,652 0.75%
- --------------------------------------------------------------------------------
Natural Resources Focus Fund $ 135,222 0.65%
- --------------------------------------------------------------------------------
Prime Bond Fund $2,330,935 0.42%
- --------------------------------------------------------------------------------
Quality Equity Fund $3,758,987 0.43%
- --------------------------------------------------------------------------------
Reserve Assets Fund $ 109,945 0.50%
- --------------------------------------------------------------------------------
Special Value Focus Fund $3,594,897 0.75%
- --------------------------------------------------------------------------------
Merrill Lynch Asset Management is part of Merrill Lynch Asset Management Group,
which had approximately $515 billion in investment company and other portfolio
assets under management as of March 1999. This amount includes assets managed
for Merrill Lynch affiliates.
*Fundamental Growth Focus Fund commenced operations on April ____, 2000.
MERRILL LYNCH VARIABLE SERIES FUNDS A-15
<PAGE>
[ICON] Management of the Fund
ADDITIONAL INFORMATION
- --------------------------------------------------------------------------------
Investment Adviser -- Merrill Lynch Asset Management, L.P., 800 Scudders Mill
Road, Plainsboro, New Jersey 08536, has been selected as the investment adviser
of the Company.
Independent Auditors -- Deloitte & Touche LLP, Princeton Forrestal Village,
116-300 Village Boulevard, 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, 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 -- Financial Data Services, Inc. ("FDS"),
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.
FDS will receive an annual fee of $5,000 per Fund and will be entitled to
reimbursement of out-of-pocket expenses.
Legal Counsel -- Clifford Chance Rogers & Wells LLP, New York, New York, is
counsel for the Company.
A-16 MERRILL LYNCH VARIABLE SERIES FUNDS
<PAGE>
Appendix
Merrill Lynch Variable Series Funds
Class B Shares
PAGE
[ICON] YOUR ACCOUNT
- --------------------------------------------------------------------------------
The Insurance Companies ................................................... A-3
Investment Strategies ..................................................... A-3
Types of Investment Risk .................................................. A-8
How to Buy and Sell Shares ................................................ A-12
[ICON] MANAGEMENT OF THE FUND
- --------------------------------------------------------------------------------
Merrill Lynch Asset Management ............................................ A-15
[ICON] FOR MORE INFORMATION
- --------------------------------------------------------------------------------
Shareholder Reports ................................................. Back Cover
Statement of Additional Information ................................. Back Cover
MERRILL LYNCH VARIABLE SERIES FUNDS
<PAGE>
Your Account [ICON]
THE INSURANCE COMPANIES
- --------------------------------------------------------------------------------
Shares of the Funds are sold to separate accounts of insurance companies (the
"Insurance Companies") to fund certain variable life insurance contracts and/or
variable annuities (the "Contracts") issued by the Insurance Companies. Certain
Insurance Companies may be affiliates of Merrill Lynch Asset Management, L.P.,
the Funds' adviser.
Shares of the Funds are owned by the Insurance Companies, not Contract owners. A
Contract owner has no direct interest in the shares of a Fund, but only in the
Contract. A Contract is described in the prospectus for that Contract. That
prospectus describes the relationship between changes in the value of shares of
a Fund, and the benefits provided under a Contract. The prospectus for a
Contract also describes various fees payable to the Insurance Company and
charges to the separate account made by the Insurance Company with respect to
the Contract. Because shares of the Funds will be sold only to the Insurance
Companies for the separate accounts, the terms "shareholder" and "shareholders"
in this Prospectus refer to the Insurance Companies.
More than one Insurance Company may invest in each Fund. It is possible that a
difference may arise among the interests of Insurance Companies that invest in a
Fund or the holders of different types of Contracts--for example, if applicable
state insurance law or Contract owner instructions prevent an Insurance Company
from continuing to invest in a Fund following a change in the Fund's investment
policies, or if different tax laws apply to variable life insurance contracts
and variable annuities. The Fund and the Insurance Companies will attempt to
monitor events to prevent such differences from arising. If a conflict between
Insurance Companies occurs, or between life insurance policies and annuity
contracts, however, the Fund may be required to take actions that are adverse to
the interests of a particular Insurance Company and its Contract owners, or to
the interests of holders of a particular type of Contract.
INVESTMENT STRATEGIES
- --------------------------------------------------------------------------------
This section contains a discussion of certain investment strategies that may be
used by the Funds. The forepart of this Prospectus indicates which of the
following strategies may be used by each Fund. The risks associated with each of
these strategies are described in greater detail in the following section
MERRILL LYNCH VARIABLE SERIES FUNDS A-3
<PAGE>
[ICON] Your Account
of this Appendix, "Types of Investment Risk". As with any mutual fund, there can
be no guarantee that a Fund will meet its goals or that a Fund's performance
will be positive for any period of time.
Borrowing and Leverage -- Each Fund may borrow for temporary emergency purposes
including to meet redemptions. Borrowing may exaggerate changes in the net asset
value of Fund shares and in the yield on the Fund's portfolio. Borrowing will
cost the Fund interest expense and other fees. The cost of borrowing may reduce
the Fund's return. Borrowing involves leverage risk.
Short-Term Investments -- Each Fund will normally invest a portion of its assets
in short-term debt securities, such as commercial paper or treasury bills
agreements. As a temporary measure for defensive purposes, each Fund may invest
more heavily in these securities, without limitation. A Fund may also increase
its investment in these securities when Fund management is unable to find enough
attractive long-term investments, to reduce exposure to long-term investments
when management believes it is advisable to do so on a temporary basis, or to
meet redemptions. Investments in short-term debt securities can be sold easily
and have limited risk of loss but earn only limited returns. Short-term
investments may therefore limit the potential for a fund to achieve its
investment objective. Short-term investments involve credit risk.
Repurchase Agreements -- Each Fund may invest in repurchase agreements. A
repurchase agreement involves the purchase of a security together with a
simultaneous agreement to resell the security to the seller at a later date at
approximately the purchase price less an amount that represents interest to the
buyer. Repurchase agreements are considered relatively safe, liquid investments
for short-term cash, but involve the risk that the seller will fail to
repurchase the security and that the Fund will have to attempt to sell the
security in the market for its current value, which may be less than the amount
the Fund paid for the security. Repurchase agreements involve credit risk.
Securities Lending -- Each Fund may lend a portion of its portfolio securities.
A Fund may lend portfolio securities to financial institutions in return for
collateral in the form of government securities or cash. A Fund making a
securities loan will either receive a fee from the borrower or pay the borrower
interest in return for the right to seek to invest cash collateral at a higher
rate. If a borrower fails to return a Fund's security, the Fund will have to
attempt to liquidate the borrower's collateral, which may be worth less than the
Fund's security. Securities loans involve leverage risk and credit risk.
A-4 MERRILL LYNCH VARIABLE SERIES FUNDS
<PAGE>
Short-Term Trading -- Each Fund can buy and sell securities whenever it sees a
market opportunity, and therefore each Fund may engage in short-term trading.
Short-term trading may increase a Fund's expenses and have tax consequences.
Short-term trading involves market risk and selection risk.
When-Issued Securities, Delayed Delivery Securities and Forward Commitments --
When-issued and delayed-delivery securities and forward commitments involve the
risk that the security a Fund buys will lose value prior to its delivery. There
also is the risk that the security will not be issued or that the other party
will not meet its obligation. If this occurs, the Fund both loses the investment
opportunity for the assets it has set aside to pay for the security and any gain
in the security's price. When-issued and delayed delivery securities and forward
commitments involve market risk, selection risk and leverage risk.
Non-Investment Grade Securities -- Non-investment grade securities, otherwise
known as "junk bonds", are debt securities that are rated below investment grade
by the major rating agencies or are unrated securities that Fund management
believes are of comparable quality. Although junk bonds generally pay higher
rates of interest than investment grade bonds, they are high risk investments
that may cause income and principal losses for a Fund. Junk bonds generally are
less liquid and experience more price volatility than higher rated debt
securities. The issuers of junk bonds may have a larger amount of outstanding
debt relative to their assets than issuers of investment grade bonds. In the
event of an issuer bankruptcy, claims of other creditors may have priority over
the claims of junk bond holders, leaving few or no assets available to repay
junk bond holders. Junk bonds involve credit risk, market risk, selection risk,
valuation risk and liquidity risk, and certain junk bonds may also involve
information risk, political risk or currency risk.
Foreign Securities -- Certain Funds may invest in foreign securities. Foreign
investing involves special risks not present in U.S. securities that may
increase the chance a Fund will lose money, including foreign currency risk and
the possibility of substantial volatility due to adverse political, economic or
other developments. Foreign securities may also be less liquid and harder to
value than U.S. securities. These risks are greater for investments in emerging
markets. Foreign investing involves market risk, selection risk and political
risk, and certain foreign investments may also involve credit risk, information
risk, valuation risk, currency risk and liquidity risk.
MERRILL LYNCH VARIABLE SERIES FUNDS A-5
<PAGE>
[ICON] Your Account
Restricted and Illiquid Securities -- Each Fund may invest a portion of its
assets in restricted and illiquid securities, which are investments that the
Fund cannot easily resell within seven days at current value or that have
contractual or legal restrictions on resale. If the Fund buys illiquid
securities it may be unable to quickly resell them or may be able to sell them
only at a price below current value. Restricted and illiquid securities involve
liquidity risk, market risk, selection risk and valuation risk, and may involve
information risk.
Covered Call Options -- Certain Funds can sell covered call options, which are
options that give the purchaser the right to require a Fund to sell a security
owned by the Fund to the purchaser at a specified price within a limited time
period. These Funds may also sell the purchaser a right to require the Fund to
make a payment based on the level of an index that is closely correlated with
some of the Fund's holdings. A Fund will receive a premium (an upfront payment)
for selling a covered call option, and if the option expires unexercised because
the price of the underlying security has gone down the premium received by the
Fund will partially offset any losses on the underlying security. By writing a
covered call option, however, a Fund limits its ability to sell the underlying
security and gives up the opportunity to profit from any increase in the value
of the underlying security beyond the sale price specified in the option.
Covered call options involve market risk, correlation risk, liquidity risk and
selection risk.
Indexed Derivative Securities -- Certain Funds may invest in debt securities the
potential returns of which are directly related to changes in an underlying
index or interest rate, known as indexed securities. The return on indexed
securities will rise when the underlying index or interest rate rises and fall
when the index or interest rate falls. Some funds may also invest in securities
whose return is inversely related to changes in an index or interest rate. In
general, inverse securities change in value in a manner that is opposite to most
securities -- that is, the return of inverse securities will decrease when the
index increases in value and increase in value when the index decreases.
Investments in indexed and inverse securities may subject the Fund to the risks
of reduced or eliminated interest payments and losses of principal. In addition,
certain indexed and inverse securities may increase or decrease in value at a
greater rate than the underlying index, which effectively leverages the Fund's
investment. As a result, the market value of such securities will generally be
more volatile than that of other securities.
A-6 MERRILL LYNCH VARIABLE SERIES FUNDS
<PAGE>
Indexed and inverse securities involve credit risk, market risk and selection
risk, and may also involve leverage risk, valuation risk, political risk,
currency risk, liquidity risk or correlation risk.
Futures and Options -- Certain Funds may use futures and options. Futures are
exchange-traded contracts involving the obligation of the seller to deliver, and
the buyer to receive, certain assets (or a money payment based on the change in
value of certain assets or an index) at a specified time. Futures involve
leverage risk and correlation risk and may involve currency risk and political
risk. Options are exchange-traded or private contracts involving the right of a
holder to deliver (a "put") or receive (a "call") certain assets (or a money
payment based on the change of certain assets or an index) from another party at
a specified price within a specified time period. Options involve leverage risk
and correlation risk. Private options also involve credit risk, valuation risk
and liquidity risk. Options may involve currency risk and political risk.
The Funds will use futures and options primarily for hedging purposes -- that
is, to offset the risk that other holdings may decrease in value or that
potential investment opportunities may increase in value before the Fund can
fully implement its investment strategy. The Funds may use options, however, to
enhance total return as well as for hedging purposes. While hedging can reduce
losses, it can also reduce or eliminate gains if markets move in a different
manner than anticipated by the Fund or if the cost of the future or option
outweighs the benefit of the hedge. Hedging also involves the risk that changes
in the value of the future or option will not match those of the holdings being
hedged as expected by the Fund, in which case losses on the holdings being
hedged may not be reduced.
Currency Contracts -- Certain Funds may buy securities denominated or quoted in
currencies other than the U.S. dollar. Changes in foreign currency exchange
rates will affect the value of the securities of the Fund. In order to seek to
limit such changes, certain Funds may buy or sell contracts relating to foreign
currencies for hedging purposes. Hedging is a strategy in which a currency
contract is used to offset the risk that other Fund holdings may decrease in
U.S. dollar value as the result of changes in exchange rates. Losses on the
other investment may be substantially reduced by gains on a currency contract
that reacts in an opposite manner to market movements. While hedging can reduce
losses, it can also reduce or eliminate gains if exchange rates move in a
different manner than anticipated by the Fund or if the cost of the currency
contract outweighs the benefit of the hedge. Hedging also involves the risk that
changes in the value of the currency contract will
MERRILL LYNCH VARIABLE SERIES FUNDS A-7
<PAGE>
[ICON] Your Account
not match those of the holdings being hedged as expected by the Fund, in which
case any losses on the holdings being hedged may not be reduced. A Fund may not
be able to (or may not try to) hedge all currency risks, and there is no
guaranty that a Fund's currency hedging, if attempted, will be successful. A
Fund may attempt to hedge through several different types of currency contracts,
including currency forwards, currency options and currency-indexed instruments.
Currency contracts involve currency risk, market risk, political risk and
correlation risk and may also involve credit risk, valuation risk and liquidity
risk, leverage risk and liquidity risk.
TYPES OF INVESTMENT RISK
- --------------------------------------------------------------------------------
This section contains a discussion of various risks that may be associated with
certain investment strategies. The forepart of this Prospectus indicates which
investment strategies may be used by each Fund.
Correlation Risk -- The risk that changes in the value of two investments do not
track or offset each other in the manner anticipated by Fund management.
Correlation risk is associated with hedging transactions, in which a Fund uses a
derivative to offset the risk that other Fund holdings may decrease in value or
that potential investment opportunities may increase in value before the Fund
can fully implement its investment strategy. Correlation risk means that changes
in the value of the derivative may not match those of the holdings being hedged
as expected by the Fund, in which case any losses on the holdings or potential
holdings being hedged may not be reduced.
Credit Risk -- The risk that the issuer of an investment or other party to a
trade will be unable to honor its obligations to a Fund.
Currency Risk -- The risk that changes in the exchange rate between currencies
will adversely affect the value (in U.S. dollar terms) of an investment.
Generally, when the U.S. dollar rises in value against a foreign currency, a
security denominated in that currency loses value to a U.S. investor because the
currency is worth fewer U.S. dollars.
Information Risk -- The risk that important information about a security or
market is inaccurate, unreliable or unavailable.
Leverage Risk -- The risk associated with certain types of investments or
trading strategies (such as borrowing money to increase the amount of
A-8 MERRILL LYNCH VARIABLE SERIES FUNDS
<PAGE>
investments) that relatively small market movements may result in large changes
in value of an investment. Certain investments or trading strategies that
involve leverage can result in losses that greatly exceed the amount originally
invested.
Liquidity Risk -- The risk that certain securities may be difficult or
impossible to sell at the time that a Fund would like or at the price that a
Fund believes the security is currently worth.
Market Risk/Interest Rate Risk -- The risk that the entire market will undergo
an unanticipated change in value, including the possibility that the market will
go down sharply and unpredictably. For fixed-income investments, this includes
the risk that the value of an investment will decrease as a result of changes in
interest rates. Generally, when interest rates increase, fixed-income securities
decrease in value and longer-term fixed-income securities decrease in value more
than short-term fixed-income securities.
Political Risk -- The risk of losses arising from government or legal events,
such as changes in tax or trade laws, imposition of currency controls, adverse
court or administrative rulings, or change of a government or political system.
Selection Risk -- The risk that a specific Fund investment will underperform the
market.
Valuation Risk -- The risk that a Fund has valued an investment at a higher
price than it can actually obtain upon a sale.
SPECIAL RISKS ASSOCIATED WITH FOREIGN INVESTMENTS GENERALLY
- --------------------------------------------------------------------------------
Foreign Market Risk -- Since a Fund may invest in foreign securities, it offers
the potential for more diversification than an investment only in the United
States. This is because stocks traded on foreign markets have often (though not
always) performed differently than stocks in the United States. However, such
investments involve special risks not present in U.S. investments that can
increase the chances that a Fund will lose money. In particular, investment in
foreign securities involves the following risks, which are generally greater for
investments in emerging markets.
MERRILL LYNCH VARIABLE SERIES FUNDS A-9
<PAGE>
[ICON] Your Account
o The economies of some foreign markets often do not compare favorably
with that of the United States in areas such as growth of gross
domestic product, reinvestment of capital, resources and balance of
payments. Some of these economies may rely heavily on particular
industries or foreign capital. They may be more vulnerable to adverse
diplomatic developments, the imposition of economic sanctions against
a particular country or countries, changes in international trading
patterns, trade barriers and other protectionist or retaliatory
measures.
o Investments in foreign markets may be adversely affected by
governmental actions such as the imposition of capital controls,
nationalization of companies or industries, expropriation of assets or
the imposition of punitive taxes.
o The governments of certain countries may prohibit or impose
substantial restrictions on foreign investing in their capital markets
or in certain industries. Any of these actions could severely affect
security prices. They could also impair a Fund's ability to purchase
or sell foreign securities or transfer its assets or income back into
the United States, or otherwise adversely affect the Fund's
operations.
o Other foreign market risks include foreign exchange controls,
difficulties in pricing securities, defaults on foreign government
securities, difficulties in enforcing favorable legal judgments in
foreign courts and political and social instability. Legal remedies
available to investors in some foreign countries may be less extensive
than those available to investors in the United States.
o Because there are generally fewer investors on foreign exchanges and a
smaller number of shares traded each day, it may be difficult for a
Fund to buy and sell securities on those exchanges. In addition,
prices of foreign securities may go up and down more than prices of
securities traded in the United States.
o Foreign markets may have different clearance and settlement
procedures. In certain markets, settlements may be unable to keep pace
with the volume of securities transactions. If this occurs, settlement
may be delayed and
A-10 MERRILL LYNCH VARIABLE SERIES FUNDS
<PAGE>
a Fund's assets may be uninvested and not earning returns. A Fund may
miss investment opportunities or be unable to sell an investment
because of these delays.
Certain Risks of Holding Fund Assets Outside the United States -- A Fund
generally holds its foreign securities and cash in foreign banks and securities
depositories. Some foreign banks and securities depositories may be recently
organized or new to the foreign custody business. In addition, there may be
limited or no regulatory oversight over their operations. Also, the laws of
certain countries may put limits on a Fund's ability to recover its assets if a
foreign bank, depository or issuer of a security, or any of their agents, goes
bankrupt. In addition, it is often more expensive for a Fund to buy, sell and
hold securities in certain foreign markets than in the United States. The
increased expense of investing in foreign markets reduces the amount a Fund can
earn on its investments and typically results in a higher operating expense
ratio for a Fund than investment companies invested only in the United States.
European Economic and Monetary Union ("EMU") -- A number of European countries
have entered into EMU in an effort to reduce trade barriers between themselves
and eliminate fluctuations in their currencies. EMU establishes a single
European currency (the euro), which was introduced on January 1, 1999 and is
expected to replace the existing national currencies of all initial EMU
participants by July 1, 2002. Certain securities (beginning with government and
corporate bonds) were redenominated in the euro. These securities trade and make
dividend and other payments only in euros. Like other investment companies and
business organizations, including the companies in which a Fund invests, a Fund
could be adversely affected:
o If the transition to euro, or EMU as a whole, does not proceed as
planned.
o If a participating country withdraws from EMU.
o If the computing, accounting and trading systems used by a Fund's
service providers, or by other entities with which a Fund or its
service providers do business, are not capable of recognizing the euro
as a distinct currency.
Currency Risk -- Securities in which a Fund invests may be denominated or quoted
in currencies other than the U.S. dollar. Changes in foreign currency exchange
rates affect the value of a Fund's portfolio. Generally, when the U.S. dollar
rises in value against a foreign currency, a security
MERRILL LYNCH VARIABLE SERIES FUNDS A-11
<PAGE>
[ICON] Your Account
denominated in that currency loses value because the currency is worth fewer
U.S. dollars. Conversely, when the U.S. dollar decreases in value against a
foreign currency, a security denominated in that currency gains value because
the currency is worth more U.S. dollars. This risk, generally known as "currency
risk", means that a stronger U.S. dollar will reduce returns for U.S. investors
while a weak U.S. dollar will increase those returns.
Governmental Supervision and Regulation/Accounting Standard -- Many foreign
governments supervise and regulate stock exchanges, brokers and the sale of
securities less than the United States does. Some countries may not have laws to
protect investors the way that the United States' securities laws do. For
example, some countries may have no laws or rules against insider trading.
Insider trading occurs when a person buys or sells a company's securities based
on non-public information about that company. Accounting standards in other
countries are not necessarily the same as in the United States. If the
accounting standards in another country do not require as much detail as U.S.
accounting standards, it may be harder for Fund Management to completely and
accurately determine a company's financial condition. Also, brokerage
commissions and other costs of buying or selling securities often are higher in
foreign countries than they are in the United States. This reduces the amount a
Fund can earn on investments.
Emerging Market Risks -- The risks of foreign investments are usually much
greater for emerging markets. Investments in emerging markets may be considered
speculative. Emerging markets include those in countries defined as emerging or
developing by the World Bank, the International Finance Corporation, or the
United Nations. Emerging markets are riskier because they develop unevenly and
may never fully develop. They are more likely to experience hyperinflation and
currency devaluations, which adversely affects returns to U.S. investors. In
addition, the securities markets in many of these countries have far lower
trading volumes and less liquidity than developed markets. Since these markets
are so small, they may be more likely to suffer sharp and frequent price changes
or long-term price depression because of adverse publicity, investor
perceptions, or the actions of a few large investors. In addition, traditional
measures of investment value used in the United States, such as price to
earnings ratios, may not apply to certain small markets.
Many emerging markets have histories of political instability and abrupt changes
in policies. As a result, their governments are more likely to take actions that
are hostile or detrimental to private enterprise or foreign
A-12 MERRILL LYNCH VARIABLE SERIES FUNDS
<PAGE>
Net Asset Value -- the market value of a
Fund's total assets after deducting
liabilities divided by the number of
shares outstanding.
investment than those of more developed countries. Certain emerging markets may
also face other significant internal or external risks, including the risk of
war, and ethnic, religious, and racial conflicts. In addition, governments in
many emerging market countries participate to a significant degree in their
economies and securities markets, which may impair investment and economic
growth.
HOW TO BUY AND SELL SHARES
- --------------------------------------------------------------------------------
The Company is offering through this prospectus Class B shares in each of its
Funds to the Insurance Companies. The price of shares purchased by the Insurance
Companies is based on the next calculation of the per share net asset value of
the Fund after an order is placed.
The Company may reject any order to buy shares and may suspend the sale of
shares at any time.
The Company will redeem all full and fractional shares of the Funds for cash.
The price of redeemed shares is based on the next calculation of net asset value
after a redemption order is placed.
HOW SHARES ARE PRICED
- --------------------------------------------------------------------------------
When an Insurance Company purchases shares, the Insurance Company pays the net
asset value. This is the offering price. Shares are also redeemed at their net
asset value. Each Fund calculates its net asset value (generally by using market
quotations) each day the New York Stock Exchange is open, fifteen minutes after
the close of business on the Exchange (the Exchange generally closes at 4:00
p.m. Eastern time). Securities held by the Domestic Money Market and Reserve
Assets Funds with a remaining maturity of 60 days or less are generally valued
on an amortized cost basis. Under this method of valuation, a security is
initially valued at cost on the date of purchase, and then the Domestic Money
Market and Reserve Assets Fund amortize the value of the security at a constant
rate until the maturity of the
MERRILL LYNCH VARIABLE SERIES FUNDS A-13
<PAGE>
[ICON] Your Account
Dividends -- ordinary income and capital
gains paid to shareholders. Dividends
will be reinvested in additional Fund
shares as they are paid.
security, regardless of the impact of fluctuating interest rates on the market
value of the security. The net asset value used in determining the price for the
purchase or redemption of shares is the next one calculated after the purchase
or redemption order is placed. Foreign securities owned by a Fund may trade on
weekends or other days when a Fund does not price its shares. As a result, the
Fund's net asset value may change on days when an Insurance Company will not be
able to purchase or redeem the Fund's shares. The Domestic Money Market Fund and
the Reserve Assets Fund will seek to maintain a net asset value of $1.00 per
Share.
