<PAGE> 1
<TABLE>
<S> <C>
TABLE OF CONTENTS
- -----------------------------------------------
Summary 1
- -----------------------------------------------
Summary of Expenses 3
- -----------------------------------------------
Financial Highlights 5
- -----------------------------------------------
Investment Objectives, Policies and Risk
Factors 15
- -----------------------------------------------
Investment Manager and Underwriter 33
- -----------------------------------------------
Dividends and Taxes 37
- -----------------------------------------------
Net Asset Value 38
- -----------------------------------------------
Purchase of Shares 40
- -----------------------------------------------
Redemption or Repurchase of Shares 45
- -----------------------------------------------
Special Features 49
- -----------------------------------------------
Performance 53
- -----------------------------------------------
Capital Structure 54
- -----------------------------------------------
Appendix A--Portfolio Composition 56
- -----------------------------------------------
Appendix B--Ratings of Investments 57
- -----------------------------------------------
</TABLE>
This combined prospectus of the Kemper Fixed Income Funds contains information
about each of the Funds that you should know before investing and should be
retained for future reference. A Statement of Additional Information dated
December 1, 1995, has been filed with the Securities and Exchange Commission and
is incorporated herein by reference. It is available upon request without charge
from the Funds at the address or telephone number on this cover or the firm from
which this prospectus was obtained.
THE FUNDS' SHARES ARE NOT DEPOSITS OR OBLIGATIONS OF, OR GUARANTEED OR ENDORSED
BY, ANY BANK, NOR ARE THEY FEDERALLY INSURED BY THE FEDERAL DEPOSIT INSURANCE
CORPORATION, THE FEDERAL RESERVE BOARD OR ANY OTHER AGENCY. INVESTMENT IN A
FUND'S SHARES INVOLVES RISK, INCLUDING THE POSSIBLE LOSS OF PRINCIPAL.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
KEMPER IJKLM(LOGO)
FIXED
INCOME
FUNDS
PROSPECTUS December 1, 1995
KEMPER FIXED INCOME FUNDS
120 South LaSalle Street, Chicago, Illinois 60603
1-800-621-1048
This prospectus describes a choice of eight fixed income investment portfolios
managed by Kemper Financial Services, Inc.
KEMPER ADJUSTABLE RATE U.S. GOVERNMENT FUND
KEMPER CASH RESERVES FUND
KEMPER DIVERSIFIED INCOME FUND
KEMPER U.S. GOVERNMENT SECURITIES FUND
KEMPER HIGH YIELD FUND
KEMPER INCOME AND CAPITAL PRESERVATION FUND
KEMPER U.S. MORTGAGE FUND
KEMPER SHORT-INTERMEDIATE GOVERNMENT FUND
Kemper Cash Reserves Fund, Kemper U.S. Mortgage Fund and Kemper
Short-Intermediate Government Fund are each a series of Kemper Portfolios.
KEMPER DIVERSIFIED INCOME FUND MAY AND KEMPER HIGH YIELD FUND DOES INVEST
PRIMARILY IN LOWER RATED BONDS, COMMONLY REFERRED TO AS "JUNK BONDS."
INVESTMENTS OF THIS TYPE ARE SUBJECT TO A GREATER RISK OF LOSS OF PRINCIPAL AND
INTEREST THAN INVESTMENTS IN HIGHER RATED SECURITIES. PURCHASERS SHOULD
CAREFULLY ASSESS THE RISKS ASSOCIATED WITH AN INVESTMENT IN THESE FUNDS.
AN INVESTMENT IN KEMPER CASH RESERVES FUND IS NEITHER INSURED NOR GUARANTEED BY
THE U.S. GOVERNMENT. THERE CAN BE NO ASSURANCE THAT THE FUND WILL BE ABLE TO
MAINTAIN A STABLE NET ASSET VALUE OF $1.00 PER SHARE.
<PAGE> 2
KEMPER FIXED INCOME FUNDS
120 SOUTH LASALLE STREET, CHICAGO, ILLINOIS 60603, TELEPHONE 1-800-621-1048
SUMMARY
INVESTMENT OBJECTIVES. The eight open-end, diversified, management investment
companies or portfolios thereof (the "Funds") covered in this combined
prospectus are as follows:
KEMPER ADJUSTABLE RATE U.S. GOVERNMENT FUND (the "Adjustable Rate Fund") seeks
high current income consistent with low volatility of principal.
KEMPER CASH RESERVES FUND (the "Cash Reserves Fund") seeks maximum current
income to the extent consistent with stability of principal from a portfolio of
high quality money market instruments.
KEMPER DIVERSIFIED INCOME FUND (the "Diversified Fund") seeks a high current
return.
KEMPER U.S. GOVERNMENT SECURITIES FUND (the "Government Fund") seeks high
current income, liquidity and security of principal.
KEMPER HIGH YIELD FUND (the "High Yield Fund") seeks the highest level of
current income obtainable from a professionally managed, diversified portfolio
of fixed income securities which the Fund's investment manager considers
consistent with reasonable risk.
KEMPER INCOME AND CAPITAL PRESERVATION FUND (the "Income and Capital Fund")
seeks as high a level of current income as is consistent with prudent investment
management, preservation of capital and ready marketability of its portfolio.
KEMPER U.S. MORTGAGE FUND (the "Mortgage Fund") seeks maximum current return
from U.S. Government securities.
KEMPER SHORT-INTERMEDIATE GOVERNMENT FUND (the "Short-Intermediate Government
Fund") seeks, with equal emphasis, high current income and preservation of
capital from a portfolio composed primarily of short and intermediate-term U.S.
Government securities.
Each Fund (other than the Cash Reserves Fund) may engage in options and
financial futures transactions. The Diversified, High Yield and Income and
Capital Funds each may invest a portion of its assets in foreign securities and
engage in related foreign currency transactions. See "Investment Objectives,
Policies and Risk Factors."
RISK FACTORS. There is no assurance that the investment objective of any Fund
will be achieved and investment in each Fund includes risks that vary in kind
and degree depending upon the investment policies of that Fund. The returns and
net asset value of each Fund will fluctuate (except that the Cash Reserves Fund
seeks to maintain a net asset value of $1.00 per share). Investors should note
that investments in high yield securities by certain Funds (principally the
Diversified and High Yield Funds) entail relatively greater risk of loss of
income and principal than investments in higher rated securities and market
prices of high yield securities may fluctuate more than market prices of higher
rated securities. Foreign investments by certain Funds involve risk and
opportunity considerations not typically associated with investing in U.S.
companies. The U.S. Dollar value of a foreign security tends to decrease when
the value of the U.S. Dollar rises against the foreign currency in which the
security is denominated and tends to increase when the value of the U.S. Dollar
falls against such currency. Thus, the U.S. Dollar value of foreign securities
in a Fund's portfolio, and the Fund's net asset value, may change in response to
changes in currency exchange rates even though the value of the foreign
securities in local currency terms may not have changed. While a Fund's
investments in foreign securities will principally be in developed countries,
the Fund may invest a portion of its assets in developing or "emerging" markets,
which involve exposure to economic structures that are generally less diverse
and mature than in the United States, and to political systems that may be less
stable. There are special risks associated with options, financial futures and
foreign currency transactions and there is no assurance that use of those
investment techniques will be successful. The government guarantee of the U.S.
Government securities in which certain Funds invest (principally the Adjustable
Rate, Government, Mortgage and Short-Intermediate Government Funds) does not
guarantee the market value of the shares of such Funds. Normally,
1
<PAGE> 3
the value of investments in U.S. Government securities, as with most debt
securities, varies inversely with changes in interest rates. See "Investment
Objectives, Policies and Risk Factors."
PURCHASES AND REDEMPTIONS. Each Fund provides investors with the option of
purchasing shares in the following ways:
<TABLE>
<S> <C>
Class A Shares..................... Offered at net asset value plus a maximum sales charge of 4.5%
(3.5% for the Adjustable Rate and Short-Intermediate
Government Funds) of the offering price. No initial sales
charge applies to purchases of Class A shares of the Cash
Reserves Fund, but the applicable sales charge applies for
exchanges of such shares into Class A shares of other Kemper
Mutual Funds. Reduced sales charges apply to purchases of
$100,000 or more. The redemption within one year of Class A
shares purchased at net asset value under the Large Order NAV
Purchase Privilege may be subject to a 1% contingent deferred
sales charge.
Class B Shares..................... Offered at net asset value, subject to a Rule 12b-1
distribution fee and a contingent deferred sales charge that
declines from 4% to zero on certain redemptions made within
six years of purchase. Class B shares automatically convert
into Class A shares (which have lower ongoing expenses) six
years after purchase.
Class C Shares..................... Offered at net asset value without an initial or contingent
deferred sales charge, but subject to a Rule 12b-1
distribution fee. Class C shares do not convert into another
class.
</TABLE>
Each class of shares represents interests in the same portfolio of investments
of a Fund. The minimum initial investment is $1,000 and each investment
thereafter must be at least $100. Shares are redeemable at net asset value,
which may be more or less than original cost, subject, in the case of Class A
shares purchased under the Large Order NAV Purchase Privilege and for Class B
shares, to any applicable contingent deferred sales charge. See "Purchase of
Shares" and "Redemption or Repurchase of Shares."
INVESTMENT MANAGER AND UNDERWRITER. Kemper Financial Services, Inc. ("KFS")
serves as investment manager, principal underwriter and administrator for each
Fund. KFS is paid an investment management fee by each Fund based upon the
average daily net assets of that Fund at an effective annual rate that differs
for each Fund. Kemper Distributors, Inc. ("KDI"), a wholly owned subsidiary of
KFS, is principal underwriter and administrator for each Fund. For Class B
shares and Class C shares, KDI receives a Rule 12b-1 distribution fee of .75 of
1% of average daily net assets. KDI also receives the amount of any contingent
deferred sales charges paid on the redemption of shares. Administrative services
are provided to shareholders under administrative services agreements with KDI.
Each Fund pays an administrative services fee at the annual rate of up to .25 of
1% of average daily net assets of each class of the Fund, which KDI pays to
financial services firms. See "Investment Manager and Underwriter."
DIVIDENDS. The Cash Reserves Fund's net investment income is declared as a
dividend daily, and dividends are reinvested or paid in cash monthly. Each of
the other Funds normally distributes monthly dividends of net investment income
and distributes any net realized short-term and long-term capital gains at least
annually. Income and capital gain dividends of a Fund are automatically
reinvested in additional shares of that Fund, without a sales charge, unless the
shareholder makes a different election. See "Dividends and Taxes."
GENERAL. In the opinion of the staff of the Securities and Exchange Commission,
the use of this combined prospectus may make each Fund liable for any
misstatement or omission in this prospectus regardless of the particular Fund to
which it pertains.
2
<PAGE> 4
SUMMARY OF EXPENSES
<TABLE>
<CAPTION>
SHAREHOLDER TRANSACTION EXPENSES (APPLICABLE TO ALL
FUNDS)(1) CLASS A CLASS B CLASS C
-------- ------------------- -------
<S> <C> <C> <C>
Maximum Sales Charge on Purchases %(2)
(as a percentage of offering price).................... 3.5*/4.5 None None
Maximum Sales Charge on Reinvested Dividends............. None None None
Redemption Fees.......................................... None None None
Exchange Fee............................................. None None None
Deferred Sales Charge (as a percentage of redemption None(3) 4% during the first None
proceeds).............................................. year, 3% during the
second and third
years, 2% during
the fourth and
fifth years and 1%
in the sixth year
</TABLE>
* 3.5% APPLIES TO THE ADJUSTABLE RATE AND SHORT-INTERMEDIATE GOVERNMENT FUNDS
ONLY.
- ---------------
(1) Investment dealers and other firms may independently charge additional fees
for shareholder transactions or for advisory services; please see their
materials for details.
(2) Reduced sales charges apply to purchases of $100,000 or more. See "Purchase
of Shares -- Initial Sales Charge Alternative -- Class A Shares." No initial
sales charge applies to purchases of Class A shares of the Cash Reserves
Fund but the applicable sales charge applies for exchanges into Class A
shares of other Kemper Mutual Funds.
(3) The redemption within one year of shares purchased at net asset value under
the Large Order NAV Purchase Privilege may be subject to a 1% contingent
deferred sales charge. See "Purchase of Shares -- Initial Sales Charge
Alternative -- Class A Shares."
CLASS A SHARES
<TABLE>
<CAPTION>
ANNUAL FUND INCOME SHORT-
OPERATING EXPENSES ADJUSTABLE CASH HIGH AND INTERMEDIATE
(as a percentage of average net RATE RESERVES DIVERSIFIED GOVERNMENT YIELD CAPITAL MORTGAGE GOVERNMENT
assets) FUND FUND FUND FUND FUND FUND FUND FUND
------- ------- ------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Management Fees................ .55% .40% .56% .41% .53% .53% .50% .55%
12b-1 Fees..................... None None None None None None None None
Other Expenses................. .55% .52% .53% .31% .37% .37% .44% .50%
------- ------- ------- ------- ------- ------- ------- -------
Total Operating Expenses....... 1.10% .92% 1.09% .72% .90% .90% .94% 1.05%
====== ====== ====== ====== ====== ====== ====== ======
</TABLE>
CLASS B SHARES
<TABLE>
<CAPTION>
ANNUAL FUND INCOME SHORT-
OPERATING EXPENSES ADJUSTABLE CASH HIGH AND INTERMEDIATE
(as a percentage of average net RATE RESERVES DIVERSIFIED GOVERNMENT YIELD CAPITAL MORTGAGE GOVERNMENT
assets) FUND FUND FUND FUND FUND FUND FUND FUND
------- ------- ------- ------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Management Fees................ .55% .40% .56% .41% .53% .53% .50% .55%
12b-1 Fees(4).................. .75% .75% .75% .75% .75% .75% .75% .75%
Other Expenses................. .55% .64% .73% .53% .49% .53% .54% .61%
------- ------- ------- ------- ------- ------- ------- -------
Total Operating Expenses....... 1.85% 1.79% 2.04% 1.69% 1.77% 1.81% 1.79% 1.91%
====== ====== ====== ====== ====== ====== ====== ======
</TABLE>
- ---------------
(4) Long-term shareholders may pay more than the economic equivalent of the
maximum initial sales charges permitted by the National Association of
Securities Dealers, although KDI believes that it is unlikely because of the
automatic conversion feature described under "Purchase of Shares--Deferred
Sales Charge Alternative--Class B Shares."
3
<PAGE> 5
CLASS C SHARES
<TABLE>
<CAPTION>
ANNUAL FUND INCOME SHORT-
OPERATING EXPENSES ADJUSTABLE CASH HIGH AND INTERMEDIATE
(as a percentage of average RATE RESERVES DIVERSIFIED GOVERNMENT YIELD CAPITAL MORTGAGE GOVERNMENT
net assets) FUND FUND FUND FUND FUND FUND FUND FUND
---------- -------- ----------- ---------- ----- ------ -------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Management Fees............... .55% .40% .56% .41% .53% .53% .50% .55%
12b-1 Fees(5)................. .75% .75% .75% .75% .75% .75% .75% .75%
Other Expenses................ .49% .63% .53% .48% .43% .50% .44% .44%
----- -------- ----- ----- ----- ------ -------- -----
Total Operating Expenses...... 1.79% 1.78% 1.84% 1.64% 1.71% 1.78% 1.69% 1.74%
======== ====== ======== ========= ==== ===== ======= =========
</TABLE>
- ---------------
(5) As a result of the accrual of 12b-1 fees, long-term shareholders may pay
more than the economic equivalent of the maximum initial sales charges
permitted by the National Association of Securities Dealers.
CLASS A SHARES
<TABLE>
<CAPTION>
FUND 1 YEAR 3 YEARS 5 YEARS 10 YEARS
------------------------------ ------ ------- ------- --------
<S> <C> <C> <C> <C> <C>
EXAMPLE
You would pay the following Adjustable Rate $ 46 $69 $ 94 $164
expenses on a $1,000 Cash Reserves $ 9 $29 $ 51 $113
investment, assuming (1) 5% Diversified $56 $78 $102 $172
annual return and (2) Government $52 $67 $ 83 $130
redemption at the end of each High Yield $54 $72 $ 93 $151
time period: Income and Capital $54 $72 $ 93 $151
Mortgage $54 $74 $ 95 $155
Short-Intermediate Government $45 $67 $ 91 $159
</TABLE>
CLASS B SHARES
<TABLE>
<CAPTION>
FUND 1 YEAR 3 YEARS 5 YEARS 10 YEARS
------------------------------ ------ ------- ------- --------
<S> <C> <C> <C> <C> <C>
EXAMPLE(6)
You would pay the following Adjustable Rate $ 49 $78 $ 110 $179
expenses on a $1,000 Cash Reserves $48 $76 $107 $167
investment, assuming (1) 5% Diversified $51 $84 $120 $190
annual return and (2) Government $47 $73 $102 $150
redemption at the end of each High Yield $48 $76 $106 $164
time period: Income and Capital $48 $77 $108 $167
Mortgage $48 $76 $107 $168
Short-Intermediate Government $49 $80 $113 $180
You would pay the following Adjustable Rate $ 19 $58 $ 100 $179
expenses on the same Cash Reserves $ 18 $56 $ 97 $167
investment,
assuming no redemption: Diversified $ 21 $64 $ 110 $190
Government $ 17 $53 $ 92 $150
High Yield $ 18 $56 $ 96 $164
Income and Capital $ 19 $57 $ 98 $167
Mortgage $ 18 $56 $ 97 $168
Short-Intermediate Government $ 19 $60 $ 103 $180
</TABLE>
- ---------------
(6) Assumes conversion to Class A shares six years after purchase and was
calculated based upon the assumption that the shareholder was an owner of
the shares on the first day of the first year and the contingent deferred
sales charge was applied as follows: 1 year (3%), 3 years (2%), 5 years (1%)
and 10 years (0%). See "Redemption or Repurchase of Shares -- Contingent
Deferred Sales Charge -- Class B Shares" for more information regarding the
calculation of the contingent deferred sales charge.
4
<PAGE> 6
CLASS C SHARES
<TABLE>
<CAPTION>
FUND 1 YEAR 3 YEARS 5 YEARS 10 YEARS
------------------------------ ------ ------- ------- --------
<S> <C> <C> <C> <C> <C>
EXAMPLE
You would pay the following Adjustable Rate $ 18 $56 $ 97 $211
expenses on a $1,000 Cash Reserves $ 18 $56 $ 96 $209
investment,
assuming (1) 5% annual return Diversified $ 19 $58 $ 100 $216
and (2) redemption at the end Government $ 17 $52 $ 89 $194
of each time period: High Yield $ 17 $54 $ 93 $202
Income and Capital $ 18 $56 $ 96 $209
Mortgage $ 17 $53 $ 92 $200
Short-Intermediate Government $ 18 $55 $ 94 $205
</TABLE>
The purpose of the preceding table is to assist investors in understanding the
various costs and expenses that an investor in a Fund will bear directly or
indirectly. See "Investment Manager and Underwriter" for more information. The
Example assumes a 5% annual rate of return pursuant to requirements of the
Securities and Exchange Commission. This hypothetical rate of return is not
intended to be representative of past or future performance of any Fund. THE
EXAMPLE SHOULD NOT BE CONSIDERED TO BE A REPRESENTATION OF PAST OR FUTURE
EXPENSES. ACTUAL EXPENSES MAY BE GREATER OR LESS THAN THOSE SHOWN.
FINANCIAL HIGHLIGHTS
The tables below show financial information for each Fund expressed in terms of
one share outstanding throughout the period. The information in the table for
each Fund is covered by the report of the Fund's independent auditors. The
report for each Fund is contained in its Registration Statement and is available
from that Fund. The financial statements contained in each Fund's 1995 Annual
Report to Shareholders (and for Kemper Portfolios, the period from August 1,
1995 to September 30, 1995) are incorporated herein by reference and may be
obtained by writing or calling that Fund.
5
<PAGE> 7
ADJUSTABLE RATE FUND
<TABLE>
<CAPTION>
JULY 1, SEPTEMBER 1,
1991 TO 1987 TO
YEAR ENDED AUGUST 31, AUGUST 31, YEAR ENDED JUNE 30, JUNE 30,
CLASS A SHARES 1995 1994 1993 1992 1991 1991 1990 1989 1988
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
--------------------------------------------------------------------------------
PER SHARE OPERATING
PERFORMANCE:
Net asset value, beginning of
period $8.33 8.68 8.63 8.37 8.21 8.21 8.66 8.79 9.00
- --------------------------------------
Income from investment
operations:
Net investment income .48 .34 .47 .63 .13 .79 .81 .87 .52
- --------------------------------------
Net realized and unrealized
gain (loss) (.04) (.29) .02 .22 .17 .02 (.41) (.08) (.14)
- --------------------------------------
Total from investment
operations .44 .05 .49 .85 .30 .81 .40 .79 .38
- --------------------------------------
Less dividends:
Distribution from net
investment income .47 .40 .44 .59 .14 .81 .78 .85 .49
- --------------------------------------
Distribution from net
realized gain -- -- -- -- -- -- .07 .07 .10
- --------------------------------------
Total dividends .47 .40 .44 .59 .14 .81 .85 .92 .59
- --------------------------------------
Net asset value, end of period $8.30 8.33 8.68 8.63 8.37 8.21 8.21 8.66 8.79
- --------------------------------------
TOTAL RETURN (%): 5.52 .59 5.87 10.56 3.62 10.33 4.85 9.64 4.29
- --------------------------------------
RATIOS TO AVERAGE NET ASSETS (%)(A):
Expenses 1.10 .93 .21 .28 1.09 1.07 1.37 1.41 1.51
- --------------------------------------
Net investment income 5.76 3.96 5.44 7.02 9.45 9.62 9.60 10.10 8.63
- --------------------------------------
</TABLE>
<TABLE>
<CAPTION>
CLASS B MAY 31, 1994 CLASS C MAY 31, 1994
YEAR ENDED TO YEAR ENDED TO
CLASS B & CLASS C SHARES AUGUST 31, 1995 AUGUST 31, 1994 AUGUST 31, 1995 AUGUST 31, 1994
<S> <C> <C> <C> <C>
----------------------------------- -----------------------------------
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period $8.32 8.37 $8.33 8.37
- ------------------------------------------------------------------------------ -----------------------------------
Income from investment operations:
Net investment income .43 .07 .43 .08
- ------------------------------------------------------------------------------ -----------------------------------
Net realized and unrealized gain
(loss) (.04) (.04) (.04) (.04)
- ------------------------------------------------------------------------------ -----------------------------------
Total from investment operations .39 .03 .39 .04
- ------------------------------------------------------------------------------ -----------------------------------
Less distribution from net investment
income .40 .08 .40 .08
- ------------------------------------------------------------------------------ -----------------------------------
Net asset value, end of period $8.31 8.32 $8.32 8.33
- ------------------------------------------------------------------------------ -----------------------------------
TOTAL RETURN (%): 4.84 .34 4.89 .47
- ------------------------------------------------------------------------------ -----------------------------------
RATIOS TO AVERAGE NET ASSETS (%):
Expenses 1.85 1.96 1.79 1.88
- ------------------------------------------------------------------------------ -----------------------------------
Net investment income 5.01 3.36 5.07 3.52
- ------------------------------------------------------------------------------ -----------------------------------
</TABLE>
<TABLE>
<CAPTION>
JULY 1, SEPTEMBER 1,
1991 TO 1987 TO
YEAR ENDED AUGUST 31, AUGUST 31, YEAR ENDED JUNE 30, JUNE 30,
ALL CLASSES 1995 1994 1993 1992 1991 1991 1990 1989 1988
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
---------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets at end of
period
(in thousands) $129,757 202,815 212,694 174,967 76,749 75,012 75,913 75,704 59,054
- -----------------------------------
Portfolio turnover rate
(%) 308 533 138 309 228 259 278 265 201
- -----------------------------------
</TABLE>
(a) KFS agreed to waive its management fee and to absorb certain other operating
expenses of the Adjustable Rate Fund through December 31, 1992. Thereafter,
these expenses were gradually reinstated through January 31, 1994. Without this
agreement, the ratio of expenses to average net assets and the ratio of net
investment income to average net assets for Class A Shares would have been .99%
and 3.90%, respectively, for fiscal 1994, .95% and 4.70%, respectively, for
fiscal 1993, and .90% and 6.40%, respectively, for fiscal 1992.