DIVIDENDS AND TAXES
- --------------------------------------------------------------------------------
The Domestic Money Market and Reserve Assets Funds will declare dividends daily
and will reinvest dividends monthly in additional full and fractional shares of
those Funds. The Global Bond Focus, Government Bond, High Current Income and
Prime Bond Funds will declare dividends monthly and reinvest dividends monthly
in additional shares of those Funds. The Global Utility Fund will declare
dividends quarterly and will reinvest dividends quarterly in additional shares
of the Fund. The American Balanced, Basic Value Focus, Capital Focus, Developing
Capital Markets Focus, Fundamental Growth Focus, Global Growth Focus, Global
Strategy Focus, Index 500, International Equity Focus, Natural Resources Focus,
Quality Equity and Special Value Focus Funds will declare dividends at least
annually and will reinvest dividends at least annually in additional shares of
the respective Funds.
Dividends paid by the Company may be included in a Insurance Company's gross
income. The tax treatment of these dividends depends on the Insurance Company's
tax status. A description of an Insurance Company's tax status is contained in
the prospectus for the Contract.
A-14 MERRILL LYNCH VARIABLE SERIES FUNDS
<PAGE>
Management of the Fund [ICON]
MERRILL LYNCH ASSET MANAGEMENT
- --------------------------------------------------------------------------------
Merrill Lynch Asset Management, the Company's Investment Adviser, manages the
Company's investments and its business operations under the overall supervision
of the Company's Board of Directors. The Investment Adviser has the
responsibility for making all investment decisions for the Company. The
Investment Adviser has a sub-advisory agreement with Merrill Lynch Asset
Management U.K. Limited, an affiliate, under which the Investment Adviser may
pay a fee for services it receives.
Management
Fee for
Year Ended % of Its
Fund Name December 31, 1998 Avg Net Assets
- --------------------------------------------------------------------------------
American Balance Fund $1,043,157 0.55%
- --------------------------------------------------------------------------------
Basic Value Focus Fund $4,516,100 0.60%
- --------------------------------------------------------------------------------
Capital Focus Fund $ 61,312 0.60%
- --------------------------------------------------------------------------------
Developing Capital Markets Focus Fund $1,126,826 1.00%
- --------------------------------------------------------------------------------
Domestic Money Market Fund $1,765,415 0.50%
- --------------------------------------------------------------------------------
Fundamental Growth Focus Fund* N/A N/A
- --------------------------------------------------------------------------------
Global Bond Focus Fund $ 430,336 0.60%
- --------------------------------------------------------------------------------
Global Growth Focus Fund $ 49,823 0.75%
- --------------------------------------------------------------------------------
Global Strategy Focus Fund $5,364,685 0.65%
- --------------------------------------------------------------------------------
Global Utility Focus Fund $ 829,080 0.60%
- --------------------------------------------------------------------------------
Government Bond Fund $1,195,999 0.50%
- --------------------------------------------------------------------------------
High Current Income Fund $2,630,447 0.47%
- --------------------------------------------------------------------------------
Index 500 Fund $ 965,368 0.30%
- --------------------------------------------------------------------------------
International Equity Focus Fund $2,370,652 0.75%
- --------------------------------------------------------------------------------
Natural Resources Focus Fund $ 135,222 0.65%
- --------------------------------------------------------------------------------
Prime Bond Fund $2,330,935 0.42%
- --------------------------------------------------------------------------------
Quality Equity Fund $3,758,987 0.43%
- --------------------------------------------------------------------------------
Reserve Assets Fund $ 109,945 0.50%
- --------------------------------------------------------------------------------
Special Value Focus Fund $3,594,897 0.75%
- --------------------------------------------------------------------------------
Merrill Lynch Asset Management is part of Merrill Lynch Asset Management Group,
which had approximately $515 billion in investment company and other portfolio
assets under management as of March 1999. This amount includes assets managed
for Merrill Lynch affiliates.
*Fundamental Growth Focus Fund commenced operations on April ____, 2000.
MERRILL LYNCH VARIABLE SERIES FUNDS A-15
<PAGE>
[ICON] Management of the Fund
ADDITIONAL INFORMATION
- --------------------------------------------------------------------------------
Investment Adviser -- Merrill Lynch Asset Management, L.P., 800 Scudders Mill
Road, Plainsboro, New Jersey 08536, has been selected as the investment adviser
of the Company.
Independent Auditors -- Deloitte & Touche LLP, Princeton Forrestal Village,
116-300 Village Boulevard, 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, 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 -- Financial Data Services, Inc. ("FDS"),
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.
FDS will receive an annual fee of $5,000 per Fund and will be entitled to
reimbursement of out-of-pocket expenses.
Legal Counsel -- Clifford Chance Rogers & Wells LLP, New York, New York, is
counsel for the Company.
A-16 MERRILL LYNCH VARIABLE SERIES FUNDS
<PAGE>
For More Information [ICON]
Shareholder Reports
Additional information about the investments of each of the Fund is available in
the Company's annual and semi-annual reports to shareholders. In the Company's
annual report you will find a discussion of the market conditions and investment
strategies that significantly affected each Fund's performance during its last
fiscal year. You may obtain these reports at no cost by calling (609) 282-2800.
Statement of Additional Information
The Company's Statement of Additional Information contains further information
about each Fund and is incorporated by reference (legally considered to be part
of this prospectus). You may request a free copy by writing the Company at
Merrill Lynch Variable Series Funds, Inc. P.O. Box 9011, Princeton, New Jersey
08543-9011 or by calling (609) 282-2800.
Contact the Company at the telephone number or address indicated above, if you
have any questions.
Information about the Company (including the Statement of Additional
Information) can be reviewed and copied at the SEC's Public Reference Room in
Washington, D.C. Call 1-800-SEC-0330 for information on the operation of the
public reference room. This information is also available on the SEC's Internet
site at http://www.sec.gov and copies may be obtained upon payment of a
duplicating fee by writing the Public Reference Section of the SEC, Washington,
D.C. 20549-6009.
You should rely only on the information contained in this Prospectus. No one is
authorized to provide you with information that is different from information
contained in this Prospectus.
Investment Company Act file #811-3290
(C)Fund Asset Management, L.P.
[LOGO] Merrill Lynch
Merrill Lynch
Variable Series Funds, Inc.
April __, 2000
<PAGE>
The information in this statement of additional information is not complete and
may be changed. This statement of additional information is not an offer to sell
these securities and is not soliciting an offer to buy these securities in any
state where the offer or sale is not permitted.
SUBJECT TO COMPLETION
PRELIMINARY STATEMENT OF ADDITIONAL INFORMATION DATED JANUARY 13, 2000
STATEMENT OF ADDITIONAL INFORMATION
Merrill Lynch Variable Series Funds, Inc.
P.O. Box 9011, Princeton, New Jersey 08543-9011 o 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 nineteen separate funds (hereinafter referred to as the "Funds" or
individually as a "Fund"): Merrill Lynch American Balanced Fund, Merrill Lynch
Basic Value Focus Fund, Merrill Lynch Capital Focus Fund, Merrill Lynch
Developing Capital Markets Focus Fund, Merrill Lynch Domestic Money Market Fund,
Merrill Lynch Fundamental Growth Focus Fund, Merrill Lynch Global Bond Focus
Fund, Merrill Lynch Global Growth Focus Fund, Merrill Lynch Global Strategy
Focus Fund, Merrill Lynch Global Utility Focus Fund, Merrill Lynch Government
Bond Fund, Merrill Lynch High Current Income Fund, Merrill Lynch Index 500 Fund,
Merrill Lynch International Equity Focus Fund, Merrill Lynch Natural Resources
Focus Fund, Merrill Lynch Prime Bond Fund, Merrill Lynch Quality Equity Fund,
Merrill Lynch Reserve Assets Fund and Merrill Lynch Special Value Focus Fund.
Two separate classes of common stock ("Common Stock"), Class A Common Stock and
Class B Common Stock, are issued for each Fund.
The shares of the Funds are sold to separate accounts ("Separate Accounts")
of certain insurance companies (the "Insurance Companies") including Merrill
Lynch Life Insurance Company ("MLLIC") and ML Life Insurance Company of New York
("ML of New York") to fund benefits under variable annuity contracts (the
"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. MLLIC and ML of New York are wholly
owned subsidiaries of Merrill Lynch & Co., Inc., as is the Company's investment
adviser, Merrill Lynch Asset Management, L.P. (the "Investment Adviser").
-----------------------
This Statement of Additional Information of the Company is not a prospectus
and should be read in conjunction with the Prospectus of The Company (the
"Prospectus") dated April __, 2000 which has been filed with the Securities and
Exchange Commission and can be obtained upon request and without charge by
calling (800) MER-FUND or writing the Company at the above address. The
Prospectus is incorporated by reference into the Statement of Additional
Information and this Statement of Additional Information is incorporated by
reference into The Prospectus.
-----------------------
Merrill Lynch Asset Management -- Manager
Merrill Lynch Funds Distributor -- Distributor
-----------------------
The date of this Statement of Additional Information is April __, 2000.
<PAGE>
TABLE OF CONTENTS
Page
-----
The Insurance Companies ............................................ 2
Investment Restrictions ............................................ 16
Management of The Company .......................................... 22
Investment Advisory Arrangements ................................... 25
Determination of Net Asset Value ................................... 29
Portfolio Transactions and Brokerage ............................... 30
Purchase of Shares ................................................. 32
Redemption of Shares ............................................... 32
Dividends and Taxes ................................................ 33
Distribution Arrangements .......................................... 35
Performance Data ................................................... 35
Average Annual Total Return ........................................ 36
Additional Information ............................................. 38
Financial Statements ............................................... 40
Annex A ............................................................ 41
<PAGE>
The Insurance Companies
Shares of the portfolios of Merrill Lynch Variable Series Funds, Inc. (each
a "Fund") are sold to separate accounts ("Separate Accounts") of insurance
companies ("Insurance Companies") to fund certain variable life insurance
contracts and/or variable annuities (together, "Contracts") issued by such
companies. Certain Insurance Companies may be affiliates of Merrill Lynch Asset
Management, L.P., the Fund's adviser. 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. A Contract is described in the prospectus for
that 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 Statement of Additional Information refer to the Insurance Companies.
Non-Diversified Funds
The Developing Capital Markets Focus, Global Bond Focus, Global Strategy
Focus, Index 500, and Natural Resources 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 of 1986, as amended (the "Code" or the "Internal
Revenue Code"). To qualify as a regulated investment company, a Fund, at the
close of each fiscal quarter, may not have more than 25% of its total assets
invested in the securities (except obligations of the U.S. Government, its
agencies or instrumentalities) of any one issuer and with respect to 50% of its
assets, (i) may not have more than 5% of its total assets invested in the
securities of any one issuer and (ii) may not own more than 10% of the
outstanding voting securities of any one issuer.
Fixed Income Security Ratings
The Developing Capital Markets Focus Fund, the High Current Income Fund,
the Capital Focus Fund, Global Utility Focus Fund and the International Equity
Focus Fund may invest in fixed-income securities rated below investment grade
(i.e., securities rated Ba or below by Moody's Investors Service, Inc.
("Moody's") or BB or below by Standard & Poor's Ratings Group ("Standard &
Poor's") at the time of investment). However, securities purchased by a Fund may
subsequently be downgraded. Such securities may continue to be held and will be
sold only if, in the judgment of the Investment Adviser, it is advantageous to
do so. Securities in 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 Annex
A of this Statement of Additional Information for a fuller description of
corporate bond ratings.
Maturity of Fixed Income Investments
Certain Funds that invest in fixed-income securities have limits on the
maturity of each fixed-income investment or on the average maturity of the
portfolio. For purposes of applying these limits, each Fund will consider a
fixed-income security's maturity to be its stated maturity (the date the issuer
is scheduled to make its final payment of principal), except that
o for a security with an unconditional put entitling a Fund to receive
the security's approximate amortized cost, the maturity will be
considered to be the next put date;
o for mortgage-backed and other amortizing securities, the maturity will
be considered to be the average life remaining (the length of time it
is expected to take to retire half of the remaining principal through
amortizing payments) based on prepayment assumptions that the
Investment Adviser believes to be reasonable;
o for a variable or floating rate investment grade security that the
Investment Adviser believes will have a market value approximating
amortized cost on the next interest reset date, the maturity will be
considered to be the next reset date; and
2
<PAGE>
o for a Fund that operates under SEC rules that specifically define the
maturity of a security, the maturity of a security will be the maturity
determined in a manner consistent with the SEC rules.
Portfolio Strategies
Restricted Securities. From time to time a Fund may invest in securities
the disposition of which is subject to legal restrictions, such as restrictions
imposed by the Securities Act of 1933 (the "Securities Act") on the resale of
securities acquired in private placements. If registration of such securities
under the Securities Act is required, such registration may not be readily
accomplished and if such securities may be sold without registration, such
resale may be permissible only in limited quantities. In either event, a Fund
may not be able to sell its restricted securities at a time which, in the
judgment of the Investment Adviser, would be most opportune.
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, 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 certain junk bonds, money market
securities and securities that are freely tradeable in their primary market
offshore may be deemed liquid if acquired by a Fund pursuant to Rule 144A. The
Board, however, will retain 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.
Foreign Securities. The Basic Value Focus, Developing Capital Markets
Focus, Special Value Focus, Global Strategy Focus, Global Bond Focus, Global
Utility Focus, High Current Income, International Equity Focus, Natural
Resources Focus, Prime Bond, Quality Equity, Global Growth Focus, Capital Focus,
Reserve Assets and Fundamental Growth Focus Funds may invest in securities of
foreign issuers. The Index 500 Fund may also invest in securities of foreign
issuers to the extent such issuers are included in the Standard & Poor's 500
Composite Stock Price Index (the "S&P Index"). 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
economic, political, social or diplomatic developments, and the difficulty of
assessing economic trends in foreign countries. Foreign legal systems may differ
from the U.S. legal system, and 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 that 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 Developing Capital Markets Focus, Global Bond Focus,
Global Strategy Focus, Global Utility Focus, International Equity Focus, Global
Growth Focus Fund and Natural Resources 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 directly affect the
3
<PAGE>
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 Developing Capital Markets Focus, Global Bond Focus, Global Strategy Focus,
Global Utility Focus, International Equity Focus, Natural Resources Focus,
Global Growth Focus, Capital Focus, Quality Equity and Fundamental Growth Focus
Funds will purchase only securities issued in dollar denominations.
The securities markets of many countries at times in the past have moved
relatively independently of one another due to different economic, financial,
political and social factors. When such lack of correlation, or negative
correlation, in movements of these securities markets occurs, it may reduce risk
for a Fund's portfolio as a whole. This negative correlation also may offset
unrealized gains a Fund has derived from movements in a particular market. To
the extent the various markets move independently, total portfolio volatility is
reduced when the various markets are combined into a single portfolio. of
course, movements in the various securities markets may be offset by changes in
foreign currency exchange rates. Exchange rates frequently move independently of
securities markets in a particular country. As a result, gains in a particular
securities market may be affected by changes in exchange rates.
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, that are often heightened for investments in smaller capital
markets.
There may be less publicly available information about an issuer in a
foreign market, particularly one in a smaller capital market, than would be
available about a United States company, and it may not be subject to
accounting, auditing and financial reporting standards and requirements
comparable to those of United States companies. As a result, traditional
investment measurements, such as price/earnings ratios, as used in the United
States, may not be applicable in certain capital markets.
Smaller capital markets, while often growing in trading volume, have
substantially less volume than United States markets, and securities in many
smaller capital markets are less liquid and their prices may be more volatile
than securities of comparable United States companies. Brokerage commissions,
custodial services, and other costs relating to investment in smaller capital
markets are generally more expensive than in the United States. Such markets
have different clearance and settlement procedures, and in certain markets there
have been times when settlements have been unable to keep pace with the volume
of securities transactions, making it difficult to conduct such transactions.
Further, satisfactory custodial services for investment securities may not be
available in some countries having smaller capital markets, which may result in
a Fund which invests in these markets incurring additional costs and delays in
transporting and custodying such securities outside such countries. Delays in
settlement could result in temporary periods when assets of such a Fund are
uninvested and no return is earned thereon. The inability of a Fund to make
intended security purchases due to settlement problems could cause the Fund to
miss attractive investment opportunities. Inability to dispose of a portfolio
security due to settlement problems could result either in losses to the Fund
due to subsequent declines in value of the portfolio security or, if the Fund
has entered into a contract to sell the security, could result in possible
liability to the purchaser. There is generally less government supervision and
regulation of exchanges, brokers and issuers in countries having smaller capital
markets than there is in the United States.
As a result, management of a Fund that 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.
4
<PAGE>
A Fund may invest in countries in which foreign investors, including management
of the Fund, have had no or limited prior experience.
Certain of the Funds may invest in debt securities issued by foreign
governments. Investments in foreign government debt securities, particularly
those of emerging market country governments, involve special risks. Certain
emerging market countries have historically experienced, and may continue to
experience, high rates of inflation, high interest rates, exchange rate
fluctuations, large amounts of external debt, balance of payments and trade
difficulties and extreme poverty and unemployment. The issuer or governmental
authority that controls the repayment of an emerging market country's debt may
not be able or willing to repay the principal and/or interest when due in
accordance with the terms of such debt. A debtor's willingness or ability to
repay principal and interest due in a timely manner may be affected by, among
other factors, its cash flow situation, and, in the case of a government debtor,
the extent of its foreign reserves, the availability of sufficient foreign
exchange on the date a payment is due, the relative size of the debt service
burden to the economy as a whole and the political constraints to which a
government debtor may be subject. Government debtors may default on their debt
and may also be dependent on expected disbursements from foreign governments,
multilateral agencies and others abroad to reduce principal and interest
arrearages on their debt. Holders of government debt, including the Fund, may be
requested to participate in the rescheduling of such debt and to extend further
loans to government debtors.
As a result of the foregoing, a government obligor may default on its
obligations. If such an event occurs, a Fund may have limited legal recourse
against the issuer and/or guarantor. Remedies must, in some cases, be pursued in
the courts of the defaulting party itself, and the ability of the holder of
foreign government debt securities to obtain recourse may be subject to the
political climate in the relevant country. Government obligors in developing and
emerging market countries are among the world's largest debtors to commercial
banks, other governments, international financial organizations and other
financial institutions. Some 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 Global Utility Focus Fund, International Equity Focus Fund, Developing
Capital Markets Focus Fund, Capital Focus Fund, Global Growth Focus Fund and
Fundamental Growth Focus Fund may invest in the securities of foreign issuers in
the form of American Depositary Receipts ("ADRs"), European Depositary 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 Funds 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.
The Developing Capital Markets Focus and International Equity Focus Funds
may invest a significant portion of their assets 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.
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
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Investment Company Act, the Developing Capital Markets Focus, Global Growth
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.
Rules adopted under the Investment Company Act permit the Funds to maintain
their foreign securities and cash in the custody of certain eligible non-U.S.
banks and securities depositories. Certain banks in foreign countries may not be
eligible sub-custodians for the Funds, in which event the Funds may be precluded
from purchasing securities in certain foreign countries in which they otherwise
would invest or the Funds may incur additional costs and delays in providing
transportation and custody services for such securities outside of such
countries. The Funds may encounter difficulties in effecting on a timely basis
portfolio transactions with respect to any securities of issuers held outside
their countries. Other banks that are eligible foreign sub-custodians may be
recently organized or otherwise lack extensive operating experience. In
addition, in certain countries there may be legal restrictions or limitations on
the ability of the Funds to recover assets held in custody by foreign
sub-custodians in the event of the bankruptcy of the sub-custodian.
Convertibles. The American Balanced Fund, the Basic Value Fund, the Capital
Focus Fund, the Developing Capital Markets Fund, the Fundamental Growth Focus
Fund, the Global Bond Focus Fund, the Global Growth Focus Fund, the
International Equity Focus Fund, the Natural Resources Focus Fund, the Prime
Bond Fund, the Quality Equity Fund and the Special Value Focus Fund are each
authorized to invest in convertible securities. Convertible securities entitle
the holder to receive interest payments paid on corporate debt securities or the
dividend preference on a preferred stock until such time as the convertible
security matures or is redeemed or until the holder elects to exercise the
conversion privilege. Synthetic convertible securities may be either (i) a debt
security or preferred stock that may be convertible only under certain
contingent circumstances or that may pay the holder a cash amount based on the
value of shares of underlying common stock partly or wholly in lieu of a
conversion right (a "Cash-Settled Convertible") or (ii) a combination of
separate securities chosen by the Investment Adviser in order to create the
economic characteristics of a convertible security, i.e., a fixed income
security paired with a security with equity conversion features, such as an
option or warrant (a "Manufactured Convertible").
The characteristics of convertible securities make them appropriate
investments for an investment company seeking a high total return from capital
appreciation and investment income. These characteristics include the potential
for capital appreciation as the value of the underlying common stock increases,
the relatively high yield received from dividend or interest payments as
compared to common stock dividends and decreased risks of decline in value
relative to the underlying common stock due to their fixed-income nature. As a
result of the conversion feature, however, the interest rate or dividend
preference on a convertible security is generally less than would be the case if
the securities were issued in nonconvertible form.
In analyzing convertible securities, the Investment Adviser will consider
both the yield on the convertible security and the potential capital
appreciation that is offered by the underlying common stock.
Convertible securities are issued and traded in a number of securities
markets. For the past several years, the principal markets have been the United
States, the Euromarket and Japan. Issuers during this period have included major
corporations domiciled in the United States, Japan, France, Switzerland, Canada
and the United Kingdom. Even in cases where a substantial portion of the
convertible securities held by the Fund are denominated in United
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States dollars, the underlying equity securities may be quoted in the currency
of the country where the issuer is domiciled. With respect to convertible
securities denominated in a currency different from that of the underlying
equity securities, the conversion price may be based on a fixed exchange rate
established at the time the security is issued. As a result, fluctuations in the
exchange rate between the currency in which the debt security is denominated and
the currency in which the share price is quoted will affect the value of the
convertible security. As described below, certain Funds are authorized to enter
into foreign currency hedging transactions in which they may seek to reduce the
effect of such fluctuations.
Apart from currency considerations, the value of convertible securities is
influenced by both the yield of nonconvertible securities of comparable issuers
and by the value of the underlying common stock. The value of a convertible
security viewed without regard to its conversion feature (i.e., strictly on the
basis of its yield) is sometimes referred to as its "investment value." To the
extent interest rates change, the investment value of the convertible security
typically will fluctuate. However, at the same time, the value of the
convertible security will be influenced by its "conversion value," which is the
market value of the underlying common stock that would be obtained if the
convertible security were converted. Conversion value fluctuates directly with
the price of the underlying common stock. If, because the common stock is at a
low price, the conversion value is substantially below the investment value of
the convertible security, the price of the convertible security is governed
principally by its investment value.
To the extent the conversion value of a convertible security increases to a
point that approximates or exceeds its investment value, the price of the
convertible security will be influenced principally by its conversion value. A
convertible security will sell at a premium over the conversion value to the
extent investors place value on the right to acquire the underlying common stock
while holding a fixed-income security. The yield and conversion premium of
convertible securities issued in Japan and the Euromarket are frequently
determined at levels that cause the conversion value to affect their market
value more than the securities' investment value.
Holders of convertible securities generally have a claim on the assets of
the issuer prior to the common stockholders but may be subordinated to other
debt securities of the same issuer. A convertible security may be subject to
redemption at the option of the issuer at a price established in the charter
provision, indenture or other governing instrument pursuant to which the
convertible security was issued. If a convertible security held by a Fund is
called for redemption, the Fund will be required to redeem the security, convert
it into the underlying common stock or sell it to a third party. Certain
convertible debt securities may provide a put option to the holder which
entitles the holder to cause the security to be redeemed by the issuer at a
premium over the stated principal amount of the debt security under certain
circumstances.
As indicated above, convertible securities may include either Cash-Settled
Convertibles or Manufactured Convertibles. Cash-Settled Convertibles are
instruments that are created by the issuer and have the economic characteristics
of traditional convertible securities but may not actually permit conversion
into the underlying equity securities in all circumstances. As an example, a
private company may issue a Cash-Settled Convertible that is convertible into
common stock only if the company successfully completes a public offering of its
common stock prior to maturity and otherwise pays a cash amount to reflect any
equity appreciation. Manufactured Convertibles are created by the Investment
Adviser by combining separate securities that possess one of the two principal
characteristics of a convertible security, i.e., fixed income ("fixed income
component") or a right to acquire equity securities ("convertible component").
The fixed income component is achieved by investing in nonconvertible fixed
income securities, such as nonconvertible bonds, preferred stocks and money
market instruments. The convertibility component is achieved by investing in
call options, warrants, LEAPS, or other securities with equity conversion
features ("equity features") granting the holder the right to purchase a
specified quantity of the underlying stocks within a specified period of time at
a specified price or, in the case of a stock index option, the right to receive
a cash payment based on the value of the underlying stock index.
A Manufactured Convertible differs from traditional convertible securities
in several respects. Unlike a traditional convertible security, which is a
single security having a unitary market value, a Manufactured Convertible is
comprised of two or more separate securities, each with its own market value.
Therefore, the total "market value" of such a Manufactured Convertible is the
sum of the values of its fixed-income component and its convertibility
component.
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More flexibility is possible in the creation of a Manufactured Convertible
than in the purchase of a traditional convertible security. Because many
corporations have not issued convertible securities, the Investment Adviser may
combine a fixed income instrument and an equity feature with respect to the
stock of the issuer of the fixed income instrument to create a synthetic
convertible security otherwise unavailable in the market. The Investment Adviser
may also combine a fixed income instrument of an issuer with an equity feature
with respect to the stock of a different issuer when the Investment Adviser
believes such a Manufactured Convertible would better promote the Fund's
objective than alternative investments. For example, the Investment Adviser may
combine an equity feature with respect to an issuer's stock with a fixed income
security of a different issuer in the same industry to diversify a Fund's credit
exposure, or with a U.S. Treasury instrument to create a Manufactured
Convertible with a higher credit profile than a traditional convertible security
issued by that issuer. A Manufactured Convertible also is a more flexible
investment in that its two components may be purchased separately and, upon
purchasing the separate securities, "combined" to create a Manufactured
Convertible. For example, a Fund may purchase a warrant for eventual inclusion
in a Manufactured Convertible while postponing the purchase of a suitable bond
to pair with the warrant pending development of more favorable market
conditions.
The value of a Manufactured Convertible may respond differently to certain
market fluctuations than would a traditional convertible security with similar
characteristics. For example, in the event a Fund created a Manufactured
Convertible by combining a short-term U.S. Treasury instrument and a call option
on a stock, the Manufactured Convertible would likely outperform a traditional
convertible of similar maturity and which is convertible into that stock during
periods when Treasury instruments outperform corporate fixed income securities
and underperform during periods when corporate fixed-income securities
outperform Treasury instruments.
Warrants. The Global Growth Focus Fund and the Fundamental Growth Focus
Fund are each authorized to invest in warrants. A warrant gives its holder the
option to purchase another security, usually stock, for a certain period of time
at a set price. Buying a warrant does not make a Fund a shareholder of the
underlying stock. The warrant holder has no right to dividends or votes on the
underlying stock. A warrant does not carry any right to assets of the issuer,
and for this reason investment in warrants may be more speculative than other
equity-based investments.
Liquidity. In order to assure that each Fund has sufficient liquidity, as a
matter of operating policy no Fund may invest more than 15% of its net assets in
securities for which market disposition is not readily available. Market
disposition may not be readily available for repurchase agreements maturing in
more than seven days and for securities having restrictions on resale.
Lending of Portfolio Securities. Each Fund of the Company may from time to
time lend securities (but not in excess of 20%, or in the case of the Global
Growth Focus Fund 331/3%) 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.
Subject to any applicable investment restriction, each Fund may from time
to time loan securities from its portfolio to brokers, dealers and financial
institutions and receive collateral in cash, securities issued or guaranteed by
the U.S. Government or, in the case of the Domestic Money Market and Reserve
Assets Fund, cash equivalents 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. Such cash collateral will be invested in
short-term securities, the income from which will increase the return to the
Fund. The Fund will retain all rights of beneficial ownership as to the loaned
portfolio securities, including voting rights and rights to interest or other
distributions, and will have the right to regain record ownership of loaned
securities to exercise such beneficial rights. Such loans will be terminable at
any time. The Fund may pay reasonable finders', administrative and custodial
fees to persons unaffiliated with the Fund in connection with the arranging of
such loans. The dividends, interest and other distributions received by the
Company on loaned securities may, for tax purposes, be treated as income other
than qualified income for the 90% test discussed under "Dividends, Distributions
and Taxes-Federal Income Taxes." The Company intends to lend portfolio
securities only to the extent that such activity does not jeopardize the
Company's qualification as a regulated investment company under Subchapter M of
the Code.
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Forward Commitments. Securities may be purchased or sold on a delayed
delivery basis or may be purchased on a forward commitment basis by each of the
Company's Funds at fixed purchase terms with periods of up to 180 days between
the commitment and settlement dates. The purchase will be recorded on the date
the purchasing Fund enters into the commitment and the value of security will
thereafter be reflected in the calculation of the Fund's net asset value. The
value of the security on the delivery date may be more or less than its purchase
price. A separate account of the Fund will be established with the Fund's
custodian (the "Custodian") consisting of cash or liquid securities having a
market value at all times until the delivery date at least equal to the amount
of its commitments in connection with such delayed delivery and purchase
transactions. Although a Fund will generally enter into forward commitments with
the intention of acquiring securities for its portfolio, it may dispose of a
commitment prior to settlement if the Investment Adviser deems it appropriate to
do so. There can, of course, be no assurance that the judgment upon which these
techniques are based will be accurate or that such techniques when applied will
be effective. The Funds will enter into forward commitment arrangements only
with respect to securities in which they may otherwise invest.
Standby Commitment Agreements. The High Current Income Fund, Global Utility
Focus Fund, International Equity Focus Fund, Global Growth Focus Fund and
Developing Capital Markets Focus Fund may from time to time enter into standby
commitment agreements. Such agreements commit a 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, regardless of whether or not
the security is ultimately issued, which is typically approximately 0.5% of the
aggregate purchase price of the security which the Fund has committed to
purchase. A Fund will enter into such agreements only for the purpose of
investing in the security underlying the commitment at a yield and price which
is considered advantageous to the Fund. A Fund will not enter into a standby
commitment with a remaining term in excess of 45 days and will limit its
investment in such commitments so that the aggregate purchase price of the
securities subject to such commitments, together with the value of portfolio
securities subject to legal restrictions on resale, will not exceed 10% of its
assets taken at the time of acquisition of such commitment or security. A 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. Since the issuance of
the security underlying the commitment is at the option of the issuer, a Fund
may bear the risk of a decline in the value of such security and may not benefit
from an appreciation in the value of the security during the commitment period.
The purchase of a security subject to a standby commitment agreement and
the related commitment fee will be recorded on the date on which the security
can reasonably be expected to be issued and the value of the security will
thereafter be reflected in the calculation of a Fund's net asset value. If the
security is issued, the cost basis of the security will be adjusted by the
amount of the commitment fee. In the event the security is not issued, the
commitment fee will be recorded as income on the expiration date of the standby
commitment.
Eurodollar and Yankeedollar Obligations. The Reserve Assets Fund (and, for
temporary or defensive purposes, the Natural Resources Focus, Global Strategy
Focus, Global Bond Focus, Global Utility Focus, International Equity Focus,
Developing Capital Markets Focus, Quality Equity and Fundamental Growth Focus
Funds) may invest in obligations issued by foreign branches or subsidiaries of
U.S. banks ("Eurodollar" obligations), by U.S. branches or subsidiaries of
foreign banks ("Yankeedollar" obligations), or by foreign depository
institutions and their foreign branches and subsidiaries ("foreign bank
obligations"). Investment in such obligations may involve different risks from
the risks of investing in obligations of U.S. banks. Such risks include adverse
political and economic developments, the possible imposition of withholding
taxes on interest income payable on such obligations, the possible seizure or
nationalization of foreign deposits and the possible establishment of exchange
controls or other foreign governmental laws or restrictions which might
adversely affect the payment of principal and interest. Generally the issuers of
such obligations are subject to fewer U.S. regulatory requirements than are
applicable to U.S. banks. Foreign depository institutions and their foreign
branches and subsidiaries, and foreign branches or subsidiaries of U.S. banks,
may be subject to less stringent
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reserve requirements than U.S. banks. U.S. branches or subsidiaries of foreign
banks are subject to the reserve requirements of the state in which they are
located. There may be less publicly available information about a foreign
depository institution, branch or subsidiary, or a U.S. branch or subsidiary of
a foreign bank, than about a U.S. bank, and such institutions may not be subject
to the same accounting, auditing and financial record keeping standards and
requirements as U.S. banks. Evidence of ownership of Eurodollar and foreign bank
obligations may be held outside of the United States, and a Fund may be subject
to the risks associated with the holding of such property overseas. Eurodollar
and foreign bank obligations of the Fund held overseas will be held by foreign
branches of the Custodian for the Fund or by other U.S. or foreign banks under
subcustodian arrangements complying with the requirements of the Investment
Company Act of 1940.
Derivative Instruments
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 below.
Indexed and Inverse Securities
The Domestic Money Market Fund, the Global Bond Focus Fund, the Global
Strategy Focus Fund, the Global Utility Focus Fund, the Government Bond Fund,
the Index 500 Fund, the International Equity Focus Fund, the Natural Resources
Focus Fund, the Prime Bond Fund, the Developing Capital Markets Focus Fund, the
Global Growth Focus Fund, the Fundamental Growth Focus Fund and the Reserve
Assets 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
Standard & Poor's 500 Composite Index (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
Bond Focus Fund, the Global Strategy Focus Fund, the Global Utility Focus Fund,
the Index 500 Fund, the International Equity Focus Fund, the Global Growth Focus
Fund, the Natural Resources Focus Fund and the Fundamental Growth 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,
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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 Bond Focus Fund, the
Global Strategy Focus Fund, the Index 500 Fund, the International Equity Focus
Fund, the Global Growth Focus Fund, the Natural Resources Focus Fund and the
Fundamental Growth 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 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 American Balanced Fund, the Basic Value Focus Fund,
the Developing Capital Markets Focus Fund, the Special Value Focus Fund, the
Global Bond Focus Fund, the Global Strategy Focus Fund, the Global Utility Focus
Fund, the Index 500 Fund, the International Equity Focus Fund, the Natural
Resources Focus Fund, the Global Growth Focus Fund, the Capital Focus Fund, the
Quality Equity Fund and the Fundamental Growth Focus 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 Bond Focus Fund, the
Global Strategy Focus Fund, the Global Utility Focus Fund, the Index 500 Fund,
the International Equity Focus Fund, the Global Growth Focus Fund, the Natural
Resources Focus Fund and the Fundamental Growth 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
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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 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 Bond Focus Fund, the
Global Strategy Focus Fund, the Global Utility Focus Fund, the Index 500 Fund,
the International Equity Focus Fund, the Global Growth Focus Fund, the Natural
Resources Focus Fund and the Fundamental Growth 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.
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Foreign Exchange Transactions
The Developing Capital Markets Focus Fund, the Global Bond Focus Fund, the
Global Strategy Focus Fund, the Global Utility Focus Fund, the International
Equity Focus Fund, the Natural Resources Focus Fund, the Global Growth Focus
Fund, the Capital Focus Fund, the Quality Equity Fund and the Fundamental Growth
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 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. There can be no assurance that a fund will
be able to enter into hedging transactions or that such transactions, if
attempted, will be effective.
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 adverse movements in currency
exchange rates occur. It may not be possible for a Fund to hedge against
currency
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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 or cost-effective (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 derivatives for hedging purposes involves the risk of imperfect
correlation in movements in the value of the derivatives and the value of the
instruments being hedged. If the value of the derivatives 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.
Each Fund intends to enter into transactions involving derivatives 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 derivative 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 derivative without incurring
substantial losses, if at all.
Certain transactions in derivatives (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 derivatives 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 derivatives 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
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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
derivatives 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 Derivatives
No Fund may use any derivative 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 or natural
resource index.
Risks of High Yield Securities
The Developing Capital Markets Focus Fund, High Current Income Fund,
International Equity Focus Fund and Capital 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. 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 Developing Capital Markets Focus Fund, High Current Income Fund,
International Equity Focus Fund and Capital 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.
High yield securities frequently have call or redemption features that
would permit an issuer to repurchase the security from the Fund. If a call were
exercised by the issuer during a period of declining interest rates, the Fund
likely would have to replace such called security with a lower yielding
security, thus decreasing the net investment income to the Fund and dividend to
shareholders.
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 Developing Capital Markets Focus Fund, High Current
Income Fund, International Equity Focus Fund and Capital 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 Developing Capital
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Markets Focus Fund, High Current Income Fund, Capital Focus Fund and
International Equity 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 Developing Capital Markets
Focus Fund, High Current Income Fund, Capital Focus Fund and International
Equity 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 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 Developing Capital Markets Focus
Fund, High Current Income Fund, Capital Focus Fund and International Equity
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.
INVESTMENT RESTRICTIONS
The Company has adopted the following fundamental and non-fundamental
restrictions and policies relating to the investment of the assets of the Funds
and their activities. The fundamental policies set forth below may not be
changed without the approval of the holders of a majority of the outstanding
voting shares of each Fund affected (which for this purpose and under the
Investment Company Act of 1940 means the lesser of (i) 67% of the shares
represented at a meeting at which more than 50% of the outstanding shares of the
affected Fund are represented or (ii) more than 50% of the outstanding shares of
the affected Fund). The investment objective of each Fund is non-fundamental,
and as such, may be changed by the Company's Board of Directors, except that the
investment objective of the American Balanced Fund, Developing Capital Markets
Focus Fund, Natural Resources Focus Fund and International Equity Focus Fund are
fundamental, and as such may not be changed without the approval of the holders
of a majority of the outstanding shares of each such Fund.
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Restrictions Applicable To The Domestic Money Market Fund
The Domestic Money Market Fund may not purchase any security other than
money market and other securities described under "Investment Objectives and
Policies" in the Domestic Money Market Fund's Prospectus. In addition, the
Domestic Money Market Fund may not purchase securities of foreign issuers
(including Eurodollar and Yankeedollar obligations). In addition, the Domestic
Money Market Fund may not:
(1) invest more than 10% of its total assets (taken at market value at
the time of each investment) in the securities (other than U.S. Government or
government agency securities) of any one issuer (including repurchase
agreements with any one bank) except that up to 25% of the value of the
Fund's total assets may be invested without regard to such 10% limitation.
(2) alone, or together with any other Fund or Funds, make investments
for the purpose of exercising control or management.
(3) purchase securities of other investment companies, except in
connection with a merger, consolidation, acquisition or reorganization.
(4) purchase or sell interests in oil, gas or other mineral exploration
or development programs, commodities, commodity contracts or real estate,
except that the Fund may invest in securities secured by real estate or
interests therein or securities issued by companies which invest in real
estate or interest therein.
(5) purchase any securities on margin except that the Company may obtain
such short-term credit as may be necessary for the clearance of purchases and
sales of portfolio securities.
(6) make short sales of securities or maintain a short position or
write, purchase or sell puts, calls, straddles, spreads or combination
thereof.
(7) make loans to other persons; provided that the Fund may purchase
money market securities or enter into repurchase agreements; lend securities
owned or held by it pursuant to (8) below; and provided further that for
purposes of this restriction the acquisition of a portion of an issue of
publicly distributed bonds, debentures or other corporate debt securities or
of government obligations, short-term commercial paper, certificates of
deposit and bankers' acceptances shall not be deemed the making of a loan.
(8) lend its portfolio securities in excess of 20% of its total assets,
taken at market value at the time of the loan, provided that such loans are
made according to the guidelines set forth below and the guidelines of the
Securities and Exchange Commission and the Company's Board of Directors,
including maintaining collateral from the borrower equal at all times to the
current market value of the securities loaned.
(9) borrow amounts in excess of 20% of its total assets, taken at market
value, and then only from banks as a temporary measure for extraordinary or
emergency purposes. The borrowing provisions shall not apply to reverse
repurchase agreements. Usually only "leveraged" investment companies may
borrow in excess of 5% of their assets; however, the Fund will not borrow to
increase income but only to meet redemption requests which might otherwise
require untimely dispositions of portfolio securities. The Fund will not
purchase securities while borrowings are outstanding.
(10) mortgage, pledge, hypothecate or in any manner transfer (except as
provided in (8) above), as security for indebtedness, any securities owned or
held by the Fund except as may be necessary in connection with borrowings
mentioned in (9) above, and then such mortgaging, pledging or hypothecating
may not exceed 25% of the Fund's total assets, taken at market value at the
time thereof. Although the Fund has the authority to mortgage, pledge or
hypothecate more than 10% of its total assets under this investment
restriction (10), as a matter of operating policy, the Fund will not
mortgage, pledge or hypothecate in excess of 10% of total net assets.
(11) act as an underwriter of securities, except insofar as the Fund may
be deemed an underwriter under the Securities Act of 1933 in selling
portfolio securities.
(12) purchase, either alone or together with any other Fund or Funds,
more than 10% of the outstanding securities of an issuer except that such
restriction does not apply to U.S. Government or government agency
securities, bank money instruments or repurchase agreements.
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<PAGE>
(13) invest in securities (except for repurchase agreements or variable
amount master notes) with legal or contractual restrictions on resale or for
which no readily available market exists or in securities of issuers (other
than issuers of government agency securities) having a record, together with
predecessors, of less than three years of continuous operation if, regarding
all such securities, more than 10% of its total assets (taken at market
value) would be invested in such securities.
(14) enter into repurchase agreements if, as a result thereof, more than
10% of the Fund's total assets (taken at market value at the time of each
investment) would be subject to repurchase agreements maturing in more than
seven days.
(15) enter into reverse repurchase agreements if, as a result thereof,
the Fund's obligations with respect to reverse repurchase agreements would
exceed one-third of the Fund's net assets (defined to be total assets, taken
at market value, less liabilities other than reverse repurchase agreements).
(16) invest more than 25% of its total assets (taken at market value at
the time of each investment) in the securities of issuers in any particular
industry (other than U.S. Government securities, government agency securities
or bank money instruments).
Restrictions Applicable to the Reserve Assets Fund
The Reserve Assets Fund may not purchase any security other than money
market and other securities described under "Investment Objectives and Policies"
in the Prospectus for the Reserve Assets Fund. In addition, the Reserve Assets
Fund may not:
(1) invest more than 10% of its total assets (taken at market value at
the time of each investment) in the securities (other than U.S. Government or
government agency securities) of any one issuer (including repurchase
agreements with any one bank) except that up to 25% of the value of the
Fund's total assets may be invested without regard to such 10% limitation.
(2) alone, or together with any other Fund or Funds, make investments
for the purpose of exercising control or management.
(3) purchase securities of other investment companies, except in
connection with a merger, consolidation, acquisition or reorganization.
(4) purchase or sell interests in oil, gas or other mineral exploration
or development programs, commodities, commodity contracts or real estate,
except that the Fund may invest in securities secured by real estate or
interests therein or securities issued by companies which invest in real
estate or interest therein.
(5) purchase any securities on margin except that the Company may obtain
such short-term credit as may be necessary for the clearance of purchases and
sales of portfolio securities.
(6) make short sales of securities or maintain a short position or
write, purchase or sell puts, calls, straddles, spreads or combinations
thereof.
(7) make loans to other persons; provided that the Fund may purchase
money market securities or enter into repurchase agreements; lend securities
owned or held by it pursuant to (8) below; and provided further that for
purposes of this restriction the acquisition of a portion of an issue of
publicly-distributed bonds, debentures or other corporate debt securities or
of government obligations, short-term commercial paper, certificates of
deposit and bankers' acceptances shall not be deemed the making of a loan.
(8) lend its portfolio securities in excess of 20% of its total assets,
taken at market value at the time of the loan, provided that such loans are
made according to the guidelines set forth below and the guidelines of the
Securities and Exchange Commission and the Company's Board of Directors,
including maintaining collateral from the borrower equal at all times to the
current market value of the securities loaned.
(9) borrow amounts in excess of 20% of its total assets, taken at market
value and then only from banks as a temporary measure for extraordinary or
emergency purposes. The borrowing provisions shall not apply to reverse
repurchase agreements. Usually only "leveraged" investment companies may
borrow in excess of 5% of their assets; however, the Fund will not borrow to
increase income but only to meet redemption requests
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<PAGE>
which might otherwise require untimely dispositions of portfolio securities. The
Fund will not purchase securities while borrowings are outstanding.
(10) mortgage, pledge, hypothecate or in any manner transfer (except as
provided in (8) above), as security for indebtedness, any securities owned or
held by the Fund except as may be necessary in connection with borrowings
mentioned in (9) above, and then such mortgaging, pledging or hypothecating
may not exceed 25% of the Fund's total assets, taken at market value at the
time thereof. As a matter of operating policy, the Fund will not mortgage,
pledge or hypothecate in excess of 10% of total net assets.
(11) act as an underwriter of securities, except insofar as the Fund may
be deemed an underwriter under the Securities Act of 1933 in selling
portfolio securities.
(12) purchase, either alone or together with any other Fund or Funds,
more than 10% of the outstanding securities of an issuer except that such
restriction does not apply to U.S. Government or government agency
securities, bank money instruments or repurchase agreements.
(13) invest in securities (except for repurchase agreements or variable
amount master notes) with legal or contractual restrictions on resale or for
which no readily available market exists or in securities of issuers (other than
issuers of government agency securities) having a record, together with
predecessors, of less than three years of continuous operation if, regarding all
such securities, more than 5% of its total assets (taken at market value) would
be invested in such securities.
(14) enter into repurchase agreements if, as a result thereof, more than
10% of the Fund's total assets (taken at market value at the time of each
investment) would be subject to repurchase agreements maturing in more than
seven days.
(15) enter into reverse repurchase agreements if, as a result thereof,
the Fund's obligations with respect to reverse repurchase agreements would
exceed one-third of the Fund's net assets (defined to be total assets, taken
at market value, less liabilities other than reverse repurchase agreements).
(16) invest more than 25% of its total assets (taken at market value at
the time of each investment) in the securities of issuers in any particular
industry (other than U.S. Government securities, government agency securities
or bank money instruments).
Restrictions Applicable to each of the Funds (Except the Domestic Money Market
Fund and the Reserve Assets Fund)
Under the fundamental investment restrictions, each of the Funds (unless
noted otherwise below) may not:
1. Make any investment inconsistent with the Fund's classification as a
diversified company under the Investment Company Act.(1)
2. Invest more than 25% of its assets, taken at market value, in the
securities of issuers in any particular industry (excluding the U.S.
Government and its agencies and instrumentalities).(2)
3. Make investments for the purpose of exercising control or
management.(3)
4. Purchase or sell real estate, except that the Fund may invest in
securities directly or indirectly secured by real estate or interests therein
or issued by companies which invest in real estate or interests therein.
5. Make loans to other persons, except that the acquisition of bonds,
debentures or other corporate debt securities and investment in government
obligations, commercial paper, pass-through instruments, certificates of
deposit, bankers acceptances, repurchase agreements or any similar
instruments shall not be deemed to be the making of a loan, and except
further that the Fund may lend its portfolio securities, provided that the
lending of portfolio securities may be made only in accordance with
applicable law and the guidelines set forth in the Prospectus and Statement
of Additional Information, as they may be amended from time to time.
6. Issue senior securities to the extent such issuance would violate
applicable law.
7. Borrow money, except that (i) the Fund may borrow from banks (as
defined in the Investment Company Act) in amounts up to 331/3% of its total
assets (including the amount borrowed), (ii) the Fund may borrow up
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to an additional 5% of its total assets for temporary purposes, (iii) the
Fund may obtain such short-term credit as may be necessary for the clearance
of purchases and sales of portfolio securities and (iv) the Fund may purchase
securities on margin to the extent permitted by applicable law. The Fund may
not pledge its assets other than to secure such borrowings or, to the extent
permitted by the Fund's investment policies as set forth in the Prospectus
and Statement of Additional Information, as they may be amended from time to
time, in connection with hedging transactions, short sales, when-issued and
forward commitment transactions and similar investment strategies.
8. Underwrite securities of other issuers except insofar as the Fund
technically may be deemed an underwriter under the Securities Act of 1933 in
selling portfolio securities.
9. Purchase or sell commodities or contracts on commodities, except to
the extent the Fund may do so in accordance with applicable law and the
Prospectus and Statement of Additional Information, as they may be amended
from time to time, and without registering as a commodity pool operator under
the Commodity Exchange Act.