6
<PAGE> 8
CASH RESERVES FUND
<TABLE>
<CAPTION>
JANUARY 10,
AUGUST 1, 1995 1992 TO
TO SEPTEMBER 30, YEAR ENDED JULY 31, JULY 31,
1995 1995 1994 1993 1992
<S> <C> <C> <C> <C> <C>
CLASS A SHARES
------------------------------------------------------------
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period $ 1.00 1.00 1.00 1.00 1.00
- ------------------------------------------------------------------------------------------------------------------------
Net investment income and dividends declared .01 .05 .03 .02 .01
- ------------------------------------------------------------------------------------------------------------------------
Net asset value, end of period $ 1.00 1.00 1.00 1.00 1.00
- ------------------------------------------------------------------------------------------------------------------------
TOTAL RETURN (%): .85 4.99 2.78 2.42 1.57
- ------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS (%)(B):
Expenses .92 .89 .92 .93 1.39
- ------------------------------------------------------------------------------------------------------------------------
Net investment income 5.11 4.75 2.86 2.42 2.75
- ------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets at end of period (in thousands) $ 33,666 35,460 52,652 21,751 9,081
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
AUGUST 1, 1995
TO SEPTEMBER 30, YEAR ENDED JULY 31,
1995 1995 1994 1993 1992 1991 1990 1989 1988 1987 1986
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
CLASS B SHARES
----------------------------------------------------------------------------------------------------------
PER SHARE OPERATING
PERFORMANCE:
Net asset value,
beginning of period $ 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00
- ----------------------------------------
Net investment income
and dividends declared .01 .04 .02 .02 .03 .05 .07 .07 .05 .04 .05
- ------------------------------------------------------------------------------------------------------------------------
Net asset value, end of
period $ 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00 1.00
- ------------------------------------------------------------------------------------------------------------------------
TOTAL RETURN (%): .71 4.08 1.78 1.56 2.65 5.35 6.72 7.36 5.42 4.20 5.49
- ----------------------------------------
RATIOS TO AVERAGE NET
ASSETS (%)(B):
Expenses 1.79 1.78 1.89 1.82 2.22 2.18 2.12 2.08 2.08 2.28 2.41
- ------------------------------------------------------------------------------------------------------------------------
Net investment income 4.24 3.86 1.89 1.53 2.69 5.32 6.52 7.17 5.31 4.19 5.25
- ------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets at end of
period (in thousands) $140,617 172,493 370,930 145,057 147,138 240,994 284,977 285,194 245,604 150,683 47,788
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
MAY 31,
TO
AUGUST 1, 1995 YEAR ENDED JULY
TO SEPTEMBER 30, JULY 31, 31,
1995 1995 1994
<S> <C> <C> <C>
CLASS C SHARES
-----------------------------------------------------------
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period $ 1.00 1.00 1.00
- ------------------------------------------------------------------------------------------------------------------------
Net investment income and dividends declared .01 .04 --
- ------------------------------------------------------------------------------------------------------------------------
Net asset value, end of period $ 1.00 1.00 1.00
- ------------------------------------------------------------------------------------------------------------------------
TOTAL RETURN (%): .71 4.08 .42
- ------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS (%):
Expenses 1.78 1.76 1.80
- ------------------------------------------------------------------------------------------------------------------------
Net investment income 4.25 3.88 2.64
- ------------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets at end of period (in thousands) $2,274 5,078 735
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
(b) KFS agreed to absorb temporarily, certain operating expenses of the Cash
Reserves Fund during a portion of fiscal 1994 and 1993. Without this agreement,
ratios of expenses and net investment income to average net assets for the Class
A shares would have been 1.15% and 2.63%, respectively, for fiscal 1994 and
1.18% and 2.17%, respectively, for fiscal 1993. Ratios of expenses and net
investment income to average net assets for the Class B shares would have been
2.12% and 1.66%, respectively, for fiscal 1994 and 2.07% and 1.28%,
respectively, for fiscal 1993.
7
<PAGE> 9
DIVERSIFIED FUND
<TABLE>
<CAPTION>
DEC. 1, THIRTEEN
1990 YEAR MONTHS
TO ENDED ENDED
YEAR ENDED OCT. 31, OCT. 31, NOV. 30, NOV. 30, YEAR ENDED OCTOBER 31,
1995 1994 1993 1992 1991 1990 1989 1988 1987 1986
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
CLASS A SHARES
---------------------------------------------------------------------------------------------------
PER SHARE OPERATING
PERFORMANCE:
Net asset value, beginning
of period $5.77 6.23 5.65 5.47 4.14 5.48 6.06 6.10 7.55 7.99
- ------------------------------------------------------------------------------------------------------------------------
Income from investment
operations:
Net investment income .55 .52 .59 .63 .60 .71 .39 .13 .14 .18
- ------------------------------------------------------------------------------------------------------------------------
Net realized and
unrealized gain (loss) on
investments and foreign
currency .16 (.45) .58 .14 1.36 (1.34) .10 .72 (.55) .57
- ------------------------------------------------------------------------------------------------------------------------
Total from investment
operations .71 (.07) 1.17 .77 1.96 (.63) .49 .85 (.41) .75
- ------------------------------------------------------------------------------------------------------------------------
Less dividends:
Distribution from net
investment
income .50 .53 .59 .59 .63 .71 .40 .13 .16 .20
- ------------------------------------------------------------------------------------------------------------------------
Distribution from net
realized gain -- -- -- -- -- -- -- .02 .75 .99
- ------------------------------------------------------------------------------------------------------------------------
Paid in surplus -- -- -- -- -- -- .67 .74 .13 --
- ------------------------------------------------------------------------------------------------------------------------
Total dividends .50 .53 .59 .59 .63 .71 1.07 .89 1.04 1.19
- ------------------------------------------------------------------------------------------------------------------------
Net asset value, end of
period $5.98 5.77 6.23 5.65 5.47 4.14 5.48 6.06 6.10 7.55
- ------------------------------------------------------------------------------------------------------------------------
TOTAL RETURN (%): 12.90 1.02 21.60 14.59 50.58 (12.79) 8.59 15.30 (7.64) 9.90
- ------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET
ASSETS (%):
Expenses 1.09 1.12 1.10 1.19 1.21 1.15 .96 .97 .92 .85
- ------------------------------------------------------------------------------------------------------------------------
Net investment income 9.43 8.81 9.74 11.02 13.41 14.32 6.76 3.08 2.01 2.34
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
CLASS B MAY 31, 1994 CLASS C MAY 31, 1994
YEAR ENDED TO YEAR ENDED TO
OCTOBER 31, 1995 OCTOBER 31, 1994 OCTOBER 31, 1995 OCTOBER 31, 1994
<S> <C> <C> <C> <C>
CLASS B & C SHARES ------------------------------------ ------------------------------------
PER SHARE OPERATING PERFORMANCE:
$5.77 5.94 $5.79 5.95
Net asset value, beginning of period
- ---------------------------------------------------------------------------------- ----------------------------------
Income from investment operations:
Net investment income .49 .19 .50 .20
- ---------------------------------------------------------------------------------- ----------------------------------
Net realized and unrealized gain (loss) on
investments and foreign currency .16 (.17) .16 (.17)
- ---------------------------------------------------------------------------------- ----------------------------------
Total from investment operations .65 .02 .66 .03
- ---------------------------------------------------------------------------------- ----------------------------------
Less dividends from net investment income .44 .19 .45 .19
- ---------------------------------------------------------------------------------- ----------------------------------
Net asset value, end of period $5.98 5.77 $6.00 5.79
- ---------------------------------------------------------------------------------- ----------------------------------
TOTAL RETURN (%): 11.87 .35 11.95 .55
- ---------------------------------------------------------------------------------- ----------------------------------
RATIOS TO AVERAGE NET ASSETS (%):
Expenses 2.04 1.97 1.84 1.96
- ---------------------------------------------------------------------------------- ----------------------------------
Net investment income 8.48 8.01 8.68 8.02
- ---------------------------------------------------------------------------------- ----------------------------------
</TABLE>
<TABLE>
<CAPTION>
DEC. 1, THIRTEEN
1990 YEAR MONTHS
TO ENDED ENDED
YEAR ENDED OCT. 31, OCT. 31, NOV. 30, NOV. 30, YEAR ENDED OCTOBER 31,
1995 1994 1993 1992 1991 1990 1989 1988 1987 1986 1985
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
ALL CLASSES
----------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets at end of
period
(in thousands) $754,222 738,014 328,512 244,620 227,625 179,154 284,497 371,758 431,404 635,290 775,794
- ------------------------------------------------------------------------------------------------------------------------
Portfolio turnover
rate (%) 286 179 80 57 20 45 102 16 150 181 185
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
8
<PAGE> 10
GOVERNMENT FUND
<TABLE>
<CAPTION>
YEAR ENDED OCTOBER 31,
1995 1994 1993 1992 1991 1990 1989 1988 1987 1986
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
CLASS A SHARES
------------------------------------------------------------------------------------------------------------
PER SHARE OPERATING
PERFORMANCE:
Net asset value,
beginning
of year $ 8.35 9.29 9.30 9.32 8.71 9.09 9.02 9.13 9.89 9.14
- ------------------------------------------------------------------------------------------------------------------------
Income from
investment
operations:
Net investment
income .66 .67 .69 .78 .84 .85 .88 .93 .88 1.03
- ------------------------------------------------------------------------------------------------------------------------
Net realized and
unrealized gain
(loss) .56 (.97) (.01) (.02) .61 (.38) .09 (.08) (.65) .77
- ------------------------------------------------------------------------------------------------------------------------
Total from
investment
operations 1.22 (.30) .68 .76 1.45 .47 .97 .85 .23 1.80
- ------------------------------------------------------------------------------------------------------------------------
Less dividends:
Distribution from
net investment
income .65 .64 .69 .78 .84 .85 .90 .96 .91 .83
- ------------------------------------------------------------------------------------------------------------------------
Distribution from
net realized gain -- -- -- -- -- -- -- -- .08 .22
- ------------------------------------------------------------------------------------------------------------------------
Total dividends .65 .64 .69 .78 .84 .85 .90 .96 .99 1.05
- ------------------------------------------------------------------------------------------------------------------------
Net asset value, end
of year $ 8.92 8.35 9.29 9.30 9.32 8.71 9.09 9.02 9.13 9.89
- ------------------------------------------------------------------------------------------------------------------------
TOTAL RETURN (%): 15.24 (3.37) 7.60 8.44 17.41 5.53 11.51 9.73 2.35 20.59
- ------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE
NET ASSETS (%):
Expenses .72 .75 .65 .64 .63 .53 .49 .50 .51 .48
- ------------------------------------------------------------------------------------------------------------------------
Net investment
income 7.68 7.58 7.36 8.31 9.24 9.62 9.93 10.20 9.26 10.33
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
CLASS B MAY 31, 1994 CLASS C MAY 31, 1994
YEAR ENDED TO YEAR ENDED TO
OCTOBER 31, 1995 OCTOBER 31, 1994 OCTOBER 31, 1995 OCTOBER 31, 1994
<S> <C> <C> <C> <C>
CLASS B & C SHARES
-------------------------------------- --------------------------------------
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period $ 8.34 8.67 $ 8.35 8.67
- -------------------------------------------------------------------------------- ------------------------------------
Income from investment operations:
Net investment income .58 .28 .60 .29
- -------------------------------------------------------------------------------- ------------------------------------
Net realized and unrealized gain (loss) .56 (.38) .56 (.38)
- -------------------------------------------------------------------------------- ------------------------------------
Total from investment operations 1.14 (.10) 1.16 (.09)
- -------------------------------------------------------------------------------- ------------------------------------
Less dividends from net investment income .57 .23 .58 .23
- -------------------------------------------------------------------------------- ------------------------------------
Net asset value, end of period $ 8.91 8.34 $ 8.93 8.35
- -------------------------------------------------------------------------------- ------------------------------------
TOTAL RETURN (%): 14.18 (1.15) 14.33 (1.01)
- -------------------------------------------------------------------------------- ------------------------------------
RATIOS TO AVERAGE NET ASSETS (%):
Expenses 1.69 1.71 1.64 1.68
- -------------------------------------------------------------------------------- ------------------------------------
Net investment income (loss) 6.71 7.09 6.76 7.12
- -------------------------------------------------------------------------------- ------------------------------------
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED OCTOBER 31,
1995 1994 1993 1992 1991 1990 1989 1988 1987 1986
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
ALL CLASSES
-------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets at end
of year
(in thousands) $4,738,415 4,941,451 6,686,735 6,683,092 5,544,095 4,565,689 4,540,382 4,403,110 4,157,927 2,642,174
- ------------------------------------------------------------------------------------------------------------------------
Portfolio turnover
rate (%) 362 1,000 550 569 695 497 289 203 278 252
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
9
<PAGE> 11
HIGH YIELD FUND
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
1995 1994 1993 1992 1991 1990 1989 1988 1987 1986
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
CLASS A SHARES
----------------------------------------------------------------------
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of year $ 7.74 8.12 7.86 7.30 6.22 8.34 8.95 9.23 9.19 8.66
- ------------------------------------------------------------------------------------------------------------------------
Income from investment operations:
Net investment income .83 .73 .81 .85 .92 1.07 1.09 1.10 1.07 1.08
- ------------------------------------------------------------------------------------------------------------------------
Net realized and unrealized gain (loss) .20 (.35) .23 .54 1.15 (2.13) (.58) .09 .01 .50
- ------------------------------------------------------------------------------------------------------------------------
Total from investment operations 1.03 .38 1.04 1.39 2.07 (1.06) .51 1.19 1.08 1.58
- ------------------------------------------------------------------------------------------------------------------------
Less dividends:
Distribution from net investment income .76 .76 .78 .83 .99 1.06 1.12 1.11 1.04 1.05
- ------------------------------------------------------------------------------------------------------------------------
Distribution from net realized gain -- -- -- -- -- -- -- .36 -- --
- ------------------------------------------------------------------------------------------------------------------------
Total dividends .76 .76 .78 .83 .99 1.06 1.12 1.47 1.04 1.05
- ------------------------------------------------------------------------------------------------------------------------
Net asset value, end of year $ 8.01 7.74 8.12 7.86 7.30 6.22 8.34 8.95 9.23 9.19
- ------------------------------------------------------------------------------------------------------------------------
TOTAL RETURN (%): 14.10 4.64 13.92 19.96 36.82 (13.83) 5.91 14.22 12.03 19.09
- ------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS (%):
Expenses .90 .86 .80 .82 .85 .73 .67 .72 .72 .68
- ------------------------------------------------------------------------------------------------------------------------
Net investment income 10.74 9.22 10.22 11.00 14.02 14.46 12.40 12.59 11.42 11.90
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
CLASS B MAY 31, 1994 CLASS C MAY 31, 1994
YEAR ENDED TO YEAR ENDED TO
SEPTEMBER 30, 1995 SEPTEMBER 30, 1994 SEPTEMBER 30, 1995 SEPTEMBER 30, 1994
<S> <C> <C> <C> <C>
-------------------------------------- --------------------------------------
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period $ 7.73 7.96 $ 7.75 7.96
- ------------------------------------------------------------------------------ --------------------------------------
--------------------------------------
Income from investment operations:
Net investment income .76 .23 .77 .25
- ------------------------------------------------------------------------------ --------------------------------------
--------------------------------------
Net realized and unrealized gain
(loss) .20 (.23) .20 (.23)
- ------------------------------------------------------------------------------ --------------------------------------
--------------------------------------
Total from investment operations .96 -- .97 .02
- ------------------------------------------------------------------------------ --------------------------------------
--------------------------------------
Less dividends from net investment
income .69 .23 .70 .23
- ------------------------------------------------------------------------------ --------------------------------------
--------------------------------------
Net asset value, end of period $ 8.00 7.73 $ 8.02 7.75
- ------------------------------------------------------------------------------ --------------------------------------
--------------------------------------
TOTAL RETURN (%): 13.09 -- 13.13 .27
- ------------------------------------------------------------------------------ --------------------------------------
--------------------------------------
RATIOS TO AVERAGE NET ASSETS (%):
Expenses 1.77 1.80 1.71 1.74
- ------------------------------------------------------------------------------ --------------------------------------
--------------------------------------
Net investment income 9.87 8.70 9.93 8.75
- ------------------------------------------------------------------------------ --------------------------------------
--------------------------------------
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED SEPTEMBER 30,
1995 1994 1993 1992 1991 1990 1989 1988 1987 1986
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
ALL CLASSES
-------------------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets at
end of year
(in thousands) $3,527,954 3,152,029 1,957,524 1,953,509 1,673,161 1,183,943 1,552,762 978,310 452,771 323,205
- ------------------------------------------------------------------------------------------------------------------------
Portfolio turnover
rate (%) 99 93 101 69 31 37 45 76 118 95
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
10
<PAGE> 12
INCOME AND CAPITAL FUND
<TABLE>
<CAPTION>
YEAR ENDED OCTOBER 31,
1995 1994 1993 1992 1991 1990 1989 1988 1987 1986
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
CLASS A SHARES
------------------------------------------------------------------
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of year $ 7.91 8.97 8.34 8.22 7.70 8.22 8.53 8.44 9.12 8.57
- ------------------------------------------------------------------------------------------------------------------------
Income from investment operations:
Net investment income .61 .61 .63 .67 .74 .80 .84 .89 .95 1.03
- ------------------------------------------------------------------------------------------------------------------------
Net realized and unrealized gain (loss) .72 (1.03) .62 .11 .53 (.52) (.26) .12 (.71) .50
- ------------------------------------------------------------------------------------------------------------------------
Total from investment operations 1.33 (.42) 1.25 .78 1.27 .28 .58 1.01 .24 1.53
- ------------------------------------------------------------------------------------------------------------------------
Less dividends:
Distribution from net investment income .62 .59 .62 .66 .75 .80 .89 .92 .92 .98
- ------------------------------------------------------------------------------------------------------------------------
Distribution from net realized gain -- .05 -- -- -- -- -- -- -- --
- ------------------------------------------------------------------------------------------------------------------------
Total dividends .62 .64 .62 .66 .75 .80 .89 .92 .92 .98
- ------------------------------------------------------------------------------------------------------------------------
Net asset value, end of year $ 8.62 7.91 8.97 8.34 8.22 7.70 8.22 8.53 8.44 9.12
- ------------------------------------------------------------------------------------------------------------------------
TOTAL RETURN (%): 17.47 (4.86) 15.48 9.83 17.26 3.60 7.13 12.67 2.63 18.68
- ------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS (%):
Expenses .90 .94 .82 .82 .82 .73 .67 .69 .69 .69
- ------------------------------------------------------------------------------------------------------------------------
Net investment income 7.31 7.34 7.26 8.01 9.21 10.05 10.02 10.53 10.70 11.48
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
CLASS B MAY 31, 1994 CLASS C MAY 31, 1994
YEAR ENDED TO YEAR ENDED TO
CLASS B & C SHARES OCTOBER 31, 1995 OCTOBER 31, 1994 OCTOBER 31, 1995 OCTOBER 31, 1994
<S> <C> <C> <C> <C>
---------------------------------- ----------------------------------
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period $ 7.90 8.16 $ 7.90 8.16
--------------------------------
- ----------------------------------------------------------------------------------
Income from investment operations:
Net investment income .51 .23 .53 .23
--------------------------------
- ----------------------------------------------------------------------------------
Net realized and unrealized gain (loss) .72 (.26) .72 (.26)
--------------------------------
- ----------------------------------------------------------------------------------
Total from investment operations 1.23 (.03) 1.25 (.03)
--------------------------------
- ----------------------------------------------------------------------------------
Less dividends from net investment income .54 .23 .54 .23
--------------------------------
- ----------------------------------------------------------------------------------
Net asset value, end of period $ 8.59 7.90 $ 8.61 7.90
--------------------------------
- ----------------------------------------------------------------------------------
TOTAL RETURN (%): 16.12 (.45) 16.45 (.44)
--------------------------------
- ----------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS (%):
Expenses 1.81 1.92 1.78 1.89
--------------------------------
- ----------------------------------------------------------------------------------
Net investment income 6.40 6.72 6.43 6.75
--------------------------------
- ----------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED OCTOBER 31,
1995 1994 1993 1992 1991 1990 1989 1988 1987 1986
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
ALL CLASSES
--------------------------------------------------------------------------------
SUPPLEMENTAL DATA:
Net assets at end of year (in thousands) $649,427 510,432 569,145 482,009 432,490 394,131 404,995 322,229 255,779 206,108
- ------------------------------------------------------------------------------------------------------------------------
Portfolio turnover rate (%) 182 163 190 178 115 189 64 34 34 87
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
11
<PAGE> 13
MORTGAGE FUND
<TABLE>
<CAPTION>
AUGUST 1, 1995
TO SEPTEMBER 30, YEAR ENDED JULY 31, JANUARY 10, 1992
CLASS A SHARES 1995 1995 1994 1993 TO JULY 31, 1992
-------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period $ 7.06 6.96 7.56 7.78 7.81
- ------------------------------------------------------ ----------------------------------------------------------------
Income from investment operations:
Net investment income .08 .53 .51 .62 .38
- ------------------------------------------------------ ----------------------------------------------------------------
Net realized and unrealized gain (loss) .08 .09 (.59 ) (.21) (.03)
- ------------------------------------------------------ ----------------------------------------------------------------
Total from investment operations .16 .62 (.08 ) .41 .35
- ------------------------------------------------------ ----------------------------------------------------------------
Less dividends from net investment income .09 .52 .52 .63 .38
- ------------------------------------------------------ ----------------------------------------------------------------
Net asset value, end of period $ 7.13 7.06 6.96 7.56 7.78
- ------------------------------------------------------ ----------------------------------------------------------------
TOTAL RETURN (%): 2.23 9.48 (1.21) 5.52 4.76
- ------------------------------------------------------ ----------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS (%):
Expenses .94 .89 .99 .97 .94
- ------------------------------------------------------ ----------------------------------------------------------------
Net investment income 6.87 7.77 7.00 8.22 8.73
- ------------------------------------------------------ ----------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
AUGUST 1, 1995
TO SEPTEMBER 30, YEAR ENDED JULY 31,
CLASS B SHARES 1995 1995 1994 1993 1992 1991 1990 1989 1988 1987 1986
------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
PER SHARE OPERATING
PERFORMANCE:
Net asset value,
beginning of period $ 7.05 6.96 7.56 7.77 7.25 7.25 7.61 7.58 8.01 8.52 8.47
- ------------------------- -------------------------------------------------------------------------------------------------
Income from investment
operations:
Net investment income .07 .47 .45 .57 .65 .64 .66 .72 .72 .73 .76
- ------------------------- -------------------------------------------------------------------------------------------------
Net realized and
unrealized gain (loss) .08 .09 (.59) (.21) .49 .01 (.36) .07 (.33) (.41) .37
- ------------------------- -------------------------------------------------------------------------------------------------
Total from investment
operations .15 .56 (.14) .36 1.14 .65 .30 .79 .39 .32 1.13
- ------------------------- -------------------------------------------------------------------------------------------------
Less dividends:
Distribution from net
investment income .08 .47 .46 .57 .62 .65 .66 .76 .74 .69 .84
- ------------------------- -------------------------------------------------------------------------------------------------
Distribution from net
realized
gain -- -- -- -- -- -- -- -- .08 .14 .24
- ------------------------- -------------------------------------------------------------------------------------------------
Total dividends .08 .47 .46 .57 .62 .65 .66 .76 .82 .83 1.08
- ------------------------- -------------------------------------------------------------------------------------------------
Net asset value, end of
period $ 7.12 7.05 6.96 7.56 7.77 7.25 7.25 7.61 7.58 8.01 8.52
- ------------------------- -------------------------------------------------------------------------------------------------
TOTAL RETURN (%): 2.09 8.44 (2.00) 4.85 16.36 9.37 4.26 11.12 5.06 3.75 14.30
- ------------------------- -------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET
ASSETS (%):
Expenses 1.79 1.75 1.79 1.75 1.86 2.03 1.99 1.98 1.98 2.02 1.99
- ------------------------- -------------------------------------------------------------------------------------------------
Net investment income 6.02 6.91 6.27 7.44 8.70 8.86 9.00 9.62 9.28 8.70 8.94
- ------------------------- -------------------------------------------------------------------------------------------------
</TABLE>
12
<PAGE> 14
MORTGAGE FUND
<TABLE>
<CAPTION>
AUGUST 1, 1995 YEAR ENDED
TO SEPTEMBER 30, JULY 31, MAY 31, 1994
CLASS C SHARES 1995 1995 TO JULY 31, 1994
---------------------------------------------------
<S> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period $ 7.05 6.95 6.99
- ------------------------------------------------------------------------------------------------------------------------
Income from investment operations:
Net investment income .07 .48 .07
- ------------------------------------------------------------------------------------------------------------------------
Net realized and unrealized gain (loss) .08 .09 (.04)
- ------------------------------------------------------------------------------------------------------------------------
Total from investment operations .15 .57 .03
- ------------------------------------------------------------------------------------------------------------------------
Less dividend from net investment income .08 .47 .07
- ------------------------------------------------------------------------------------------------------------------------
Net asset value, end of period $ 7.12 7.05 6.95
- ------------------------------------------------------------------------------------------------------------------------
TOTAL RETURN (%): 2.10 8.65 .47
- ------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS (%):
Expenses 1.69 1.71 1.55
- ------------------------------------------------------------------------------------------------------------------------
Net investment income 6.12 6.95 6.46
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
AUGUST 1, 1995
TO SEPTEMBER 30, YEAR ENDED JULY 31,
ALL CLASSES 1995 1995 1994 1993 1992 1991 1990 1989
---------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
SUPPLEMENTAL DATA:
Net assets at end of
period in thousands) $3,493,052 3,528,329 4,158,066 5,639,097 5,602,682 4,879,832 5,178,159 6,193,674
- ------------------------------------------------------------------------------------------------------------------------
Portfolio turnover rate
(%) 249 573 963 551 376 498 206 152
- ------------------------------------------------------------------------------------------------------------------------
<CAPTION>
ALL CLASSES 1988 1987 1986
<S> <C> <C> <C>
SUPPLEMENTAL DATA:
Net assets at end of
period in thousands) 6,332,021 6,285,550 4,027,821
- ----------------------- ----------------------------------
Portfolio turnover rate
(%) 178 139 313
- ----------------------- ----------------------------------
</TABLE>
13
<PAGE> 15
SHORT-INTERMEDIATE GOVERNMENT FUND
<TABLE>
<CAPTION>
AUGUST 1, JANUARY 10,
1995 TO 1992 TO
SEPTEMBER 30, YEAR ENDED JULY 31, JULY 31,
CLASS A SHARES 1995 1995 1994 1993(D) 1992
---------------------------------------------------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period $8.09 8.11 8.63 8.65 8.59
- ------------------------------------------------------------------------------------------------------------------------
Income from investment operations:
Net investment income .09 .54 .48 .53 .29
- ------------------------------------------------------------------------------------------------------------------------
Net realized and unrealized gain (loss) (.01) (.03) (.44) (.03) .11
- ------------------------------------------------------------------------------------------------------------------------
Total from investment operations .08 .51 .04 .50 .40
- ------------------------------------------------------------------------------------------------------------------------
Less dividends from:
Distribution from net investment income .09 .53 .45 .52 .34
- ------------------------------------------------------------------------------------------------------------------------
Distribution from net realized gain -- -- .11 -- --
- ------------------------------------------------------------------------------------------------------------------------
Total dividends .09 .53 .56 .52 .34
- ------------------------------------------------------------------------------------------------------------------------
Net asset value, end of period $8.08 8.09 8.11 8.63 8.65
- ------------------------------------------------------------------------------------------------------------------------
TOTAL RETURN (%): 1.00 6.58 .41 6.01 4.87
- ------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS (%):
Expenses 1.05 1.06 1.06 1.04 .95
- ------------------------------------------------------------------------------------------------------------------------
Net investment income 6.56 6.65 5.85 6.06 7.48
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
AUGUST 1, FEBRUARY 1,
1995 TO 1989 TO
SEPTEMBER 30, YEAR ENDED JULY 31, JULY 31,
CLASS B SHARES 1995 1995 1994 1993(D) 1992 1991 1990 1989
-------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period $8.06 8.08 8.61 8.64 8.27 8.42 8.70 8.50
- ------------------------------------------------------------------------------------------------------------------------
Income from investment operations:
Net investment income .08 .47 .40 .45 .58 .69 .72 .36
- ------------------------------------------------------------------------------------------------------------------------
Net realized and unrealized gain (loss) (.01) (.03) (.44) (.02) .36 (.14) (.27) .14
- ------------------------------------------------------------------------------------------------------------------------
Total from investment operations .07 .44 (.04) .43 .94 .55 .45 .50
- ------------------------------------------------------------------------------------------------------------------------
Less dividends:
Distribution from net investment income .08 .46 .38 .46 .57 .70 .72 .30
- ------------------------------------------------------------------------------------------------------------------------
Distribution from net realized gain -- -- .11 -- -- -- .01 --
- ------------------------------------------------------------------------------------------------------------------------
Total dividends .08 .46 .49 .46 .57 .70 .73 .30
- ------------------------------------------------------------------------------------------------------------------------
Net asset value, end of period $8.05 8.06 8.08 8.61 8.64 8.27 8.42 8.70
- ------------------------------------------------------------------------------------------------------------------------
TOTAL RETURN (%): .87 5.68 (.48) 5.13 11.76 6.85 5.52 5.99
- ------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS (%):
Expenses 1.91 1.87 1.93 1.87 1.89 2.07 2.10 2.24
- ------------------------------------------------------------------------------------------------------------------------
Net investment income 5.70 5.84 4.95 5.23 6.84 8.19 8.60 8.50
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
(d) Per share data for 1993 for the Short-Intermediate Government Fund were
based upon average shares outstanding.