Under the non-fundamental investment restrictions, each of the Funds
(unless noted otherwise below) may not:
a. Purchase securities of other investment companies, except to the
extent such purchases are permitted by applicable law. As a matter of policy,
however, the Fund will not purchase shares of any registered open-end
investment company or registered unit investment trust, in reliance on
Section 12(d)(1)(F) or (G) (the "fund of funds" provisions) of the Investment
Company Act, at any time its shares are owned by another investment company
that is part of the same group of investment companies as the Fund.
b. Engage in short sales of securities or maintain a short position
except to the extent permitted by applicable law. The Fund does not currently
intend to engage in short sales or maintain a short position, except for
short sales "against the box."(4)
c. Invest in securities which cannot be readily resold because of legal
or contractual restrictions or which cannot otherwise be marketed, redeemed
or put to the issuer or a third party, if at the time of acquisition more
than 15% of its total assets would be invested in such securities. This
restriction shall not apply to securities which mature within seven days or
securities which the Board of Directors has otherwise determined to be liquid
pursuant to applicable law. Securities purchased in accordance with Rule 144A
under the Securities Act and determined to be liquid by the Board of
Directors of the Company are not subject to the limitations set forth in this
investment restriction.
d. Invest in warrants if, at the time of acquisition, its investments in
warrants, valued at the lower of cost or market value, would exceed 5% of the
Fund's total assets; included within such limitation, but not to exceed 2% of
the Fund's total assets, are warrants which are not listed on the New York
Stock Exchange or American Stock Exchange or a major foreign exchange. For
purposes of this restriction, warrants acquired by the Fund in units or
attached to securities may be deemed to be without value.(5)
e. Invest in securities of companies having a record, together with
predecessors, of less than three years of continuous operation, except to the
extent permitted under applicable law. This restriction shall not apply to
mortgage-backed securities, asset-backed securities or obligations issued or
guaranteed by the U.S. Government, its agencies or instrumentalities.(6)
f. Purchase or retain the securities of any issuer, if those individual
officers and directors of the Company, the officers and general partner of
the Investment Adviser, the directors of such general partner or the officers
and directors of any subsidiary thereof each owning beneficially more than
one-half of one percent of the securities of such issuer own in the aggregate
more than 5% of the securities of such issuer.(7)
g. Invest in real estate limited partnership interests or interests in
oil, gas or other mineral leases, or exploration or development programs,
except that the Fund may invest in securities issued by companies that engage
in oil, gas or other mineral exploration or development activities. (8)
20
<PAGE>
h. Write, purchase or sell puts, calls, straddles, spreads or
combinations thereof, except to the extent permitted in the Prospectus and
Statement of Additional Information, as they may be amended from time to
time.
i. Notwithstanding fundamental investment restriction number 7 above,
borrow amounts in excess of 5% (20% in the case of the Developing Capital
Markets Focus, the Global Bond Focus and the Fundamental Growth Focus Funds,
10% in the case of the Global Strategy Focus, Government Bond, International
Equity Focus and Natural Resources Focus Funds, and 331/3% in the case of the
Global Growth Focus Fund) of the total assets of the Fund, taken at market
value, and then only from banks as a temporary measure for extraordinary or
emergency purposes such as the redemption of Fund shares.(9)
j. Pledge greater than 10% (20% in the case of the Developing Capital
Markets Focus Fund) of its total assets, taken at market value at the time of
the pledge. For the purpose of this restriction, collateral arrangements with
respect to (i) transactions in options, foreign currency contracts, futures
contracts and options on futures contracts and (ii) initial and variation
margin are not deemed to be a pledge of assets.(10)
k. Lend its portfolio securities in excess of 20% of its total assets
(33 1/3% in the case of the Global Growth Focus Fund), taken at market value
at the time of the loan, provided however that the Quality Equity Fund may
only make loans to New York Stock Exchange Member firms, other brokerage
firms having net capital of at least $10 million and financial institutions,
such as registered investment companies, banks and insurance companies,
having at least $10 million in capital and surplus.
l. In the case of the Global Utility Focus Fund only, invest less than
65% of its total assets in equity and debt securities issued by domestic and
foreign companies in the utilities industries, except during temporary
defensive periods.
m. In the case of each of the American Balanced Fund, the Basic Value
Focus Fund, the Special Value Focus Fund, the High Current Income Fund, the
Prime Bond Fund, the Quality Equity Fund and the Fundamental Growth Focus
Fund, invest in the securities of foreign issuers except that each such Fund
(except the American Balanced Fund) may invest in securities of foreign
issuers if at the time of acquisition no more than 10% (25% in the case of
the Quality Equity Fund) of its total assets, taken at market value at the
time of the investment, would be invested in such securities. Consistent with
the general policy of the Securities and Exchange Commission, the nationality
or domicile of an issuer for determination of foreign issuer status may be
(i) the country under whose laws the issuer is organized, (ii) the country in
which the issuer's securities are principally traded, or (iii) a country in
which the issuer derives a significant proportion (at least 50%) of its
revenues or profits from goods produced or sold, investments made, or
services performed in the country, or in which at least 50% of the assets of
the issuer are situated. See "Other Portfolio Strategies-Foreign Securities"
in the Prospectus.(11)
- -------------------
(1)The Developing Capital Markets Focus, Global Bond Focus, Global Strategy
Focus, Index 500, and Natural Resource Focus Funds are classified as
non-diversified investment companies under the Investment Company Act, and
therefore this restriction is not applicable to those Funds.
(2)For purposes of this restriction, states, municipalities and their political
subdivisions are not considered to be part of any industry, and utilities
will be divided according to their services; for example, gas, gas
transmission, electricity, telecommunications and water each will be
considered a separate industry for purposes of this restriction. In addition,
this restriction will not restrict (i) the Global Utility Focus Fund, under
normal circumstances, from investing 65% or more of its total assets in
equity and debt securities issued by domestic and foreign companies in the
utilities industries (i.e., electricity, telecommunications, gas or water),
and (ii) the Natural Resources Focus Fund from investing greater than 25% of
its assets in gold-related companies.
(3)In the case of the Global Growth Focus Fund, investments in wholly-owned
investment entities created under the laws of certain countries will not be
deemed to be the making of investments for the purpose of exercising control
or management.
(4)The Global Bond Focus, Global Strategy Focus, International Equity Focus,
Global Growth Focus and Natural Resources Focus Funds may maintain short
positions in forward currency contracts, options, futures contracts and
options on futures contracts.
(5)This restriction is not applicable to the Global Growth Focus Fund, the
Capital Focus Fund and the Fundamental Growth Focus Fund.
(6)This restriction is not applicable to the Global Growth Focus Fund, the
Capital Focus Fund and the Fundamental Growth Focus Fund.
(7)This restriction is not applicable to the Global Growth Focus Fund, the
Capital Focus Fund and the Fundamental Growth Focus Fund.
(8)This restriction is not applicable to the Global Growth Focus Fund, the
Capital Focus Fund and the Fundamental Growth Focus Fund.
21
<PAGE>
(9) In addition, the American Balanced, Basic Value Focus, Developing Capital
Markets Focus, Special Value Focus, Global Strategy Focus, High Current
Income, Natural Resources Focus, Prime Bond, Quality Equity and Fundamental
Growth Focus Funds will not purchase securities while borrowings are
outstanding, except, in the case of the Developing Capital Markets Focus
Fund, (a) to honor prior commitments or (b) to exercise subscription rights
where outstanding borrowings have been obtained exclusively for settlements
of other securities transactions. The Global Bond Focus, Global Utility
Focus, International Equity Focus and Global Growth Focus Funds will not
purchase securities while borrowings in excess of 5% of its total assets
are outstanding.
(10)The Capital Focus Fund, the Global Growth Focus Fund and the Fundamental
Growth Focus Fund are permitted to pledge their assets to secure
borrowings.
(11)Notwithstanding this restriction, each of the Prime Bond Fund and the High
Current Income Fund may invest up to 25% of its total assets in securities
(i) issued, assumed or guaranteed by foreign governments, or political
subdivisions or instrumentalities thereof, (ii) assumed or guaranteed by
domestic issuers, including Eurodollar securities or (iii) issued, assumed
or guaranteed by foreign issuers having a class of securities listed for
trading on the New York Stock Exchange. The 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 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.
In addition, to comply with tax requirements for qualification as a
"regulated investment company," each Fund's investments will be limited in a
manner such that, at the close of each quarter of each fiscal year, (a) no more
than 25% of each Fund's total assets are invested in the securities of a single
issuer, and (b) with regard to at least 50% of each Fund's total assets, no more
than 5% of its total assets are invested in the securities of a single issuer.
For purposes of this restriction, each Fund will regard each state and each
political subdivision, agency or instrumentality of such state and each
multi-state agency of which such state is a member and each public authority
which issues securities on behalf of a private entity a separate issuer, except
that if the security is backed only by the assets and revenues of a
non-governmental entity then the entity with the ultimate responsibility for the
payment of interest and principal may be regarded as the sole issuer. These
tax-related limitations may be changed by the Board of Directors of each Fund to
the extent necessary to comply with changes to the Federal tax requirements.
Over-The-Counter Options
The staff of the Securities and Exchange Commission has taken the position
that purchased over-the-counter ("OTC") options and the assets used as cover for
written OTC options are illiquid securities. Therefore, the Company has adopted
an investment policy pursuant to which it will not purchase or sell OTC options
if, as a result of such transactions, the sum of the market value of OTC options
currently outstanding which are held by a Fund, the market value of the
underlying securities covered by OTC call options currently outstanding which
were sold by the Fund and margin deposits on the Fund's existing OTC options on
futures contracts exceeds 15% of the total assets of the Fund, taken at market
value, together with all other assets of the Fund which are illiquid or are
otherwise not readily marketable. However, if an OTC option is sold by a Fund to
a primary U.S. Government securities dealer recognized by the Federal Reserve
Bank of New York and if the Fund has the unconditional contractual right to
repurchase such OTC option from the dealer at a predetermined price, then the
Fund will treat as illiquid such amount of the underlying securities equal to
the repurchase price less the amount by which the option is "in-the-money"
(i.e., current market value of the underlying securities minus the option's
strike price). The repurchase price with the primary dealers is typically a
formula price which is generally based on a multiple of the premium received for
the option, plus the amount by which the option is "in-the-money." This policy
as to OTC options is not a fundamental policy of any Fund and may be amended by
the Directors of the Company without the approval of the Company's shareholders.
However, the Company will not change or modify this policy prior to the change
or modification by the Commission staff of its position.
MANAGEMENT OF THE COMPANY
Information about the Directors and executive officers of the Company,
their ages and principal occupations for at least the last five years are set
forth below. Unless otherwise noted, the address of each executive officer and
director is P.O. Box 9011, Princeton, New Jersey 08543-9011.
TERRY K. GLENN (59) -- President and Director(1)(2) -- Executive Vice
President of the Investment Adviser and Fund Asset Management, L.P. ("FAM")
(which terms as used herein include their corporate predecessors) since 1983;
President of Princeton Funds Distributors, Inc., ("PFD") since 1986 and Director
thereof since 1991; Executive Vice President and Director of Princeton Services,
Inc. ("Princeton Services") since 1993; President of Princeton Administrators,
L.P. since 1988.
22
<PAGE>
JOE GRILLS (65) -- Director -- P.O. Box 98, Rapidan, Virginia 22733. Member
of the Committee of Investment of Employee Benefit Assets of the Financial
Executives Institute ("CIEBA") since 1986; member of CIEBA's Executive Committee
since 1988 and its Chairman from 1991 to 1993; Assistant Treasurer of
International Business Machines Incorporated ("IBM") and Chief Investment
Officer of IBM Retirement Funds from 1986 until 1993; Member of the Investment
Advisory Committee of the State of New York Common Retirement Fund and the
Howard Hughes Medical Institute since 1997; Director, Duke Management Company
since 1992 and Vice Chairman since 1998; Director, LaSalle Street Fund since
1995; Director, Hotchkis and Wiley Mutual Funds since 1996; Director, Kimco
Realty Corporation since January 1997; Member of the Investment Advisory
Committee of the Virginia Retirement System since 1998; Director, Montpelier
Foundation since 1998.
WALTER MINTZ (71) -- Director -- 1114 Avenue of the Americas, New York, New
York 10036. Special Limited Partner of Cumberland Partners (investment
partnership) since 1982.
ROBERT S. SALOMON, JR. (63) -- Director -- 106 Dolphin Cove Quay, Stamford,
Connecticut 06902. Principal of STI Management (investment adviser) since 1994;
Trustee, Common Fund since 1980; Chairman and CEO of Salomon Brothers Asset
Management from 1992 until 1995; Chairman of Salomon Brothers equity mutual
funds from 1992 until 1995; Monthly columnist with Forbes Magazine since 1992;
Director of Stock Research and U.S. Equity Strategist at Salomon Brothers from
1975 until 1991.
MELVIN R. SEIDEN (69) -- Director -- 780 Third Avenue, Suite 2502, New
York, New York 10017. Director of Silbanc Properties, Ltd. (real estate,
consulting and investments) since 1987; Chairman and President of Seiden & de
Cuevas, Inc. (private investment firm) from 1964 to 1987.
STEPHEN B. SWENSRUD (66) -- Director(2)(3) -- 24 Federal Street, Suite
400,Boston, Massachusetts 02110. Chairman of Fernwood Associates (investment
adviser) since 1996; Principal, Fernwood Associates (financial consultants)
since 1975; Chairman of RPP Corporation (Manufacturing) since 1978; Director of
International Mobile Communications, Inc. (Telecommunications) since 1998.
ARTHUR ZEIKEL (67) -- Director (1)(2) -- 300 Woodland Avenue, Westfield,
New Jersey 07090. Chairman of MLAM and FAM from 1997 to 1999 and President
thereof from 1977 to 1997; Chairman of Princeton Services from 1997 to 1999,
Director thereof from 1993 to 1999 and President thereof from 1993 to 1997;
Executive Vice President of Merrill Lynch & Co., Inc. ("ML&Co.") from 1990 to
1999.
CHRISTOPHER G. AYOUB (44) -- Senior Vice President(1)(2) -- First Vice
President of the Investment Adviser since 1998; Vice President of the Investment
Adviser from 1985 to 1997.
LAWRENCE R. FULLER (58) -- Senior Vice President(1)(2) -- First Vice
President of the Investment Adviser since 1997.
KEVIN J. MCKENNA (42) -- Senior Vice President(1)(2) -- First Vice
President of the Investment Adviser since 1997; Vice President of the Investment
Adviser from 1985 to 1997.
ERIC S. MITOFSKY (45) -- Senior Vice President(1)(2) -- First Vice
President of the Investment Adviser since 1997; Vice President of the Investment
Adviser from 1992 to 1997; Senior Desk Analyst with Merrill Lynch Program
Trading Desk from 1987 to 1992.
JOSEPH T. MONAGLE, JR. (51) -- Senior Vice President(1)(2) -- Senior Vice
President and Department Head of the Global Fixed Income Division of the
Investment Adviser and associated therewith since 1977; Senior Vice President of
Princeton Services since 1993.
GRACE PINEDA (43) -- Senior Vice President(1)(2) -- First Vice President
since 1997; Vice President of the Investment Adviser since 1989. Prior to
joining the Investment Adviser, Ms. Pineda was a portfolio manager with Clemente
Capital, Inc.
KEVIN RENDINO (33) -- Senior Vice President(1)(2) -- First Vice President
since 1997; Vice President of the Investment Adviser since December 1993; Senior
Research Analyst from 1990 to 1992; Corporate Analyst from 1988 to 1990.
23
<PAGE>
THOMAS R. ROBINSON (56) -- Senior Vice President(1)(2) -- First Vice
President since 1997; Senior Portfolio Manager of the Investment Adviser since
November 1995; Manager of International Equity Strategy of ML & Co.'s Global
Securities Research and Economics Group from 1989 to 1995.
WALTER D. ROGERS (57) -- Senior Vice President(1)(2) -- First Vice
President since 1997; Vice President of the Investment Adviser since 1987; Vice
President of Continental Insurance Asset Management from 1984 to 1987.
ROBERT SHEARER (44) -- Senior Vice President(1)(2) -- First Vice President
of the Investment Adviser since January 1998; Vice President from 1997 to 1998;
Vice President and Assistant Portfolio Manager at David L. Babson and Company,
Incorporated from 1996 to 1997; Vice President/Section Manager at Concert
Capital Management from 1993 to 1996.
DANIEL V. SZEMIS (40) -- Senior Vice President(1)(2) -- First Vice
President of the Investment Adviser since 1997 -- Portfolio Manager with
Prudential Mutual Fund Investment Management Advisors from 1990 to 1996.
R. ELISE BAUM (39) -- Vice President(1)(2) -- First Vice President of the
Investment Adviser since 1999; Vice President since 1995; Senior Fund Analyst
from 1994-1995; Fund Analyst from 1993-1994; Consultant from 1992-1993.
DONALD C. BURKE (39) -- Vice President and Treasurer(1)(2) -- Senior Vice
President and Treasurer of FAM; Senior Vice President and Treasurer of Princeton
Services; Vice President and Treasurer of PFD; First Vice President of MLAM from
1997 to 1999; Vice President of MLAM from 1990 to 1997.
HARRY ESCOBAR (54) -- Vice President(1)(2) -- Director (Global Fixed
Income) of the Investment Adviser since 1998.
CLIVE D. LANG (48) -- Vice President(1) -- First Vice President with MLAM
U.K. since 1997 and Senior Quantitative Analyst for the Fund since 1996. Prior
to that, various positions with Paregora Asset Management Limited from 1990 to
1997, including Chief Investment officer (1994 to 1997).
ROBERT F. MURRAY (42) -- Vice President(1)(2) -- Vice President of the
Investment Adviser since 1993. Employed by the Investment Adviser since 1989.
JACQUELINE AYOUB (42) -- Vice President(1)(2) -- Vice President of the
Investment Adviser since January 1986.
KURT SCHANSINGER (39) -- Vice President(1)(2) -- First Vice President of
the Investment Adviser since 1997. Prior to joining the Investment Adviser, Mr.
Schansinger spent 12 years with Oppenheimer Capital, where he rose to Senior
Vice President.
ALLAN J. OSTER (36) -- Secretary -- Consultant in Legal Advisory Group of
the Investment Adviser since 1999; Associate, Drinker Biddle & Reath LLP from
1996 to 1999; Senior Counsel, U.S. Securities and Exchange Commission from 1991
to 1996.
- ---------------
(1) Interested person, as defined in the Investment Company Act of 1940, of the
Company.
(2)The officers of the Company are officers of certain other investment
companies for which the Investment Adviser or FAM acts as investment adviser.
Pursuant to the terms of the Investment Advisory Agreements, the Investment
Adviser pays all compensation of officers and employees of the Company as well
as the fees of all directors of the Company who are affiliated persons of
Merrill Lynch & Co., Inc. or its subsidiaries. The Company pays each Director
not affiliated with the Company (each a "non-interested Director") a fee of
$8,000 per year plus $1,250 for each quarterly meeting of the Board of Directors
attended, $7,500 per year for serving on the Audit Committee of the Board of
Directors plus $1,250 for each meeting of the Audit Committee attended if such
meeting is held on a day other than a day on which the Board of Directors meets,
and reimbursement of out-of-pocket expenses.
The following table sets forth for the fiscal year ended December 31, 1998
compensation paid by the Company to the non-interested Directors and for the
calendar year ended December 31, 1998, the aggregate compensation paid by all
investment companies (including the Company) advised by the Investment Adviser
and its affiliate, FAM ("MLAM/FAM Advised Funds") to the non-interested
Directors:
24
<PAGE>
<TABLE>
<CAPTION>
Pension or Total Compensation
Retirement from Company
Aggregate Benefits Accrued Estimated and MLAM/FAM
Compensation As Part of Annual Advised Funds
from Company Benefits Upon Paid To
Name of Director Company Expense Retirement Directors(1)
- --------------- ------------ -------------- ------------ ----------------
<S> <C> <C> <C> <C>
Walter Mintz(1) ......................... $25,500 None None $178,583
Melvin R. Seiden(1) ..................... 25,500 None None 178,583
Stephen B. Swendsrud(1) ................. 25,500 None None 195,583
Joe Grills(1) ........................... 25,500 None None 198,333
Robert S. Salomon, Jr.(1) ............... 25,500 None None 178,583
</TABLE>
- ------------------
(1)The Directors serve on the boards of MLAM/FAM Advised Funds as follows: Mr.
Grills (23 registered investment companies consisting of 55 portfolios); Mr.
Mintz (20 registered investment companies consisting of 41 portfolios); Mr.
Salomon (20 registered investment companies consisting of 41 portfolios); Mr.
Seiden (20 registered investment companies consisting of 41 portfolios); and
Mr. Swensrud (23 registered investment companies consisting of 56
portfolios).
Mr. Zeikel and the officers of the Company owned on March 31, 1999 in the
aggregate less than 1% of the outstanding Common Stock of Merrill Lynch & Co.,
Inc. The Company has an Audit Committee consisting of all of the directors of
the Company who are not interested persons of the Company.
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).
INVESTMENT ADVISORY ARRANGEMENTS
The Company has entered into eight separate investment advisory agreements
(the "Investment Advisory Agreements") relating to the Funds with Merrill Lynch
Asset Management, L.P. ("MLAM"), the Investment Adviser (the "Investment
Advisor"), a wholly owned subsidiary of Merrill Lynch & Co., Inc. The principal
business address of the Investment Adviser is 800 Scudders Mill Road,
Plainsboro, New Jersey 08536. The Investment Adviser or its affiliate, Fund
Asset Management, L.P. ("FAM"), currently acts as the investment adviser to over
100 other registered investment companies. The Investment Adviser also offers
portfolio management and portfolio analysis services to individuals and
institutions. As of December 1998, FAM and MLAM had a total of $501 billion in
investment company and other portfolio assets under management, including
selected accounts of certain affiliates of MLAM.
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
25
<PAGE>
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.
The principal executive officers and directors of the Investment Adviser
are Jeffery M. Peek, President; Terry K. Glenn, Executive Vice President; Robert
W. Crook, Senior Vice President; Linda L. Federici, Senior Vice President;
Vincent R. Giordano, Senior Vice President; Michael J. Hennewinkel, Senior Vice
President, General Counsel, Director and Secretary; Philip L. Kirstein, Senior
Vice President; Ronald M. Kloss, Senior Vice President; Debra W. Landsman-Yaros,
Senior Vice President; Stephen M. M. Miller, Senior Vice President; Joseph T.
Monagle, Jr., Senior Vice President; Gregory Upah, Senior Vice President; and
Brian A. Murdock, Senior Vice President; Donald C. Burke, Senior Vice President;
Michael G. Clark, Senior Vice President and Mark A. DeSario, Senior Vice
President.
Securities held by any Fund may also be held by other funds for which the
Investment Adviser or FAM acts as an adviser or by investment advisory clients
of the Investment Adviser. Because of different investment objectives or other
factors, a particular security may be bought for one or more clients when one or
more clients are selling the same security. If purchases or sales of securities
for any Fund or other funds for which the Investment Adviser or FAM acts as
investment adviser or for their advisory clients arise for consideration at or
about the same time, transactions in such securities will be made, insofar as
feasible, for the respective funds and clients in a manner deemed equitable to
all. To the extent that transactions on behalf of more than one client of the
Investment Adviser or FAM during the same period may increase the demand for
securities being purchased or the supply of securities being sold, there may be
an adverse effect on price.
Advisory Fee. As compensation for its services to the Company and its
Funds, the Investment Adviser receives a fee from the Company at the end of each
month at an annual rate of 0.75% of the average daily net assets of each of the
Special Value Focus Fund, Global Growth Focus Fund, and International Equity
Focus Fund, 0.60% of the average daily net assets of the Capital Focus Fund,
0.65% of the average daily net assets of each of the Natural Resources Focus
Fund, Fundamental Growth Focus Fund and Global Strategy Focus Fund, 0.55% of the
average daily net assets of the American Balanced Fund, 0.50% of the average
daily net assets of the Domestic Money Market Fund and Government Bond Fund,
0.60% of the average daily net assets of the Basic Value Focus Fund, Global Bond
Focus Fund and Global Utility Focus Fund, 1.00% of the average daily net assets
of the Developing Capital Markets Focus Fund, 0.30% of the average daily net
assets of the Index 500 Fund and at the following annual rates with respect to
the other Funds:
Reserve Assets Fund
Portion of average daily value of net assets of the Fund:
Advisory Fee
------------
Not exceeding $500 million .................................... 0.500%
In excess of $500 million but not exceeding $750 million ...... 0.425%
In excess of $750 million but not exceeding $1 billion ........ 0.375%
In excess of $1 billion but not exceeding $1.5 billion ........ 0.350%
In excess of $1.5 billion but not exceeding $2 billion ........ 0.325%
In excess of $2 billion but not exceeding $2.5 billion ........ 0.300%
In excess of $2.5 billion ..................................... 0.275%
Quality Equity Fund
Portion of average daily value of net assets of the Fund:
Advisory Fee
------------
Not exceeding $250 million .................................... 0.500%
In excess of $250 million but not exceeding $500 million ...... 0.450%
In excess of $300 million but not exceeding $400 million ...... 0.425%
In excess of $400 million ..................................... 0.400%
26
<PAGE>
Prime Bond Fund and High Current Income Fund
Portion of aggregate average daily value of net assets of both Funds:
<TABLE>
<CAPTION>
Advisory Fee
High Current Prime Bond
Income Fund Fund
------------ ------------
<S> <C> <C>
Not exceeding $250 million ........................................... 0.55% 0.50%
In excess of $250 million but not exceeding $500 million ............. 0.50% 0.45%
In excess of $500 million but not exceeding $750 million ............. 0.45% 0.40%
In excess of $750 million ............................................ 0.40% 0.35%
</TABLE>
These fee rates for the Prime Bond Fund and High Current Income Fund are
applied to the average daily net assets of each Fund, with the reduced rates
shown below applicable to portions of each Fund to the extent that the aggregate
of the average daily net assets of the combined Fund exceed $250 million, $300
million, $400 million and $800 million (each such amount being a "breakpoint
level"). The portion of the assets of a Fund to which the rate at each
breakpoint level applies will be determined on a "uniform percentage" basis. The
uniform percentage applicable to a breakpoint level is determined by dividing
the amount of the aggregate of the average daily net assets of the combined Fund
that falls within that breakpoint level by the aggregate of the average daily
net assets of the combined Fund. The amount of the fee for a Fund at each
breakpoint level is determined by multiplying the average daily net assets of
that Fund by the uniform percentage applicable to that breakpoint level and
multiplying the product by the advisory fee rate.
The Investment Adviser and Merrill Lynch Life Agency, Inc. ("MLLA") entered
into two reimbursement agreements, dated April 30, 1985 and February 11, 1992
and amended effective October 9, 1997 (as so amended, the "Reimbursement
Agreements"), that provide that the expenses paid by each Fund (excluding
interest, taxes, brokerage fees and commissions and extraordinary charges such
as litigation costs, and excluding the distribution fees if any imposed on Class
B shares of such Fund) will be limited to 1.25% of its average net assets. Any
such expenses in excess of this percentage will be reimbursed to the Fund by the
Investment Adviser which, in turn, will be reimbursed by MLLA. The Reimbursement
Agreements may be amended or terminated by the parties thereto upon prior
written notice to the Company. For the fiscal year ended December 31, 1998, the
Investment Adviser earned fees of $1,126,826 for the Developing Capital Markets
Focus Fund of which $193,001 was voluntarily waived. For the fiscal year ended
December 31, 1997, the Investment Adviser earned fees of $30,733,366 and
reimbursed $217,067 for the Developing Capital Markets Focus Fund, and $78,164
for the Government Bond Fund. For the fiscal year ended December 31, 1996, the
Investment Adviser earned fees of $765,718 for the Developing Capital Markets
Focus Fund of which $52,388 was voluntarily waived, $297,926 for the Government
Bond Fund of which $264,214 was voluntarily waived, and $1,638 for the Index 500
Fund, all of which was voluntarily waived. In addition, the Investment Adviser
has also reimbursed the Index 500 Fund $1,651 in additional expenses.
The Investment Advisory Agreements relating to the Company's Funds, unless
earlier terminated as described below, will continue in effect from year to year
if approved annually (a) by the Board of Directors of the Company or by a
majority of the outstanding shares of the respective Funds, and (b) by a
majority of the directors who are not parties to such contracts or interested
persons (as defined in the Investment Company Act of 1940) of any such party.
The Board of Directors of the Company approved the continuation of the
Investment Advisory Agreements relating to all Funds, at a meeting held on April
13, 1999. The Investment Advisory Agreements are not assignable and may be
terminated without penalty on 60 days' written notice at the option of either
party or by the vote of the shareholders of the respective Funds.
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 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.
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<PAGE>
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.
Payment of Expenses. The Investment Advisory Agreements obligate the
Investment Adviser to provide investment advisory services and to pay all
compensation of and furnish office space for officers and employees of the
Company connected with investment and economic research, trading and investment
management of the Funds, as well as the fees of all directors of the Company who
are affiliated persons of Merrill Lynch & Co., Inc. or any of its subsidiaries.
Each Fund will pay all other expenses incurred in its operation, including a
portion of the Company's general administrative expenses allocated on the basis
of the Fund's asset size. Expenses that will be borne directly by the Funds
include redemption expenses, expenses of portfolio transactions, shareholder
servicing costs, expenses of registering the shares under federal and state
securities laws, pricing costs (including the daily calculation of net asset
value), interest, certain taxes, charges of the Custodian and Transfer Agent and
other expenses attributable to a particular Fund. Expenses which will be
allocated on the basis of size of the respective Funds include directors' fees,
legal expenses, state franchise taxes, auditing services, costs of printing
proxies and stock certificates, Securities and Exchange Commission fees,
accounting costs and other expenses properly payable by the Company and
allocable on the basis of size of the respective Funds. Accounting services are
provided for the Company by the Investment Adviser, and the Company reimburses
the Investment Adviser for its costs in connection with such services. For the
fiscal years ended December 31, 1998, December 31, 1997, and December 31, 1996
the amount of such reimbursement was $1,151,573, $1,157,644 and $903,975,
respectively. Depending upon the nature of the lawsuit, litigation costs may be
directly applicable to the Funds or allocated on the basis of the size of the
respective Funds. The Board of Directors has determined that this is an
appropriate method of allocation of expenses.
During the Company's fiscal year ended December 31, 1998, the total
operating expenses attributable to the Class A Shares 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, expressed as a percentage
of each Fund's average net assets were as follows: 0.68% of the Reserve Asset's
Fund's average net assets, 0.48% of the Prime Bond Fund's average net assets,
0.53% of the High Current Income Fund's average net assets, 0.49% of the Quality
Equity Fund's average net assets, 0.81% of the Special Value Focus Fund's
average net assets, 0.36% of the Index 500 Fund's average net assets, 0.88% of
the Natural Resources Focus Fund's average net assets, 0.62% of the American
Balanced Fund's average net assets, 0.56% of the Domestic Money Market Fund's
average net assets, 0.72% of the Global Strategy Focus Fund's average net
assets, 0.66% of the Basic Value Focus Fund's average net assets, 0.75% of the
Global Bond Focus Fund's average net assets, 0.68% of the Global Utility Focus
Fund's average net assets, 0.89% of the International Equity Focus Fund's
average net assets, 1.42% of the Developing Capital Markets Focus Fund's average
net assets, 0.56% of the Government Bond Fund's average net assets, 1.03% of the
Global Growth Focus Fund's average net assets, 0.86% of the Capital Focus Fund's
average net assets.
During the Company's fiscal year ended December 31, 1998, the total
operating expenses attributable to the Class B Shares 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, expressed as a percentage
of each Fund's average net assets, were as follows: 0.97% of the Special Value
Focus Fund's average net assets, 0.82% of the Basic Value Focus Fund's average
net assets, and 1.72% of the Developing Capital Markets Focus Fund's average net
assets.
The Funds have adopted a Distribution Plan (the "Plan") with regards to the
Class B Common Stock of each Fund, pursuant to Rule 12b-1 under the Investment
Company Act. The Plan permits the Company to pay to each Insurance Company that
enters into an agreement with the Company to provide distribution related
services to Contract owners, a fee, at the end of each month, of up to 0.15% of
the net asset value of the Class B Common Stock of each Fund held by such
Insurance Company. Such services include, but are not limited to, (a) the
printing and mailing of Fund prospectuses, statements of additional information,
any supplements thereto and shareholder reports for existing and prospective
Contract owners, (b) services relating to the development, preparation, printing
and mailing of Company advertisements, sales literature and other promotional
materials describing and/or relating to the Company and including materials
intended for use within the Insurance Company, (c) holding seminars and sales
meetings designed to promote the distribution of the Class B Shares of the
Funds, (d) obtaining information and providing explanations to Contract owners
regarding the investment
28
<PAGE>
objectives and policies and other information about the Company and its Funds,
including the performance of the Funds, (e) training sales personnel regarding
the Company and the Funds, (f) compensating sales personnel in connection with
the allocation of cash values and premiums of the Separate Accounts of the
Insurance Company, (g) providing personal services and/or maintenance of the
Separate Accounts with respect to Class B Shares of the Funds attributable to
such accounts, and (h) financing any other activity that the Company's Board of
Directors determines is primarily intended to result in the sale of Class B
Shares. For the fiscal year ended December 31, 1998, the Company paid an
aggregate of $3,570 in fees pursuant to the Plan to various Insurance Companies
providing services under the Plan.
DETERMINATION OF NET ASSET VALUE
The net asset value of each class of 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
(generally 4:00 p.m., Eastern time) on each day the New York Stock Exchange
("NYSE") is open for business. The NYSE is open on business days other than
national holidays and Good Friday. The net asset value per share of each class
of shares of a Fund other than the Domestic Money Market and Reserve Assets
Funds is computed by dividing the sum of the value of the securities plus any
cash or other assets (including interest and dividends accrued) held by such
Fund and attributable to such class minus all liabilities (including accrued
expenses) attributable to such class by the total number of shares of such class
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.
Except with respect to securities held by the Domestic Money Market and
Reserve Assets Funds 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) on the
exchange on which such securities are traded as of the close of business on the
day the securities are being valued, or, lacking any sales, at the last
available bid price for long positions and at the last available ask price for
short positions. Long positions in 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, provided however that the Index 500 Fund will
value its portfolio holdings which trade on the NASDAQ national market system at
the last sale price prior to the time of valuation. Short positions in
securities traded in the OTC market are valued at the last available ask price
in the OTC market prior to the time of valuation. In cases where securities are
traded on more than one exchange, the securities are valued on the exchange
designated by under the authority of the Directors as the primary market.
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 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 and Reserve Assets Funds 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(SM) 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, 1998, American Balanced Fund, Global Strategy
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<PAGE>
Focus Fund, Global Utility Focus Fund, High Current Income Fund, Government Bond
Fund, Prime Bond Fund and Capital Focus Fund paid MLSPS $263, $155, $29, $5,613,
$2,880, $8,190 and $57, respectively.
Since the net investment income of the Domestic Money Market and Reserve
Assets Funds (including realized gains and losses on its portfolio securities)
is declared as a dividend each time the net income of the Funds are determined
(see "Dividends, Distributions and Taxes"), the net asset value per share of the
Funds normally remains at $1.00 per share immediately after each such
determination and dividend declaration. The Board of Directors of the Company
expects that the Domestic Money Market and Reserve Assets Funds will have a
positive net income at the time of each determination. If for any reason the net
income of either Fund is a negative amount (i.e., net realized and unrealized
losses and expenses exceed interest income), that Fund will reduce the number of
its outstanding shares. This reduction will be effected by having the Separate
Accounts of the Insurance Companies proportionately contribute to the capital of
the Fund the necessary shares that represent the amount of the excess upon such
determination. It is anticipated that the Insurance Companies will agree to such
contribution in these circumstances. Any such contribution will be treated as a
negative dividend for purposes of the Net Investment Factor under the Contracts
described in the Prospectus for the Contracts. See "Dividends, Distributions and
Taxes" for a discussion of the tax effect of such a reduction. This procedure
will permit the net asset value per share of the Domestic Money Market and
Reserve Assets Funds to be maintained at a constant value of $1.00 per share.
If in the view of the Board of Directors of the Company it is inadvisable
to continue the practice of maintaining the net asset value of the Domestic
Money Market and Reserve Assets Funds at $1.00 per share, the Board of Directors
of the Company reserves the right to alter the procedure. The Company will
notify the Insurance Companies of any such alteration.
Each of the International Equity Focus Fund, Global Utility Focus Fund,
Global Bond Focus Fund, Global Growth Focus Fund, and Developing Capital Markets
Focus Fund may invest a substantial portion of its assets in foreign securities
which are traded on days on which such Fund's net asset value is not computed.
On any such day, shares of such a Fund may not be purchased or redeemed since
shares of a Fund may only be purchased or redeemed on days on which the Fund's
net asset value is computed.
Securities held by the Domestic Money Market and Reserve Assets Funds with
a remaining maturity of 60 days or less are valued on an amortized cost basis,
unless particular circumstances dictate otherwise. Under this method of
valuation, the security is initially valued at cost on the date of purchase (or
in the case of securities purchased with more than 60 days remaining to
maturity, the market value on the 61st day prior to maturity); and thereafter
the Domestic Money Market and Reserve Assets Funds assume a constant
proportionate amortization in value until maturity of any discount or premium,
regardless of the impact of fluctuating interest rates on the market value of
the security. For purposes of this method of valuation, the maturity of a
variable rate certificate of deposit is deemed to be the next coupon date on
which the interest rate is to be adjusted. If, due to the impairment of the
creditworthiness of the issuer of a security held by either Fund or to other
factors with respect to such security, the fair value of such security is not
fairly reflected through the amortized cost method of valuation, such security
will be valued at fair value as determined in good faith by the Board of
Directors.
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.
If the securities in which a particular Fund of the Company invests are
traded primarily in the over-the-counter market, where possible, the Fund will
deal directly with the dealers who make a market in the securities involved,
except in those circumstances where better prices and execution are available
elsewhere. Such dealers usually are acting as principals for their own account.
On occasions, securities may be purchased directly from
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<PAGE>
the issuer. Bonds and money market securities are generally traded on a net
basis and do not normally involve either brokerage commissions or transfer
taxes. The cost of executing portfolio securities transactions of each Fund will
primarily consist of brokerage commissions or underwriter or dealer spreads.
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. Since
over-the-counter transactions are usually principal transactions, affiliated
persons of the Company, including Merrill Lynch Government Securities Inc.
("GSI"), Merrill Lynch Money Markets Inc. ("MMI") and Merrill Lynch, Pierce,
Fenner & Smith Incorporated ("Merrill Lynch"), may not serve as the Company's
dealer in connection with such transactions except pursuant to exemptive orders
from the Securities and Exchange Commission, such as the one described below.
However, affiliated persons of the Company may serve as its broker in
over-the-counter transactions conducted on an agency basis, subject to the
Company's policy of obtaining best price and execution. The Company may not
purchase securities from any underwriting syndicate of which Merrill Lynch is a
member except in accordance with rules and regulations under the Investment
Company Act of 1940.
The Securities and Exchange Commission has issued an exemptive order
permitting the Company to conduct principal transactions with respect to the
Domestic Money Market and Reserve Assets Funds with GSI and MMI in U.S.
Government and government agency securities, and certain other money market
securities, subject to a number of conditions, including conditions designed to
insure that the prices to the Funds available from GSI and MMI are equal to or
better than those available from other sources. GSI and MMI have informed the
Company that they will in no way, at any time, attempt to influence or control
the activities of the Company or the Investment Adviser in placing such
principal transactions. The exemptive order allows GSI and MMI to receive a
dealer spread on any transaction with the Company no greater than their
customary dealer spreads for transactions of the type involved. Certain court
decisions have raised questions as to whether investment companies should seek
to "recapture" brokerage commissions and underwriting and dealer spreads by
effecting their purchases and sales through affiliated entities. In order to
effect such an arrangement, the Company would be required to seek an exemption
from the Investment Company Act so that it could engage in principal
transactions with affiliates. The Board of Directors has considered the
possibilities of seeking to recapture spreads for the benefit of the Company
and, after reviewing all factors deemed relevant, has made a determination not
to seek such recapture at this time. The Board will reconsider this matter from
time to time. The Company will take such steps as may be necessary to effect
recapture, including the filing of applications for exemption under the
Investment Company Act of 1940, if the Directors should determine that recapture
is in the best interests of the Company or otherwise required by developments in
the law.
While the Investment Adviser seeks to obtain the most favorable net results
in effecting transactions in the Funds' portfolio securities, dealers who
provide supplemental investment research of the Investment Adviser may receive
orders for transactions by the Funds. Such supplemental research services
ordinarily consist of assessments and analysis of the business or prospects of a
company, industry or economic sector. If, in the judgment of the Investment
Adviser, a particular Fund or Funds will be benefited by such supplemental
research services, the Investment Adviser is authorized to pay spreads or
commissions to brokers or dealers furnishing such services which are in excess
of spreads or commissions which another broker or dealer may charge for the same
transaction. Information so received will be in addition to and not in lieu of
the services required to be performed by the Investment Adviser under the
Investment Advisory Agreements. The expenses of the Investment Adviser will not
necessarily be reduced as a result of the receipt of such supplemental
information. In some cases, the Investment Adviser may use such supplemental
research in providing investment advice to its other investment advisory
accounts. For the fiscal year ended December 31, 1998, the Company paid
brokerage commissions of $9,859,536, of which $616,864 was paid to Merrill
Lynch. For the fiscal year ended December 31, 1998, the brokerage commissions
paid to Merrill Lynch represented 6.25% of the aggregate brokerage commissions
paid and involved 6.91% of the Company's dollar amount of transactions involving
payment of commissions during the year. For the fiscal year ended December 31,
1997, the Company paid brokerage commissions of $8,344,021, of which $302,843
was paid to Merrill Lynch. For the fiscal year ended December 31, 1996, the
Company paid brokerage commissions of $6,656,814, of which $266,405 was paid to
Merrill Lynch.
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Portfolio Turnover
Each Fund has a different expected rate of portfolio turnover; however, rate of
portfolio turnover will not be a limiting factor when management of the Company
deems it appropriate to purchase or sell securities for a Fund. Because of the
short-term nature of the securities in which the Domestic Money Market and
Reserve Assets Funds will invest, and because such Funds' investments will be
constantly changing in response to market conditions, no portfolio turnover rate
may be accurately stated for the Domestic Money Market and Reserve Assets Funds.
Below are portfolio turnover rates for each of the Funds, for the fiscal
years ended December 31, 1998 and December 31, 1997:
1998 1997
---- ----
American Balanced Fund ........................... 102.47% 136.71%
Basic Value Focus Fund ........................... 113.44% 95.52%
Capital Focus Fund* .............................. 29.48%
Developing Capital Markets Focus Fund ............ 121.06% 93.62%
Fundamental Growth Focus Fund** .................. N/A N/A
Global Bond Focus Fund ........................... 127.93% 568.76%
Global Growth Focus Fund* ........................ 15.25%
Global Strategy Focus Fund ....................... 120.59% 108.66%
Global Utility Focus Fund ........................ 5.20% 7.70%
Government Bond Fund ............................. 43.10% 117.65%
High Current Income Fund ......................... 33.63% 53.63%
Index 500 Fund ................................... 11.92% 36.85%
International Equity Focus Fund .................. 126.23% 127.96%
Natural Resources Focus Fund ..................... 29.65% 20.93%
Prime Bond Fund .................................. 103.24% 89.22%
Quality Equity Fund .............................. 100.29% 100.08%
Special Value Focus Fund ......................... 56.29% 147.06%
- -------------
* Commencement of operations is June 5, 1998.
** Commencement of operations is April __, 2000.
PURCHASE OF SHARES
The Company continuously offers shares of Class A Common Stock of each of
the Funds and shares of Class B Common Stock of the Basic Value Focus Fund,
Developing Capital Markets Focus Fund and the Special Value Focus Fund to the
Insurance Companies at prices equal to the respective per share net asset value
of the Funds. Princeton Funds Distributor, Inc. (the "Distributor"), a wholly
owned subsidiary of the Investment Adviser, acts as the distributor of the
shares.
The Company will offer shares of Class B Stock in each of its other Funds
to the Insurance Companies at the per share price of the Class A Common Stock of
the corresponding Fund until such time as a share of Class B Common Stock is
purchased, and thereafter, the Company will continuously offer shares of Class B
Common Stock at prices equal to the respective per share net asset value of the
Class B Common Stock of the Funds. The Distributor 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.
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.
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The right to redeem shares or to receive payment with respect to any
redemption may only be suspended for any period during which trading on the New
York Stock Exchange is restricted as determined by the Securities and Exchange
Commission or such Exchange is closed (other than customary weekend and holiday
closings), for any period during which an emergency exists as defined by the
Securities and Exchange Commission as a result of which disposal of portfolio
securities or determination of the net asset value of each Fund is not
reasonably practicable, and for such other periods as the Securities and
Exchange Commission may by order permit for the protection of shareholders of
each Fund.
DIVIDENDS AND TAXES
Dividends
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 and Reserve
Assets Funds, 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 and
Reserve Assets Funds (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 and Reserve Assets Funds
are declared daily and reinvested monthly in additional full and fractional
shares of such Fund. Dividends from net investment income of the Global Bond
Focus, Government Bond, High Current Income and Prime Bond 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 American Balanced, Basic Value Focus, Capital Focus, Developing Capital
Markets Focus, Special Value Focus, Global Strategy Focus, Global Growth Focus,
Index 500, International Equity Focus, National Resources Focus, Quality Equity
and Fundamental Growth 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 and
Reserve Assets Funds, 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.
Federal Income Taxes
Under the Internal Revenue Code of 1986, as amended (the "Code"), each Fund
of the Company will be treated as a separate corporation for federal income tax
purposes and, thus, each Fund is required to satisfy the qualification
requirements under the Code for treatment as a regulated investment company.
There will be no offsetting of capital gains and losses among the Funds. Each
Fund intends to continue to qualify as a regulated investment company under
certain provisions of 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. To qualify for
treatment as a regulated investment company, a Fund must, among other things,
derive in each taxable year at least 90% of its gross income from dividends,
interest, payments with respect to securities loans, and gains from the sale or
other disposition of securities and derive less than 30% of its gross income in
each taxable year from the gains (without deduction for losses) from the sale or
other disposition of stocks, securities, certain options, futures or forward
contracts and certain foreign currencies held for less than three months. In
addition, the Code requires that each Fund meet certain diversification
requirements, including the requirement that not more than 25% of the value of a
Fund's total assets be invested in the securities (other than U.S. Government
securities or the securities of other regulated investment companies) of any one
issuer. Each of the Company's Funds, including the Natural Resources Focus Fund,
intends to comply with the above-described requirements.
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On occasion, some amount of the dividends of the Domestic Money Market Fund
or the Reserve Assets Fund for a fiscal year may constitute a return of capital,
in which case such amount would be applied against and reduce the Separate
Account's tax basis in shares of such Fund. If such amount were to exceed the
Separate Account's tax basis for shares of the Domestic Money Market Fund or the
Reserve Assets Fund, the excess would be treated as gain from the sale or
exchange of such shares.
On occasion the net income of the Domestic Money Market Fund or the Reserve
Assets Fund may be a negative amount as a result of a net decline in the value
of the portfolio securities of the Fund which is in excess of the interest
earned. Consequently, the Fund will reduce the number of its outstanding shares
to reflect the negative net income. The adjustment may result in gross income to
shareholders in excess of the net dividend credited to such shareholders for a
period. In such a case, such shareholders' tax basis in the shares of the
Domestic Money Market Fund or the Reserve Assets Fund may be adjusted to reflect
the difference between taxable income and net dividends actually distributed.
Such difference may be realized as a capital loss when the shares are
liquidated.
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.
Certain Funds may invest in securities rated in the medium to lower rating
categories of nationally recognized rating organizations, and in unrated
securities ("high yield securities"), as described in the Prospectus and in this
Statement of Additional Information. Some of these high yield securities may be
purchased at a discount and may therefore cause the Fund to accrue and
distribute income before amounts due under the obligations are paid. In
addition, a portion of the interest payments on such high yield securities may
be treated as dividends for Federal income tax purposes; in such case, if the
issuer of such high yield securities is a domestic corporation, dividend
payments by the Fund will be eligible for the dividends received deduction to
the extent of the deemed dividend portion of such interest payments.
Certain Funds may invest up to 10% of their total assets in securities of
closed-end investment companies. If the Fund purchases shares of an investment
company (or similar investment entity) organized under foreign law, the Fund
will be treated as owning shares in a passive foreign investment company
("PFIC") for U.S. Federal income tax purposes. The Fund may be subject to U.S.
Federal income tax, and an additional tax in the nature of interest (the
"interest charge"), on a portion of the distributions from such a company and on
gain from the disposition of the shares of such a company (collectively referred
to as "excess distributions"), even if such excess distributions are paid by the
Fund as a dividend to its shareholders. The Fund may be eligible to make an
election with respect to certain PFICs in which it owns shares that will allow
it to avoid the taxes on excess distributions. However, such election may cause
the Fund to recognize income in a particular year in excess of the distributions
received from such PFICs. Alternatively, under recent legislation, the Fund
could elect to "mark to market" at the end of each taxable year all shares that
it holds in PFICs. If it made this election, the Fund would recognize as
ordinary income any increase in the value of such shares over their adjusted
basis and as ordinary loss any decrease in such value to the extent it did not
exceed prior increases. By making the mark-to-market election, the Fund could
avoid imposition of the interest charge with respect to distributions from
PFICs, but in any particular year might be required to recognize income in
excess of the distributions it received from PFICs and its proceeds from
dispositions of PFIC stock.
The Treasury Department has authority to issue regulations concerning the
recharacterization of principal and interest payments with respect to debt
obligations issued in hyperinflationary currencies, which may include the
currencies of certain countries in which the Fund intends to invest. No such
regulations have been issued.
34
<PAGE>
The foregoing is a general and abbreviated summary of the applicable
provisions of the Code and Treasury Regulations presently in effect. For the
complete provisions, reference should be made to the pertinent Code sections and
the Treasury Regulations promulgated thereunder. The Code and these Regulations
are subject to change by legislative or administrative action, and such change
may apply retroactively.
DISTRIBUTION ARRANGEMENTS
The Company has entered into a distribution agreement (the "Distribution
Agreement") with Merrill Lynch Funds Distributor, Inc. with respect to the sale
of the Company's shares, other than shares of the Class A Common Stock and Class
B Common Stock of the Global Growth Fund and the Capital Focus Fund, to the
Distributor for resale to Insurance Companies' accounts. Such shares will be
sold at their respective net asset values and therefore will involve no sales
charge. The Distributor is a wholly owned subsidiary of the Investment Adviser.
The continuation of the Distribution Agreement was approved by the Company's
Board of Directors at a meeting held on April 13, 1999.
The Distribution Agreement is subject to the same renewal requirements and
termination provisions as the Investment Advisory Agreements described above.
PERFORMANCE DATA
From time to time the average annual total return and other total return data,
as well as yield, of one or more of the Company's Funds may be included in
advertisements or information furnished to present or prospective Contract
Owners. Total return and yield figures are based on the Fund's historical
performance and are not intended to indicate future performance. Average annual
total return and yield are determined in accordance with formulas specified by
the Securities and Exchange Commission. In connection with its reorganization on
December 6, 1996, the Global Bond Focus Fund (i) acquired substantially all of
the assets and assumed substantially all the liabilities of the International
Bond Fund, a separate Fund of the Company, (ii) implemented a change in its
investment objective and policies from seeking high current income from a global
portfolio of fixed income securities, including non-investment grade securities,
to seeking a high total investment return by investing in a global portfolio of
investment grade fixed income securities and (iii) changed its name from the
World Income Focus Fund to its current name. For the period from the
commencement of the World Income Focus Fund's operations through its
reorganization on December 6, 1996, the portfolio of the Fund included debt
securities rated below investment grade (i.e., junk bonds). On December 6, 1996,
the Government Bond Fund (i) implemented a change in its investment objective so
that the Fund may invest in any debt securities issued or guaranteed by the U.S.