14
<PAGE> 16
SHORT-INTERMEDIATE GOVERNMENT FUND
<TABLE>
<CAPTION>
AUGUST 1, MAY 31,
1995 TO YEAR ENDED 1994 TO
SEPTEMBER 30, JULY 31, JULY 31,
CLASS C SHARES 1995 1995 1994
------------------------------------
<S> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period $8.06 8.08 8.09
- ------------------------------------------------------------------------------------------------------------------------
Income from investment operations:
Net investment income .09 .47 .07
- ------------------------------------------------------------------------------------------------------------------------
Net realized and unrealized loss (.01) (.03) (.01 )
- ------------------------------------------------------------------------------------------------------------------------
Total from investment operations .08 .44 .06
- ------------------------------------------------------------------------------------------------------------------------
Less dividends from net investment income .08 .46 .07
- ------------------------------------------------------------------------------------------------------------------------
Net asset value, end of period $8.06 8.06 8.08
- ------------------------------------------------------------------------------------------------------------------------
TOTAL RETURN (%): 1.00 5.73 .77
- ------------------------------------------------------------------------------------------------------------------------
RATIOS TO AVERAGE NET ASSETS (%):
Expenses 1.74 1.78 1.83
- ------------------------------------------------------------------------------------------------------------------------
Net investment income 5.87 5.93 5.54
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
AUGUST 1,
1995 TO
SEPTEMBER 30, YEAR ENDED JULY 31,
ALL CLASSES 1995 1995 1994 1993 1992 1991 1990
--------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
SUPPLEMENTAL DATA:
Net assets at end of period (in thousands) $ 239,619 246,248 266,640 283,249 191,716 104,279 51,741
- ------------------------------------------------------------------------------------------------------------------------
Portfolio turnover (%) 173 597 916 339 120 180 89
- ------------------------------------------------------------------------------------------------------------------------
</TABLE>
NOTES FOR ALL FUNDS:
Ratios have been determined on an annualized basis, except that total return is
not annualized and does not reflect the effect of any sales charges. The
Adjustable Rate, Diversified, Government, High Yield and Income and Capital
Funds are separate Massachusetts business trusts and the Cash Reserves, Mortgage
and Short-Intermediate Government Funds are separate portfolios of Kemper
Portfolios, a Massachusetts business trust. See "Capital Structure."
As discussed under "Investment Manager and Underwriter," effective May 31, 1994,
the investment management fee for each Fund changed, resulting in an increased
fee for the Adjustable Rate, Government, High Yield and Income and Capital Funds
and a decreased fee for the Cash Reserves, Diversified, Mortgage and
Short-Intermediate Government Funds.
INVESTMENT OBJECTIVES, POLICIES AND RISK FACTORS
The following information sets forth each Fund's investment objective and
policies. Each Fund's returns and net asset value will fluctuate (except that
the Cash Reserves Fund seeks to maintain a net asset value of $1.00 per share)
and there is no assurance that any Fund will achieve its objective.
ADJUSTABLE RATE FUND. The Adjustable Rate Fund seeks high current income
consistent with low volatility of principal. Under normal market conditions, the
Fund will, as a fundamental policy, invest at least 65% of its total assets in
adjustable rate securities issued or guaranteed by the U.S. Government, its
agencies or instrumentalities ("U.S. Government Securities"). See "Government
Fund" below concerning U.S. Government Securities and the risks related to those
securities, including the fact that the government guarantee of such securities
in the Fund's
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<PAGE> 17
portfolio does not guarantee the net asset value of the Fund's shares. The Fund
is designed for the investor who seeks a higher yield than a stable price money
market fund or an insured bank certificate of deposit and less fluctuation in
net asset value than a longer-term bond fund; unlike money market funds,
however, the Fund does not seek to maintain a stable net asset value and, unlike
an insured bank certificate of deposit, the Fund's shares are not insured. There
is no assurance that the Fund will achieve its objective.
Adjustable rate securities bear interest at rates that adjust at periodic
intervals in response to changes in market levels of interest rates generally.
As the interest rates are reset periodically, yields on such securities will
gradually align themselves to reflect changes in market interest rates. The
adjustable interest rate feature of the securities in which the Fund invests
generally will act as a buffer to reduce sharp changes in the Fund's net asset
value in response to normal interest rate fluctuations. As the interest rates on
the Fund's investments are reset periodically, yields of portfolio securities
will gradually align themselves to reflect changes in market rates and should
cause the net asset value of the Fund's shares to fluctuate less dramatically
than it would if the Fund invested in long-term, fixed rate securities.
Adjustable rate securities allow the Fund to participate in increases in
interest rates through periodic adjustments in the interest rate resulting in
both higher current yields and lower price fluctuations. During periods of
declining interest rates, of course, the coupon rates may readjust downward,
resulting in lower yields to the Fund. Further, because of this feature, the
value of adjustable rate mortgages is unlikely to rise during periods of
declining interest rates to the same extent as fixed rate instruments. As with
other mortgage-backed securities, interest rate declines may result in
accelerated prepayment of mortgages, and the proceeds from such prepayments must
be reinvested at lower prevailing interest rates. However, during periods of
rising interest rates, changes in the coupon rate lag behind changes in the
market rate, possibly resulting in a lower net asset value until the coupon
resets to market rates. Thus, investors could suffer some principal loss if they
sold their shares of the Fund before the interest rates on portfolio investments
are adjusted to reflect current market rates. During periods of extreme
fluctuations in interest rates, the Fund's net asset value will fluctuate as
well.
The Fund may invest without limit in Mortgage-Backed Securities, as described
under "Mortgage Fund" below. Mortgage-Backed Securities can have either a fixed
rate of interest or an adjustable rate. Adjustable rate mortgage securities in
which the Fund generally invests would have the same characteristics as
described above with respect to adjustable rate securities. In addition, since
most mortgage securities in the Fund's portfolio will generally have annual
reset caps of 100 to 200 basis points (1-2%), fluctuation in interest rates
above these levels could cause such mortgage securities to "cap out" and to
behave more like long-term, fixed rate debt securities.
To help protect the value of the Fund's portfolio from interest rate
fluctuations, the Fund may engage in interest rate swaps and purchase interest
rate "caps" and "floors." The Fund will enter into these transactions primarily
to preserve a return or spread on a particular investment or portion of its
portfolio or to protect against any increase in the price of securities the Fund
anticipates purchasing. The Fund intends to use these transactions as a hedge
and not as a speculative investment. There is no assurance that these
transactions will be successful. The Fund will not sell interest rate caps or
floors that it does not own.
Interest rate swaps are the exchange by the Fund with another party of their
respective commitments to pay or receive interest with respect to a notional
(agreed upon) principal amount, for example, an exchange of floating rate
payments for fixed rate payments. Interest rate swaps are generally entered into
to permit the party seeking a floating or fixed rate obligation, as the case may
be, the opportunity to acquire such obligation at a lower rate than is directly
available in the credit market. The success of such a transaction depends in
large part on the availability of fixed rate obligations at a low enough coupon
rate to cover the cost involved.
The purchase of an interest rate cap entitles the purchaser, to the extent that
a specified index exceeds a predetermined interest rate, to receive payments of
interest on a notional principal amount from the party selling the interest rate
cap. The purchase of an interest rate floor entitles the purchaser, to the
extent that a specified index falls below a predetermined interest rate, to
receive payments of interest on a notional principal amount from the party
selling such interest rate floor.
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<PAGE> 18
The Fund may also invest up to 35% of its total assets in securities other than
adjustable rate U.S. Government Securities including, without limitation,
privately issued Mortgage-Backed Securities, commercial paper and other debt
obligations of corporations and other business organizations, certificates of
deposit, bankers' acceptances and time deposits and other debt securities such
as convertible securities and preferred stocks. These securities will, at the
time of purchase, be rated within the two highest grades (Aaa or Aa) assigned by
Moody's Investors Service, Inc.("Moody's"), or (AAA or AA) by Standard & Poor's
Corporation ("S&P"), or will be non-rated but of comparable quality in the
opinion of the investment manager.
The Fund also may invest in obligations collateralized by a portfolio or pool of
mortgages, Mortgage-Backed Securities, U.S. Government Securities or other
assets and may engage in options and financial futures transactions, securities
lending, delayed delivery transactions and other portfolio strategies. See
"Additional Investment Information" below.
Additional information concerning the Adjustable Rate Fund appears in the
"Additional Information--Adjustable Rate Fund" section under "Investment
Policies and Techniques" in the Statement of Additional Information.
CASH RESERVES FUND. The Cash Reserves Fund seeks maximum current income to the
extent consistent with stability of principal from a portfolio of the following
types of U.S. Dollar denominated money market instruments that mature in 12
months or less:
1. Obligations of, or guaranteed by, the U.S. or Canadian Governments, their
agencies or instrumentalities. The two broad categories of U.S. Government debt
instruments are: (a) direct obligations of the U.S. Treasury and (b) securities
issued or guaranteed by agencies and instrumentalities of the U.S. Government.
Some obligations issued or guaranteed by agencies or instrumentalities of the
U.S. Government are backed by the full faith and credit of the United States and
others are backed exclusively by the agency or instrumentality with limited
rights of the issuer to borrow from the U.S. Treasury.
2. Bank certificates of deposit, time deposits or bankers' acceptances limited
to U.S. banks or Canadian chartered banks having total assets in excess of $1
billion.
3. Bank certificates of deposit, time deposits or bankers' acceptances of U.S.
branches of foreign banks having total assets in excess of $10 billion.
4. Commercial paper rated Prime-1 or Prime-2 by Moody's or A-1 or A-2 by S&P, or
commercial paper or notes issued by companies with an unsecured debt issue
outstanding currently rated A or higher by Moody's or S&P where the obligation
is on the same or a higher level of priority as the rated issue, and investments
in other corporate obligations such as publicly traded bonds, debentures and
notes rated A or higher by Moody's or S&P.
5. Repurchase agreements of obligations which are suitable for investment under
the categories set forth above. Repurchase agreements are discussed under
"Additional Investment Information" below.
In addition, the Fund limits its investments to securities that meet the quality
and diversification requirements of Rule 2a-7 under the Investment Company Act
of 1940. See "Net Asset Value."
To the extent the Fund purchases Eurodollar certificates of deposit issued by
London branches of U.S. banks, or commercial paper issued by foreign entities,
consideration will be given to their marketability, possible restrictions on
international currency transactions and regulations imposed by the domicile
country of the foreign issuer. Eurodollar certificates of deposit may not be
subject to the same regulatory requirements as certificates issued by U.S. banks
and associated income may be subject to the imposition of foreign taxes. The
Fund will normally invest at least 25% of its net assets in instruments issued
by domestic or foreign banks.
The Fund seeks to maintain its net asset value at $1.00 per share by valuing its
portfolio of investments on the amortized cost method in accordance with Rule
2a-7. While the Fund will make every effort to maintain a fixed net asset value
of $1.00 per share, there can be no assurance that this objective will be
achieved. See "Net Asset Value."
The Fund may invest in instruments bearing rates of interest that are adjusted
periodically or which "float" continuously according to formulae intended to
minimize fluctuations in values of the instruments ("Variable Rate Securities").
The interest rate of Variable Rate Securities is ordinarily determined by
reference to or is a percentage
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<PAGE> 19
of an objective standard. Generally, the changes in the interest rate on
Variable Rate Securities reduce the fluctuation in the market value of such
securities. Accordingly, as interest rates decrease or increase, the potential
for capital appreciation or depreciation is less than for fixed rate
obligations. Some Variable Rate Securities ("Variable Rate Demand Securities")
have a demand feature entitling the purchaser to resell the securities to the
issuer at an amount approximately equal to amortized cost or the principal
amount thereof plus accrued interest. As is the case for other Variable Rate
Securities, the interest rate on Variable Rate Demand Securities varies
according to some objective standard intended to minimize fluctuation in the
values of the instruments. The Fund determines the maturity of Variable Rate
Securities in accordance with Securities and Exchange Commission rules that
allow the Fund to consider certain of such instruments as having maturities
earlier than the maturity date on the face of the instrument.
Section 4(2) Paper. Subject to its investment objectives and policies, the Fund
may invest in commercial paper issued by major corporations under the Securities
Act of 1933 in reliance on the exemption from registration afforded by Section
3(a)(3) thereof. Such commercial paper may be issued only to finance current
transactions and must mature in nine months or less. Trading of such commercial
paper is conducted primarily by institutional investors through investment
dealers, and individual investor participation in the commercial paper market is
very limited. The Fund also may invest in commercial paper issued in reliance on
the so-called "private placement" exemption from registration afforded by
Section 4(2) of the Securities Act of 1933 ("Section 4(2) paper"). Section 4(2)
paper is restricted as to disposition under the federal securities laws, and
generally is sold to institutional investors such as the Fund who agree that
they are purchasing the paper for investment and not with a view to public
distribution. Any resale by the purchaser must be in an exempt transaction.
Section 4(2) paper normally is resold to other institutional investors like the
Fund through or with the assistance of the issuer or investment dealers who make
a market in the Section 4(2) paper, thus providing liquidity. The investment
manager considers the legally restricted but readily saleable Section 4(2) paper
to be liquid; however, pursuant to procedures approved by the Board of Trustees,
if a particular investment in Section 4(2) paper is not determined to be liquid,
that investment will be included within the limitation on illiquid securities.
The investment manager monitors the liquidity of the Fund's investments in
Section 4(2) paper on a continuing basis. See "Investment Restrictions" in the
Statement of Additional Information.
DIVERSIFIED FUND. The Diversified Fund seeks high current return. The Fund
pursues its objective by investing primarily in fixed income securities and
dividend-paying common stocks and by writing options. Current return includes
interest income, common stock dividends and any net short-term gains.
Investment in fixed income securities will include corporate debt obligations,
U.S. and Canadian Government securities, obligations of U.S. and Canadian
banking institutions, convertible securities, preferred stocks, and cash and
cash equivalents, including repurchase agreements. Investment in equity
securities will primarily be in dividend-paying common stocks. The percentage of
assets invested in fixed income and equity securities will vary from time to
time depending upon the judgment of the investment manager as to general market
and economic conditions, trends in yields and interest rates and changes in
fiscal or monetary policies. The Fund may invest up to 50% of its total assets
in foreign securities that are traded principally in securities markets outside
the United States. Foreign securities present certain risks in addition to those
presented by domestic securities, including risks associated with currency
fluctuations, possible imposition of foreign governmental regulations or taxes
adversely affecting portfolio securities and generally different degrees of
liquidity, market volatility and availability of information. See "Special Risk
Factors--Foreign Securities" below.
The Fund may invest without limit in high yield, fixed income securities,
commonly referred to as "junk bonds," that are in the lower rating categories
and those that are non-rated. The high yield, fixed income securities (debt and
preferred stock issues, including convertibles and assignments or participations
in loans) in which the Fund may invest normally offer a current yield or yield
to maturity that is significantly higher than the yield available from
securities rated in the four highest categories assigned by S&P or Moody's. The
characteristics of the securities in the Fund's portfolio, such as the maturity
and the type of issuer, will affect yields and yield differentials, which vary
over
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<PAGE> 20
time. The actual yield realized by the investor is subject, among other things,
to the Fund's expenses and the investor's transaction costs.
The Fund may also purchase options on securities and index options, purchase and
sell financial futures contracts and options on financial futures contracts,
engage in foreign currency transactions, engage in delayed delivery transactions
and lend its portfolio securities. See "Special Risk Factors--Foreign
Securities" and "Additional Investment Information" below. Under normal market
conditions, the Fund will invest at least 65% of its total assets in income
producing investments. In periods of unusual market conditions, the Fund may,
for defensive purposes, temporarily retain all or any part of its assets in cash
or cash equivalents.
There are market and investment risks with any security and the value of an
investment in the Fund will fluctuate over time. In seeking to achieve its
investment objective, the Fund will invest in fixed income securities based on
the investment manager's analysis without relying on any published ratings. The
Fund will invest in a particular fixed income security if in the investment
manager's view, the increased yield offered, regardless of published ratings, is
sufficient to compensate for a reasonable element of assumed risk. Since
investments will be based upon the investment manager's analysis rather than
upon published ratings, achievement of the Fund's goals may depend more upon the
abilities of the investment manager than would otherwise be the case.
Investments in lower rated or non-rated securities, while generally providing
greater income and opportunity for gain than investments in higher rated
securities, entail greater risk of loss of income and principal. (The High Yield
Fund may also invest in lower rated and non-rated securities but may not invest
in dividend-paying common stocks and has more limited option writing authority
than the Diversified Fund.) See "Special Risk Factors--High Yield (High Risk)
Bonds" and "Appendix B--Ratings of Investments" below.
Since interest rates vary with changes in economic, market, political and other
conditions, there can be no assurance that historic interest rates are
indicative of rates that may prevail in the future. The values of fixed income
securities in the Fund's portfolio will fluctuate depending upon market factors
and inversely with current interest rate levels. The market value of equity
securities in the Fund's portfolio will also fluctuate with market and other
conditions.
GOVERNMENT FUND. The Government Fund seeks high current income, liquidity and
security of principal by investing in obligations issued or guaranteed by the
U.S. Government or its agencies, and by obtaining rights to acquire such
securities. The Fund's yield and net asset value will fluctuate and there can be
no assurance that the Fund will attain its objective.
The Fund intends to invest some or all of its assets in Government National
Mortgage Association ("GNMA") Certificates of the modified pass-through type.
These GNMA Certificates are debt securities issued by a mortgage banker or other
mortgagee and represent an interest in one or a pool of mortgages insured by the
Federal Housing Administration or guaranteed by the Veterans Administration.
GNMA guarantees the timely payment of monthly installments of principal and
interest on modified pass-through Certificates at the time such payments are
due, whether or not such amounts are collected by the issuer of these
Certificates on the underlying mortgages.
The National Housing Act provides that the full faith and credit of the United
States is pledged to the timely payment of principal and interest by GNMA of
amounts due on these GNMA Certificates, and an assistant attorney general of the
United States has rendered an opinion that this guarantee by GNMA is a general
obligation of the United States backed by its full faith and credit.
Mortgages included in single family residential mortgage pools backing an issue
of GNMA Certificates have a maximum maturity of 30 years. Scheduled payments of
principal and interest are made to the registered holders of GNMA Certificates
(such as the Fund) each month. Unscheduled prepayments of mortgages included in
these pools occur as a result of the prepayment or refinancing of such mortgages
by homeowners or as a result of the foreclosure of such mortgages. Such
prepayments are passed through to the registered holders of GNMA Certificates
with the regular monthly payments of principal and interest, which has the
effect of reducing future payments on such Certificates. That portion of monthly
payments received by the Fund which represents interest and discount will be
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<PAGE> 21
included in the Fund's net investment income. See "Dividends and Taxes."
Principal payments on a GNMA Certificate will be reinvested by the Fund.
The balance of the Fund's assets, other than those invested in GNMA Certificates
and options and financial futures contracts as discussed below, will be invested
in obligations issued or guaranteed by the United States or by its agencies.
There are two broad categories of U.S. Government-related debt instruments: (a)
direct obligations of the U.S. Treasury, and (b) securities issued or guaranteed
by U.S. Government agencies. Examples of direct obligations of the U.S. Treasury
are Treasury Bills, Notes, Bonds and other debt securities issued by the U.S.
Treasury. These instruments are backed by the "full faith and credit" of the
United States. They differ primarily in interest rates, the length of maturities
and the dates of issuance. Some obligations issued or guaranteed by agencies of
the U.S. Government are backed by the full faith and credit of the United States
(such as Maritime Administration Title XI Ship Financing Bonds and Agency for
International Development Housing Guarantee Program Bonds) and others are backed
only by the rights of the issuer to borrow from the U.S. Treasury (such as
Federal Home Loan Bank Bonds and Federal National Mortgage Association Bonds).
With respect to securities supported only by the credit of the issuing agency or
by an additional line of credit with the U.S. Treasury, there is no guarantee
that the U.S. Government will provide support to such agencies and such
securities may involve risk of loss of principal and interest. U.S. Government
Securities may include "zero coupon" securities that have been stripped by the
U.S. Government of their unmatured interest coupons (see "Investment Policies
and Techniques--Zero Coupon Government Securities" in the Statement of
Additional Information for a discussion of their features and risks) and
collateralized obligations issued or guaranteed by a U.S. Government agency or
instrumentality (see "Collateralized Obligations" below).
U.S. Government Securities of the type in which the Fund may invest have
historically involved little risk of loss of principal if held to maturity. The
government guarantee of the U.S. Government Securities in the Fund's portfolio,
however, does not guarantee the net asset value of the shares of the Fund. There
are market risks inherent in all investments in securities and the value of an
investment in the Fund will fluctuate over time. Normally, the value of the
Fund's investments varies inversely with changes in interest rates. For example,
as interest rates rise the value of the Fund's investments will tend to decline,
and as interest rates fall the value of the Fund's investments will tend to
increase. In addition, the potential for appreciation in the event of a decline
in interest rates may be limited or negated by increased principal prepayments
in respect to certain Mortgage-Backed Securities, such as GNMA Certificates.
Prepayments of high interest rate Mortgage-Backed Securities during times of
declining interest rates will tend to lower the return of the Fund and may even
result in losses to the Fund if some securities were acquired at a premium. With
respect to U.S. Government Securities supported only by the credit of the
issuing agency or by an additional line of credit with the U.S. Treasury, there
is no guarantee that the U.S. Government will provide support to such agencies
and such securities may involve risk of loss of principal and interest. The Fund
will not invest in Mortgage-Backed Securities issued by private issuers.
The Fund may also write (sell) and purchase options on securities, index
options, financial futures contracts and options on financial futures contracts
in connection with attempts to hedge its portfolio investments and not for
speculation. See "Additional Investment Information" below.
HIGH YIELD FUND. The primary objective of the High Yield Fund is to achieve the
highest level of current income obtainable from a professionally managed,
diversified portfolio of fixed income securities which the investment adviser
considers consistent with reasonable risk. As a secondary objective, the Fund
will seek capital gain where consistent with its primary objective.
The high yield, fixed income securities (debt and preferred stock issues,
including convertibles and assignments or participations in loans) in which the
Fund intends to invest are commonly referred to as "junk bonds" and normally
offer a current yield or yield to maturity that is significantly higher than the
yield available from securities rated in the four highest categories assigned by
S&P or Moody's. The characteristics of the securities in the Fund's portfolio,
such as the maturity and the type of issuer, will affect yields and yield
differentials, which vary over time. The actual yield realized by the investor
is subject, among other things, to the Fund's expenses and the investor's
transaction costs.
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<PAGE> 22
There are market and investment risks with any security and the value of an
investment in the Fund may fluctuate over time. In seeking to achieve its
investment objectives, the Fund will invest in fixed income securities based on
the investment manager's analysis without relying on published ratings. The Fund
will invest in a particular security if in the view of the investment manager
the increased yield offered, regardless of published ratings, is sufficient to
compensate for a reasonable element of assumed risk. Since investments will be
based upon the investment manager's analysis rather than upon published ratings,
achievement of the Fund's goals may depend more upon the abilities of the
investment manager than would otherwise be the case. Investment in high yield
securities, while providing greater income and opportunity for gain than
investment in higher rated securities, entails relatively greater risk of loss
of income and principal. See "Special Risk Factors--High Yield (High Risk)
Bonds" and "Appendix B--Ratings of Investments" below.
As a secondary objective, the Fund will seek capital gain where consistent with
its primary objective. However, the Fund intends to hold portfolio securities to
maturity unless yields on alternative investments, based on current market
prices, are more attractive than those on securities held in the Fund's
portfolio or unless the investment manager determines defensive strategies
should be implemented.
The Fund anticipates that under normal circumstances 90 to 100% of its assets
will be invested in fixed income securities (debt and preferred stock issues,
including convertibles). The Fund may invest in common stocks, rights or other
equity securities when consistent with the Fund's objectives, but will generally
hold such equity investments only as a result of purchases of unit offerings of
fixed income securities which include such securities or in connection with an
actual or proposed conversion or exchange of fixed income securities.
The Fund may invest all or a portion of its assets in money market instruments
such as obligations of the U.S. Government, its agencies or instrumentalities;
other debt securities rated within the three highest grades by Moody's or S&P;
commercial paper rated within the two highest grades by either of such rating
services; bank certificates of deposit or bankers' acceptances of domestic or
Canadian charter banks having total assets in excess of $1 billion; and any of
the foregoing investments subject to short-term repurchase agreements (an
instrument under which the purchaser acquires ownership of the underlying
obligation and the seller agrees, at the time of sale, to repurchase the
obligation at a mutually agreed upon time and price). The Fund may also purchase
and sell options on securities, index options, financial futures contracts and
options on financial futures contracts in connection with attempts to hedge its
portfolio investments and not for speculation; and it may purchase foreign
securities and engage in foreign currency transactions. See "Special Risk
Factors--Foreign Securities" and "Additional Investment Information" below.
INCOME AND CAPITAL FUND. The Income and Capital Fund seeks as high a level of
current income as is consistent with prudent investment management, preservation
of capital and ready marketability of its portfolio by investing primarily in a
diversified portfolio of investment grade debt securities. Specifically, at
least 90% of the Fund's assets will be invested in the following categories: (a)
corporate debt securities which are rated Aaa, Aa, A or Baa by Moody's or AAA,
AA, A or BBB by S&P; (b) obligations of, or guaranteed by, the United States,
its agencies or instrumentalities; (c) obligations (payable in U.S. Dollars) of,
or guaranteed by, the government of Canada or any instrumentality or political
subdivision thereof; (d) commercial paper rated Prime-1 or Prime-2 by Moody's or
A-1 or A-2 by S&P; (e) bank certificates of deposit or bankers' acceptances
issued by domestic or Canadian chartered banks having total deposits in excess
of $1 billion; (f) options on securities, index options, financial futures
contracts and options on financial futures contracts as described under
"Additional Investment Information" in connection with attempts to hedge its
portfolio investments and not for speculation; and (g) cash and cash
equivalents.
There are market and investment risks with any security and the value of an
investment in the Fund may fluctuate over time. Normally, the value of the
Fund's investments varies inversely with changes in interest rates. There can be
no assurance that the objective of the Fund will be achieved. Corporate debt
securities rated within the four highest grades by Moody's or S&P are generally
considered to be "investment grade." Like higher rated securities, securities
rated in the BBB or Baa categories are considered to have adequate capacity to
pay principal and interest, although they may have fewer protective provisions
than higher rated securities and thus may be adversely affected by severe
economic circumstances and are considered to have speculative characteristics.
The Fund may invest up
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<PAGE> 23
to 10% of its total assets in fixed income securities that are rated below BBB
by S&P and Baa by Moody's or are non-rated. For a discussion of lower rated and
non-rated securities, commonly referred to as "junk bonds," and related risks,
see "Special Risk Factors--High Yield (High Risk) Bonds" and "Appendix
B--Ratings of Investments" below. The Fund may also invest in foreign securities
and engage in foreign currency transactions. See "Special Risk Factors--Foreign
Securities" below.
MORTGAGE FUND. The Mortgage Fund seeks maximum current return from a portfolio
of U.S. Government Securities. Additionally, the Fund may engage in options and
financial futures transactions which relate to U.S. Government Securities and
may purchase or sell securities on a when-issued or delayed delivery basis. See
"Additional Investment Information" below for a discussion of such transactions
applicable to the Fund.
As a non-fundamental policy, at least 65% of the Fund's total assets normally
will be invested in "Mortgage-Backed Securities." Mortgage-Backed Securities are
securities that directly or indirectly represent a participation in, or are
secured by and payable from, mortgage loans secured by real property. There are
currently three basic types of Mortgage-Backed Securities: (a) those issued or
guaranteed by the U.S. Government or one of its agencies or instrumentalities,
such as the Government National Mortgage Association ("Ginnie Mae" or "GNMA"),
the Federal National Mortgage Association ("Fannie Mae" or "FNMA") and the
Federal Home Loan Mortgage Corporation ("Freddie Mac" or "FHLMC"); (b) those
issued by private issuers that represent an interest in or are collateralized by
Mortgage-Backed Securities issued or guaranteed by the U.S. Government or one of
its agencies or instrumentalities; and (iii) those issued by private issuers
that represent an interest in or are collateralized by whole mortgage loans or
Mortgage-Backed Securities without a government guarantee but usually having
some form of private credit enhancement. The dominant issuers or guarantors of
Mortgage-Backed Securities today are GNMA, FNMA and FHLMC. GNMA creates mortgage
securities from pools of government guaranteed or insured (Federal Housing
Authority or Veterans Administration) mortgages originated by mortgage bankers,
commercial banks, and savings and loan associations. FNMA and FHLMC issue
Mortgage-Backed Securities from pools of conventional and federally insured
and/or guaranteed residential mortgages obtained from various entities,
including savings and loan associations, savings banks, commercial banks, credit
unions and mortgage bankers. Mortgage-Backed Securities issued by GNMA, FNMA and
FHLMC are considered U.S. Government Securities. The Fund will not invest in
Mortgage-Backed Securities issued by private issuers.
U.S. Government Securities of the type in which the Fund may invest have
historically involved little risk of loss of principal if held to maturity. The
government guarantee of the securities in the Fund, however, does not guarantee
the net asset value of the shares of the Fund. There are market risks inherent
in all investments in securities and the value of an investment in the Fund will
fluctuate over time. Normally, the value of the Fund's investments varies
inversely with changes in interest rates. For example, as interest rates rise,
the value of the Fund's investments will tend to decline and, as interest rates
fall, the value of the Fund's investments will tend to increase. In addition,
the potential for appreciation in the event of a decline in interest rates may
be limited or negated by increased principal prepayments in respect to certain
Mortgage-Backed Securities, such as GNMA Certificates. Prepayment of high
interest rate Mortgage-Backed Securities during times of declining interest
rates will tend to lower the return of the Fund and may even result in losses to
the Fund if some securities were acquired at a premium.
SHORT-INTERMEDIATE GOVERNMENT FUND. The Short-Intermediate Government Fund
seeks, with equal emphasis, high current income and preservation of capital from
a portfolio composed primarily of short and intermediate-term U.S. Government
Securities. Under normal market conditions, the Fund will, as a fundamental
policy, invest at least 65% of its total assets in U.S. Government Securities
and repurchase agreements of U.S. Government Securities. See "Government Fund"
above for a discussion of U.S. Government Securities and the risks related to
those securities, including the fact that the government guarantee of U.S.
Government Securities in the Fund does not guarantee the net asset value of the
shares of the Fund.
Under normal market conditions, the Fund will maintain a Dollar-weighted average
portfolio maturity of more than two years but less than five years. The maturity
of a security held by the Fund will generally be considered to be the time
remaining until repayment of the principal amount of such security, except that
the maturity of a security may be considered to be a shorter period in the case
of (a) contractual rights to dispose of a security, because such rights
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<PAGE> 24
limit the period during which the Fund bears a market risk with respect to the
security, and (b) Mortgage-Backed Securities, because of possible prepayment of
principal on the mortgages underlying such securities. Short and
intermediate-term securities generally are more stable and less susceptible to
principal decline than longer term securities. While short and intermediate-term
securities in most cases offer lower yields than securities with longer
maturities, the Fund will seek to enhance income through limited investment in
fixed income securities other than U.S. Government Securities. The investment
manager believes that investment in short and intermediate-term securities
allows the Fund to seek both high current income and preservation of capital.
There is, however, no assurance that the Fund's objective will be achieved. The
return and net asset value of the Fund will fluctuate over time.
Up to 35% of the total assets of the Fund may be invested in fixed income
securities other than U.S. Government Securities. Such other fixed income
securities include: (a) corporate debt securities that are rated at the time of
purchase within the four highest grades by either Moody's (Aaa, Aa, A, or Baa)
or S&P (AAA, AA, A, or BBB); (b) commercial paper that is rated at the time of
purchase within the two highest grades by either Moody's (Prime-1 or Prime-2) or
S&P (A-1 or A-2); (c) bank certificates of deposit (including term deposits) or
bankers' acceptances issued by domestic banks (including their foreign branches)
and Canadian chartered banks having total assets in excess of $1 billion; and
(d) repurchase agreements with respect to any of the foregoing. Corporate debt
securities rated within the four highest grades by Moody's or S&P are generally
considered to be "investment grade." Like higher rated securities, securities
rated in the BBB or Baa categories are considered to have adequate capacity to
pay principal and interest, although they may have fewer protective provisions
than higher rated securities and thus may be adversely affected by severe
economic circumstances and are considered to have speculative characteristics.
During temporary defensive periods when the investment manager deems it
appropriate, the Fund may invest all or a portion of its assets in cash or
short-term high quality money market instruments, including short-term U.S.
Government Securities and repurchase agreements with respect to such securities.
The yields on these securities tend to be lower than the yields on other
securities to be purchased by the Fund.
The Fund may purchase or sell securities on a when-issued or delayed delivery
basis. The Fund may invest in collateralized obligations which, consistent with
the limitations reflected above, may be privately issued or may be issued or
guaranteed by U.S. Government agencies or instrumentalities. The Fund also may
engage in options or financial futures transactions in connection with attempts
to hedge its portfolio investments and not for speculation. See "Additional
Investment Information" below.
SPECIAL RISK FACTORS--HIGH YIELD (HIGH RISK) BONDS. As stated above, the
Diversified Fund may and the High Yield Fund does invest a substantial portion
of their assets in fixed income securities offering high current income. Subject
to its specific investment objective and policies as described above, the Income
and Capital Fund may invest up to 10% of its assets in such securities. Such
high yield (high risk), fixed income securities ordinarily will be in the lower
rating categories (securities rated below the fourth category) of recognized
rating agencies or will be non-rated. Lower-rated and non-rated securities,
which are commonly referred to as "junk bonds," have widely varying
characteristics and quality. These lower rated and non-rated fixed income
securities are considered, on balance, as predominantly speculative with respect
to capacity to pay interest and repay principal in accordance with the terms of
the obligation and generally will involve more credit risk than securities in
the higher rating categories. Accordingly, an investment in the Diversified or
High Yield Funds may not constitute a complete investment program and may not be
appropriate for all investors.
The market values of such securities tend to reflect individual corporate
developments to a greater extent than do those of higher rated securities, which
react primarily to fluctuations in the general level of interest rates. Such
lower rated securities also are more sensitive to economic conditions than are
higher rated securities. Adverse publicity and investor perceptions regarding
lower rated bonds, whether or not based on fundamental analysis, may depress the
prices for such securities. These and other factors adversely affecting the
market value of high yield securities will adversely affect each Fund's net
asset value.
The investment philosophy of the Diversified and High Yield Funds with respect
to high yield (high risk) bonds is based upon the premise that over the long
term a broadly diversified portfolio of high yield fixed income securities
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should, even taking into account possible losses, provide a higher net return
than that achievable on a portfolio of higher rated securities. The Funds seek
to achieve the highest yields possible while reducing relative risk through (a)
broad diversification, (b) credit analysis by the investment manager of the
issuers in which the Funds invest, (c) purchase of high yield securities at
discounts from par or stated value when practicable and (d) monitoring and
seeking to anticipate changes and trends in the economy and financial markets
that might affect the prices of portfolio securities. The investment manager's
judgment as to the "reasonableness" of the risk involved in any particular
investment will be a function of its experience in managing fixed income
investments and its evaluation of general economic and financial conditions, a
specific issuer's business and management, cash flow, earnings coverage of
interest and dividends, ability to operate under adverse economic conditions,
and fair market value of assets, and of such other considerations as the
investment manager may deem appropriate. The investment manager, while seeking
maximum current yield, will monitor current corporate developments with respect
to portfolio securities and potential investments and to broad trends in the
economy. In some circumstances, defensive strategies may be implemented to
preserve or enhance capital even at the sacrifice of current yield. Defensive
strategies, which may be used singly or in any combination, may include, but are
not limited to, investments in discount securities or investments in money
market instruments as well as futures and options strategies.
High yield (high risk) securities frequently are issued by corporations in the
growth stage of their development. They may also be issued in connection with a
corporate reorganization or a corporate takeover. Companies that issue such high
yielding securities often are highly leveraged and may not have available to
them more traditional methods of financing. Therefore, the risk associated with
acquiring the securities of such issuers generally is greater than is the case
with higher rated securities. For example, during an economic downturn or
recession, highly leveraged issuers of high yield securities may experience
financial stress. During such periods, such issuers may not have sufficient
revenues to meet their interest payment obligations. The issuer's ability to
service its debt obligations may also be adversely affected by specific
corporate developments, or the issuer's inability to meet specific projected
business forecasts, or the unavailability of additional financing. The risk of
loss from default by the issuer is significantly greater for the holders of high
yield securities because such securities are generally unsecured and are often
subordinated to other creditors of the issuer. Although some risk is inherent in
all securities ownership, holders of fixed income securities have a claim on the
assets of the issuer prior to the holders of common stock. Therefore, an
investment in fixed income securities generally entails less risk than an
investment in common stock of the same issuer.
A Fund may have difficulty disposing of certain high yield (high risk)
securities because they may have a thin trading market. Because not all dealers
maintain markets in all high yield securities, the Funds anticipate that such
securities could be sold only to a limited number of dealers or institutional
investors. The lack of a liquid secondary market may have an adverse effect on
the market price and a Fund's ability to dispose of particular issues and may
also make it more difficult for a Fund to obtain accurate market quotations for
purposes of valuing the Fund's assets. Market quotations generally are available
on many high yield issues only from a limited number of dealers and may not
necessarily represent firm bids of such dealers or prices for actual sales.
Zero coupon securities and pay-in-kind bonds involve additional special
considerations. Zero coupon securities are debt obligations that do not entitle
the holder to any periodic payments of interest prior to maturity or a specified
cash payment date when the securities begin paying current interest (the "cash
payment date") and therefore are issued and traded at a discount from their face
amount or par value. The market prices of zero coupon securities are generally
more volatile than the market prices of securities that pay interest
periodically and are likely to respond to changes in interest rates to a greater
degree than do securities paying interest currently having similar maturities
and credit quality. Zero coupon, pay-in-kind or deferred interest bonds carry
additional risk in that, unlike bonds that pay interest throughout the period to
maturity, a Fund will realize no cash until the cash payment date unless a
portion of such securities is sold and, if the issuer defaults, a Fund may
obtain no return at all on its investment.
Current federal income tax law requires the holder of a zero coupon security or
of certain pay-in-kind bonds (bonds which pay interest through the issuance of
additional bonds) to accrue income with respect to these securities prior
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to the receipt of cash payments. To maintain its qualification as a regulated
investment company and avoid liability for federal income and excise taxes, a
Fund will be required to distribute income accrued with respect to these
securities and may be required to dispose of portfolio securities under
disadvantageous circumstances in order to generate cash to satisfy these
distribution requirements.
Additional information concerning high yield (high risk) securities appears
under "Appendix A--Portfolio Composition of High Yield Bonds" and "Appendix
B--Ratings of Investments."
SPECIAL RISK FACTORS--FOREIGN SECURITIES. The Diversified, High Yield and Income
and Capital Funds have the discretion to invest a portion of their assets in
foreign securities that are traded principally in securities markets outside the
United States. These Funds currently limit investment in foreign securities not
publicly traded in the United States to 50% of total assets in the case of the
Diversified Fund and 25% of total assets in the case of the High Yield and
Income and Capital Funds. These Funds may also invest without limit in U.S.
Dollar denominated American Depository Receipts ("ADRs"), which are bought and
sold in the United States and are not subject to the preceding limitation. In
connection with their foreign securities investments, these Funds may, to a
limited extent, engage in foreign currency exchange, options and futures
transactions as a hedge and not for speculation. See "Additional Investment
Information--Options and Financial Futures Transactions and Foreign Currency
Transactions." The Cash Reserves Fund and the Short-Intermediate Government
Funds may, subject to their respective quality standards, invest in U.S.
Dollar-denominated securities of foreign issuers.
Foreign securities involve currency risks. The U.S. Dollar value of a foreign
security tends to decrease when the value of the U.S. Dollar rises against the
foreign currency in which the security is denominated and tends to increase when
the value of the U.S. Dollar falls against such currency. Fluctuations in
exchange rates may also affect the earning power and asset value of the foreign
entity issuing the security. Dividend and interest payments may be repatriated
based on the exchange rate at the time of disbursement or payment, and
restrictions on capital flows may be imposed. Losses and other expenses may be
incurred in converting between various currencies.
Foreign securities may be subject to foreign government taxes that reduce their
attractiveness. Other risks of investing in such securities include political or
economic instability in the country involved, the difficulty of predicting
international trade patterns and the possible imposition of exchange controls.
The prices of such securities may be more volatile than those of domestic
securities and the markets for such securities may be less liquid. In addition,
there may be less publicly available information about foreign issuers than
about domestic issuers. Many foreign issuers are not subject to uniform
accounting, auditing and financial reporting standards comparable to those
applicable to domestic issuers. There is generally less regulation of stock
exchanges, brokers, banks and listed companies abroad than in the United States.
With respect to certain foreign countries, there is a possibility of
expropriation or diplomatic developments that could affect investment in these
countries.
EMERGING MARKETS. While a Fund's investments in foreign securities will
principally be in developed countries, a Fund may make investments in developing
or "emerging" countries, which involve exposure to economic structures that are
generally less diverse and mature than in the United States, and to political
systems that may be less stable. A developing or emerging market country can be
considered to be a country that is in the initial stages of its
industrialization cycle. Currently, emerging markets generally include every
country in the world other than the United States, Canada, Japan, Australia, New
Zealand, Hong Kong, Singapore and most Western European countries. Currently,
investing in many emerging markets may not be desirable or feasible because of
the lack of adequate custody arrangements for a Fund's assets, overly burdensome
repatriation and similar restrictions, the lack of organized and liquid
securities markets, unacceptable political risks or other reasons. As
opportunities to invest in securities in emerging markets develop, a Fund may
expand and further broaden the group of emerging markets in which it invests. In
the past, markets of developing or emerging market countries have been more
volatile than the markets of developed countries; however, such markets often
have provided higher rates of return to investors. The investment manager
believes that these characteristics can be expected to continue in the future.
Many of the risks described above relating to foreign securities generally will
be greater for emerging markets than for developed countries. For instance,
economies in individual developing markets may differ favorably or unfavorably
from the U.S. economy in such respects as growth of gross domestic product,
rates of inflation, currency
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<PAGE> 27
depreciation, capital reinvestment, resource self-sufficiency and balance of
payments positions. Many emerging markets have experienced substantial rates of
inflation for many years. Inflation and rapid fluctuations in inflation rates
have had and may continue to have very negative effects on the economies and
securities markets of certain developing markets. Economies in emerging markets
generally are dependent heavily upon international trade and, accordingly, have
been and may continue to be affected adversely by trade barriers, exchange
controls, managed adjustments in relative currency values and other
protectionist measures imposed or negotiated by the countries with which they
trade. These economies also have been and may continue to be affected adversely
by economic conditions in the countries with which they trade.
Also, the securities markets of developing countries are substantially smaller,
less developed, less liquid and more volatile than the securities markets of the
United States and other more developed countries. Disclosure, regulatory and
accounting standards in many respects are less stringent than in the United
States and other developed markets. There also may be a lower level of
monitoring and regulation of developing markets and the activities of investors
in such markets, and enforcement of existing regulations has been extremely
limited.
In addition, brokerage commissions, custodial services and other costs relating
to investment in foreign markets generally are more expensive than in the United
States; this is particularly true with respect to emerging markets. Such markets
have different settlement and clearance procedures. In certain markets there
have been times when settlements have been unable to keep pace with the volume
of securities transactions, making it difficult to conduct such transactions.
Such settlement problems may cause emerging market securities to be illiquid.
The inability of a Fund to make intended securities purchases due to settlement
problems could cause the Fund to miss attractive investment opportunities.
Inability to dispose of a portfolio security caused by settlement problems could
result either in losses to a Fund due to subsequent declines in value of the
portfolio security or, if a Fund has entered into a contract to sell the
security, could result in possible liability to the purchaser. Certain emerging
markets may lack clearing facilities equivalent to those in developed countries.
Accordingly, settlements can pose additional risks in such markets and
ultimately can expose a Fund to the risk of losses resulting from a Fund's
inability to recover from a counterparty.
The risk also exists that an emergency situation may arise in one or more
emerging markets as a result of which trading securities may cease or may be
substantially curtailed and prices for a Fund's portfolio securities in such
markets may not be readily available. A Fund's portfolio securities in the
affected markets will be valued at fair value determined in good faith by or
under the direction of the Board of Trustees.
Investment in certain emerging market securities is restricted or controlled to
varying degrees. These restrictions or controls may at times limit or preclude
foreign investment in certain emerging market securities and increase the costs
and expenses of a Fund. Emerging markets may require governmental approval for
the repatriation of investment income, capital or the proceeds of sales of
securities by foreign investors. In addition, if a deterioration occurs in an
emerging market's balance of payments, the market could impose temporary
restrictions on foreign capital remittances.
FIXED INCOME. Since most foreign fixed income securities are not rated, a Fund
will invest in foreign fixed income securities based on the investment manager's
analysis without relying on published ratings. Since such investments will be
based upon the investment manager's analysis rather than upon published ratings,
achievement of a Fund's goals may depend more upon the abilities of the
investment manager than would otherwise be the case.
The value of the foreign fixed income securities held by a Fund, and thus the
net asset value of the Fund's shares, generally will fluctuate with (a) changes
in the perceived creditworthiness of the issuers of those securities, (b)
movements in interest rates, and (c) changes in the relative values of the
currencies in which a Fund's investments in fixed income securities are
denominated with respect to the U.S. Dollar. The extent of the fluctuation will
depend on various factors, such as the average maturity of a Fund's investments
in foreign fixed income securities, and the extent to which a Fund hedges its
interest rate, credit and currency exchange rate risks. Many of the foreign
fixed income obligations in which a Fund will invest will have long maturities.
A longer average maturity generally is associated with a higher level of
volatility in the market value of such securities in response to changes in
market conditions.
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Investments in sovereign debt, including Brady Bonds, involve special risks.
Brady Bonds are debt securities issued under a plan implemented to allow debtor
nations to restructure their outstanding commercial bank indebtedness. Foreign
governmental issuers of debt or the governmental authorities that control the
repayment of the debt may be unable or unwilling to repay principal or pay
interest when due. In the event of default, there may be limited or no legal
recourse in that, generally, remedies for defaults must be pursued in the courts
of the defaulting party. Political conditions, especially a sovereign entity's
willingness to meet the terms of its fixed income securities, are of
considerable significance. Also, there can be no assurance that the holders of
commercial bank loans to the same sovereign entity may not contest payments to
the holders of sovereign debt in the event of default under commercial bank loan
agreements. In addition, there is no bankruptcy proceeding with respect to
sovereign debt on which a sovereign has defaulted, and a Fund may be unable to
collect all or any part of its investment in a particular issue.
Foreign investment in certain sovereign debt is restricted or controlled to
varying degrees, including requiring governmental approval for the repatriation
of income, capital or proceed of sales by foreign investors. These restrictions
or controls may at times limit or preclude foreign investment in certain
sovereign debt or increase the costs and expenses of a Fund. A significant
portion of the sovereign debt in which a Fund may invest is issued as part of
debt restructuring and such debt is to be considered speculative. There is a
history of defaults with respect to commercial bank loans by public and private
entities issuing Brady Bonds. All or a portion of the interest payments and/or
principal repayment with respect to Brady Bonds may be uncollateralized.
PRIVATIZED ENTERPRISES. Investments in foreign securities may include securities
issued by enterprises that have undergone or are currently undergoing
privatization. The governments of certain foreign countries have, to varying
degrees, embarked on privatization programs contemplating the sale of all or
part of their interests in state enterprises. A Fund's investments in the
securities of privatized enterprises include privately negotiated investments in
a government or state-owned or controlled company or enterprise that has not yet
conducted an initial equity offering, investments in the initial offering of
equity securities of a state enterprise or former state enterprise and
investments in the securities of a state enterprise following its initial equity
offering.
In certain jurisdictions, the ability of foreign entities, such as a Fund, to
participate in privatizations may be limited by local law, or the price or terms
on which the Fund may be able to participate may be less advantageous than for
local investors. Moreover, there can be no assurance that governments that have
embarked on privatization programs will continue to divest their ownership of
state enterprises, that proposed privatizations will be successful or that
governments will not re-nationalize enterprises that have been privatized.
In the case of the enterprises in which a Fund may invest, large blocks of the
stock of those enterprises may be held by a small group of stockholders, even
after the initial equity offerings by those enterprises. The sale of some
portion or all of those blocks could have an adverse effect on the price of the
stock of any such enterprise.
Prior to making an initial equity offering, most state enterprises or former
state enterprises go through an internal reorganization or management. Such
reorganizations are made in an attempt to better enable these enterprises to
compete in the private sector. However, certain reorganizations could result in
a management team that does not function as well as the enterprises's prior
management and may have a negative effect on such enterprise. In addition, the
privatization of an enterprise by its government may occur over a number of
years, with the government continuing to hold a controlling position in the
enterprise even after the initial equity offering for the enterprise.
Prior to privatization, most of the state enterprises in which a Fund may invest
enjoy the protection of and receive preferential treatment from the respective
sovereigns that own or control them. After making an initial equity offering
these enterprises may no longer have such protection or receive such
preferential treatment and may become subject to market competition from which
they were previously protected. Some of these enterprises may not be able to
effectively operate in a competitive market and may suffer losses or experience
bankruptcy due to such competition.
DEPOSITORY RECEIPTS. For many foreign securities, there are U.S. Dollar
denominated ADRs, which are bought and sold in the United States and are issued
by domestic banks. ADRs represent the right to receive securities of foreign
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<PAGE> 29
issuers deposited in the domestic bank or a correspondent bank. ADRs do not
eliminate all the risk inherent in investing in the securities of foreign
issuers, such as changes in foreign currency exchange rates. However, by
investing in ADRs rather than directly in foreign issuers' stock, the Fund
avoids currency risks during the settlement period. In general, there is a
large, liquid market in the United States for most ADRs. The Funds may also
invest in European Depository Receipts ("EDRs"), which are receipts evidencing
an arrangement with a European bank similar to that for ADRs and are designed
for use in the European securities markets. EDRs are not necessarily denominated
in the currency of the underlying security.