Government, its agencies or instrumentalities without regard to remaining
maturity and (ii) changed its name from the Intermediate Government Bond Fund to
its current name. For the period from the commencement of the Fund's operations
through December 6, 1996, the portfolio of the Intermediate Government Bond Fund
consisted primarily of intermediate-term debt securities issued or guaranteed by
the U.S. Government, its agencies or instrumentalities with a maximum maturity
not to exceed fifteen years. As a result of the foregoing changes in the
investment objective of each of the Global Bond Focus Fund and the Government
Bond Fund, the performance information set forth herein and in the Prospectus
for the period prior to December 6, 1996 may not be indicative of future
performance of each Fund.
Average annual total return quotations for the specified periods are
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 is 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. Because no shares of Class B Common Stock
of the Prime Bond Fund, the High Current Income Fund, the Global Bond Focus Fund
and the Government Bond Fund were in issue prior to December 31, 1997, the yield
information below relates to Class A Common Stock only. The yield for the 30-day
period ending December 31,
35
<PAGE>
1998 was 5.78% for the Prime Bond Fund, 10.39% for the High Current Income Fund,
3.85% for the Global Bond Focus Fund and 4.67% for the Government Bond 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 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.
The Reserve Assets Fund and the Domestic Money Market Fund normally compute
annualized yield by determining the net change for a seven-day base period,
exclusive of capital changes, in the value of a hypothetical pre-existing
account having a balance of one share at the beginning of the period, dividing
the net change in account value by the value of the account at the beginning of
the base period to obtain the base period return, and multiplying the base
period return by 365 and then dividing by seven. Under this calculation, the
yield does not reflect realized and unrealized gains and losses on portfolio
securities. The Funds may also include its yield in advertisements, calculated
in the same manner as set forth above but including realized and unrealized
gains and losses. The Securities and Exchange Commission also permits the
calculation of a standardized effective or compounded yield. This is computed by
compounding the unannualized base period return by dividing the base period by
seven, adding one to the quotient, raising the sum to the 365th power, and
subtracting one from the result. This compounded yield calculation also excludes
realized or unrealized gains or losses on portfolio securities.
Set forth below is average annual total return information for the shares
of each of the Company's Funds, other than the Reserve Assets Fund and Domestic
Money Market Fund. The 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 total return.
AVERAGE ANNUAL TOTAL RETURN
<TABLE>
<CAPTION>
Redeemable Value
Expressed as a of a Hypothetical
Percentage Based on a $1,000 Investment
Average Annual Total Return Hypothetical $1,000 at the End of the
for Class A Shares Investment Period
-------------------------- ---------------------- -----------------
<S> <C> <C>
PRIME BOND FUND:
One Year Ended December 31, 1998 ........................ 7.85% $1,078.50
Five Years Ended December 31, 1998 ...................... 6.50% $1,369.80
Ten Years Ended December 31, 1998 ....................... 8.81% $2,325.70
HIGH CURRENT INCOME FUND:
One Year Ended December 31, 1998 ........................ (3.09)% $ 969.50
Five Years Ended December 31, 1998 ...................... 6.23% $1,352.60
Ten Years Ended December 31, 1998 ....................... 10.37% $2,682.50
QUALITY EQUITY FUND:
One Year Ended December 31, 1998 ........................ 15.58% $1,155.80
Five Years Ended December 31, 1998 ...................... 15.35% $2,041.80
Ten Years Ended December 31, 1998 ....................... 15.20% $4,116.20
</TABLE>
36
<PAGE>
<TABLE>
<CAPTION>
<S> <C> <C>
SPECIAL VALUE FOCUS FUND:
One Year Ended December 31, 1998 ........................ (6.50)% $ 935.00
Five Years Ended December 31, 1998 ...................... 8.85% $1,528.00
Ten Years Ended December 31, 1998 ....................... 10.60% $2,739.80
INDEX 500 FUND:
One Year Ended December 31, 1998 ........................ 28.28% $1,282.80
Inception* Through December 31, 1998 .................... 30.76% $1,732.40
NATURAL RESOURCES FOCUS FUND:
One Year Ended December 31, 1998 ........................ (15.30)% $ 847.00
Five Years Ended December 31, 1998 ...................... (0.79)% $ 961.40
Ten Years Ended December 31, 1998 ....................... 1.92% $1,209.80
AMERICAN BALANCED FUND:
One Year Ended December 31, 1998 ........................ 13.56% $1,135.60
Five Years Ended December 31, 1998 ...................... 11.05% $1,689.20
Ten years Ended December 31, 1998 ....................... 11.32% $2,923.30
GLOBAL STRATEGY FOCUS FUND:
One Year Ended December 31, 1998 ........................ 8.87% $1,088.70
Five Years Ended December 31, 1998 ...................... 8.49% $1,503.20
Inception* Through December 31, 1998 .................... 9.56% $1,867.00
BASIC VALUE FOCUS FUND:
One Year Ended December 31, 1998 ........................ 9.44% $1,094.40
Five Years Ended December 31, 1998 ...................... 15.40% $2,046.60
Inception* Through December 31, 1998 .................... 15.80% $2,241.00
GLOBAL BOND FOCUS FUND:
One Year Ended December 31, 1998 ....................... 12.62% $1,126.20
Five Years Ended December 31, 1998 ..................... 6.75% $1,386.30
Inception* Through December 31, 1998 ................... 7.23% $1,468.10
GLOBAL UTILITY FOCUS FUND:
One Year Ended December 31, 1998 ....................... 24.06% $1,240.60
Five Years Ended December 31, 1998 ..................... 14.95% $2,006.90
Inception* Through December 31, 1998 ................... 14.87% $2,144.40
INTERNATIONAL EQUITY FOCUS FUND:
One Year Ended December 31, 1998 ....................... 7.80% $1,078.00
Five Years Ended December 31, 1998 ..................... 3.07% $1,163.40
Inception* Through December 31, 1998 ................... 4.64% $1,283.30
DEVELOPING CAPITAL MARKETS FOCUS FUND:
One Year Ended December 31, 1998 ....................... (29.39)% $ 706.10
Inception* Through December 31, 1998 ................... (7.74)% $ 686.60
GOVERNMENT BOND FUND:
One Year Ended December 31, 1998 ....................... 8.76% $1,087.60
Inception* Through December 31, 1998 ................... 7.87% $1,423.80
CAPITAL FOCUS FUND
Inception* Through December 31, 1998 ................... (2.40)% $ 976.00
GLOBAL GROWTH FOCUS FUND
Inception* Through December 31, 1999 ................... 8.20% $1,082.00
FUNDAMENTAL GROWTH FOCUS FUND
Inception* ............................................. N/A N/A
</TABLE>
37
<PAGE>
<TABLE>
<CAPTION>
Redeemable Value
Expressed as a of a Hypothetical
Percentage Based on a $1,000 Investment
Average Annual Total Return Hypothetical $1,000 at the End of the
for Class B Shares Investment Period
-------------------------- ---------------------- -----------------
<S> <C> <C>
SPECIAL VALUE FOCUS FUND
One Year Ended December 31, 1998 ....................... (6.52)% $ 934.80
Inception* Through December 31, 1998 ................... (14.47)% $ 830.40
BASIC VALUE FOCUS FUND:
One Year Ended December 31, 1998 ....................... 9.28% $1,092.80
Inception* Through December 31, 1998 ................... 7.67% $1,089.40
DEVELOPING CAPITAL MARKETS FOCUS FUND:
One Year Ended December 31, 1998 ....................... (29.51)% $ 704.90
Inception* Through December 31, 1998 ................... (26.60)% $ 698.80
</TABLE>
- -------------
* Inception for the Class A Common Stock of the Global Strategy Focus Fund is
February 28, 1992; Basic Value Focus Fund is July 1, 1993; Global Bond Focus
Fund is July 1, 1993; Global Utility Focus Fund is July 1, 1993;
International Equity Focus Fund is July 1, 1993; Developing Capital Markets
Focus Fund is May 2, 1994; Government Bond Fund is May 2, 1994; Index 500
Fund is December 13, 1996; Capital Focus Fund is June 5, 1998; and Global
Growth Focus Fund is June 5, 1998. Inception for the Class B Common Stock of
the Basic Value Focus Fund is November 3, 1997; Developing Capital Markets
Focus Fund is November 3, 1997; Special Value Focus Fund is October 23, 1997;
Fundamental Growth Focus Fund is April __, 2000.
ADDITIONAL INFORMATION
Under a separate agreement Merrill Lynch has granted the Company the right
to use the "Merrill Lynch" name and has reserved the right to withdraw its
consent to the use of such name by the Company at any time, or to grant the use
of such name to any other company, and the Company has granted Merrill Lynch,
under certain conditions, the use of any other name it might assume in the
future, with respect to any corporation organized by Merrill Lynch.
Organization of the Company
The Company was incorporated on October 16, 1981, and operations of its
Reserve Assets Fund commenced on November 12, 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 and the American
Balanced Fund commenced operations on June 1, 1988 and June 1, 1988,
respectively. 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 Bond Focus, Global Utility Focus and International
Equity Focus Funds commenced operations on July 1, 1993. The Developing Capital
Markets Focus Fund and Government Bond Fund commenced operations on May 2, 1994.
The Index 500 Fund commenced operations on December 13, 1996. The Global Growth
Focus Fund and the Capital Focus Fund commenced operations on or about June 5,
1998. The Fundamental Growth Focus Fund commenced operations on April , 2000.
The authorized capital stock of the Company consists of 4,100,000,000
shares of Class A Common Stock, par value $0.10 per share, and 3,700,000,000
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 nineteen classes designated
Merrill Lynch American Balanced Fund Common Stock, Merrill Lynch Basic Value
Focus Fund Common Stock, Merrill Lynch Capital Focus Fund Common Stock, Merrill
Lynch Developing Capital Markets Focus Fund Common Stock, Merrill Lynch Domestic
Money Market Fund Common Stock, Merrill Lynch Fundamental Growth Focus Fund,
Merrill Lynch Global Bond Focus Fund Common Stock, Merrill Lynch Global Strategy
Focus Fund Common Stock, Merrill Lynch Global Utility Focus Fund Common Stock,
Merrill Lynch Global Growth Focus Fund Common Stock, Merrill Lynch Government
Bond Fund Common Stock, Merrill Lynch High Current Income Fund Common Stock,
Merrill Lynch Index 500 Common Stock, Merrill Lynch International Equity Focus
Fund Common Stock, Merrill Lynch Natural Resources Focus Fund Common Stock,
Merrill Lynch Prime Bond Fund Common Stock, Merrill Lynch Quality Equity Fund
Common Stock, Merrill Lynch Reserve Assets Fund Common Stock and Merrill Lynch
Special Value Focus Fund Common Stock, respectively. The Company may, from time
to time, at the sole discretion of its Board of Directors and without the need
to obtain the approval of its shareholders or of Contract owners, offer and sell
shares of one or more of such classes. Each class consists
38
<PAGE>
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 Global
Bond Focus Fund Common Stock which consists of 200,000,000 Class A shares and
200,000,000 Class B shares, Global Strategy Focus Fund Common Stock which
consists of 200,000,000 Class A shares and 200,000,000 Class B shares, Basic
Value Focus Fund Common Stock which consists of 300,000,000 Class A shares and
100,000,000 Class B shares, High Current Income Fund Common Stock which consists
of 200,000,000 Class A shares and 100,000,000 Class B shares and Prime Bond Fund
Common Stock which consists of 200,000,000 Class A shares and 100,000,000 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 of 1940
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.
Family Life purchased $1,000 worth of shares of each of the Natural
Resources Focus Fund and the American Balanced Fund on April 29, 1988 and
$1,999,000 worth of shares of each 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 Bond 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 each of the Global Bond Focus Fund and
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 and, on May 16, 1994, $2,000,000 worth of shares of the Government Bond
Fund. On December 13, 1996, MLLIC purchased $10,000,000 worth of shares of the
Index 500 Fund. On April 16, 1998, MLLIC purchased $1,000 worth of shares of the
Global Growth Focus Fund and $1,000 worth of shares of the Capital Focus Fund.
[On April __, 2000, MLLIC purchased $1,000 worth of shares of the Fundamental
Growth Focus Fund.]
In connection with a reorganization on December 6, 1996 conducted by the
Company with respect to certain of its Funds, the Company, with the approval of
the affected shareholders of the Funds, caused (i) Global Bond Focus Fund (a) to
acquire substantially all of the assets and assume substantially all the
liabilities of the International Bond Fund, a separate Fund of the Company, (b)
to implement a change in its investment objective and policies from seeking high
current income from a global portfolio of fixed income securities, including
non-investment grade securities, to seeking a high total investment return by
investing in a global portfolio of investment grade fixed income securities and
(c) to change its name from the World Income Focus Fund to its current name;
(ii) the Government Bond Fund (x) to implement a change in its investment
objective so that the Fund may invest in any debt securities issued or
guaranteed by the U.S. Government, its agencies or instrumentalities without
regard to remaining maturity and (y) to change its name from the Intermediate
Government Bond Fund to its current name; and (iii) the Global Strategy Focus
Fund to acquire substantially all of the assets and assume substantially all the
liabilities of the Flexible Strategy Fund, a separate Fund of the Company.
39
<PAGE>
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, 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
Financial Data Services, Inc. ("FDS"), 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. FDS will receive an annual fee of
$5,000 per Fund and will be entitled to reimbursement of out-of-pocket expenses.
Legal Counsel
Clifford Chance Rogers & Wells LLP, 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 ___________, 2000,
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.
FINANCIAL STATEMENTS
The Company's audited financial statements are incorporated in this
Statement of Additional Information by reference to its 1998 annual report to
shareholders. You may request a copy of the annual report at no charge by
calling (609) 282-2800.
40
<PAGE>
ANNEX A
DESCRIPTION OF TEMPORARY INVESTMENTS AND CORPORATE BOND RATINGS
U.S. Government Securities
The Domestic Money Market Fund, Reserve Assets Fund, Capital Focus Fund and
the Government Bond 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, Reserve Assets Fund, Capital Focus Fund and
the Government Bond 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.
Depositary Institutions Money Instruments
The Domestic Money Market Fund, Reserve Assets Fund and Capital Focus 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 Funds' option, at par on the coupon dates. The dealers'
obligations to repurchase these instruments are subject to conditions imposed by
the various dealers; such conditions typically are the continued credit standing
of the issuer and the existence of reasonably orderly market conditions. The
Funds are also able to sell variable rate certificates of deposit in the
secondary market. Variable rate certificates of deposit normally carry a higher
interest rate than comparable fixed rate certificates of deposit because
variable rate certificates of deposit generally have a longer stated maturity
than comparable fixed rate certificates of deposit. As a matter of policy, the
Domestic Money Market Fund will invest only in these types of instruments
issued/guaranteed 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.
The Reserve Assets Fund and Capital Focus Fund (and, for temporary or
defensive purposes, the Natural Resources Focus Fund, Global Strategy Focus
Fund, Global Bond Focus Fund, Global Utility Focus Fund, International Equity
Focus Fund, Developing Capital Markets Focus Fund and the Quality Equity Fund)
may invest in certificates of deposit and bankers' acceptances issued by foreign
branches or subsidiaries of U.S. banks ("Eurodollar" obligations) or U.S.
branches or subsidiaries of foreign banks ("Yankeedollar" obligations). The Fund
may invest only in Eurodollar obligations which by their terms are general
obligations of the U.S. parent bank and meet the other criteria discussed below.
Yankeedollar obligations in which the Fund may invest must be issued by U.S.
branches or subsidiaries of foreign banks which are subject to state or federal
banking regulations in the U.S. and by their terms must be general obligations
of the foreign parent. In addition, the Fund will limit its investments in
Yankeedollar obligations to obligations issued by banking institutions with more
than $1 billion in assets.
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<PAGE>
The Reserve Assets Fund and Capital Focus Fund (and, for temporary or
defensive purposes, the Natural Resources Focus Fund, Global Strategy Focus
Fund, Global Bond Focus Fund, Global Utility Focus Fund, International Equity
Focus Fund, Developing Capital Markets Focus Fund and the Quality Equity Fund)
may also invest in U.S. dollar-denominated obligations of foreign depository
institutions and their foreign branches and subsidiaries, such as certificates
of deposit, bankers' acceptances, time deposits and deposit notes. The
obligations of such foreign 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.
Such investments will only be made if determined to be of comparable quality to
other investments permissible for the Reserve Assets Fund. The Reserve Assets
Fund will not invest more than 25% of its total assets (taken at market value at
the time of each investment) in these obligations.
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, Reserve Assets Fund and Capital Focus 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 and Reserve Assets 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 Funds' portfolio securities, see "Portfolio
Restrictions" in the Prospectuses to the Domestic Money Market Fund and Reserve
Assets Fund.
The Reserve Assets Fund and Capital Focus Fund (and, for temporary or
defensive purposes, the Natural Resources Focus Fund, Global Strategy Focus
Fund, Global Bond 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.
42
<PAGE>
Repurchase Agreements
Repurchase Agreements; Purchase and Sale Contracts. Each Fund may invest in
securities pursuant to repurchase agreements or purchase and sale contracts.
Under a repurchase agreement, the seller agrees, upon entering into the contract
with the Fund, to repurchase a security (typically a security issued or
guaranteed by the U.S. government) at a mutually agreed upon time and price,
thereby determining the yield during the term of the agreement. This results in
a fixed yield for the Fund insulated from fluctuations in the market value of
the underlying security during such period, although, to the extent the
repurchase agreement is not denominated in U.S. dollars, the Fund's return may
be affected by currency fluctuations. Repurchase agreements may be entered into
only with a member bank of the Federal Reserve System, a primary dealer in U.S.
government securities or an affiliate thereof. A purchase and sale contract is
similar to a repurchase agreement, but purchase and sale contracts, unlike
repurchase agreements, allocate interest on the underlying security to the
purchaser during the term of the agreement and generally do not require the
seller to provide additional securities in the event of a decline in the market
value of the purchased security during the term of the agreement. 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 and Reserve
Assets Funds will not enter into repurchase agreements maturing in more than 30
days.
Reverse Repurchase Agreements. The Domestic Money Market and Reserve Assets
Funds may enter into reverse repurchase agreements, which involve the sale of
money market securities held by the Funds, with an agreement to repurchase the
securities at an agreed upon price, date, and interest payment. The Funds 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 Funds 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 applicable 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. ("Moody's"):
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.
43
<PAGE>
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 maybe in
default or there may be present elements of danger with respect to
principal or interest.
Ca Bonds which are rated Ca represent obligations which are speculative in a
high degree. Such issues are often in default or have other market
shortcomings.
C Bonds which are rated C are the lowest rated class of bonds and issues so
rated can be regarded as having extremely poor prospects of ever attaining
any real investment standing.
Note: Moody's applies numerical modifiers, 1, 2 and 3 in each generic
rating classification from Aa through B in its corporate bond rating system. The
modifier 1 indicates that the security ranks in the higher end of its generic
rating category; the modifier 2 indicates a mid-range ranking; and the modifier
3 indicates that the issue ranks in the lower end of its generic rating
category.
Standard & Poor's Ratings Services ("Standard & Poor's"):
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.
44
<PAGE>
PART C. OTHER INFORMATION
Item 23. Exhibits.
Exhibit
Number Description
------- -----------
1(a) -- Articles of Incorporation of Registrant(a)
1(b) -- Form of Articles Supplementary of Registrant(b)
1(c) -- Form of Articles of Amendment of Registrant(c)
1(d) -- Form of Articles Supplementary of Registrant(d)
1(e) -- Form of Articles Supplementary of Registrant(e)
1(f) -- Form of Articles Supplementary of Registrant(f)
1(g) -- Articles Supplementary to Registrant's Articles of
Incorporation relating to the redesignation of shares of
common stock as Merrill Lynch Basic Value Focus Fund Common
Stock, Merrill Lynch World Income Focus Fund Common Stock,
Merrill Lynch Global Utility Focus Fund Common Stock and
Merrill Lynch International Equity Focus Fund Common
Stock(s)
1(h) -- Articles Supplementary to Registrant's Articles of
Incorporation relating to the designation of shares of
common stock as Merrill Lynch Developing Capital Markets
Focus Fund Common Stock, Merrill Lynch International Bond
Fund Common Stock and Merrill Lynch Intermediate Government
Bond Fund Common Stock(u)
1(i) -- Articles Supplementary to Registrant's Articles of
Incorporation relating to the designation of shares of
common stock as Merrill Lynch Index 500 Fund Common Stock(w)
1(j) -- Form of Articles of Amendment to Registrant's Articles of
Incorporation relating to the reclassification of Merrill
Lynch Flexible Strategy Fund Common Stock as Merrill Lynch
Global Strategy Focus Fund Common Stock, the
reclassification of the Merrill Lynch International Bond
Fund Common Stock as Merrill Lynch World Income Focus Fund
Common Stock, the change in name of the class of shares of
common stock designated as Merrill Lynch Intermediate
Government Bond Fund to Merrill Lynch Government Bond Fund,
and the change in the name of the class of shares of common
stock designated as Merrill Lynch World Income Focus Fund to
Merrill Lynch Global Bond Focus Fund(x)
1(k) -- Form of Articles of Amendment to Registrant's Articles of
Incorporation relating to designation of Class A and Class B
shares(z) 1(l) -- Form of Articles of Amendment
redesignating the Class A and Class B Shares of the Equity
Growth Fund as Class A and Class B Shares of the Special
Value Focus Fund(dd)
1(m) -- Form of Articles Supplementary to Registrant's Articles of
Incorporation relating to the designation of shares of
common stock as Merrill Lynch Global Growth Focus Fund
Common Stock and Merrill Lynch Capital Focus Fund(ff)
1(n) -- Form of Articles Supplementary to Registrant's Articles of
Incorporation relating to the designation of shares of
common stock as Merrill Lynch Fundamental Growth Focus Fund
Common Stock and a change in the amount of Class A Shares of
the Merrill Lynch Basic Value Focus Fund, Merrill Lynch High
Current Income Fund, and Merrill Lynch Prime Bond Fund*
2 -- By-Laws of Registrant, as amended(g)
3 -- None
4 -- Specimen certificate for shares of common stock of
Registrant(h)
5(a) -- Investment Advisory Agreement for Merrill Lynch Reserve
Assets Fund(i)
5(b) -- Investment Advisory Agreement for the Merrill Lynch Prime
Bond Fund, Merrill Lynch High Current Income Fund, Merrill
Lynch Quality Equity Fund and Merrill Lynch Special Value
Focus Fund(j)
5(c) -- Form of Investment Advisory Agreement for Merrill Lynch
Index 500 Fund(y)
5(d) -- Form of Investment Advisory Agreement for Merrill Lynch
Natural Resources Focus Fund and Merrill Lynch American
Balanced Fund(l)
5(e) -- Form of Investment Advisory Agreement for Merrill Lynch
Domestic Money Market Fund and Merrill Lynch Global Strategy
Focus Fund(m)
5(f) -- Form of Investment Advisory Agreement for Merrill Lynch
Basic Value Focus Fund, Merrill Lynch Global Bond Focus
Fund, Merrill Lynch Global Utility Focus Fund and Merrill
Lynch International Equity Focus Fund(t)
C-1
<PAGE>
Exhibit
Number Description
------- -----------
5(g) -- Form of Investment Advisory Agreement for Merrill Lynch
Developing Capital Markets Focus Fund and Merrill Lynch
Government Bond Fund(u)
5(h) -- Form of Sub-Advisory Agreement between Merrill Lynch Asset
Management L.P. and Merrill Lynch Asset Management U.K.
Limited(hh)
5(i) -- Form of Investment Advisory Agreement for Merrill Lynch
Global Growth Focus Fund and Merrill Lynch Capital Focus
Fund(ee)
5(j) -- Form of Investment Advisory Agreement for Merrill Lynch
Fundamental Growth Focus Fund*
6(a) -- Form of Distribution Agreement(n)
6(b) -- Form of Distribution Agreement relating to the Class B
shares(aa)
7 -- None
8(a) -- Form of Custodian Agreement(o)
8(b) -- Form of Custodian Agreement with Brown Brothers Harriman &
Co.(bb)
9(a) -- Form of Transfer Agency, and Dividend Disbursing
Agreement(p)
9(b) -- Form of Agreement relating to the use of the
"Merrill Lynch" name(q)
10 -- Opinion of Counsel (filed with Rule 24F-2 Notice)
11 -- Inapplicable
12 -- None
13 -- None
14 -- None
15 -- Form of Distribution Plan relating to Class B shares(cc)
16 -- Calculation of Performance Data(r)
24 -- Power of Attorney for Robert S. Salomon, Jr.(v)
27 -- Financial Data Schedules(gg)
- ------------------
(a) Incorporated by reference to Exhibit 1 to the Registrant's Registration
Statement on Form N-1A (the "Registration Statement").
(b) Incorporated by reference to Exhibit 1(b) to Post-Effective Amendment No. 1
to the Registration Statement.