ADDITIONAL INVESTMENT INFORMATION. A Fund will not normally engage in the
trading of securities for the purpose of realizing short-term profits, but will
adjust its portfolio as considered advisable in view of prevailing or
anticipated market conditions and its investment objective. Accordingly, a Fund
may sell fixed income securities in anticipation of a rise in interest rates and
purchase such securities for inclusion in its portfolio in anticipation of a
decline in interest rates. Frequency of portfolio turnover will not be a
limiting factor should the investment manager deem it desirable to purchase or
sell securities. The portfolio turnover rates for the Funds are listed under
"Financial Highlights." Since securities with maturities of less than one year
are excluded from portfolio turnover rate calculations, the portfolio turnover
rate for the Cash Reserves Fund is zero. High portfolio turnover (over 100%)
involves correspondingly greater brokerage commissions or other transaction
costs. Higher portfolio turnover may result in the realization of greater net
short-term capital gains. In order to continue to qualify as a regulated
investment company for federal income tax purposes, less than 30% of the annual
gross income of a Fund must be derived from the sale or other disposition of
securities and certain other investments held by a Fund for less than three
months. See "Dividends and Taxes" in the Statement of Additional Information.
A Fund (other than the Adjustable Rate, Cash Reserves and Short-Intermediate
Government Funds) may take full advantage of the entire range of maturities of
fixed income securities and may adjust the average maturity of its portfolio
from time to time, depending upon its assessment of relative yields on
securities of different maturities and its expectations of future changes in
interest rates. Thus, the average maturity of a Fund's portfolio may be
relatively short (under 5 years, for example) at some times and relatively long
(over 10 years, for example) at other times. Generally, since shorter term debt
securities tend to be more stable than longer term debt securities, the
portfolio's average maturity will be shorter when interest rates are expected to
rise and longer when interest rates are expected to fall. The effective
Dollar-weighted average portfolio maturity of the Adjustable Rate Fund generally
will range from less than one year to five years. The effective Dollar-weighted
average portfolio maturity of the Short-Intermediate Government Fund generally
will be more than two years but less than five years. The Cash Reserves Fund
will invest only in securities with remaining maturities of 12 months or less
and maintains a Dollar-weighted average portfolio maturity of 90 days or less in
accordance with Rule 2a-7 under the Investment Company Act of 1940.
The Adjustable Rate, Cash Reserves, Mortgage and Short-Intermediate Government
Funds each may not borrow money except as a temporary measure for extraordinary
or emergency purposes and then only in an amount up to one-third of the value of
its total assets in order to meet redemption requests without immediately
selling any portfolio securities. If, for any reason, the current value of a
Fund's total assets falls below an amount equal to three times the amount of its
indebtedness from money borrowed, the Fund will, within three days (not
including Sundays and holidays), reduce its indebtedness to the extent
necessary. A Fund will not borrow for leverage purposes. The Adjustable Rate
Fund may pledge up to 15% of its total assets to secure any such borrowings.
The Diversified, Government, High Yield and Income and Capital Funds may each
borrow money only for temporary or emergency purposes and not for leverage
purposes, and then only in an amount up to 5% of its assets, in order to meet
redemption requests without immediately selling any portfolio securities or
other assets. These Funds, except for the Government Fund, may not pledge their
assets in an amount exceeding the amount of the borrowings secured by such
pledge. The Government Fund may pledge up to 7 1/2% of its assets to secure any
such borrowings.
A Fund will not purchase illiquid securities, including repurchase agreements
maturing in more than seven days, if, as a result thereof, more than 15% of the
Fund's net assets, valued at the time of the transaction, would be invested in
such securities, except that the Cash Reserves and Mortgage Funds may not
purchase illiquid securities if more
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than 10% of their total assets (net assets for Cash Reserves Fund) would be
invested in such securities. See "Investment Policies and
Techniques--Over-the-Counter Options" in the Statement of Additional Information
for a description of the extent to which over-the-counter traded options are in
effect considered as illiquid for purposes of a Fund's limit on illiquid
securities.
Each Fund has adopted certain fundamental investment restrictions which are
presented in the Statement of Additional Information and that, together with the
investment objective and policies of a Fund (for the Adjustable Rate Fund,
however, only those policies specifically designated in this prospectus as
fundamental), cannot be changed without approval by holders of a majority of its
outstanding voting shares. As defined in the Investment Company Act of 1940,
this means the lesser of the vote of (a) 67% of the shares of a Fund present at
a meeting where more than 50% of the outstanding shares are present in person or
by proxy; or (b) more than 50% of the outstanding shares of a Fund. Policies of
the Adjustable Rate Fund that are neither designated as fundamental nor
incorporated into any of the fundamental investment restrictions referred to
above may be changed by the Board of Trustees of the Fund without shareholder
approval.
OPTIONS AND FINANCIAL FUTURES TRANSACTIONS. A Fund (other than the Cash Reserves
Fund) may deal in options on securities and securities indexes, which options
may be listed for trading on a national securities exchange or traded
over-the-counter. In connection with their foreign securities investments, the
Diversified, High Yield and Income and Capital Funds may also purchase and sell
foreign currency options.
The Diversified Fund may write (sell) covered call options on up to 100% of net
assets and may write (sell) secured put options on up to 50% of net assets. The
Adjustable Rate, Government, High Yield and Income and Capital Funds each may
write (sell) covered call and secured put options on up to 25% of its net
assets. Each such Fund may purchase put and call options provided that no more
than 5% of its net assets may be invested in premiums on such options.
A call option gives the purchaser the right to buy, and the writer the
obligation to sell, the underlying security or other asset at the exercise price
during the option period. A put option gives the purchaser the right to sell,
and the writer the obligation to buy, the underlying security or other asset at
the exercise price during the option period. The writer of a covered call owns
securities or other assets that are acceptable for escrow and the writer of a
secured put invests an amount not less than the exercise price in eligible
securities or other assets to the extent that it is obligated as a writer. If a
call written by a Fund is exercised, the Fund foregoes any possible profit from
an increase in the market price of the underlying security or other asset over
the exercise price plus the premium received. In writing puts, there is a risk
that a Fund may be required to take delivery of the underlying security or other
asset at a disadvantageous price.
Over-the-counter traded options ("OTC options") differ from exchange traded
options in several respects. They are transacted directly with dealers and not
with a clearing corporation, and there is a risk of non-performance by the
dealer as a result of the insolvency of such dealer or otherwise, in which event
a Fund may experience material losses. However, in writing options the premium
is paid in advance by the dealer. OTC options are available for a greater
variety of securities and other assets, and a wider range of expiration dates
and exercise prices, than for exchange traded options.
A Fund (other than the Cash Reserves Fund) may engage in financial futures
transactions. Financial futures contracts are commodity contracts that obligate
the long or short holder to take or make delivery of a specified quantity of a
financial instrument, such as a security, or the cash value of a securities
index during a specified future period at a specified price. A Fund will "cover"
futures contracts sold by the Fund and maintain in a segregated account certain
liquid assets in connection with futures contracts purchased by the Fund as
described under "Investment Policies and Techniques" in the Statement of
Additional Information. In connection with their foreign securities investments,
the Diversified, High Yield and Income and Capital Funds may also engage in
foreign currency financial futures transactions. A Fund will not enter into any
futures contracts or options on futures contracts if the aggregate of the
contract value of the outstanding futures contracts of the Fund and futures
contracts subject to outstanding options written by the Fund would exceed 50% of
the total assets of the Fund.
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The Funds may engage in financial futures transactions and may use index options
as an attempt to hedge against market risks. For example, if a Fund owned
long-term bonds and interest rates were expected to rise, it could sell
financial futures contracts. If interest rates did increase, the value of the
bonds in the Fund would decline, but this decline would be offset in whole or in
part by an increase in the value of the Fund's futures contracts. If, on the
other hand, long-term interest rates were expected to decline, the Fund could
hold short-term debt securities and benefit from the income earned by holding
such securities, while at the same time the Fund could purchase futures
contracts on long-term bonds or the cash value of a securities index. Thus, the
Fund could take advantage of the anticipated rise in the value of long-term
bonds without actually buying them. The futures contracts and short-term debt
securities could then be liquidated and the cash proceeds used to buy long-term
bonds.
Futures contracts entail risks. If the investment manager's judgment about the
general direction of interest rates, markets or exchange rates is wrong, the
overall performance may be poorer than if no such contracts had been entered
into. There may be an imperfect correlation between movements in prices of
futures contracts and portfolio assets being hedged. In addition, the market
prices of futures contracts may be affected by certain factors. For example, if
participants in the futures market elect to close out their contracts rather
than meet margin requirements, distortions in the normal relationship between
the underlying assets and futures market could result. Price distortions also
could result if investors in futures contracts decide to make or take delivery
of underlying securities or other assets rather than engage in closing
transactions because of the resultant reduction in the liquidity of the futures
market. In addition, because, from the point of view of speculators, margin
requirements in the futures market are less onerous than margin requirements in
the cash market, increased participation by speculators in the futures market
could cause temporary price distortions. Due to the possibility of price
distortions in the futures market and because of the imperfect correlation
between movements in the prices of securities or other assets and movements in
the prices of futures contracts, a correct forecast of market trends by the
investment manager still may not result in a successful hedging transaction. If
any of these events should occur, a Fund could lose money on the financial
futures contracts and also on the value of its portfolio assets. The costs
incurred in connection with futures transactions could reduce a Fund's return.
Index options involve risks similar to those risks relating to transactions in
financial futures contracts described above. Also, an option purchased by a Fund
may expire worthless, in which case a Fund would lose the premium paid therefor.
A Fund may engage in futures transactions only on commodities exchanges or
boards of trade. A Fund will not engage in transactions in index options,
financial futures contracts or related options for speculation, but only as an
attempt to hedge against changes in interest rates or market conditions
affecting the values of securities which the Fund owns or intends to purchase.
FOREIGN CURRENCY TRANSACTIONS. The Diversified, High Yield and Income and
Capital Funds may each invest a limited portion of its assets in securities
denominated in foreign currencies. These Funds may engage in foreign currency
transactions in connection with their investments in foreign securities but will
not speculate in foreign currency exchange.
The value of the foreign securities investments of a Fund measured in U.S.
Dollars (including ADRs) may be affected favorably or unfavorably by changes in
foreign currency exchange rates and exchange control regulations, and the Fund
may incur costs in connection with conversions between various currencies. A
Fund will conduct its foreign currency exchange transactions either on a spot
(i.e., cash) basis at the spot rate prevailing in the foreign currency exchange
market, or through forward contracts to purchase or sell foreign currencies. A
forward foreign currency exchange contract involves an obligation to purchase or
sell a specific currency at a future date, which may be any fixed number of days
from the date of the contract agreed upon by the parties, at a price set at the
time of the contract. These contracts are traded directly between currency
traders (usually large commercial banks) and their customers.
When a Fund enters into a contract for the purchase or sale of a security
denominated in a foreign currency, it may want to establish the U.S. Dollar cost
or proceeds, as the case may be. By entering into a forward contract in U.S.
Dollars for the purchase or sale of the amount of foreign currency involved in
an underlying security transaction, the
30
<PAGE> 32
Fund is able to protect itself against a possible loss between trade and
settlement dates resulting from an adverse change in the relationship between
the U.S. Dollar and such foreign currency. However, this tends to limit
potential gains that might result from a positive change in such currency
relationships. A Fund may also hedge its foreign currency exchange rate risk by
engaging in foreign currency financial futures and options transactions.
When the investment manager believes that the currency of a particular foreign
country may suffer a substantial decline against the U.S. Dollar, it may enter
into a forward contract to sell an amount of foreign currency approximating the
value of some or all of the Fund's securities denominated in such foreign
currency. The forecasting of short-term currency market movement is extremely
difficult and whether such a short-term hedging strategy will be successful is
highly uncertain.
It is impossible to forecast with absolute precision the market value of
portfolio securities at the expiration of a contract. Accordingly, it may be
necessary for a Fund to purchase additional currency on the spot market (and
bear the expense of such purchase) if the market value of the security is less
than the amount of foreign currency the Fund is obligated to deliver when a
decision is made to sell the security and make delivery of the foreign currency
in settlement of a forward contract. Conversely, it may be necessary to sell on
the spot market some of the foreign currency received upon the sale of the
portfolio security if its market value exceeds the amount of foreign currency
the Fund is obligated to deliver.
A Fund will not enter into forward contracts or maintain a net exposure in such
contracts where the Fund would be obligated to deliver an amount of foreign
currency in excess of the value of the Fund's securities or other assets
denominated in that currency. The Diversified, High Yield and Income and Capital
Funds do not intend to enter into forward contracts for the purchase of a
foreign currency if they would have more than 15% of the value of their total
assets committed to such contracts. The Funds segregate cash or liquid
high-grade securities in an amount not less than the value of each Fund's total
assets committed to forward foreign currency exchange contracts entered into for
the purchase of a foreign currency. If the value of the securities segregated
declines, additional cash or securities are added so that the segregated amount
is not less than the amount of the Fund's commitments with respect to such
contracts. A Fund generally does not enter into a forward contract with a term
longer than one year.
DERIVATIVES. In addition to options and financial futures transactions,
consistent with its objective, each Fund may invest in a broad array of
financial instruments and securities in which the value of the instrument or
security is "derived" from the performance of an underlying asset or a
"benchmark" such as a security index, an interest rate or a foreign currency
("derivatives"). Derivatives are most often used to manage investment risk, to
increase or decrease exposure to an asset class or benchmark (as a hedge or to
enhance return), or to create an investment position indirectly (often because
it is more efficient or less costly than direct investment). The types of
derivatives used by each Fund and the techniques employed by the investment
manager may change over time as new derivatives and strategies are developed or
regulatory changes occur.
SPECIAL RISK FACTORS--OPTIONS, FUTURES, FOREIGN CURRENCIES AND OTHER
DERIVATIVES. The Statement of Additional Information contains further
information about the characteristics, risks and possible benefits of options,
futures, foreign currency and other derivative transactions. See "Investment
Policies and Techniques" in the Statement of Additional Information. The
principal risks are: (a) possible imperfect correlation between movements in the
prices of options, currencies, futures or other derivatives contracts and
movements in the prices of the securities or currencies hedged, used for cover
or that the derivatives intended to replicate; (b) lack of assurance that a
liquid secondary market will exist for any particular option, futures, foreign
currency or other derivatives contract at any particular time; (c) the need for
additional skills and techniques beyond those required for normal portfolio
management; (d) losses on futures contracts resulting from market movements not
anticipated by the investment manager; (e) the possible need to defer closing
out certain options, futures or other derivatives contracts in order to continue
to qualify for beneficial tax treatment afforded "regulated investment
companies" under the Internal Revenue Code; and (f) the possible non-performance
of the counter-party to the derivative contract.
DELAYED DELIVERY TRANSACTIONS. Any of the Funds (other than the Cash Reserves
Fund) may purchase or sell portfolio securities on a when-issued or delayed
delivery basis. When-issued or delayed delivery transactions involve a
commitment by a Fund to purchase or sell securities with payment and delivery to
take place in the future
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<PAGE> 33
(not to exceed 120 days from trade date for the Government Fund) in order to
secure what is considered to be an advantageous price or yield to the Fund at
the time of entering into the transaction. The value of fixed yield securities
to be delivered in the future will fluctuate as interest rates vary. Because a
Fund is required to set aside cash or liquid high-grade securities to satisfy
its commitments to purchase when-issued or delayed delivery securities,
flexibility to manage the Fund's investments may be limited if commitments to
purchase when-issued or delayed delivery securities were to exceed 25% of the
value of its assets.
To the extent a Fund engages in when-issued or delayed delivery transactions, it
will do so for the purpose of acquiring portfolio securities consistent with the
Fund's investment objective and policies. A Fund reserves the right to sell
these securities before the settlement date if deemed advisable.
In when-issued or delayed delivery transactions, delivery of the securities
occurs beyond normal settlement periods, but the Fund would not pay for such
securities or start earning interest on them until they are delivered. However,
when the Fund purchases securities on a when-issued or delayed delivery basis,
it immediately assumes the risks of ownership, including the risk of price
fluctuation. Failure to deliver a security purchased on a when-issued or delayed
delivery basis may result in a loss or missed opportunity to make an alternative
investment. Depending on market conditions, the Fund's when-issued and delayed
delivery purchase commitments could cause its net asset value per share to be
more volatile, because such securities may increase the amount by which its
total assets, including the value of when-issued and delayed delivery securities
it holds, exceed its net assets.
REPURCHASE AGREEMENTS. Each Fund may invest in repurchase agreements, under
which it acquires ownership of a security and the broker-dealer or bank agrees
to repurchase the security at a mutually agreed upon time and price, thereby
determining the yield during the Fund's holding period. In the event of a
bankruptcy or other default of a seller of a repurchase agreement, the Fund
might have expenses in enforcing its rights, and could experience losses,
including a decline in the value of the underlying securities and loss of
income. The securities underlying a repurchase agreement will be
marked-to-market every business day so that the value of such securities is at
least equal to the investment value of the repurchase agreement, including any
accrued interest thereon. In addition, the Fund must take physical possession of
the security or receive written confirmation of the purchase and a custodial or
safekeeping receipt from a third party or be recorded as the owner of the
security through the Federal Reserve Book-Entry System. Repurchase agreements
will be limited to transactions with financial institutions believed by the
investment adviser to present minimal credit risk. The investment manager will
monitor on an on-going basis the creditworthiness of the broker-dealers and
banks with which the Funds may engage in repurchase agreements. Repurchase
agreements maturing in more than seven days will be considered as illiquid for
purposes of the Funds' limitations on illiquid securities.
LENDING OF PORTFOLIO SECURITIES. Consistent with applicable regulatory
requirements, the Funds (other than the Government Fund) may lend securities
(principally to broker-dealers) without limit where such loans are callable at
any time and are continuously secured by segregated collateral (cash or U.S.
Government Securities) equal to no less than the market value, determined daily,
of the securities loaned. The Funds will receive amounts equal to dividends or
interest on the securities loaned. The Funds will also earn income for having
made the loan. Any cash collateral pursuant to these loans will be invested in
short-term money market instruments. As with other extensions of credit, there
are risks of delay in recovery or even loss of rights in the collateral should
the borrower of the securities fail financially. However, the loans would be
made only to firms deemed by the investment manager to be of good standing, and
when the investment manager believes the potential earnings to justify the
attendant risk. Management will limit such lending to not more than one-third of
the value of a Fund's total assets.
COLLATERALIZED OBLIGATIONS. Subject to its investment objective and policies, a
Fund may purchase collateralized obligations, including interest only ("IO") and
principal only ("PO") securities. A collateralized obligation is a debt security
issued by a corporation, trust or custodian, or by a U.S. Government agency or
instrumentality, that is collateralized by a portfolio or pool of mortgages,
Mortgage-Backed Securities, U.S. Government Securities or other assets. The
issuer's obligation to make interest and principal payments is secured by the
underlying pool or portfolio of securities. Collateralized obligations issued or
guaranteed by a U.S. Government agency or instrumentality, such as the Federal
Home Loan Mortgage Corporation, are considered U.S. Government Securities for
purposes of this
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<PAGE> 34
prospectus. Privately-issued collateralized obligations collateralized by a
portfolio of U.S. Government Securities are not direct obligations of the U.S.
Government or any of its agencies or instrumentalities and are not considered
U.S. Government Securities for purposes of this prospectus. A variety of types
of collateralized obligations are available currently and others may become
available in the future.
Since the collateralized obligations may be issued in classes with varying
maturities and interest rates, the investor may obtain greater predictability of
maturity than with direct investments in mortgage-backed securities. Classes
with shorter maturities may have lower volatility and lower yield while those
with longer maturities may have higher volatility and higher yield. This
provides the investor with greater control over the characteristics of the
investment in a changing interest rate environment. With respect to interest
only and principal only securities, an investor has the option to select from a
pool of underlying collateral the portion of the cash flows that most closely
corresponds to the investor's forecast of interest rate movements. These
instruments tend to be highly sensitive to prepayment rates on the underlying
collateral and thus place a premium on accurate prepayment projections by the
investor.
A Fund (other than the Cash Reserves Fund) may invest in collateralized
obligations whose yield floats inversely against a specified index rate. These
"inverse floaters" are more volatile than conventional fixed or floating rate
collateralized obligations and the yield thereon, as well as the value thereof,
will fluctuate in inverse proportion to changes in the index upon which interest
rate adjustments are based. As a result, the yield on an inverse floater will
generally increase when market yields (as reflected by the index) decrease and
decrease when market yields increase. The extent of the volatility of inverse
floaters depends on the extent of anticipated changes in market rates of
interest. Generally, inverse floaters provide for interest rate adjustments
based upon a multiple of the specified interest index, which further increases
their volatility. The degree of additional volatility will be directly
proportional to the size of the multiple used in determining interest rate
adjustments.
Additional information concerning collateralized obligations is contained in the
Statement of Additional Information under "Investment Policies and
Techniques--Collateralized Obligations."
INVESTMENT MANAGER AND UNDERWRITER
INVESTMENT MANAGER. Kemper Financial Services, Inc. ("KFS"), 120 South LaSalle
Street, Chicago, Illinois 60603, is the investment manager of each Fund and
provides each Fund with continuous professional investment supervision. KFS is
one of the largest investment managers in the country and has been engaged in
the management of investment funds for more than forty-five years. KFS and its
affiliates provide investment advice and manage investment portfolios for the
Kemper Funds, Kemper insurance companies, Kemper Corporation and other
corporate, pension, profit-sharing and individual accounts representing
approximately $60 billion under management (including approximately $16 billion
in U.S. Government securities). KFS acts as investment manager or principal
underwriter for 26 open-end and seven closed-end investment companies, with 64
separate investment portfolios, representing more than 3 million shareholder
accounts. KFS is a wholly-owned subsidiary of Kemper Financial Companies, Inc.,
which is a financial services holding company that is more than 99% owned by
Kemper Corporation ("Kemper"), a diversified insurance and financial services
holding company.
Kemper has entered into a definitive agreement with an investor group led by
Zurich Insurance Company ("Zurich") pursuant to which Kemper would be acquired
by the investor group in a merger transaction. As part of the transaction,
Zurich or an affiliate would purchase KFS. The Kemper and Zurich boards have
approved the transaction. In addition, because the transaction would constitute
an assignment of the Funds' investment management agreements with KFS and
potentially, Rule 12b-1 agreements under the Investment Company Act of 1940, and
therefore a termination of such agreements. KFS has received approval of new
agreements from the Funds' boards and shareholders. Consummation of the
transaction is subject to remaining contingencies, including state insurance
department regulatory approvals. The investor group has informed Kemper that it
expects the transaction to close early in 1996.
Responsibility for overall management of each Fund rests with its Board of
Trustees and officers. Professional investment supervision is provided by KFS.
The investment management agreements provide that KFS shall act as each Fund's
investment adviser, manage its investments and provide it with various services
and facilities. For
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Funds that invest in foreign securities, KFS will from time to time use the
services of Kemper Investment Management Company Limited, 1 Fleet Place, London
EC4M 7RQ, a wholly owned subsidiary of KFS, with respect to foreign securities
investments of the Funds including analysis, research, execution and trading
services.
J. Patrick Beimford, Jr. has been the portfolio manager since October, 1995 for
the Government Fund (and from 1981 through May, 1995) and the Mortgage Fund (and
from 1992 through May, 1995). Mr. Beimford (since October, 1995 and from 1992
through May, 1995) is also a portfolio co-manager with Michelle M. Keeley (since
1994) of the Short-Intermediate Government Fund. Mr. Beimford (since October,
1995 and from 1992 through May, 1995) and Elizabeth A. Byrnes (since 1994) are
portfolio co-managers of the Adjustable Rate Fund. Mr. Beimford joined KFS in
April 1976 and is currently an Executive Vice President and Chief Investment
Officer--Fixed Income Investments of KFS and a Vice President of each Fund. He
received a B.S.I.M. in Business from Purdue University, West Lafayette, Indiana,
and an M.B.A. in Finance from the University of Chicago, Chicago, Illinois. Mr.
Beimford is a Chartered Financial Analyst. Ms. Keeley, a First Vice President of
KFS and a Vice President of the Short-Intermediate Government Fund, joined KFS
in 1990 and, prior thereto, worked in the fixed income institutional sales
department of a national securities firm. She received a B.A. in International
Relations from Michigan State University, East Lansing, Michigan and an M.M. in
Finance from the Kellogg Graduate School of Business, Northwestern University,
Chicago, Illinois. Ms. Byrnes joined KFS in 1982 and is a First Vice President
of KFS and a Vice President of the Adjustable Rate Fund. She received a B.A.
from Miami University, Oxford, Ohio.
Frank J. Rachwalski, Jr. is the portfolio manager of the Cash Reserves Fund. He
has served in this capacity since the Fund commenced operations in February
1984. Mr. Rachwalski joined KFS in January 1973 and is currently a Senior Vice
President of KFS and a Vice President of the Fund. He received a B.B.A. and an
M.B.A. from Loyola University, Chicago, Illinois.
Michael A. McNamara (since 1990) and Harry E. Resis, Jr. (since 1992) are the
portfolio co-managers of the High Yield Fund. Mr. McNamara joined KFS in
February 1972 and is a Senior Vice President of KFS and a Vice President of the
Fund. He received a B.S. in Business Administration from the University of
Missouri, St. Louis, Missouri, and an M.B.A. in Finance from Loyola University,
Chicago, Illinois. Mr. Resis joined KFS in June, 1988 and is currently a Senior
Vice President of KFS and a Vice President of the Fund. He received a B.A. in
Finance from Michigan State University, East Lansing, Michigan. Mr. Resis holds
a number of NYSE and NASD licenses.
Robert Cessine is the portfolio manager (since 1994) and a Vice President of the
Income and Capital Fund. Mr. Cessine joined KFS in 1993 and is a Senior Vice
President of KFS and director of investment grade corporate and sovereign bond
research. Before joining KFS in 1993, Mr. Cessine was a senior corporate bond
analyst and chairman of the bond selection committee of an investment management
company. He received a B.S. in Economics from the University of Wisconsin,
Madison, Wisconsin, an M.S. in Agricultural and Resource Economics from the
University of Maryland, Baltimore/College Park, Maryland and an M.S. in Finance
from the University of Wisconsin, Madison, Wisconsin. Mr. Cessine is a Chartered
Financial Analyst.
Diversified Income Fund is managed by a team of portfolio managers who are
specialists in the basic sectors in which it invests. Messrs J. Patrick
Beimford, Jr., Robert S. Cessine, Gordon K. Johns, Michael A. McNamara, Harry E.
Resis, Jr., and Jonathan W. Trutter are the members of the team. Mr. Johns
joined Kemper in 1988 and is Executive Vice President of KFS and managing
director of Kemper Investment Management Company Limited in London. Previously,
he was head of international fixed income fund management at an investment bank
in London. He received a B.A. in law from Balliol College in Oxford, United
Kingdom. Mr. Trutter is a First Vice President of KFS. Before joining KFS in
1989, he was a vice president in commercial banking. Mr. Trutter has an A.B.
with dual majors in East Asian Languages and International Relations from the
University of Southern California, Los Angeles California and an M.B.A. from
Kellogg Graduate School of Management at Northwestern University, Chicago,
Illinois. He is also a Certified Public Accountant. See above for information on
the background of Messrs. Beimford, Cessine, McNamara and Resis.
KFS has a Fixed Income Investment Committee that determines overall investment
strategy for fixed income portfolios managed by KFS. The Fixed Income Committee
is currently comprised of the following members: J. Patrick Beimford, Jr.,
Robert S. Cessine, Frank E. Collecchia, George Klein, Michael A. McNamara,
Christopher J.
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Mier, Frank J. Rachwalski, Jr., Harry E. Resis, Jr., Robert H. Schumacher, John
E. Silvia, Stephen B. Timbers, Jonathan W. Trutter and Christopher T. Vincent.
The portfolio managers work together as a team with the Fixed Income Committee
and various fixed income analysts and traders to manage the Funds. Analysts
provide market, economic and financial research and analysis that is used by the
Fixed Income Committee to establish broad parameters for the Funds, including
duration and cash levels. In addition, credit research by analysts is used by
portfolio managers in selecting securities appropriate for the Funds' policies.
The KFS International Fixed Income Investments area, directed by Gordon K.
Johns, provides research and analysis regarding foreign investments to the
portfolio managers. After investment decisions are made, fixed income traders
execute the portfolio manager's instructions through various broker-dealer
firms.
The Funds pay KFS investment management fees, payable monthly, at the annual
rates shown below. Before May 31, 1994, the Funds paid fees under different fee
schedules that are described in "Investment Manager and Underwriter" in the
Statement of Additional Information.
<TABLE>
<CAPTION>
ADJUSTABLE RATE, INCOME DIVERSIFIED
AND CAPITAL, MORTGAGE CASH AND
AVERAGE DAILY NET ASSETS AND SHORT-INTERMEDIATE GOV'T RESERVES HIGH YIELD GOVERNMENT
- -------------------------------------------- ---------------------------- -------- ---------- ----------
<S> <C> <C> <C> <C>
$0 - $250 million........................... .55% .40% .58% .45%
$250 million - $1 billion................... .52 .38 .55 .43
$1 billion - $2.5 billion................... .50 .35 .53 .41
$2.5 billion - $5 billion................... .48 .32 .51 .40
$5 billion - $7.5 billion................... .45 .30 .48 .38
$7.5 billion - $10 billion.................. .43 .28 .46 .36
$10 billion - $12.5 billion................. .41 .26 .44 .34
Over $12.5 billion.......................... .40 .25 .42 .32
</TABLE>
PRINCIPAL UNDERWRITER. Pursuant to an underwriting and distribution services
agreement ("distribution agreement") with each Fund, Kemper Distributors, Inc.
("KDI"), 120 South LaSalle Street, Chicago, Illinois 60603, a wholly owned
subsidiary of KFS, is the principal underwriter and distributor of each Fund's
shares and acts as agent of each Fund in the sale of its shares. KDI bears all
its expenses of providing services pursuant to the distribution agreement,
including the payment of any commissions. KDI provides for the preparation of
advertising or sales literature and bears the cost of printing and mailing
prospectuses to persons other than shareholders. KDI bears the cost of
qualifying and maintaining the qualification of Fund shares for sale under the
securities laws of the various states and each Fund bears the expense of
registering its shares with the Securities and Exchange Commission. KDI may
enter into related selling group agreements with various broker-dealers,
including affiliates of KDI, that provide distribution services to investors.
KDI also may provide some of the distribution services. Before February 1, 1995,
KFS was the Funds' principal underwriter and distributor.
Class A Shares. KDI receives no compensation from the Funds as principal
underwriter for Class A shares and pays all expenses of distribution of each
Fund's Class A shares under the distribution agreements not otherwise paid by
dealers or other financial services firms. As indicated under "Purchase of
Shares," KDI retains the sales charge upon the purchase of shares and pays or
allows concessions or discounts to firms for the sale of each Fund's shares.
Class B Shares. For its services under the distribution agreement, KDI receives
a fee from each Fund, payable monthly, at the annual rate of .75% of average
daily net assets of each Fund attributable to Class B shares. This fee is
accrued daily as an expense of Class B shares. KDI also receives any contingent
deferred sales charges. See "Redemption or Repurchase of Shares--Contingent
Deferred Sales Charge--Class B Shares." KDI currently compensates firms for
sales of Class B shares at a commission rate of 3.75%.
Class C Shares. For its services under the distribution agreement, KDI receives
a fee from each Fund, payable monthly, at the annual rate of .75% of average
daily net assets of each Fund attributable to Class C shares. This fee is
accrued daily as an expense of Class C shares. KDI currently pays firms for
sales of Class C shares a distribution fee,
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payable quarterly, at an annual rate of .75% of net assets attributable to Class
C shares maintained and serviced by the firm. A firm becomes eligible for the
distribution fee based upon assets in accounts in the month of purchase and the
fee continues until terminated by KDI or a Fund.
Rule 12b-1 Plan. Since each distribution agreement provides for fees payable as
an expense of the Class B shares and the Class C shares that are used by KDI to
pay for distribution services for those classes, that agreement is approved and
reviewed separately for the Class B shares and the Class C shares in accordance
with Rule 12b-1 under the Investment Company Act of 1940, which regulates the
manner in which an investment company may, directly or indirectly, bear the
expenses of distributing its shares. The table below shows amounts paid in
connection with each Fund's Rule 12b-1 Plan during its 1995 fiscal year.
<TABLE>
<CAPTION>
DISTRIBUTION EXPENSES DISTRIBUTION FEES CONTINGENT DEFERRED
INCURRED BY PAID BY FUND SALES CHARGES PAID
UNDERWRITER TO UNDERWRITER TO UNDERWRITER
---------------------- ---------------------- -------------------
FUND CLASS B CLASS C CLASS B CLASS C CLASS B
- ------------------------------------- ---------- ------- ---------- ------- -------------------
<S> <C> <C> <C> <C> <C>
Adjustable Rate...................... $ 241,000 69,000 35,000 8,000 30,000
Cash Reserves+....................... $5,789,000 354,000 2,125,000 33,000 1,629,000
Diversified.......................... $2,421,000 84,000 1,925,000 14,000 688,000
Government........................... $2,537,000 109,000 254,000 19,000 91,000
High Yield........................... $7,183,000 424,000 7,344,000 68,000 1,785,000
Income and Capital................... $1,470,000 67,000 289,000 12,000 86,000
Mortgage+............................ $4,770,000 47,000 15,132,000 5,000 4,977,000
Short-Intermediate Government+....... $1,301,000 169,000 1,979,000 19,000 1,011,000
</TABLE>
- ---------------
+ Includes amounts paid during fiscal year ended July 31, 1995 and fiscal period
from August 1, 1995 to September 30, 1995.
If a Rule 12b-1 Plan is terminated in accordance with its terms, the obligation
of a Fund to make payments to KDI pursuant to the Plan will cease and the Fund
will not be required to make any payments past the termination date. Thus, there
is no legal obligation for the Fund to pay any expenses incurred by KDI in
excess of its fees under a Plan, if for any reason the Plan is terminated in
accordance with its terms. Future fees under the Plan may or may not be
sufficient to reimburse KDI (or KFS as predecessor to KDI) for its expenses
incurred.
ADMINISTRATIVE SERVICES. KDI also provides information and administrative
services for shareholders of each Fund pursuant to administrative services
agreements ("administrative agreements"). KDI may enter into related
arrangements with various financial services firms, such as broker-dealer firms
or banks ("firms"), that provide services and facilities for their customers or
clients who are shareholders of the Funds. Such administrative services and
assistance may include, but are not limited to, establishing and maintaining
shareholder accounts and records, processing purchase and redemption
transactions, answering routine inquiries regarding each Fund and its special
features and such other services as may be agreed upon from time to time and
permitted by applicable statute, rule or regulation. KDI bears all its expenses
of providing services pursuant to the administrative agreement, including the
payment of any service fees. For services under the administrative agreements,
each Fund pays KDI a fee, payable monthly, at an annual rate of up to .25% of
average daily net assets of each class of such Fund. With respect to Class A
shares, KDI then pays each firm a service fee at an annual rate of (a) up to
.15% of net assets (.25% for the Cash Reserves, Mortgage and Short-Intermediate
Government Funds) of those accounts that it maintains and services for each Fund
attributable to shares acquired prior to October 1, 1993, and (b) up to .25% of
net assets of those accounts that it maintains and services for each Fund
attributable to Class A shares acquired on or after October 1, 1993. With
respect to Class B shares and Class C shares, KDI pays each firm a service fee,
payable quarterly, at an annual rate of up to .25% of net assets of those
accounts in the Fund that it maintains and services attributable to Class B
shares and Class C shares, respectively. Firms to which service fees may be paid
include broker-dealers affiliated with KDI. A firm becomes eligible for the
service fee based on assets in the accounts in the month following the month of
purchase (in the month of purchase for Class C shares) and the fee continues
until
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<PAGE> 38
terminated by KDI or a Fund. The fees are calculated monthly and paid quarterly.
KDI may advance to financial services firms the first year service fee related
to Class B shares sold by such firms at a rate of up to .25% of the purchase
price of such shares. As compensation therefor, KDI may retain the
administrative services fee paid by a Fund with respect to such shares for the
first year after purchase. Financial services firms will become eligible for
future service fees with respect to such shares commencing in the thirteenth
month following the month of purchase.
KDI also may provide some of the above services and may retain any portion of
the fee under the administrative agreements not paid to firms to compensate
itself for administrative functions performed for each Fund. Currently, the
administrative services fee payable to KDI is based only upon Fund assets in
accounts for which there is a firm listed on a Fund's records and it is intended
that KDI will pay all the administrative services fee that it receives from each
Fund to firms in the form of service fees. The effective administrative services
fee rate to be charged against all assets of each Fund while this procedure is
in effect will depend upon the proportion of Fund assets that is in accounts for
which there is a firm of record, as well as, with respect to Class A shares
(except for the Cash Reserves, Mortgage and Short-Intermediate Government
Funds), the date when shares representing such assets were purchased.
CUSTODIAN, TRANSFER AGENT AND SHAREHOLDER SERVICE AGENT. Investors Fiduciary
Trust Company ("IFTC"), 127 West 10th Street, Kansas City, Missouri 64105, as
custodian, and State Street Bank and Trust Company, 225 Franklin Street, Boston,
Massachusetts 02110, as sub-custodian, have custody of all securities and cash
of each Fund maintained in the United States. For Funds that invest in foreign
securities, The Chase Manhattan Bank, N.A., Chase MetroTech Center, Brooklyn,
New York 11245, as custodian, has custody of all securities and cash of each
Fund held outside the United States. IFTC also is the Funds' transfer agent and
dividend-paying agent. Pursuant to a services agreement with IFTC, Kemper
Service Company, an affiliate of KFS, serves as "Shareholder Service Agent" of
the Funds and as such, performs all of IFTC's duties as transfer agent and
dividend-paying agent. For a description of custodian, transfer agent and
shareholder service agent fees payable to IFTC and the Shareholder Service
Agent, see "Investment Manager and Underwriter" in the Statement of Additional
Information.
PORTFOLIO TRANSACTIONS. KFS places all orders for purchases and sales of a
Fund's securities. Subject to seeking best execution of orders, KFS may consider
sales of shares of a Fund and other funds managed by KFS or its affiliates as a
factor in selecting broker-dealers. See "Portfolio Transactions" in the
Statement of Additional Information.
DIVIDENDS AND TAXES
DIVIDENDS. The Cash Reserves Fund's net investment income is declared as a
dividend daily, and dividends are reinvested or paid in cash monthly. Each other
Fund normally declares and distributes monthly dividends of net investment
income and distributes any net realized short-term and long-term capital gains
at least annually.
Dividends paid by a Fund as to each class of its shares will be calculated in
the same manner, at the same time and on the same day. The level of income
dividends per share (as a percentage of net asset value) will be lower for Class
B and Class C shares than for Class A shares primarily as a result of the
distribution services fee applicable to Class B and Class C shares.
Distributions of capital gains, if any, will be paid in the same amount for each
class.
Income dividends and capital gain dividends, if any, of a Fund will be credited
to shareholder accounts in full and fractional shares of the same class of that
Fund at net asset value, except that, upon written request to the Shareholder
Service Agent, a shareholder may select one of the following options:
(1) To receive income and short-term capital gain dividends in cash and
long-term capital gain dividends in shares of the same class at net asset
value; or
(2) To receive income and capital gain dividends in cash.
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<PAGE> 39
Any dividends of a Fund that are reinvested normally will be reinvested in
shares of the same class of that same Fund. However, upon written request to the
Shareholder Service Agent, a shareholder may elect to have dividends of a Fund
invested in shares of the same class of another Kemper Fund at the net asset
value of such class of such other fund. See "Special Features--Class A
Shares--Combined Purchases" for a list of such other Kemper Funds. To use this
privilege of investing dividends of a Fund in shares of another Kemper Fund,
shareholders must maintain a minimum account value of $1,000 in the Fund
distributing the dividends and a minimum account value of $1,000 in the Kemper
Fund in which dividends are reinvested. The Funds reinvest dividend checks (and
future dividends) in shares of that same Fund and class if checks are returned
as undeliverable.
TAXES. Each Fund intends to continue to qualify as a regulated investment
company under Subchapter M of the Internal Revenue Code (the "Code") and, if so
qualified, will not be liable for federal income taxes to the extent its
earnings are distributed. Dividends derived from net investment income and net
short-term capital gains are taxable to shareholders as ordinary income and
long-term capital gain dividends are taxable to shareholders as long-term
capital gain regardless of how long the shares have been held and whether
received in cash or shares. Long-term capital gain dividends received by
individual shareholders are taxed at a maximum rate of 28%. Dividends declared
in October, November or December to shareholders of record as of a date in one
of those months and paid during the following January are treated as paid on
December 31 of the calendar year declared. A portion of the dividends paid by
the Diversified or High Yield Funds may qualify for the dividends received
deduction available to corporate shareholders. However, it is anticipated that
only a small portion, if any, of the dividends paid by such Funds will so
qualify. No portion of the dividends paid by the Adjustable Rate, Cash Reserves,
Government, Income and Capital, Mortgage or Short-Intermediate Government Funds
will qualify for the dividends received deduction.
A dividend received shortly after the purchase of shares reduces the net asset
value of the shares by the amount of the dividend and, although in effect a
return of capital, will be taxable to the shareholder. If the net asset value of
shares were reduced below the shareholder's cost by dividends representing gains
realized on sales of securities, such dividends would be a return of investment
though taxable as stated above.
Fund dividends that are derived from interest on direct (but not guaranteed)
obligations of the U.S. Government and certain of its agencies and
instrumentalities may be exempt from state and local taxes in certain states. In
other states, arguments can be made that such distributions should be exempt
from state and local taxes based on federal law, 31 U.S.C. Section 3124, and the
U.S. Supreme Court's interpretation of that provision in American Bank and Trust
Co. v. Dallas County, 463 U.S. 855 (1983). Shareholders should consult their tax
advisers regarding the possible exclusion of such portion of their dividends for
state and local income tax purposes.
Each Fund is required by law to withhold 31% of taxable dividends and redemption
proceeds paid to certain shareholders who do not furnish a correct taxpayer
identification number (in the case of individuals, a social security number) and
in certain other circumstances. Trustees of qualified retirement plans and
403(b)(7) accounts are required by law to withhold 20% of the taxable portion of
any distribution that is eligible to be "rolled over." The 20% withholding
requirement does not apply to distributions from Individual Retirement Accounts
("IRAs") or any part of a distribution that is transferred directly to another
qualified retirement plan, 403(b)(7) account, or IRA. Shareholders should
consult with their tax advisers regarding the 20% withholding requirement.
After each transaction, shareholders will receive a confirmation statement
giving complete details of the transaction except that statements will be sent
quarterly for transactions involving dividend reinvestment and periodic
investment and redemption programs. Information for income tax purposes,
including information regarding any foreign taxes and credits, will be provided
after the end of the calendar year. Shareholders are encouraged to retain copies
of their account confirmation statements or year-end statements for tax
reporting purposes. However, those who have incomplete records may obtain
historical account transaction information at a reasonable fee.
NET ASSET VALUE
For each Fund except the Cash Reserves Fund, the net asset value per share is
determined separately for each class by dividing the value of the Fund's net
assets attributable to that class by the number of shares of that class
outstanding. The per share net asset value of the Class B and Class C shares of
a Fund (other than the Cash Reserves
38
<PAGE> 40
Fund) will generally be lower than that of the Class A shares of the Fund
because of the higher expenses borne by the Class B and Class C shares. Fixed
income securities are valued by using market quotations, or independent pricing
services that use prices provided by market makers or estimates of market values
obtained from yield data relating to instruments or securities with similar
characteristics. Portfolio securities that are primarily traded on a domestic
securities exchange or securities listed on the NASDAQ National Market are
valued at the last sale price on the exchange or market where primarily traded
or listed or, if there is no recent sale price available, at the last current
bid quotation. Portfolio securities that are primarily traded on foreign
securities exchanges are generally valued at the preceding closing values of
such securities on their respective exchanges where primarily traded. A security
that is listed or traded on more than one exchange is valued at the quotation on
the exchange determined to be the primary market for such security by the Board
of Trustees or its delegates. Securities not so traded or listed are valued at
the last current bid quotation if market quotations are available. Equity
options are valued at the last sale price unless the bid price is higher or the
ask price is lower, in which event such bid or asked price is used. Exchange
traded fixed income options are valued at the last sale price unless there is no
sale price, in which event current prices provided by market makers are used.
Over-the-counter traded options are valued based upon current prices provided by
market makers. Financial futures and options thereon are valued at the
settlement price established each day by the board of trade or exchange on which
they are traded. Other securities and assets are valued at fair value as
determined in good faith by the Board of Trustees. Because of the need to obtain
prices as of the close of trading on various exchanges throughout the world, the
calculation of net asset value of a Fund investing in foreign securities does
not necessarily take place contemporaneously with the determination of the
prices of the Fund's foreign securities, which may be made prior to the
determination of net asset value. For purposes of determining the net asset
value of a Fund investing in foreign securities, all assets and liabilities
initially expressed in foreign currency values will be converted into U.S.
Dollar values at the mean between the bid and offered quotations of such
currencies against U.S. Dollars as last quoted by a recognized dealer. If an
event were to occur, after the value of a security was so established but before
the net asset value per share was determined, which was likely to materially
change the net asset value, then that security would be valued using fair value
considerations by the Board of Trustees or its delegates. On each day the New
York Stock Exchange (the "Exchange") is open for trading, the net asset value is
determined as of the earlier of 3:00 p.m. Chicago time or the close of the
Exchange.
For the Cash Reserves Fund, the net asset value per share is determined
separately for each class as of the earlier of 3:00 p.m. Chicago time or the
close of the Exchange on each day the Exchange is open for trading. The Fund
seeks to maintain a net asset value of $1.00 per share in each class but there
is no assurance that it will do so. The net asset value per share of a class is
determined by dividing the Fund's net assets attributable to that class by the
total number of shares of the class outstanding. The Fund values its portfolio
instruments at amortized cost, which means that they are valued at their
acquisition cost (as adjusted for amortization of premium or discount) rather
than at current market value. Calculations are made to compare the value of its
investments valued at amortized cost with market-based values. Market-based
values are obtained by using actual quotations provided by market makers,
estimates of market value, or values obtained from yield data relating to
classes of money market instruments published by reputable sources at the mean
between the bid and asked prices for the instruments. If a deviation of 1/2 of
1% or more were to occur between the Fund's $1.00 per share net asset value,
calculated at amortized cost, and the net asset value per share calculated by
reference to market-based quotations, or if there is any other deviation which
the Board of Trustees believes would result in a material dilution to
shareholders or purchasers, the Board of Trustees will promptly consider what
action, if any, should be initiated. In order to value its investments at
amortized cost, the Fund purchases only securities with a maturity of 12 months
or less and maintains a Dollar-weighted average portfolio maturity of 90 days or
less. In addition, the Fund limits its portfolio investments to securities that
meet the quality and diversification requirements of Rule 2a-7. Under the
quality requirements of Rule 2a-7, the Fund may only purchase U.S. Dollar
denominated instruments that are determined to present minimal credit risks and
that are at the time of acquisition "Eligible Securities" as defined in Rule
2a-7. "Eligible Securities" under Rule 2a-7 include only securities that are
rated in the top two rating categories by the required number of nationally
recognized statistical rating organizations (at least two or, if only one such
organization has rated the security, that one organization) or, if unrated, are
deemed comparable in quality. The diversification requirements of Rule 2a-7
provide generally that the Fund may not at the time of acquisition invest more
than 5% of its assets in securities of any one issuer or invest more than 5% of
its assets in
39
<PAGE> 41
securities that are Eligible Securities that have not been rated in the highest
category by the required number of rating organizations or, if unrated, have not
been deemed comparable, except U.S. Government Securities and repurchase
agreements of such securities. See "Investment Objectives and Policies--Cash
Reserves Fund."
PURCHASE OF SHARES
ALTERNATIVE PURCHASE ARRANGEMENTS. Class A shares of each Fund (other than the
Cash Reserves Fund), are sold to investors subject to an initial sales charge.
Class A shares of the Cash Reserves Fund exchanged into Class A shares of
another Kemper Mutual Fund are subject to the applicable sales charge of the
Kemper Mutual Fund at the time of the exchange. Class B shares are sold without
an initial sales charge but are subject to higher ongoing expenses than Class A
shares and a contingent deferred sales charge payable upon certain redemptions.
Class B shares automatically convert to Class A shares six years after issuance.
Class C shares are sold without an initial or a contingent deferred sales charge
but are subject to higher ongoing expenses than Class A shares and do not
convert into another class. When placing purchase orders, investors must specify
whether the order is for Class A, Class B or Class C shares.
The primary distinctions among the classes of each Fund's shares lie in their
initial and contingent deferred sales charge structures and in their ongoing
expenses, including asset-based sales charges in the form of Rule 12b-1
distribution fees. These differences are summarized in the table below. See,
also, "Summary of Expenses." Each class has distinct advantages and
disadvantages for different investors, and investors may choose the class that
best suits their circumstances and objectives.
<TABLE>
<CAPTION>
ANNUAL 12B-1 FEES
(AS A % OF AVERAGE DAILY
SALES CHARGE NET ASSETS) OTHER INFORMATION
---------------------------------- ------------------------ ----------------------------------
<S> <C> <C> <C>
Class A* Maximum initial sales charge of None Initial sales charge waived or
4.5% of the public offering price reduced for certain purchases
(3.5% for the Adjustable Rate and
Short-Intermediate Government
Funds)
Class B Maximum contingent deferred sales 0.75% Shares convert to Class A shares
charge of 4% of redemption six years after issuance
proceeds; declines to zero after
six years
Class C None 0.75% No conversion feature
</TABLE>
- ---------------
* No initial sales charge applies to purchases of Class A shares of the Cash
Reserves Fund, but the applicable sales charge applies for exchanges into
Class A shares of other Kemper Mutual Funds.
The minimum initial investment for each Fund is $1,000 and the minimum
subsequent investment is $100. The minimum initial investment for an Individual
Retirement Account is $250 and the minimum subsequent investment is $50. Under
an automatic investment plan, such as Bank Direct Deposit, Payroll Direct
Deposit or Government Direct Deposit, the minimum initial and subsequent
investment is $50. These minimum amounts may be changed at any time in
management's discretion. In order to begin accruing income dividends as soon as
possible, purchasers may wire payment to the Fund's custodian, Investors
Fiduciary Trust Company, 127 West 10th Street, Kansas City, Missouri 64105.
The Cash Reserves Fund seeks to be as fully invested as possible at all times in
order to achieve maximum income. Since the Fund will be investing in instruments
which normally require immediate payment in Federal Funds (monies credited to a
bank's account with its regional Federal Reserve Bank), the Fund has adopted
certain procedures for the convenience of its shareholders and to ensure that
the Fund receives investable funds. (a) Wire transfer. Orders received by wire
transfer in the form of Federal Funds will be effected at the next determined
net asset value after receipt by the Fund's Shareholder Service Agent and such
shares will receive the dividend for the next calendar day following the day
when the purchase is effective. If payment is wired in Federal Funds, the
payment should be wired to Investors Fiduciary Trust Company, 127 West 10th
Street, Kansas City, Missouri 64105, the custodian for the Fund. If payment is
to be wired, the firm which services the account should handle the details of
the transaction. (b) Check. Orders for purchase accompanied by a check or other
negotiable bank draft will be accepted and effected as of the close of the
Exchange on the business day following receipt and such shares will
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<PAGE> 42
receive the dividend for the next calendar day following the day when the
purchase is effective. (c) Dealer Trades. Orders processed through dealers or
other financial services firms, including trades via Fund/SERV, will be effected
at the net asset value effective on the trade date. These purchases will begin
earning dividends the calendar day following the payment date. See "Dividends
and Taxes" for more information.
Share certificates will not be issued unless requested in writing. It is
recommended that investors not request share certificates unless needed for a
specific purpose. You cannot redeem shares by telephone or wire transfer or use
the telephone exchange privilege if share certificates have been issued. A lost
or destroyed certificate is difficult to replace and can be expensive to the
shareholder (a bond worth 2% or more of the certificate value is normally
required).
INITIAL SALES CHARGE ALTERNATIVE--CLASS A SHARES. The public offering price of
Class A shares for purchasers of the Adjustable Rate and Short-Intermediate
Government Funds choosing the initial sales charge alternative is the net asset
value plus a sales charge, as set forth below.