(c) Incorporated by reference to Exhibit 1(c) to Post-Effective Amendment No. 7
to the Registration Statement.
(d) Incorporated by reference to Exhibit 1(d) to Post-Effective Amendment No.
10 to the Registration Statement.
(e) Incorporated by reference to Exhibit 1(e) to Post-Effective Amendment No.
12 to the Registration Statement.
(f) Incorporated by reference to Exhibit 1(f) to Post-Effective Amendment No.
16 to the Registration Statement
("Post-Effective Amendment No. 16").
(g) Incorporated by reference to Exhibit 2 to Post-Effective Amendment No. 11
to the Registration Statement ("Post-Effective Amendment No. 11").
(h) Incorporated by reference to Exhibit 4 to Post-Effective Amendment No. 4 to
the Registration Statement ("Post-Effective Amendment No. 4").
(i) Incorporated by reference to Exhibit 5(a) to Post-Effective Amendment No. 8
to the Registration Statement ("Post-Effective Amendment No. 8").
(j) Incorporated by reference to Exhibit 5(b) to Post-Effective Amendment No. 8.
(k) Incorporated by reference to Exhibit 9(c) to Post-Effective Amendment No.
24 to Registrant's Registration Statement ("Post-Effective Amendment No.
24").
(l) Incorporated by reference to Exhibit 5(d) to Post-Effective Amendment No.
11.
(m) Incorporated by reference to Exhibit 5(e) to Post-Effective Amendment No.
16.
(n) Incorporated by reference to Exhibit 6(a) to Amendment No. 1 to
Registrant's Registration Statement ("Amendment No. 1").
(o) Incorporated by reference to Exhibit 8 to Post-Effective Amendment No. 2 to
the Registration Statement.
(p) Incorporated by reference to Exhibit 9(a) to Post-Effective Amendment No. 4
to the Registration Statement.
(q) Incorporated by reference to Exhibit 9(b) to Amendment No. 1 to the
Registration Statement.
(r) Incorporated by reference to Exhibit 16 to Post-Effective Amendment No. 13
to the Registration Statement.
C-2
<PAGE>
(s) Incorporated by reference to Exhibit 1(g) to Post-Effective Amendment No.
20 to the Registration Statement.
(t) Incorporated by reference to Exhibit 5(f) to Post-Effective Amendment No.
20 to the Registration Statement.
(u) Incorporated by reference to Exhibit 5(g) to Post-Effective Amendment No.
21 to the Registration Statement.
(v) Incorporated by reference to Exhibit 24 to Post-Effective Amendment No. 24.
(w) Incorporated by reference to Exhibit 1(i) to Post-Effective Amendment No.
26 to the Registration Statement.
(x) Incorporated by reference to Exhibit 1(j) to Post-Effective Amendment No.
26 to the Registration Statement.
(y) Incorporated by reference to Exhibit 5(c) to Post-Effective Amendment No.
26 to the Registration Statement.
(z) Incorporated by reference to Exhibit 1(k) to Post-Effective Amendment No.
27 to the Registration Statement.
(aa) Incorporated by reference to Exhibit 6(b) to Post-Effective Amendment No.
27 to the Registration Statement.
(bb) Incorporated by reference to Exhibit 8(b) to Post-Effective Amendment No.
27 to the Registration Statement.
(cc) Incorporated by reference to Exhibit 15 to Post-Effective Amendment No. 27
to the Registration Statement.
(dd) Incorporated by reference to Exhibit 1(l) to Post-Effective Amendment No.
28 to the Registration Statement.
(ee) Incorporated by reference to Exhibit 5(i) to Post-Effective Amendment No.
30 to the Registration Statement.
(ff) Incorporated by reference to Exhibit 1(m) to Post-Effective Amendment No.
30 to the Registration Statement.
(gg) Incorporated by reference to Exhibit 11 to Post-Effective Amendment No. 32
to the Registration Statement.
(hh) Incorporated by reference to Exhibit 5(h) to Post-Effective Amendment No.
27 to the Registration Statement.
* Filed herewith.
Item 24. Persons Controlled by or under Common Control with Registrant.
Registrant does not control any other person. Except that substantially all
of Registrant's issued and outstanding shares are and will be held by Merrill
Lynch Life Insurance Company, ML Life Insurance Company of New York and Family
Life Insurance Company for their Separate Accounts, the Registrant is not under
common control with any other person.
Item 25. Indemnification.
Under Section 2-418 of the Maryland General Corporation Law, with respect
to any proceedings against a present or former director, officer, agent or
employee (a "corporate representative") of the Registrant, except a proceeding
brought by or on behalf of the Registrant, the Registrant may indemnify the
corporate representative against expenses, including attorneys' fees and
judgments, fines and amounts paid in settlement actually and reasonably incurred
by the corporate representative in connection with the proceeding, if; (i) he
acted in good faith and in a manner he reasonably believed to be in or not
opposed to the best interests of the Registrant; and (ii) with respect to any
criminal proceeding, he had no reasonable cause to believe his conduct was
unlawful. The Registrant is also authorized under Section 2-418 of the Maryland
General Corporation Law to indemnify a corporate representative under certain
circumstances against expenses incurred in connection with the defense of a suit
or action by or in the right of the Registrant. Under each Distribution
Agreement, the Registrant has agreed to indemnify the Distributor against any
loss, liability, claim, damage or expense arising out of any untrue statement of
a material fact, or an omission to state a material fact, in any registration
statement, prospectus or report to shareholders of the Registrant. Reference is
made to Article VI of Registrant's Certificate of Incorporation, Article VI of
Registrant's By-Laws, Section 2-418 of the Maryland General Corporation Law and
Section 9 of each Distribution Agreement.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933, as amended (the "Act"), may be permitted to Directors, officers and
controlling persons of the Registrant and the principal underwriter pursuant to
the foregoing provisions or otherwise, the Registrant has been advised that in
the opinion of the Securities and Exchange Commission such indemnification is
against public policy as expressed in the Act and is, therefore, unenforceable.
In the event that a claim for indemnification against such liabilities (other
than the payment by the Registrant of expenses incurred or paid by a Director,
officer, or controlling person of the Registrant and the principal underwriter
in connection with the successful defense of any action, suit or proceeding) is
asserted by such Director, officer or controlling person or the principal
underwriter in connection with the shares being registered, the Registrant will,
unless in the opinion of its counsel the matter has been settled by controlling
precedent, submit to a court of appropriate jurisdiction the question whether
such indemnification by it is against public policy as expressed in the Act and
will be governed by the final adjudication of such issue.
C-3
<PAGE>
Item 26. Business and Other Connections of Manager.
Merrill Lynch Asset Management, L.P. (the "Manager" or "MLAM"), acts as the
investment adviser for the following open-end registered investment companies:
Merrill Lynch Adjustable Rate Securities Fund, Inc., Merrill Lynch Americas
Income Fund, Inc., Merrill Lynch Asset Builder Program, Inc., Merrill Lynch
Asset Growth Fund, Inc., Merrill Lynch Asset Income Fund, Inc., Merrill Lynch
Capital Fund, Inc., Merrill Lynch Developing Capital Markets Fund, Inc., Merrill
Lynch Convertible Fund, Inc., Merrill Lynch Dragon Fund, Inc., Merrill Lynch
Disciplined Equity Fund, Inc., Merrill Lynch EuroFund, Merrill Lynch Fundamental
Growth Fund, Inc., Merrill Lynch Fund for Tomorrow, Inc., Merrill Lynch Global
Allocation Fund, Inc., Merrill Lynch Global Bond Fund for Investment and
Retirement, Merrill Lynch Global Convertible Fund, Inc., Merrill Lynch Global
Growth Fund, Inc., Merrill Lynch Global Holdings, Inc., Merrill Lynch Global
Resources Trust, Merrill Lynch Global SmallCap Fund, Inc., Merrill Lynch Global
Technology Fund, Inc., Merrill Lynch Global Utility Fund, Inc., Merrill Lynch
Global Value Focus Fund, Inc., Merrill Lynch Growth Fund, Merrill Lynch
Healthcare Fund, Inc., Merrill Lynch Intermediate Government Bond Fund, Merrill
Lynch International Equity Fund, Merrill Lynch Latin America Fund, Inc., Merrill
Lynch Middle East/Africa Fund, Inc., Merrill Lynch Municipal Series Trust,
Merrill Lynch Pacific Fund, Inc., Merrill Lynch Ready Assets Trust, Merrill
Lynch Real Estate Fund, Inc., Merrill Lynch Retirement Series Trust, Merrill
Lynch Series Fund, Inc., Merrill Lynch Short-Term Global Income Fund, Inc.,
Merrill Lynch Strategic Dividend Fund, Merrill Lynch U.S.A. Government Reserves,
Merrill Lynch U.S. Treasury Money Fund, Merrill Lynch Utility Income Fund, Inc.
and Merrill Lynch Variable Series Funds, Inc. and Hotchkis and Wiley Funds
(advised by Hotchkis and Wiley, a division of MLAM); and the following
closed-end registered investment companies: Merrill Lynch High Income Municipal
Bond Fund, Inc., Merrill Lynch Senior Floating Rate Fund, Inc., and Merrill
Lynch Senior Floating Rate Fund II, Inc. MLAM also acts as subadviser to Merrill
Lynch World Strategy Portfolio and Merrill Lynch Basic Value Equity Portfolio,
two investment portfolios of EQ Advisors Trust.
Fund Asset Management, L.P. ("FAM"), an affiliate of the Investment
Adviser, acts as the investment adviser for the following open-end registered
investment companies: CBA Money Fund, CMA Government Securities Fund, CMA Money
Fund, CMA Multi-State Municipal Series Trust, CMA Tax-Exempt Fund, CMA Treasury
Fund, The Corporate Fund Accumulation Program, Inc., Financial Institutions
Series Trust, Merrill Lynch Basic Value Fund, Inc., Merrill Lynch California
Municipal Series Trust, Merrill Lynch Corporate Bond Fund, Inc., Merrill Lynch
Corporate High yield Fund, Inc., Merrill Lynch Emerging Tigers Fund, Inc.,
Merrill Lynch Federal Securities Trust, Merrill Lynch Funds for Institutions
Series, Merrill Lynch Multi-State Limited maturity Municipal Series Trust,
Merrill Lynch Multi-State Municipal Series Trust, Merrill Lynch Municipal Bond
Fund, Inc., Merrill Lynch Phoenix Fund, Inc., Merrill Lynch Puerto Rico
Tax-Exempt Fund, Inc., Merrill Lynch Special Value Fund, Inc., Merrill Lynch
World Income Fund, Inc., and The Municipal Fund Accumulation Program, Inc.; and
the following closed-end registered investment companies: Apex Municipal Fund,
Inc., Corporate High Yield Fund, Inc., Corporate High Yield Fund II, Inc.,
Corporate High Yield Fund III, Inc., Debt Strategies Fund, Inc., Debt Strategies
Fund II, Inc., Debt Strategies Fund III, Inc., Income Opportunities Fund 1999,
Inc., Income Opportunities Fund 2000, Inc., Merrill Lynch Municipal Strategy
Fund, Inc., MuniAssets Fund, Inc., MuniEnhanced Fund, Inc., MuniHoldings Fund,
Inc., MuniHoldings Fund II, Inc., MuniHoldings Insured Fund, Inc., MuniHoldings
Insured Fund II, Inc., MuniHoldings Insured Fund III, Inc., MuniHoldings
California Insured Fund, Inc., MuniHoldings California Insured Fund II, Inc.,
MuniHoldings California Insured Fund III, Inc., MuniHoldings California Insured
Fund IV, Inc., MuniHoldings California Insured Fund V, Inc., MuniHoldings
Florida Insured Fund, MuniHoldings Florida Insured Fund II, MuniHoldings Florida
Insured Fund III, MuniHoldings Florida Insured Fund IV, MuniHoldings Florida
Insured Fund V, Inc., MuniHoldings New Jersey Insured Fund, Inc., MuniHoldings
New Jersey Insured Fund II, Inc., MuniHoldings New Jersey Insured Fund III,
Inc., MuniHoldings New Jersey Fund IV, Inc., MuniHoldings New York Fund, Inc.,
MuniHoldings New York Insured Fund, Inc., MuniHoldings Michigan Insured Fund,
Inc., MuniHoldings Pennsylvania Insured Fund, MuniHoldings Insured Fund, Inc.,
MuniHoldings Insured Fund II, Inc., MuniHoldings New York Insured Fund II, Inc.,
MuniHoldings New York Insured Fund III, Inc., MuniHoldings New York Insured Fund
IV, Inc., MuniInsured Fund, Inc., MuniVest Fund, Inc., MuniVest Fund II, Inc.,
MuniVest Florida Fund, MuniVest Michigan Insured Fund, Inc., MuniVest New Jersey
Fund, Inc., MuniVest Pennsylvania Insured Fund, MuniYield Arizona Fund, Inc.,
MuniYield California Fund, Inc., MuniYield California Insured Fund, Inc.,
MuniYield California Insured Fund II, Inc., MuniYield Florida Fund, MuniYield
Florida Insured Fund, MuniYield Fund, Inc., MuniYield
C-4
<PAGE>
Insured Fund, Inc., MuniYield Michigan Fund, Inc., MuniYield Michigan Insured
Fund, Inc., MuniYield New Jersey Fund, Inc., MuniYield New Jersey Insured Fund,
Inc., MuniYield New York Insured Fund, Inc., MuniYield New York Insured Fund II,
Inc., MuniYield Pennsylvania Fund, MuniYield Quality Fund, Inc., MuniYield
Quality Fund II, Inc., Senior High Income Portfolio, Inc. and Worldwide
DollarVest Fund, Inc.
The address of each of these investment companies is P.O. Box 9011,
Princeton, New Jersey 08543-9011. The address of Merrill Lynch Funds for
Institutions Series is One Financial Center, 23rd Floor, Boston, Massachusetts
02111-2646. The address of the Manager and FAM is also P.O. Box 9011, Princeton,
New Jersey 08543-9011. The address of Princeton Funds Distributor, Inc. (PFD)
and of Merrill Lynch Funds Distributor, Inc. ("MLFD") is P.O. Box 9081,
Princeton, New Jersey 08543-9081. The address of Merrill Lynch, Pierce, Fenner &
Smith Incorporated ("Merrill Lynch") and Merrill Lynch & Co., Inc. ("ML & Co.")
is World Financial Center, North Tower, 250 Vesey Street, New York, New York
10281. The address of Merrill Lynch Financial Data Services, Inc. ("MLFDS") is
4800 Deer Lake Drive East, Jacksonville, Florida 32246-6484.
Set forth below is a list of each executive officer and director of the
Investment Adviser indicating each business, profession, vocation or employment
of a substantial nature in which each such person has been engaged since
December 1, 1997 for his, her own account or in the capacity of director,
officer, partner or trustee. In addition, Mr. Glenn is President and Mr. Burke
is Treasurer of all or substantially all of the investment companies described
in the first two paragraphs of this Item 26, and Messrs. Giordano, Harvey,
Kirstein and Monagle are directors or officers of one or more of such companies.
<TABLE>
<CAPTION>
Positions with Other Substantial Business,
Name Investment Adviser Profession, Vocation or Employment
- ----- ----------------- --------------------------------
<S> <C> <C>
ML & Co Limited Partner Financial Services Holding Company; Limited Partner of MLAM
Princeton Services General Partner General Partner of MLAM ("Princeton Services")
Jeffrey M. Peek President President of MLAM; President and Director of Princeton Services;
Executive Vice President of ML & Co.; Managing Director and
Co-Head of the Investment Banking Division of Merrill Lynch in 1997;
Senior Vice President and Director of the Global Securities and
Economics Division of Merrill Lynch from 1995 to 1997.
Terry K. Glenn Executive Vice Executive Vice President of MLAM and FAM;
President Executive Vice President and Director of Princeton Services;
President and Director of PFD; President of Princeton
Administrations, L.P.
Robert W. Crook Senior Vice President Senior Vice President of MLFD; Vice President of MLFD and Vice
President of FAM
Donald C. Burke Senior Vice President Senior Vice President and Treasurer of MLAM; Senior Vice President
and Treasurer and Treasurer of Princeton Services; Vice President and Treasurer
of PFD; First Vice President of MLAM from 1997 to 1999; Vice President
of MLAM from 1990 to 1997; Director of Taxation of MLAM
Michael G. Clark Senior Vice President Senior Vice President of MLAM; Senior Vice President of Princeton
Services
Mark A. Desario Senior Vice President Senior Vice President of FAM; Senior Vice President of Princeton
Services
Linda L. Federici Senior Vice President Senior Vice President of MLAM and FAM; Senior Vice President of
Princeton Services
</TABLE>
C-5
<PAGE>
<TABLE>
<CAPTION>
Positions with Other Substantial Business,
Name Investment Adviser Profession, Vocation or Employment
- ----- ----------------- --------------------------------
<S> <C> <C>
Vincent R. Giordano Senior Vice President Senior Vice President of MLAM; Senior Vice President of Princeton
Services
Michael J. Hennewinkel Senior Vice President, Senior Vice President, General Counsel
General Counsel and of MLAM; Senior Vice Secretary
and Secretary President of Princeton Services
Philip L. Kirstein Senior Vice President Senior Vice President of MLAM; Senior Vice President, General
Counsel, Director and Secretary of Princeton Services
Ronald M. Kloss Senior Vice President Senior Vice President of MLAM; Senior Vice President of Princeton
Services
Debra Landsman-Yaros Senior Vice President Senior Vice President of MLAM; Vice President of MLFD; Senior Vice
President of Princeton Services, Vice President of PDF
Stephen M. M. Miller Senior Vice President Executive Vice President of Princeton Administrators, L.P.; Senior
Vice President of Princeton Services
Joseph T. Monagle, Jr Senior Vice President Senior Vice President of MLAM; Senior Vice President of Princeton
Services
Brian A. Murdock Senior Vice President Senior Vice President of MLAM; Senior Vice President of Princeton
Services
Gregory D. Upah Senior Vice President Senior Vice President of MLAM; Senior Vice President of Princeton
Services
</TABLE>
(b) Merrill Lynch Asset Management U.K. Limited ("MLAM U.K.") acts as
sub-adviser for the following registered investment companies; Corporate High
yield Fund, Inc., Corporate High yield Fund II, Inc., Income Opportunities Fund
1999, Inc., Income Opportunities Fund 2000, Inc., Merrill Lynch Americas Income
Inc., Merrill Lynch Asset Builder Program, Inc., Merrill Lynch Asset Growth Fund
Inc., Merrill Lynch Asset Income Fund, Inc., Merrill Lynch Basic Value Fund,
Inc., Merrill Lynch Capital Fund, Inc., Merrill Lynch Consults International
Portfolio, Merrill Lynch Convertible Fund, Inc., Merrill Lynch Corporate Bond
Fund, Inc., Merrill Lynch Corporate High yield Fund, Inc., Merrill Lynch
Developing Capital Markets Fund, Inc., Merrill Lynch Dragon Fund, Inc., Merrill
Lynch Emerging Tigers Fund, Inc., Merrill Lynch EuroFund, Merrill Lynch
Fundamental Growth Fund, Inc., Merrill Lynch Global Allocation Fund, Inc.,
Merrill Lynch Global Bond Fund for Investment and Retirement, Merrill Lynch
Global Convertible Fund, Inc., Merrill Lynch Global Holdings, Inc., Merrill
Lynch Global Growth Fund, Inc., Merrill Lynch Global Resources Trust, Merrill
Lynch Global SmallCap Fund, Inc., Merrill Lynch Global Utility Fund, Inc.,
Merrill Lynch Global Value Fund, Inc., Merrill Lynch Growth Fund, Merrill Lynch
Healthcare Fund, Inc., Merrill Lynch International Equity Fund, Merrill Lynch
Latin America Fund, Inc., Merrill Lynch Middle East/Africa Fund, Inc., Merrill
Lynch Pacific Fund, Inc., Merrill Lynch Phoenix Fund, Inc., Merrill Lynch Series
Trust Fund, Inc., Merrill Lynch Short-Term Global Income Fund, Inc., Merrill
Lynch Real Estate Fund, Inc., Merrill Lynch Special Value Fund, Inc., Merrill
Lynch Real Estate Fund, Inc., Merrill Lynch Special Value Fund, Inc., Merrill
Lynch Strategic Dividend Fund, Merrill Lynch Technology Fund, Inc., Merrill
Lynch Utility Income Fund, Inc., Merrill Lynch Variable Series Funds, Inc.,
Merrill Lynch World Income Fund, Inc., and Worldwide DollarVest Fund, Inc. The
address of each of these investment companies is P.O. Box 9011, Princeton, New
Jersey 08543-9011. The address of MLAM U.K. is Milton Gate, 1 Moor Lane, London
EC2Y 9HA, England.
C-6
<PAGE>
Set forth below is a list of each executive officer and director of MLAM
U.K. indicating each business profession, vocation or employment of a
substantial nature in which each such person had been engaged since December 31,
1997, for his or her own account or in the capacity of director, officer,
partner or trustee. In addition, Messrs. Albert, Bascand, Glenn, Richard and
Yardley are officers of one or more of the registered investment companies
listed in the first two paragraphs of this Item 26:
<TABLE>
<CAPTION>
Position with Other Substantial Business,
Name Investment Adviser Profession, Vocation or Employment
- ----- ----------------- --------------------------------
<S> <C> <C>
Alan J. Albert .............. Senior Managing Director Vice President of the Manager
Nicholas C.D. Hall .......... Director Director of Merrill Lynch Europe PLC, General Counsel of
Merrill Lynch International Private Banking Group
Carol Ann Langham ........... Company Secretary None
Debra Anne Searle ........... Assistant Company None
Secretary
</TABLE>
Item 27. Principal Underwriters.
(a) MLFD, a division of PFD, acts as the principal underwriter for the
Registrant and for each of the registered investment companies referred to in
the first two paragraphs of Item 26 except CBA Money Fund, CMA Government
Securities Fund, CMA Money Fund, CMA Multi-State Municipal Series Trust, CMA
Tax-Exempt Fund, CMA Treasury Fund, The Corporate Fund Accumulation Program,
Inc., and The Municipal Fund Accumulation Program; and MLFD also acts as
principal underwriter for the following closed-end registered investment
companies: Merrill Lynch High Income Municipal Bond Fund, Inc., Merrill Lynch
Municipal Strategy Fund, Inc., Merrill Lynch Senior Floating Rate Fund, Inc.,
and Merrill Lynch Senior Floating Rate Fund II, Inc. A separate division of PFD
acts as the principal underwriter of a number of other investment companies.
(b) Set forth below is information concerning each director and officer of
MLFD. The principal business address of each such person is Box 9081, Princeton,
New Jersey 08543-9081, except that the address of Messrs. Crook, Brady, Breen,
Fatseas and Wasel, is One Financial Center, Boston, Massachusetts 02111-2646.
<TABLE>
<CAPTION>
Positions and Offices Positions and Offices
Name with Underwriter with Registrant
- ----- ---------------------- ----------------------------------
<S> <C> <C>
Terry K. Glenn ............................. President President and Director
Michael G. Clark ........................... Vice President and Treasurer None
Robert W. Crook ............................ Senior Vice President None
Michael J. Brady ........................... Vice President None
William M. Breen ........................... Vice President None
Donald C. Burke ............................ Vice President Vice President and Treasurer
James T. Fatseas ........................... Vice President None
Debra W. Landsman-Yaros .................... Vice President None
Michelle T. Lau ............................ Vice President None
Salvatore Venezia .......................... Vice President None
William Wasel .............................. Vice President None
Robert Harris .............................. Secretary None
</TABLE>
(c) Not applicable.
Item 28. Location of Accounts and Records.
All accounts, books and other documents required to be maintained by
Section 31(a) of the Investment Company Act of 1940 as amended and the Rules
thereunder will be maintained at the offices of the Registrant, its Investment
Adviser, its Custodian, and its Transfer Agent.
C-7
<PAGE>
Item 29. Management Services.
Other than as set forth in the Prospectus constituting Part A of the
Registration Statement and under the captions "Management of the Company" and
"Investment Advisory Arrangements" in the Statement of Additional Information
constituting Part B of the Registration Statement, the Registrant is not a party
to any management-related service contract.
Item 30. Undertakings.
The Registrant undertakes to furnish each person to whom a prospectus is
delivered with a copy of the Registrant's latest annual report to shareholders,
upon request, and without charge.
The Company hereby undertakes to comply with the restrictions on
indemnification set forth in Investment Company Act Release No. IC-11330,
September 2, 1980.
C-8
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933 and the
Investment Company Act of 1940, the Registrant has duly caused this amendment to
its Registration Statement to be signed on its behalf by the undersigned,
thereunto duly authorized, in the Township of Plainsboro, and State of New
Jersey, on the 13th day of January, 2000.
MERRILL LYNCH VARIABLE SERIES FUND, INC.
(Registrant)
By /s/ TERRY K. GLENN
------------------------------------
(Terry K. Glenn, President)
Pursuant to the requirements of the Securities Act of 1933, this Amendment
to the Registrant's Registration Statement has been signed below by the
following persons in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
<S> <C> <C> <C>
Signature Title Date
--------- ---- ----
/s/ TERRY K. GLENN President and Director January 13, 2000
- ------------------------------------------------ (Principal Executive Officer)
(Terry K. Glenn)
* Director
- ------------------------------------------------
(Joe Grills)
* Director
- -------------------------------------------------
(Walter Mintz)
* Director
- -------------------------------------------------
(Robert S. Salomon, Jr.)