ADJUSTABLE RATE AND SHORT-INTERMEDIATE GOVERNMENT FUNDS
<TABLE>
<CAPTION>
Sales Charge
----------------------------------
Allowed
to
As a Dealers
As a Percentage as a
Percentage of Percentage
of Net of
Offering Asset Offering
Amount of Purchase Price Value* Price
---- ---- ----
<S> <C> <C> <C>
Less than $100,000........................................ 3.50% 3.63% 3.00%
$100,000 but less than $250,000........................... 3.00 3.09 2.50
$250,000 but less than $500,000........................... 2.50 2.56 2.25
$500,000 but less than $1 million......................... 2.00 2.04 1.75
$1 million and over....................................... .00** .00** ***
</TABLE>
- ---------------
* Rounded to the nearest one-hundredth percent.
** Redemption of shares may be subject to a contingent deferred sales charge as
discussed below.
*** Commission is payable by KDI as discussed below.
The public offering price of Class A shares for purchasers of the Diversified,
Government, High Yield, Income and Capital and Mortgage Funds choosing the
initial sales charge alternative is the net asset value plus a sales charge, as
set forth below.
DIVERSIFIED, GOVERNMENT, HIGH YIELD, INCOME AND CAPITAL AND MORTGAGE FUNDS
<TABLE>
<CAPTION>
Sales Charge
----------------------------------
Allowed
to
As a Dealers
As a Percentage as a
Percentage of Percentage
of Net of
Offering Asset Offering
Amount of Purchase Price Value* Price
---- ---- ----
<S> <C> <C> <C>
Less than $100,000........................................ 4.50% 4.71% 4.00%
$100,000 but less than $250,000........................... 3.50 3.63 3.00
$250,000 but less than $500,000........................... 2.60 2.67 2.25
$500,000 but less than $1 million......................... 2.00 2.04 1.75
$1 million and over....................................... .00** .00** ***
</TABLE>
- ---------------
* Rounded to the nearest one-hundredth percent.
** Redemption of shares may be subject to a contingent deferred sales charge as
discussed below.
*** Commission is payable by KDI as discussed below.
Each Fund receives the entire net asset value of all its Class A shares sold.
KDI, the Funds' principal underwriter, retains the sales charge on sales of
Class A shares from which it allows discounts from the applicable public
offering price to investment dealers, which discounts are uniform for all
dealers in the United States and its territories. The normal discount allowed to
dealers is set forth in the above table. Upon notice to all dealers with whom it
has sales agreements, KDI may reallow up to the full applicable sales charge, as
shown in the above table, during periods and for transactions specified in such
notice and such reallowances may be based upon attainment of minimum sales
41
<PAGE> 43
levels. During periods when 90% or more of the sales charge is reallowed, such
dealers may be deemed to be underwriters as that term is defined in the
Securities Act of 1933.
Class A shares of a Fund may be purchased at net asset value to the extent that
the amount invested represents the net proceeds from a redemption of shares of a
mutual fund for which KFS or an affiliate does not serve as investment manager
("non-Kemper fund") provided that: (a) the investor has previously paid either
an initial sales charge in connection with the purchase of the non-Kemper fund
shares redeemed or a contingent deferred sales charge in connection with the
redemption of the non-Kemper fund shares, and (b) the purchase of Fund shares is
made within 90 days after the date of such redemption. To make such a purchase
at net asset value, the investor or the investor's dealer must, at the time of
purchase, submit a request that the purchase be processed at net asset value
pursuant to this privilege. The redemption of the shares of the non-Kemper fund
is, for federal income tax purposes, a sale upon which a gain or loss may be
realized.
Class A shares of a Fund may be purchased at net asset value by: (a) any
purchaser provided that the amount invested in such Fund or other Kemper Mutual
Funds listed under "Special Features--Class A Shares--Combined Purchases" totals
at least $1,000,000 including purchases of Class A shares pursuant to the
"Combined Purchases," "Letter of Intent" and "Cumulative Discount" features
described under "Special Features;" or (b) a participant-directed qualified
retirement plan described in Code Section 401(a) or a participant-directed
non-qualified deferred compensation plan described in Code Section 457 provided
in either case that such plan has not less than 200 eligible employees (the
"Large Order NAV Purchase Privilege"). Redemption within one year of shares
purchased under the Large Order NAV Purchase Privilege may be subject to a
contingent deferred sales charge. See "Redemption or Repurchase of
Shares--Contingent Deferred Sales Charge--Large Order NAV Purchase Privilege."
KDI may in its discretion compensate investment dealers or other financial
services firms in connection with the sale of Class A shares of a Fund to
employer sponsored employee benefit plans using the subaccount recordkeeping
system made available through the Shareholder Service Agent at net asset value
in accordance with the Large Order NAV Purchase Privilege up to the following
amounts: 1.00% of the net asset value of shares sold on amounts up to $5 million
in any calendar year, .50% on the next $5 million and .25% on amounts over $10
million in such calendar year. KDI may in its discretion compensate investment
dealers or other financial services firms in connection with the sale of Class A
shares of each Fund to other purchasers at net asset value in accordance with
the Large Order NAV Purchase Privilege up to the following amounts: .70% of the
net asset value of shares sold on amounts up to $3 million, .50% on the next $2
million and .25% on amounts over $5 million. For purposes of determining the
appropriate commission percentage to be applied to a particular sale under the
foregoing schedules, KDI will consider the cumulative amount invested by the
purchaser in a Fund and other Kemper Mutual Funds listed under "Special
Features--Class A Shares--Combined Purchases," including purchases pursuant to
the "Combined Purchases," "Letter of Intent" and "Cumulative Discount" features
referred to above. The privilege of purchasing Class A shares of a Fund at net
asset value under the Large Order NAV Purchase Privilege is not available if
another net asset value purchase privilege also applies (including the purchase
of Class A shares of the Cash Reserves Fund).
Class A shares may be sold at net asset value in any amount to: (a) officers,
trustees, directors, employees (including retirees) and sales representatives of
a Fund, its investment manager, its principal underwriter or certain affiliated
companies, for themselves or members of their families; (b) registered
representatives and employees of broker-dealers having selling group agreements
with KDI and officers, directors and employees of service agents of the Funds,
for themselves or their spouses or dependent children; (c) shareholders who
owned shares of Kemper-Dreman Fund, Inc. ("KDF") on September 8, 1995, and have
continuously owned shares of KDF (or a Kemper Fund acquired by exchange of KDF
shares) since that date, for themselves or members of their families, and (d)
any trust or pension, profit-sharing or other benefit plan for only such
persons. Class A shares may be sold at net asset value in any amount to selected
employees (including their spouses and dependent children) of banks and other
financial services firms that provide administrative services related to order
placement and payment to facilitate transactions in shares of the Funds for
their clients pursuant to an agreement with KDI or one of its affiliates. Only
those employees of such banks and other firms who as part of their usual duties
provide services related to
42
<PAGE> 44
transactions in Fund Class A shares may purchase Fund shares at net asset value
hereunder. Class A shares may be sold at net asset value in any amount to unit
investment trusts sponsored by Everen Securities, Inc. In addition, unitholders
of unit investment trusts sponsored by Everen Securities, Inc. or its
predecessors may purchase a Fund's Class A shares at net asset value through
reinvestment programs described in the prospectuses of such trusts that have
such programs. Class A shares of a Fund may be sold at net asset value through
certain investment advisers registered under the Investment Advisers Act of 1940
and other financial services firms that adhere to certain standards established
by KDI, including a requirement that such shares be sold for the benefit of
their clients participating in a "wrap account" or similar program under which
such clients pay a fee to the investment adviser or other firm. Such shares are
sold for investment purposes and on the condition that they will not be resold
except through redemption or repurchase by the Funds. The Funds may also issue
Class A shares at net asset value in connection with the acquisition of the
assets of or merger or consolidation with another investment company, or to
shareholders in connection with the investment or reinvestment of income and
capital gain dividends.
Effective on a date discussed below, Class A shares of a Fund may be purchased
at net asset value in any amount by members of the plaintiff class in the
proceeding known as Howard and Audrey Tabankin, et al. v. Kemper Short-Term
Global Income Fund, et al., Case No. 93 C 5231 (N.D. IL). This privilege is
generally non-transferrable and continues for the lifetime of individual class
members and for a ten year period for non-individual class members. This
privilege is subject to final approval by the court in the aforementioned
proceeding and will become effective on a date as described in appropriate court
documents, now estimated to be February 1, 1996. To make a purchase at net asset
value under this privilege, the investor must, at the time of purchase, submit a
written request that the purchase be processed at net asset value pursuant to
this privilege specifically identifying the purchaser as a member of the
"Tabankin Class." Shares purchased under this privilege will be maintained in a
separate account that includes only shares purchased under this privilege. For
more details concerning this privilege, class members should refer to the Notice
of (1) Proposed Settlement with Defendants; and (2) Hearing to Determine
Fairness of Proposed Settlement, dated August 31, 1995, issued in connection
with the aforementioned court proceeding. For sales of Fund shares at net asset
value pursuant to this privilege, KDI may at its discretion pay investment
dealers and other financial services firms a concession, payable quarterly, at
an annual rate of up to .25% of net assets attributable to such shares
maintained and serviced by the firm. A firm becomes eligible for the concession
based upon assets in accounts attributable to shares purchased under this
privilege in the month after the month of purchase and the concession continues
until terminated by KDI. The privilege of purchasing Class A shares of a Fund at
net asset value under this privilege is not available if another net asset value
purchase privilege also applies (including the purchase of Class A shares of the
Cash Reserves Fund).
The sales charge scale is applicable to purchases made at one time by any
"purchaser" which includes: an individual; or an individual, his or her spouse
and children under the age of 21; or a trustee or other fiduciary of a single
trust estate or single fiduciary account; or an organization exempt from federal
income tax under Section 501(c)(3) or (13) of the Code; or a pension,
profit-sharing or other employee benefit plan whether or not qualified under
Section 401 of the Code; or other organized group of persons whether
incorporated or not, provided the organization has been in existence for at
least six months and has some purpose other than the purchase of redeemable
securities of a registered investment company at a discount. In order to qualify
for a lower sales charge, all orders from an organized group will have to be
placed through a single investment dealer or other firm and identified as
originating from a qualifying purchaser.
DEFERRED SALES CHARGE ALTERNATIVE--CLASS B SHARES. Investors choosing the
deferred sales charge alternative may purchase Class B shares at net asset value
per share without any sales charge at the time of purchase. Since Class B shares
are being sold without an initial sales charge, the full amount of the
investor's purchase payment will be invested in Class B shares for his or her
account. A contingent deferred sales charge may be imposed upon redemption of
Class B shares. See "Redemption or Repurchase of Shares--Contingent Deferred
Sales Charge --Class B Shares."
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<PAGE> 45
KDI compensates firms for sales of Class B shares at the time of sale at a
commission rate of up to 3.75% of the amount of Class B shares purchased. KDI is
compensated by each Fund for services as distributor and principal underwriter
for Class B shares. See "Investment Manager and Underwriter."
Class B shares of a Fund will automatically convert to Class A shares of the
same Fund six years after issuance on the basis of the relative net asset value
per share. Class B shareholders of the Funds who originally acquired their
shares as Initial Shares of Kemper Portfolios, formerly known as Kemper
Investment Portfolios ("KIP"), hold them subject to the same conversion period
schedule as that of their KIP Portfolio. Class B shares originally representing
Initial Shares of a KIP Portfolio will automatically convert to Class A shares
of the applicable Fund six years after issuance of the Initial Shares for shares
issued on or after February 1, 1991 and seven years after issuance of the
Initial Shares for shares issued before February 1, 1991. The purpose of the
conversion feature is to relieve holders of Class B shares from the distribution
services fee when they have been outstanding long enough for KDI to have been
compensated for distribution related expenses. For purposes of conversion to
Class A shares, shares purchased through the reinvestment of dividends and other
distributions paid with respect to Class B shares in a shareholder's Fund
account will be converted to Class A shares on a pro rata basis.
PURCHASE OF CLASS C SHARES. The public offering price of the Class C shares of a
Fund is the next determined net asset value. No initial or contingent deferred
sales charge is imposed. Since Class C shares are sold without an initial sales
charge, the full amount of the investor's purchase payment will be invested in
Class C shares for his or her account. KDI pays firms for sales of Class C
shares a distribution fee, payable quarterly, at an annual rate of .75% of net
assets attributable to Class C shares maintained and serviced by the firm. KDI
is compensated by each Fund as distributor and principal underwriter for Class C
shares. See "Investment Manager and Underwriter."
WHICH ARRANGEMENT IS BETTER FOR YOU? The decision as to which class of shares
provides a more suitable investment for an investor depends on a number of
factors, including the amount and intended length of the investment, and for the
Cash Reserves Fund, the other Kemper Mutual Fund into which the investor may
wish to exchange in the future. Investors making investments that qualify for
reduced sales charges might consider Class A shares. Investors who prefer not to
pay an initial sales charge and who plan to hold their investment for more than
six years might consider Class B shares. Investors who prefer not to pay an
initial sales charge but who plan to redeem their shares within six years might
consider Class C shares. Orders for Class B shares or Class C shares for
$500,000 or more will be declined. Orders for Class B shares or Class C shares
by employer sponsored employee benefit plans using the subaccount record keeping
system made available through the Shareholder Service Agent will be invested
instead in Class A shares at net asset value where the combined subaccount value
in a Fund or other Kemper Mutual Funds listed under "Special Features--Class A
Shares--Combined Purchases" is in excess of $5 million including purchases
pursuant to the "Combined Purchases," "Letter of Intent" and "Cumulative
Discount" features described under "Special Features." For more information
about the three sales arrangements, consult your financial representative or the
Shareholder Service Agent. Financial services firms may receive different
compensation depending upon which class of shares they sell.
GENERAL. Banks and other financial services firms may provide administrative
services related to order placement and payment to facilitate transactions in
shares of a Fund for their clients, and KDI may pay them a transaction fee up to
the level of the discount or commission allowable or payable to dealers, as
described above. Banks are currently prohibited under the Glass-Steagall Act
from providing certain underwriting or distribution services. Banks or other
financial services firms may be subject to various state laws regarding the
services described above and may be required to register as dealers pursuant to
state law. If banking firms were prohibited from acting in any capacity or
providing any of the described services, management would consider what action,
if any, would be appropriate. KDI does not believe that termination of a
relationship with a bank would result in any material adverse consequences to a
Fund.
In addition to the discounts or commissions described above, KDI will, from time
to time, pay or allow additional discounts, commissions or promotional
incentives, in the form of cash or other compensation, to firms that sell shares
of the Funds. Non-cash compensation includes luxury merchandise and trips to
luxury resorts. In some instances, such discounts, commissions or other
incentives will be offered only to certain firms that sell or are
44
<PAGE> 46
expected to sell during specified time periods certain minimum amounts of shares
of the Funds or other funds underwritten by KDI.
Orders for the purchase of shares of a Fund will be confirmed at a price based
on the net asset value of that Fund next determined after receipt by KDI of the
order accompanied by payment. However, orders received by dealers or other
financial services firms prior to the determination of net asset value (see "Net
Asset Value") and received by KDI prior to the close of its business day will be
confirmed at a price based on the net asset value effective on that day ("trade
date"). The Funds reserve the right to determine the net asset value more
frequently than once a day if deemed desirable. Dealers and other financial
services firms are obligated to transmit orders promptly. Collection may take
significantly longer for a check drawn on a foreign bank than for a check drawn
on a domestic bank. Therefore, if an order is accompanied by a check drawn on a
foreign bank, funds must normally be collected before shares will be purchased.
See "Purchase and Redemption of Shares" in the Statement of Additional
Information.
Investment dealers and other firms provide varying arrangements for their
clients to purchase and redeem the Funds' shares. Some may establish higher
minimum investment requirements than set forth above. Firms may arrange with
their clients for other investment or administrative services. Such firms may
independently establish and charge additional amounts to their clients for such
services, which charges would reduce the clients' return. Firms also may hold
the Funds' shares in nominee or street name as agent for and on behalf of their
customers. In such instances, the Funds' transfer agent will have no information
with respect to or control over the accounts of specific shareholders. Such
shareholders may obtain access to their accounts and information about their
accounts only from their firm. Certain of these firms may receive compensation
from the Funds through the Shareholder Service Agent for recordkeeping and other
expenses relating to these nominee accounts. In addition, certain privileges
with respect to the purchase and redemption of shares or the reinvestment of
dividends may not be available through such firms. Some firms may participate in
a program allowing them access to their clients' accounts for servicing
including, without limitation, transfers of registration and dividend payee
changes; and may perform functions such as generation of confirmation statements
and disbursement of cash dividends. Such firms, including affiliates of KDI, may
receive compensation from the Funds through the Shareholder Service Agent for
these services. This prospectus should be read in connection with such firms'
material regarding their fees and services.
The Funds reserve the right to withdraw all or any part of the offering made by
this prospectus and to reject purchase orders. Also, from time to time, each
Fund may temporarily suspend the offering of any class of its shares to new
investors. During the period of such suspension, persons who are already
shareholders of such class of the Fund normally are permitted to continue to
purchase additional shares of such class and to have dividends reinvested.
Shareholders should direct their inquiries to Kemper Service Company, 811 Main
Street, Kansas City, Missouri 64105-2005 or to the firm from which they received
this prospectus.
REDEMPTION OR REPURCHASE OF SHARES
GENERAL. Any shareholder may require a Fund to redeem his or her shares. When
shares are held for the account of a shareholder by the Funds' transfer agent,
the shareholder may redeem them by sending a written request with signatures
guaranteed to Kemper Mutual Funds, Attention: Redemption Department, P.O. Box
419557, Kansas City, Missouri 64141-6557. When certificates for shares have been
issued, they must be mailed to or deposited with the Shareholder Service Agent,
along with a duly endorsed stock power and accompanied by a written request for
redemption. Redemption requests and a stock power must be endorsed by the
account holder with signatures guaranteed by a commercial bank, trust company,
savings and loan association, federal savings bank, member firm of a national
securities exchange or other eligible financial institution. The redemption
request and stock power must be signed exactly as the account is registered
including any special capacity of the registered owner. Additional documentation
may be requested, and a signature guarantee is normally required, from
institutional and fiduciary account holders, such as corporations, custodians
(e.g., under the Uniform Transfers to Minors Act), executors, administrators,
trustees or guardians.
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<PAGE> 47
The redemption price for shares of a Fund will be the net asset value per share
of that Fund next determined following receipt by the Shareholder Service Agent
of a properly executed request with any required documents as described above.
Payment for shares redeemed will be made in cash as promptly as practicable but
in no event later than seven days after receipt of a properly executed request
accompanied by any outstanding share certificates in proper form for transfer.
When a Fund is asked to redeem shares for which it may not have yet received
good payment, it may delay transmittal of redemption proceeds until it has
determined that collected funds have been received for the purchase of such
shares, which will be up to 15 days from receipt by a Fund of the purchase
amount. The redemption within one year of Class A shares purchased at net asset
value under the Large Order NAV Purchase Privilege may be subject to a 1%
contingent deferred sales charge (see "Purchase of Shares") and the redemption
of Class B shares may be subject to a contingent deferred sales charge (see
"Contingent Deferred Sales Charge--Class B Shares" below).
Because of the high cost of maintaining small accounts, the Funds reserve the
right to redeem an account (and, in the case of Class B shares, impose any
applicable contingent deferred sales charge) that falls below the minimum
investment level, currently $1,000, as a result of redemptions. Currently,
Individual Retirement Accounts and employee benefit plan accounts are not
subject to this procedure. A shareholder will be notified in writing and will be
allowed 60 days to make additional purchases to bring the account value up to
the minimum investment level before a Fund redeems the shareholder's account.
The investment required to reach that level may be made at net asset value
(without any initial sales charge in the case of Class A shares).
Shareholders can request the following telephone privileges: expedited wire
transfer redemptions and EXPRESS-Transfer transactions (see "Special Features")
and exchange transactions for individual and institutional accounts and
pre-authorized telephone redemption transactions for certain institutional
accounts. Shareholders may choose these privileges on the account application or
by contacting the Shareholder Service Agent for appropriate instructions. Please
note that the telephone exchange privilege is automatic unless the shareholder
refuses it on the account application. A Fund or its agents may be liable for
any losses, expenses or costs arising out of fraudulent or unauthorized
telephone requests pursuant to these privileges unless the Fund or its agents
reasonably believe, based upon reasonable verification procedures, that the
telephonic instructions are genuine. The SHAREHOLDER WILL BEAR THE RISK OF LOSS,
including loss resulting from fraudulent or unauthorized transactions, as long
as the reasonable verification procedures are followed. The verification
procedures include recording instructions, requiring certain identifying
information before acting upon instructions and sending written confirmations.
TELEPHONE REDEMPTIONS. If the proceeds of the redemption (prior to the
imposition of any contingent deferred sales charge in the case of Class B
shares) are $50,000 or less and the proceeds are payable to the shareholder of
record at the address of record, normally a telephone request or a written
request by any one account holder without a signature guarantee is sufficient
for redemptions by individual or joint account holders, and trust, executor and
guardian account holders (excluding custodial accounts for gifts and transfers
to minors), provided the trustee, executor or guardian is named in the account
registration. Other institutional account holders and guardian account holders
of custodial accounts for gifts and transfers to minors may exercise this
special privilege of redeeming shares by telephone request or written request
without signature guarantee subject to the same conditions as individual account
holders and subject to the limitations on liability described under "General"
above, provided that this privilege has been pre-authorized by the institutional
account holder or guardian account holder by written instruction to the
Shareholder Service Agent with signatures guaranteed. Telephone requests may be
made by calling 1-800-621-1048. Shares purchased by check or through
EXPRESS-Transfer or Bank Direct Deposit may not be redeemed under this privilege
of redeeming shares by telephone request until such shares have been owned for
at least 15 days. This privilege of redeeming shares by telephone request or by
written request without a signature guarantee may not be used to redeem shares
held in certificated form and may not be used if the shareholder's account has
had an address change within 30 days of the redemption request. During periods
when it is difficult to contact the Shareholder Service Agent by telephone, it
may be difficult to use the telephone redemption privilege, although investors
can still redeem by mail. The Funds reserve the right to terminate or modify
this privilege at any time.
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<PAGE> 48
REPURCHASES (CONFIRMED REDEMPTIONS). A request for repurchase may be
communicated by a shareholder through a securities dealer or other financial
services firm to KDI, which each Fund has authorized to act as its agent. There
is no charge by KDI with respect to repurchases; however, dealers or other firms
may charge customary commissions for their services. Dealers and other financial
services firms are obligated to transmit orders promptly. The repurchase price
will be the net asset value of the Fund next determined after receipt of a
request by KDI. However, requests for repurchases received by dealers or other
firms prior to the determination of net asset value (see "Net Asset Value") and
received by KDI prior to the close of KDI's business day will be confirmed at
the net asset value effective on that day. The offer to repurchase may be
suspended at any time. Requirements as to stock powers, certificates, payments
and delay of payments are the same as for redemptions.
EXPEDITED WIRE TRANSFER REDEMPTIONS. If the account holder has given
authorization for expedited wire redemption to the account holder's brokerage or
bank account, shares of a Fund can be redeemed and proceeds sent by federal wire
transfer to a single previously designated account. Requests received by the
Shareholder Service Agent prior to the determination of net asset value will
result in shares being redeemed that day at the net asset value of the Fund
effective on that day and normally the proceeds will be sent to the designated
account the following business day. Delivery of the proceeds of a wire
redemption request of $250,000 or more may be delayed by the Fund for up to
seven days if the investment manager deems it appropriate under then current
market conditions. Once authorization is on file, the Shareholder Service Agent
will honor requests by telephone at 1-800-621-1048 or in writing, subject to the
limitations on liability described under "General" above. The Funds are not
responsible for the efficiency of the federal wire system or the account
holder's financial services firm or bank. The Funds currently do not charge the
account holder for wire transfers. The account holder is responsible for any
charges imposed by the account holder's firm or bank. There is a $1,000 wire
redemption minimum (including any contingent deferred sales charge). To change
the designated account to receive wire redemption proceeds, send a written
request to the Shareholder Service Agent with signatures guaranteed as described
above or contact the firm through which shares of the Fund were purchased.
Shares purchased by check or through EXPRESS-Transfer or Bank Direct Deposit may
not be redeemed by wire transfer until such shares have been owned for at least
15 days. Account holders may not use this privilege to redeem shares held in
certificated form. During periods when it is difficult to contact the
Shareholder Service Agent by telephone, it may be difficult to use the expedited
redemption privilege. The Funds reserve the right to terminate or modify this
privilege at any time.
CONTINGENT DEFERRED SALES CHARGE--LARGE ORDER NAV PURCHASE PRIVILEGE. A
contingent deferred sales charge of 1% may be imposed upon redemption of Class A
shares that are purchased under the Large Order NAV Purchase Privilege if they
are redeemed within one year of purchase. The charge will not be imposed upon
redemption of reinvested dividends or share appreciation. The charge is applied
to the value of the shares redeemed excluding amounts not subject to the charge.
The contingent deferred sales charge will be waived in the event of: (a)
redemptions by a participant-directed qualified retirement plan described in
Code Section 401(a) or a participant-directed non-qualified deferred
compensation plan described in Code Section 457; (b) redemptions by employer
sponsored employee benefit plans using the subaccount record keeping system made
available through the Shareholder Service Agent; (c) redemption of shares of a
shareholder (including a registered joint owner) who has died; (d) redemption of
shares of a shareholder (including a registered joint owner) who after purchase
of the shares being redeemed becomes totally disabled (as evidenced by a
determination by the federal Social Security Administration); and (e)
redemptions under a Fund's Systematic Withdrawal Plan at a maximum of 10% per
year of the net asset value of the account.
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<PAGE> 49
CONTINGENT DEFERRED SALES CHARGE--CLASS B SHARES. A contingent deferred sales
charge may be imposed upon redemption of Class B shares. There is no such charge
upon redemption of any share appreciation or reinvested dividends on Class B
shares. The charge is computed at the following rates applied to the value of
the shares redeemed excluding amounts not subject to the charge.