* Director
- --------------------------------------------------
(Melvin R. Seiden)
* Director
- --------------------------------------------------
(Stephen B. Swensrud)
* Director
- ---------------------------------------------------
(Arthur Zeikel)
* Treasurer (Principal Financial
- ---------------------------------------------------- and Accounting Officer)
(Donald C. Burke)
By: /s/ TERRY K. GLENN January 13, 2000
- ----------------------------------------------------
(Terry K. Glenn, Attorney-in-Fact)
</TABLE>
C-9
<PAGE>
POWER OF ATTORNEY
The undersigned, the Directors/Trustees and Officers of each of the registered
investment companies listed below, hereby authorize Terry K. Glenn, Donald C.
Burke and Joseph T. Monagle, Jr., or any of them, as attorney-in-fact, to sign
on his behalf in the capacities indicated any Registration Statement or
amendment thereto (including post-effective amendments) for each of the
following registered investment companies and to file the same, with all
exhibits thereto, with the Securities and Exchange Commission: Merrill Lynch
Asset Growth Fund, Inc.; Merrill Lynch Asset Income Fund, Inc.; Muni Assets
Fund, Inc.; Merrill Lynch Variable Series Funds, Inc.; Apex Municipal Fund,
Inc.; Merrill Lynch Corporate High Yield Fund, Inc.; Merrill Lynch Corporate
High Yield Fund II, Inc.; Merrill Lynch Corporate High Yield Fund III, Inc.;
Financial Institutions Series Trust; Income Opportunities Fund 1999, Inc.;
Income Opportunities Fund 2000, Inc.; Merrill Lynch Adjustable Rate Securities
Fund; Merrill Lynch Asset Builder Program, Inc.; Merrill Lynch Federal
Securities Trust; Merrill Lynch Fundamental Growth Fund, Inc.; Merrill Lynch
Phoenix Fund, Inc.; Merrill Lynch Real Estate Fund, Inc.; Merrill Lynch
Retirement Series Trust; MuniHoldings Insured Fund II, Inc.; MuniHoldings
Insured Fund III, Inc.; MuniInsured Fund, Inc.; and MuniYield Insured Fund, Inc.
Dated: December 3, 1999
/s/ TERRY K. GLENN
--------------------------------------------------------------
Terry K. Glenn
(President/Principal Executive Officer/Director/Trustee)
/s/ JOE GRILLS
--------------------------------------------------------------
Joe Grills
(Director/Trustee)
/s/ MELVIN R. SEIDEN
--------------------------------------------------------------
Melvin R. Seiden
(Director/Trustee)
/s/ STEPHEN B. SWENSRUD
--------------------------------------------------------------
Stephen B. Swensrud
(Director/Trustee)
/s/ DONALD C. BURKE
--------------------------------------------------------------
Donald C. Burke
(Treasurer/Director/Trustee)
/s/ WALTER MINTZ
--------------------------------------------------------------
Walter Mintz
(Director/Trustee)
/s/ ROBERT S. SALOMON, JR.
--------------------------------------------------------------
Robert S. Salomon, Jr.
(Director/Trustee)
/s/ ARTHUR ZEIKEL
--------------------------------------------------------------
Arthur Zeikel
(Director/Trustee)
C-10
<PAGE>
EXHIBIT INDEX
Exhibit
Number Description
------- -----------
1(n) -- Form of Articles Supplementary to Registrant's Articles of
Incorporation relating to the designation of shares of
common stock as Merrill Lynch Fundamental Growth Focus Fund
Common Stock and a change in the amount of Class A Shares of
the Merrill Lynch Basic Value Focus Fund, Merrill Lynch High
Current Income Fund, and Merrill Lynch Prime Bond Fund
5(j) -- Form of Investment Advisory Agreement for Merrill Lynch
Fundamental Growth Focus Fund
EXHIBIT 1(n)
MERRILL LYNCH VARIABLES SERIES FUNDS, INC.
FORM OF ARTICLES SUPPLEMENTARY
Merrill Lynch Variable Series Funds, Inc. a Maryland corporation, having
its principal office in Baltimore City, Maryland (which is hereinafter called
the "Corporation"), hereby certifies to the State Department of Assessments and
Taxation of Maryland that:
FIRST: The Corporation is registered as an open-ended company under the
Investment Company Act of 1940, as amended, with the authority to issue capital
stock as follows:
<TABLE>
<CAPTION>
Number of
Authorized
Funds Shares
----- ------
<S> <C>
Merrill Lynch American Balanced Fund Common Stock--Class A 100,000,000
Merrill Lynch Basic Value Focus Fund Common Stock--Class A 100,000,000
Merrill Lynch Capital Focus Fund--Class A 100,000,000
Merrill Lynch Developing Capital Markets Focus Fund Common Stock--Class A 100,000,000
Merrill Lynch Domestic Money Market Fund Common Stock--Class A 1,300,000,000
Merrill Lynch Special Value Focus Fund Common Stock--Class A 100,000,000
Merrill Lynch Global Bond Focus Fund Common Stock--Class A 200,000,000
Merrill Lynch Global Growth Focus Fund Common Stock--Class A 100,000,000
Merrill Lynch Global Strategy Focus Fund Common Stock--Class A 200,000,000
Merrill Lynch Global Utility Focus Fund Common Stock--Class A 100,000,000
Merrill Lynch Government Bond Fund Common Stock--Class A 100,000,000
Merrill Lynch High Current Income Fund Common Stock--Class A 100,000,000
Merrill Lynch Index 500 Fund Common Stock--Class A 100,000,000
Merrill Lynch International Equity Focus Fund Common Stock--Class A 100,000,000
Merrill Lynch Natural Resources Focus Fund Common Stock--Class A 100,000,000
Merrill Lynch Prime Bond Fund Common Stock--Class A 100,000,000
Merrill Lynch Quality Equity Fund Common Stock--Class A 100,000,000
Merrill Lynch Reserve Assets Fund Common Stock--Class A 500,000,000
Merrill Lynch American Balanced Fund Common Stock--Class B 100,000,000
Merrill Lynch Basic Value Focus Fund Common Stock--Class B 100,000,000
Merrill Lynch Capital Focus Fund--Class B 100,000,000
Merrill Lynch Developing Capital Markets Focus Fund Common Stock--Class B 100,000,000
Merrill Lynch Domestic Money Market Fund Common Stock--Class B 1,300,000,000
Merrill Lynch Special Value Focus Fund Common Stock--Class B 100,000,000
Merrill Lynch Global Bond Focus Fund Common Stock--Class B 200,000,000
Merrill Lynch Global Growth Focus Fund Common Stock--Class B 100,000,000
Merrill Lynch Global Strategy Focus Fund Common Stock--Class B 200,000,000
Merrill Lynch Global Utility Focus Fund Common Stock--Class B 100,000,000
Merrill Lynch Government Bond Fund Common Stock--Class B 100,000,000
Merrill Lynch High Current Income Fund Common Stock--Class B 100,000,000
Merrill Lynch Index 500 Fund Common Stock--Class B 100,000,000
Merrill Lynch International Equity Focus Fund Common Stock--Class B 100,000,000
Merrill Lynch Natural Resources Focus Fund Common Stock--Class B 100,000,000
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S> <C>
Merrill Lynch Prime Bond Fund Common Stock--Class B 100,000,000
Merrill Lynch Quality Equity Fund Common Stock--Class B 100,000,000
Merrill Lynch Reserve Assets Fund Common Stock--Class B 500,000,000
</TABLE>
SECOND: All shares of Class A and Class B Common Stock have a par value of
$0.10 per share. The aggregate par value of all the shares of all classes of the
Corporation's capital stock is currently Seven Hundred Twenty Million Dollars
($720,000,000).
THIRD: The Board of Directors of the Corporation, acting in accordance
with Section 2-105(c) of the General Corporation Law of the State of Maryland,
hereby increases the number of capital stock of the Corporation by 600,000,000;
100,000,000 of which shall be classified as Class A Common Stock of Merrill
Lynch Fundamental Growth Focus Fund; 100,000,000 of which shall be classified as
Class A Common Stock of Merrill Lynch Prime Bond Fund; 100,000,000 of which
shall be classified as Class A Common Stock of Merrill Lynch High Current Income
Fund; 200,000,000 of which shall be classified as Class A Common Stock of
Merrill Lynch Basic Value Focus Fund; 100,000,000 of which shall be classified
as Class B Common Stock of Merrill Lynch Fundamental Growth Focus Fund;
FOURTH: All of the shares of the Corporation's Common Stock, as classified
and designated, continue to have preferences, conversions and other rights,
voting powers, restrictions, limitations as to dividends, qualifications, and
terms and conditions of redemption as set forth in Article V of the Articles of
Incorporation of the Corporation.
FIFTH: After this increase in the number of authorized shares of capital
stock of the Corporation and classification of the shares, the Corporation will
have the authority to issue capital stock as follows:
<TABLE>
<CAPTION>
Number of
Authorized
Funds Shares
----- ------
<S> <C>
Merrill Lynch American Balanced Fund Common Stock--Class A 100,000,000
Merrill Lynch Basic Value Focus Fund Common Stock--Class A 300,000,000
Merrill Lynch Capital Focus Fund Common Stock--Class A 100,000,000
Merrill Lynch Developing Capital Markets Focus Common Stock--Class A 100,000,000
Merrill Lynch Domestic Money Market Fund Common Stock--Class A 1,300,000,000
Merrill Lynch Fundamental Growth Focus Fund--Class A 100,000,000
Merrill Lynch Special Value Focus Fund Common Stock--Class A 100,000,000
Merrill Lynch Global Bond Focus Fund Common Stock--Class A 200,000,000
Merrill Lynch Global Growth Focus Fund Common Stock--Class A 100,000,000
Merrill Lynch Global Strategy Focus Fund Common Stock--Class A 200,000,000
Merrill Lynch Global Utility Focus Fund Common Stock--Class A 100,000,000
Merrill Lynch Government Bond Fund Common Stock--Class A 100,000,000
Merrill Lynch High Current Income Fund Common Stock--Class A 200,000,000
Merrill Lynch Index 500 Fund Common Stock--Class A 100,000,000
Merrill Lynch International Equity Focus Fund Common Stock--Class A 100,000,000
Merrill Lynch Natural Resources Focus Fund Common Stock--Class A 100,000,000
Merrill Lynch Prime Bond Fund Common Stock--Class A 200,000,000
Merrill Lynch Quality Equity Fund Common Stock--Class A 100,000,000
Merrill Lynch Reserve Assets Fund Common Stock--Class A 500,000,000
Merrill Lynch American Balanced Fund Common Stock--Class B 100,000,000
Merrill Lynch Basic Value Focus Fund Common Stock--Class B 100,000,000
Merrill Lynch Capital Focus Fund Common Stock--Class B 100,000,000
Merrill Lynch Developing Capital Markets Focus Fund Common Stock--Class B 100,000,000
Merrill Lynch Domestic Money Market Fund Common Stock--Class B 1,300,000,000
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
<S> <C>
Merrill Lynch Fundamental Growth Focus Fund--Class B 100,000,000
Merrill Lynch Special Value Focus Fund Common Stock--Class B 100,000,000
Merrill Lynch Global Bond Focus Fund Common Stock--Class B 200,000,000
Merrill Lynch Global Growth Focus Fund Common Stock--Class B 100,000,000
Merrill Lynch Global Strategy Focus Fund Common Stock--Class B 200,000,000
Merrill Lynch Global Utility Focus Fund Common Stock--Class B 100,000,000
Merrill Lynch Government Bond Fund Common Stock--Class B 100,000,000
Merrill Lynch High Current Income Fund Common Stock--Class B 100,000,000
Merrill Lynch Index 500 Fund Common Stock--Class B 100,000,000
Merrill Lynch International Equity Focus Fund Common Stock--Class B 100,000,000
Merrill Lynch Natural Resources Focus Fund Common Stock--Class B 100,000,000
Merrill Lynch Prime Bond Fund Common Stock--Class B 100,000,000
Merrill Lynch Quality Equity Fund Common Stock--Class B 100,000,000
Merrill Lynch Reserve Assets Fund Common Stock--Class B 500,000,000
</TABLE>
SIXTH: All of the shares of Class A and Class B Common Stock shall have a
par value of $0.10 per share. After the increase in the number of authorized
shares of capital stock of the Corporation and classification of those shares as
Class A and Class B Common Stock of the Merrill Lynch Fundamental Growth Focus
Fund and Class A Common Stock of Merrill Lynch Prime Bond Fund, Merrill Lynch
High Current Income Fund and Merrill Lynch Basic Value Focus Fund, the aggregate
par value of all the shares of all classes of the Corporation's capital stock
will be Seven Hundred Eighty Million Dollars ($780,000,000).
SEVENTH: no other change is intended or effected.
IN WITNESS WHEREOF, Merrill Lynch Variable Series Funds, Inc. has caused
these presents to be signed in its name and on its behalf by its President and
witnessed by its Secretary on January __, 2000.
WITNESS MERRILL LYNCH VARIABLE SERIES FUNDS, INC.
Name: Name:
Title: Secretary Title: President
THE UNDERSIGNED, President of Merrill Lynch Variable Series Funds, Inc. who
executed on behalf of the Corporation the foregoing Articles Supplementary of
which this Certificate is made a part, hereby acknowledges in the name and on
behalf of said Corporation the foregoing Articles Supplementary to be the
corporate act of said Corporation and hereby certifies that to the best of his
knowledge, information, and belief the matters and facts set forth therein with
respect to the authorization and approval thereof are true in all material
respects under penalties of perjury.
Name:
Title: President
FORM OF INVESTMENT ADVISORY AGREEMENT
AGREEMENT made this _____ day of _________, 2000 between Merrill Lynch
Variable Series Funds, Inc., a Maryland corporation (the "Company"), and Merrill
Lynch Asset Management L.P., a Delaware limited partnership (the "Adviser");
WITNESSETH:
WHEREAS, the Company is engaged in business as a diversified open-end
management investment company and is registered as such under the Investment
Company Act of 1940 (the "Investment Company Act"); and
WHEREAS, the Company is currently comprised of nineteen separate Funds,
each of which pursues its investment objective through separate investment
policies; and
WHEREAS, the Adviser is engaged principally in rendering advisory services
and is registered as an investment adviser under the Investment Advisers Act of
1940; and
WHEREAS, the Adviser is currently serving as the Investment Adviser to the
Company's Reserve Assets Fund pursuant to an Investment Advisory Agreement dated
November 10, 1981 as amended on April 23, 1985; to the Company's Prime Bond
Fund, High Current Income Fund, Quality Equity Fund and Equity Growth Fund
pursuant to an Investment Advisory Agreement dated April 21, 1982 as amended on
April 23, 1985; to the Company's Natural Resources Focus Fund and American
Balanced Fund pursuant to an Investment Advisory Agreement dated April 1988; and
to the Company's Domestic Money Market Fund and Global Strategy Focus Fund
pursuant to an Investment Advisory Agreement dated October 16, 1991; to the
Company's Basic Value Focus Fund, Global Bond Focus Fund (formerly known as the
World Income Focus Fund), Global Utility Focus Fund and International Equity
Focus Fund pursuant to an Investment Advisory Agreement dated June, 1993; to the
Company's Developing Capital Markets Focus Fund and Government Bond Fund
(formerly known as the Intermediate Government Bond Fund) pursuant to an
Investment Advisory Agreement dated April, 1994; to the Company's Index 500 Fund
pursuant to an Investment Advisory Agreement dated December, 1996; and to the
Company's Global Growth Focus Fund and Capital Focus Fund pursuant to an
Investment Advisory Agreement dated April, 1998.
WHEREAS, the Company desires to retain the Adviser to render investment
supervisory and corporate administrative services to the Company's Fundamental
Growth Focus Fund (hereinafter the "Fund"), in the manner and on the terms
hereinafter set forth.
NOW, THEREFORE, in consideration of the premises and the covenants
hereinafter contained, the Company and the Adviser hereby agree as follows:
ARTICLE 1
Duties of the Adviser
The Company hereby employs the Adviser to act as the investment adviser to
and manager of the Fund and to manage the investment and reinvestment of the
asset of the Fund, and to administer its affairs, subject to the supervision of
the Board of Directors of the Company, for the period and on the terms and
conditions set forth in this Agreement. The Adviser hereby accepts such
1
<PAGE>
employment and agrees during such period, at its own expense, to render the
services and to assume the obligations herein set forth for the compensation
provided for herein. The Adviser shall for all purposes herein be deemed to be
an independent contractor and shall, unless otherwise expressly provided or
authorized, have no authority to act for or represent the Company in any way or
otherwise be deemed an agent of the Company.
(a) Investment Advisory Services. In acting as investment adviser to the
Fund, the Adviser shall regularly provide the Fund with such investment
research, advice and supervision as the latter may from time to time consider
necessary for the proper supervision of the Fund and shall furnish continuously
an investment program and shall determine from time to time what securities
shall be purchased, sold or exchanged and what portion of the assets of the
Fund's portfolio shall be held in the various securities in which it may invest,
subject always to the restrictions of the Company's Articles of Incorporation
and Bylaws, as amended from time to time, the provisions of the Investment
Company Act and the statements relating to the Fund's investment objectives,
investment policies and investment restrictions set forth in the currently
effective prospectus of the Company relating to the Fund under the Securities
Act of 1933 (the "Prospectus"). Should the Board of Directors of the Company at
any time, however, make any definitive determination as to the investment policy
of the Fund and notify the Adviser thereof, the Adviser shall be bound by such
determination for the period, if any, specified in such notice or until
similarly notified that such determination has been revoked. The Adviser shall
take, on behalf of the Company, all actions which it deems necessary to
implement the investment policies determined as provided above, and in
particular to place all orders for the purchase or sale of portfolio securities
for the Fund with brokers or dealers selected by it. In connection with the
selection of such brokers or dealers and the placing of such orders, the Adviser
is directed at all times to seek to obtain for the Fund the most favorable net
results for the Fund as determined by the Board of Directors and set forth in
the Prospectus. Subject to this requirement and the provisions of the Investment
Company Act, the Securities Exchange Act of 1934, and other applicable
provisions of law, nothing shall prohibit the Adviser from selecting brokers or
dealers with which it or the Company is affiliated.
(b) Administrative Services. In addition to the performance of investment
advisory services, the Adviser shall perform, or supervise the performance of,
administrative services in connection with the management of the Company insofar
as such services relate to and are required by the Fund. In this connection, the
Adviser agrees to (i) assist in supervising all aspects of the Company's
operations relating to the Fund, including the coordination of all matters
relating to the functions of the custodian, transfer agent, other shareholder
service agents, accountants, attorneys and other parties performing services or
operational functions for the Company relating to the Fund, (ii) provide the
Company, at the Adviser's expense, with services of persons competent to perform
such administrative and clerical functions as are necessary in order to provide
effective administration of the Company to the extent required by the Fund,
including duties in connection with shareholder relations, reports, redemption
requests and account adjustments and the maintenance of certain books and
records of the Company insofar as they relate to the Fund, and (iii) provide the
Company, at the Adviser's expense, with adequate office space and related
services necessary for its operations as contemplated in the Agreement.
ARTICLE 2
Allocation of Charges and Expenses
(a) The Adviser. The Adviser assumes and shall pay for maintaining the
staff and personnel, and shall at its own expense provide the equipment, office
space and facilities, necessary to perform its obligations under this Agreement,
and shall pay all compensation of officers of the Company and the fees of all
directors of the Company who are affiliated persons of Merrill Lynch & Co., Inc.
or its subsidiaries, and shall pay the organization costs of the Fund.
2
<PAGE>
(b) The Company. The Company assumes and shall pay all expenses of the
Fund, including, without limitation; insurance, taxes, expenses for legal and
auditing services, costs of printing proxies, stock certificates, shareholder
reports and prospectuses (except to the extent paid by the Distributor), charges
of the Custodian and Transfer Agent, expenses of redemption of shares,
Securities and Exchange Commission fees, expenses of registering the shares
under federal and state securities laws, fees and expenses of directors who are
not affiliated persons of Merrill Lynch & Co., Inc. or its subsidiaries,
accounting and pricing costs (including the daily calculation of net asset
value), interest, brokerage costs, litigation and other extraordinary or
nonrecurring expenses, and other expenses properly payable by the Company.
ARTICLE 3
Compensation of the Adviser
(a) Investment Advisory Fee. For the services rendered, the facilities
furnished and expenses assumed by the Adviser, the Company shall pay to the
Adviser at the end of each calendar month a fee at the annual rate of 0.65% of
the average daily net assets of the Fund, as determined and computed in
accordance with the description of the method of determination of net asset
value contained in the Prospectus.
(b) Expense Limitations. In the event the operating expenses of the Fund,
including the investment advisory fee applicable to the Fund payable to the
Adviser pursuant to subsection (a) hereof, for any fiscal year ending on a date
on which this Agreement is in effect, exceeds the expense limitations under
state securities laws or published regulations thereunder, as such limitations
may be raised or lowered from time to time, the Adviser shall reduce its
investment advisory fee by the extent of such excess and, if required under any
such laws or regulations, will reimburse the Fund in the amount of such excess;
provided, however, to the extent permitted under law, there shall be excluded
from such expenses the amount of any interest, taxes, brokerage commissions and
extraordinary expenses (including but not limited to legal claims and
liabilities and litigation costs and any indemnification related thereto) paid
or payable by the Company and allocated to the Fund. Whenever the expenses of
the Fund exceeds a pro rata portion of the applicable annual expense
limitations, the estimated amounts of reimbursement under such limitations shall
be applicable as an offset against the monthly payment of the advisory fee due
to the Adviser.
ARTICLE 4
Limitation of Liability of the Adviser
The Adviser shall not be liable for any error of judgment or mistake of
law or for any loss suffered by the Company in connection with any investment
policy or the purchase, sale or redemption of any securities on the
recommendation of the Adviser. Nothing herein contained shall be construed to
protect the Adviser against any liability to the Company or its security holders
to which the Adviser shall otherwise be subject by reason of willful
misfeasance, bad faith, gross negligence in the performance of its duties on
behalf of the Company, reckless disregard of the Adviser's obligations and
duties under this Agreement or the violation of any applicable law.
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ARTICLE 5
Activities of the Adviser
The services of the Adviser under this Agreement are not to be deemed
exclusive, and the Adviser shall be free to render similar services to others so
long as its services hereunder are not impaired thereby. It is understood that
directors, officers, employees and shareholders of the Company are or may become
interested in the Adviser, as directors, officers, employees or shareholders or
otherwise and that directors, officers, employees or shareholders of the Adviser
are or may become similarly interested in the Company, and that the Adviser is
or may become interested in the Company as shareholder or otherwise.
ARTICLE 6
Duration and Termination of this Agreement
This Agreement shall become effective as of the effective date of the
Company's Post Effective Amendment No. 33 to its Registration Statement, and
shall remain in force until the second anniversary of such effectiveness and
thereafter, but only so long as such continuance after the second anniversary is
specifically approved at least annually by (i) the Board of Directors of the
Company, or by the vote of a majority of the outstanding shares of the Fund, and
(ii) a majority of those directors who are not parties to this Agreement or
interested persons of any such party cast in person at a meeting called for the
purposes of voting on such approval.
This Agreement may be terminated at any time, as to the Fund, without the
payment of any penalty, by the Board of Directors of the Company or by vote of a
majority of the outstanding shares of the Fund, or by the Adviser, on sixty
days' written notice to the other party. This Agreement shall automatically
terminate in the event of its assignment.
ARTICLE 7
Definitions
The term "assignment", "affiliated person" and "interested person", when
used in this Agreement, shall have the respective meanings specified in the
Investment Company Act. As used with respect to the Company or the Fund, the
term "majority of the outstanding shares" means the lesser of (i) 67% of the
shares represented at a meeting at which more than 50% of the outstanding shares
are represented or (ii) more than 50% of the outstanding shares.
ARTICLE 8
Amendments of this Agreement
This Agreement may be amended by the parties only if such amendment is
specifically approved by the (i) the Board of Directors of the Company, or by
the vote of the majority of outstanding shares of the Fund, and (ii) a majority
of those directors of the Company who are not parties to this Agreement or
interested persons of any such party cast in person at a meeting called for the
purpose of voting on such approval.
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ARTICLE 9
Governing Law
The provisions of this Agreement shall be construed and interpreted in
accordance with the laws of the State of New York as at the time in effect and
the applicable provisions of the Investment Company Act. To the extent that the
applicable laws of the State of New York, or any of the provisions herein,
conflict with the applicable provisions of the Investment Company Act, the
latter shall control.
MERRILL LYNCH VARIABLE SERIES FUNDS,
INC.
ATTEST:
_______________________________ By: ________________________________
Secretary President
MERRILL LYNCH ASSET MANAGEMENT, L.P.
ATTEST: By: Princeton Services, Inc., its
general partner
_______________________________ By: ________________________________
Secretary President
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