<TABLE>
<CAPTION>
YEAR OF CONTINGENT
REDEMPTION DEFERRED
AFTER SALES
PURCHASE CHARGE
- ---------- ----------
<S> <C> <C>
First..................................................................... 4%
Second.................................................................... 3%
Third..................................................................... 3%
Fourth.................................................................... 2%
Fifth..................................................................... 2%
Sixth..................................................................... 1%
</TABLE>
Class B shareholders who originally acquired their shares as Initial Shares of
Kemper Portfolios, formerly known as Kemper Investment Portfolios, hold them
subject to the same CDSC schedule that applied when those shares were purchased,
as follows:
<TABLE>
<CAPTION>
CONTINGENT DEFERRED SALES CHARGE
YEAR OF ---------------------------------------------------------------------------------------
REDEMPTION SHARES PURCHASED ON OR AFTER
AFTER SHARES PURCHASED ON OR AFTER FEBRUARY 1, 1991 AND BEFORE SHARES PURCHASED BEFORE
PURCHASE MARCH 1, 1993 MARCH 1, 1993 FEBRUARY 1, 1991
----------------------- ---------------------------- ---------------------------- -----------------------
<S> <C> <C> <C>
First.................. 4% 3% 5%
Second................. 3% 3% 4%
Third.................. 3% 2% 3%
Fourth................. 2% 2% 2%
Fifth.................. 2% 1% 2%
Sixth.................. 1% 1% 1%
</TABLE>
The following example will illustrate the operation of the contingent deferred
sales charge. Assume that an investor makes a single purchase of $10,000 of a
Fund's Class B shares and that 16 months later the value of the shares has grown
by $1,000 through reinvested dividends and by an additional $1,000 in
appreciation to a total of $12,000. If the investor were then to redeem the
entire $12,000 in share value, the contingent deferred sales charge would be
payable only with respect to $10,000 because neither the $1,000 of reinvested
dividends nor the $1,000 of share appreciation is subject to the charge. The
charge would be at the rate of 3% ($300) because it was in the second year after
the purchase was made.
The rate of the contingent deferred sales charge under the schedule above is
determined by the length of the period of ownership. Investments are tracked on
a monthly basis. The period of ownership for this purpose begins the first day
of the month in which the order for the investment is received. For example, an
investment made in June, 1994 will be eligible for the 3% charge if redeemed on
or after June 1, 1995. In the event no specific order is requested, the
redemption will be made first from Class B shares representing reinvested
dividends and then from the earliest purchase of Class B shares. KDI receives
any contingent deferred sales charge directly.
The contingent deferred sales charge will be waived: (a) in the event of the
total disability (as evidenced by a determination by the federal Social Security
Administration) of the shareholder (including a registered joint owner)
occurring after the purchase of the shares being redeemed, (b) in the event of
the death of the shareholder (including a registered joint owner), (c) for
redemptions made pursuant to a systematic withdrawal plan (see "Special
Features--Systematic Withdrawal Plan" below) and (d) for redemptions made
pursuant to any IRA systematic withdrawal based on the shareholder's life
expectancy including, but not limited to, substantially equal
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<PAGE> 50
periodic payments described in Internal Revenue Code Section 72(t)(2)(A)(iv)
prior to age 59 1/2; and (e) for redemptions to satisfy required minimum
distributions after age 70 1/2 from an IRA account (with the maximum amount
subject to this waiver being based only upon the shareholder's Kemper IRA
accounts). The contingent deferred sales charge will also be waived in
connection with the following redemptions of shares held by employer sponsored
employee benefit plans maintained on the subaccount record keeping system made
available by the Shareholder Service Agent: (a) redemptions to satisfy
participant loan advances (note that loan repayments constitute new purchases
for purposes of the contingent deferred sales charge and the conversion
privilege), (b) redemptions in connection with retirement distributions (limited
at any one time to 10% of the total value of plan assets invested in a Fund),
(c) redemptions in connection with distributions qualifying under the hardship
provisions of the Internal Revenue Code and (d) redemptions representing returns
of excess contributions to such plans.
REINVESTMENT PRIVILEGE. A shareholder who has redeemed Class A shares of a Fund
(other than shares of the Cash Reserves Fund purchased directly at net asset
value) or any other Kemper Mutual Fund listed under "Special Features--Class A
Shares--Combined Purchases" may reinvest up to the full amount redeemed at net
asset value at the time of the reinvestment in Class A shares of a Fund or of
the other listed Kemper Mutual Funds. A shareholder of a Fund or other Kemper
Mutual Fund who redeems Class A shares purchased under the Large Order NAV
Purchase Privilege (see "Purchase of Shares") or Class B shares and incurs a
contingent deferred sales charge may reinvest up to the full amount redeemed at
net asset value at the time of the reinvestment in Class A shares or Class B
shares, as the case may be, of a Fund or of other Kemper Mutual Funds. The
amount of any contingent deferred sales charge also will be reinvested. These
reinvested shares will retain their original cost and purchase date for purposes
of the contingent deferred sales charge. Also, a holder of Class B shares who
has redeemed shares may reinvest up to the full amount redeemed, less any
applicable contingent deferred sales charge that may have been imposed upon the
redemption of such shares, at net asset value in Class A shares of a Fund or of
the other Kemper Mutual Funds listed under "Special Features--Class A
Shares--Combined Purchases." Purchases through the reinvestment privilege are
subject to the minimum investment requirements applicable to the shares being
purchased and may only be made for Kemper Funds available for sale in the
shareholder's state of residence as listed under "Special Features--Exchange
Privilege." The reinvestment privilege can be used only once as to any specific
shares and reinvestment must be effected within six months of the redemption. If
a loss is realized on the redemption of a Funds' shares, the reinvestment in the
same Fund may be subject to the "wash sale" rules if made within 30 days of the
redemption, resulting in a postponement of the recognition of such loss for
federal income tax purposes. The reinvestment privilege may be terminated or
modified at any time.
SPECIAL FEATURES
CLASS A SHARES -- COMBINED PURCHASES. Each Fund's Class A shares (or the
equivalent) may be purchased at the rate applicable to the discount bracket
attained by combining concurrent investments in Class A shares of any of the
following funds: Kemper Technology Fund, Kemper Total Return Fund, Kemper Growth
Fund, Kemper Small Capitalization Equity Fund, Kemper Income and Capital
Preservation Fund, Kemper Municipal Bond Fund, Kemper Diversified Income Fund,
Kemper High Yield Fund, Kemper U.S. Government Securities Fund, Kemper
International Fund, Kemper State Tax-Free Income Series, Kemper Adjustable Rate
U.S. Government Fund, Kemper Blue Chip Fund, Kemper Global Income Fund, Kemper
Target Equity Fund (series are subject to a limited offering period), Kemper
Intermediate Municipal Bond Fund, Kemper Cash Reserves Fund, Kemper U.S.
Mortgage Fund, Kemper Short-Intermediate Government Fund, Kemper-Dreman Fund,
Inc. and Kemper Value+Growth Fund ("Kemper Mutual Funds"). Except as noted
below, there is no combined purchase credit for direct purchases of shares of
Kemper Money Market Fund, Cash Equivalent Fund, Tax-Exempt California Money
Market Fund, Cash Account Trust, Tax-Exempt New York Money Market Fund or
Investors Cash Trust ("Money Market Funds"), which are not considered "Kemper
Mutual Funds" for purposes hereof. For purposes of the Combined Purchases
feature described above as well as for the Letter of Intent and Cumulative
Discount features described below, employer sponsored employee benefit plans
using the subaccount record keeping system made available through
49
<PAGE> 51
the Shareholder Service Agent may include: (a) Money Market Funds as "Kemper
Mutual Funds," (b) all classes of shares of any Kemper Mutual Fund, and (c) the
value of any other plan investments, such as guaranteed investment contracts and
employer stock, maintained on such subaccount record keeping system.
CLASS A SHARES -- LETTER OF INTENT. The same reduced sales charges for Class A
shares, as shown in the applicable prospectus, also apply to the aggregate
amount of purchases of such Kemper Mutual Funds listed above made by any
purchaser within a 24-month period under a written Letter of Intent ("Letter")
provided by KDI. The Letter, which imposes no obligation to purchase or sell
additional Class A shares, provides for a price adjustment depending upon the
actual amount purchased within such period. The Letter provides that the first
purchase following execution of the Letter must be at least 5% of the amount of
the intended purchase, and that 5% of the amount of the intended purchase
normally will be held in escrow in the form of shares pending completion of the
intended purchase. If the total investments under the Letter are less than the
intended amount and thereby qualify only for a higher sales charge than actually
paid, the appropriate number of escrowed shares are redeemed and the proceeds
used toward satisfaction of the obligation to pay the increased sales charge.
The Letter for an employer sponsored employee benefit plan maintained on the
subaccount record keeping system available through the Shareholder Service Agent
may have special provisions regarding payment of any increased sales charge
resulting from a failure to complete the intended purchase under the Letter. A
shareholder may include the value (at the maximum offering price) of all shares
of such Kemper Mutual Funds held of record as of the initial purchase date under
the Letter as an "accumulation credit" toward the completion of the Letter, but
no price adjustment will be made on such shares. Only investments in Class A
shares of a Fund are included for this privilege.
CLASS A SHARES -- CUMULATIVE DISCOUNT. Class A shares of a Fund may also be
purchased at the rate applicable to the discount bracket attained by adding to
the cost of shares of a Fund being purchased, the value of all Class A shares of
the above mentioned Kemper Mutual Funds (computed at the maximum offering price
at the time of the purchase for which the discount is applicable) already owned
by the investor.
CLASS A SHARES -- AVAILABILITY OF QUANTITY DISCOUNTS. An investor or the
investor's dealer or other financial services firm must notify the Shareholder
Service Agent or KDI whenever a quantity discount or reduced sales charge is
applicable to a purchase. Upon such notification, the investor will receive the
lowest applicable sales charge. Quantity discounts described above may be
modified or terminated at any time.
EXCHANGE PRIVILEGE. Shareholders of Class A, Class B and Class C shares may
exchange their shares for shares of the corresponding class of other Kemper
Mutual Funds in accordance with the provisions below.
Class A Shares. Class A shares of the Kemper Mutual Funds and shares of the
Money Market Funds listed under "Special Features--Class A Shares--Combined
Purchases" above may be exchanged for each other at their relative net asset
values. Shares of Money Market Funds and the Cash Reserves Fund that were
acquired by purchase (not including shares acquired by dividend reinvestment)
are subject to the applicable sales charge on exchange. Series of Kemper Target
Equity Fund are available on exchange only during the Offering Period for such
series as described in the applicable prospectus. Cash Equivalent Fund,
Tax-Exempt California Money Market Fund, Cash Account Trust, Tax-Exempt New York
Money Market Fund and Investors Cash Trust are available on exchange but only
through a financial services firm having a services agreement with KDI.
Exchanges may only be made for funds that are available for sale in the
shareholder's state of residence. Currently, Tax-Exempt California Money Market
Fund is available for sale only in California and Tax-Exempt New York Money
Market Fund is available for sale only in New York, Connecticut, New Jersey and
Pennsylvania.
Class A shares of a Fund purchased under the Large Order NAV Purchase Privilege
may be exchanged for Class A shares of another Kemper Mutual Fund or a Money
Market Fund under the exchange privilege described above without paying any
contingent deferred sales charge at the time of exchange. If the Class A shares
received on exchange are redeemed thereafter, a contingent deferred sales charge
may be imposed in accordance with the foregoing requirements provided that the
shares redeemed will retain their original cost and purchase date for purposes
of the contingent deferred sales charge.
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<PAGE> 52
Class B Shares. Class B shares of a Fund and Class B shares of any other Kemper
Mutual Fund listed under "Special Features --Class A Shares--Combined Purchases"
may be exchanged for each other at their relative net asset values. Class B
shares may be exchanged without any contingent deferred sales charge being
imposed at the time of exchange. For purposes of the contingent deferred sales
charge that may be imposed upon the redemption of the shares received on
exchange, amounts exchanged retain their original cost and purchase date.
Class C Shares. Class C shares of a Fund and Class C shares of any other Kemper
Mutual Fund listed under "Special Features--Class A Shares--Combined Purchases"
may be exchanged for each other at their relative net asset values.
General. Shares purchased by check or through EXPRESS-Transfer or Bank Direct
Deposit may not be exchanged until they have been owned for at least 15 days. In
addition, shares of a Kemper Mutual Fund (except Kemper Cash Reserves Fund)
acquired by exchange from another Kemper Mutual Fund, or from a Money Market
Fund, may not be exchanged thereafter until they have been owned for 15 days.
The total value of shares being exchanged must at least equal the minimum
investment requirement of the fund into which they are being exchanged.
Exchanges are made based on relative dollar values of the shares involved in the
exchange. There is no service fee for an exchange; however, dealers or other
firms may charge for their services in effecting exchange transactions.
Exchanges will be effected by redemption of shares of the fund held and purchase
of shares of the other fund. For federal income tax purposes, any such exchange
constitutes a sale upon which a gain or loss may be realized, depending upon
whether the value of the shares being exchanged is more or less than the
shareholder's adjusted cost basis of such shares. Shareholders interested in
exercising the exchange privilege may obtain prospectuses of the other funds
from dealers, other firms or KDI. Exchanges may be accomplished by a written
request to Kemper Mutual Funds, Attention: Exchange Department, P.O. Box 419557,
Kansas City, Missouri 64141-6557, or by telephone if the shareholder has given
authorization. Once the authorization is on file, the Shareholder Service Agent
will honor requests by telephone at 1-800-621-1048, subject to the limitations
on liability under "Redemption or Repurchase of Shares -- General." Any share
certificates must be deposited prior to any exchange of such shares. During
periods when it is difficult to contact the Shareholder Service Agent by
telephone, it may be difficult to use the telephone exchange privilege. The
exchange privilege is not a right and may be suspended, terminated or modified
at any time. Except as otherwise permitted by applicable regulations, 60 days'
prior written notice of any termination or material change will be provided.
SYSTEMATIC EXCHANGE PRIVILEGE. The owner of $1,000 or more of any class of the
shares of a Kemper Mutual Fund or Money Market Fund may authorize the automatic
exchange of a specified amount ($100 minimum) of such shares for shares of the
same class of another such Kemper Fund. If selected, exchanges will be made
automatically until the privilege is terminated by the shareholder or the Kemper
Fund. Exchanges are subject to the terms and conditions described above under
"Exchange Privilege" including the $1,000 minimum investment requirement for the
Kemper Fund acquired on exchange. This privilege may not be used for the
exchange of shares held in certificated form.
EXPRESS-TRANSFER. EXPRESS-Transfer permits the transfer of money via the
Automated Clearing House System (minimum $100 and maximum $2,500) from a
shareholder's bank, savings and loan, or credit union account to purchase shares
in a Fund. Shareholders can also redeem shares (minimum $500 and maximum $2,500)
from their Fund account and transfer the proceeds to their bank, savings and
loan, or credit union checking account. By enrolling in EXPRESS-Transfer, the
shareholder authorizes the Shareholder Service Agent to rely upon telephone
instructions from ANY PERSON to transfer the specified amounts between the
shareholder's Fund account and the predesignated bank, savings and loan or
credit union account, subject to the limitations on liability under "Redemption
or Repurchase of Shares -- General." Once enrolled in EXPRESS-Transfer, a
shareholder can initiate a transaction by calling Kemper Shareholder Services
toll free at 1-800-621-1048 Monday through Friday, 8:00 a.m. to 3:00 p.m.
Chicago time. Shareholders may terminate this privilege by sending written
notice to Kemper Service Company, P.O. Box 419415, Kansas City, Missouri
64141-6415. Termination will become effective as soon as the Shareholder Service
Agent has had a reasonable time to act upon the request. EXPRESS-Transfer
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cannot be used with passbook savings accounts or for tax-deferred plans such as
Individual Retirement Accounts ("IRAs").
BANK DIRECT DEPOSIT. A shareholder may purchase additional shares of a Fund
through an automatic investment program. With the Bank Direct Deposit Purchase
Plan, monthly investments are made automatically from the shareholder's account
at a bank, savings and loan or credit union into the shareholder's Fund account.
By enrolling in Bank Direct Deposit, the shareholder authorizes the Fund and its
agents to either draw checks or initiate Automated Clearing House debits against
the designated account at a bank or other financial institution. This privilege
may be selected by completing the appropriate section on the Account Application
or by contacting the Shareholder Service Agent for appropriate forms. A
shareholder may terminate his or her Plan by sending written notice to Kemper
Service Company, P.O. Box 419415, Kansas City, Missouri 64141-6415. Termination
by a shareholder will become effective within thirty days after the Shareholder
Service Agent has received the request. A Fund may immediately terminate a
shareholder's Plan in the event that any item is unpaid by the shareholder's
financial institution. The Funds may terminate or modify this privilege at any
time.
PAYROLL DIRECT DEPOSIT AND GOVERNMENT DIRECT DEPOSIT. A shareholder may invest
in a Fund through Payroll Direct Deposit or Government Direct Deposit. Under
these programs, all or a portion of a shareholder's net pay or government check
is automatically invested in a Fund account each payment period. A shareholder
may terminate participation in these programs by giving written notice to the
shareholder's employer or government agency, as appropriate. (A reasonable time
to act is required.) A Fund is not responsible for the efficiency of the
employer or government agency making the payment or any financial institutions
transmitting payments.
SYSTEMATIC WITHDRAWAL PLAN. The owner of $5,000 or more of a class of a Fund's
shares at the offering price (net asset value plus, in the case of Class A
shares, the initial sales charge) may provide for the payment from the owner's
account of any requested dollar amount to be paid to the owner or a designated
payee monthly, quarterly, semiannually or annually. The $5,000 minimum account
size is not applicable to Individual Retirement Accounts. The minimum periodic
payment is $100. The maximum annual rate at which Class B shares may be redeemed
under a systematic withdrawal plan is 10% of the net asset value of the account.
Shares are redeemed so that the payee will receive payment approximately the
first of the month. Any income and capital gain dividends will be automatically
reinvested at net asset value. A sufficient number of full and fractional shares
will be redeemed to make the designated payment. Depending upon the size of the
payments requested and fluctuations in the net asset value of the shares
redeemed, redemptions for the purpose of making such payments may reduce or even
exhaust the account.
The purchase of Class A shares while participating in a systematic withdrawal
plan will ordinarily be disadvantageous to the investor because the investor
will be paying a sales charge on the purchase of shares at the same time that
the investor is redeeming shares upon which a sales charge may have already been
paid. Therefore, a Fund will not knowingly permit additional investments of less
than $2,000 if the investor is at the same time making systematic withdrawals.
KDI will waive the contingent deferred sales charge on redemptions of Class B
shares made pursuant to a systematic withdrawal plan. The right is reserved to
amend the systematic withdrawal plan on 30 days' notice. The plan may be
terminated at any time by the investor or the Funds.
TAX-SHELTERED RETIREMENT PLANS. The Shareholder Service Agent provides
retirement plan services and documents and KDI can establish investor accounts
in any of the following types of retirement plans:
- - Individual Retirement Accounts ("IRAs") trusteed by IFTC. This includes
Simplified Employee Pension Plan ("SEP") IRA accounts and prototype documents.
- - 403(b)(7) Custodial Accounts also trusteed by IFTC. This type of plan is
available to employees of most non-profit organizations.
- - Prototype money purchase pension and profit-sharing plans may be adopted by
employers. The maximum annual contribution per participant is the lesser of
25% of compensation or $30,000.
Brochures describing the above plans as well as model defined benefit plans,
target benefit plans, 457 plans, 401(k) plans and materials for establishing
them are available from the Shareholder Service Agent upon request. The
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<PAGE> 54
brochures for plans trusteed by IFTC describe the current fees payable to IFTC
for its services as trustee. Investors should consult with their own tax
advisers before establishing a retirement plan.
PERFORMANCE
A Fund may advertise several types of performance information for a class of
shares, including "yield" and, for each Fund except the Cash Reserves Fund,
"average annual total return" and "total return." The Cash Reserves Fund also
may advertise its "effective yield." Performance information will be computed
separately for Class A, Class B and Class C shares. Each of these figures is
based upon historical results and is not representative of the future
performance of any class of a Fund. A Fund with fees or expenses being waived or
absorbed by KFS may also advertise performance information before and after the
effect of the fee waiver or expense absorption.
A Fund's yield is a measure of the net investment income per share earned over a
specific one month or 30-day period (seven-day period for the Cash Reserves
Fund) expressed as a percentage of the maximum offering price of the Fund's
shares at the end of the period. Yield is an annualized figure, which means that
it is assumed that a Fund generates the same level of net investment income over
a one year period. The effective yield for the Cash Reserves Fund is calculated
similarly, but the net investment income earned is assumed to be compounded when
annualized. The Cash Reserves Fund's effective yield will be slightly higher
than its yield due to this compounding. Net investment income is assumed to be
compounded semiannually when it is annualized for Funds other than the Cash
Reserves Fund.
Average annual total return and total return figures measure both the net
investment income generated by, and the effect of any realized and unrealized
appreciation or depreciation of, the underlying investments in a Fund's
portfolio for the period referenced, assuming the reinvestment of all dividends.
Thus, these figures reflect the change in the value of an investment in a Fund
during a specified period. Average annual total return will be quoted for at
least the one, five and ten year periods ending on a recent calendar quarter (or
if such periods have not yet elapsed, at the end of a shorter period
corresponding to the life of the Fund for performance purposes). Average annual
total return figures represent the average annual percentage change over the
period in question. Total return figures represent the aggregate percentage or
dollar value change over the period in question.
A Fund's performance may be compared to that of the Consumer Price Index or
various unmanaged bond indexes including, but not limited to, the Salomon
Brothers High Grade Corporate Bond Index, the Lehman Brothers Adjustable Rate
Index, the Lehman Brothers Aggregate Bond Index, the Lehman Brothers
Government/Corporate Bond Index, the Salomon Brothers Long-Term High Yield
Index, the Salomon Brothers 30 Year GNMA Index and the Merrill Lynch Market
Weighted Index and may also be compared to the performance of other mutual funds
or mutual fund indexes with similar objectives and policies as reported by
independent mutual fund reporting services such as Lipper Analytical Services,
Inc. ("Lipper"). Lipper performance calculations are based upon changes in net
asset value with all dividends reinvested and do not include the effect of any
sales charges.
Information may be quoted from publications such as Morningstar, Inc., The Wall
Street Journal, Money Magazine, Forbes, Barron's, Fortune, The Chicago Tribune,
USA Today, Institutional Investor and Registered Representative. Also, investors
may want to compare the historical returns of various investments, performance
indexes of those investments or economic indicators, including but not limited
to stocks, bonds, certificates of deposit and other bank products, money market
funds and U.S. Treasury obligations. Bank product performance may be based upon,
among other things, the BANK RATE MONITOR National Index(TM) or various
certificate of deposit indexes. Money market fund performance may be based upon,
among other things, the IBC/Donoghue's Money Fund Report(R) or Money Market
Insight(R), reporting services on money market funds. Performance of U.S.
Treasury obligations may be based upon, among other things, various U.S.
Treasury bill indexes. Certain of these alternative investments may offer fixed
rates of return and guaranteed principal and may be insured. Economic indicators
may include, without limitation, indicators of market rate trends and cost of
funds, such as Federal Home Loan Bank Board 11th District Cost of Funds Index
("COFI").
A Fund may depict the historical performance of the securities in which the Fund
may invest over periods reflecting a variety of market or economic conditions
either alone or in comparison with alternative investments, performance
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<PAGE> 55
indexes of those investments or economic indicators. A Fund may also describe
its portfolio holdings and depict its size or relative size compared to other
mutual funds, the number and make-up of its shareholder base and other
descriptive factors concerning the Fund.
The yield or price volatility of a Fund (particularly the Adjustable Rate Fund)
may be compared to various securities, such as U.S. Government Securities, or
indexes, such as the COFI referred to above or the Constant Maturity Treasury
Index ("CMT") published by the Federal Reserve Board. A Fund may include in its
sales literature and shareholder reports a quotation of the current
"distribution rate" for the Fund. Distribution rate is simply a measure of the
level of dividends distributed for a specified period. It differs from yield,
which is a measure of the income actually earned by the Fund's investments, and
from total return, which is a measure of the income actually earned by, plus the
effect of any realized and unrealized appreciation or depreciation of, such
investments during the period. Distribution rate is, therefore, not intended to
be a complete measure of performance. Distribution rate may sometimes be greater
than yield since, for instance, it may include gains from the sale of options or
other short-term and possibly long-term gains (which may be non-recurring) and
may not include the effect of amortization of bond premiums. As reflected under
"Investment Objectives and Policies--Additional Investment Information," option
writing can limit the potential for capital appreciation.
Class A shares of each Fund other than the Cash Reserves Fund are sold at net
asset value plus a maximum sales charge of 4.5% of the offering price (3.5% for
the Adjustable Rate and Short-Intermediate Government Funds). While the maximum
sales charge is normally reflected in a Fund's Class A performance figures,
certain total return calculations may not include such charge and those results
would be reduced if it were included. Class B shares and Class C shares are sold
at net asset value. Redemptions of Class B shares within the first six years
after purchase may be subject to a contingent deferred sales charge that ranges
from 4% during the first year to 0% after six years. Average annual total return
figures do, and total return figures may, include the effect of the contingent
deferred sales charge for the Class B shares that may be imposed at the end of
the period in question. Performance figures for the Class B shares not including
the effect of the applicable contingent deferred sales charge would be reduced
if it were included.
Each Fund's returns and net asset value will fluctuate and shares of a Fund are
redeemable by an investor at the then current net asset value, which may be more
or less than original cost, except that the Cash Reserves Fund seeks to maintain
a net asset value of $1.00 per share. Redemption of Class B shares may be
subject to a contingent deferred sales charge as described above. Additional
information concerning each Fund's performance appears in the Statement of
Additional Information. Additional information about each Fund's performance
also appears in its Annual Report to Shareholders, which is available without
charge from the applicable Fund.
CAPITAL STRUCTURE
The Adjustable Rate, Diversified, Government, High Yield and Income and Capital
Funds are open-end management investment companies, organized as separate
business trusts under the laws of Massachusetts. The Adjustable Rate Fund was
organized as a business trust under the laws of Massachusetts on May 28, 1987.
Prior to January 1, 1992, the Fund was known as "Kemper Enhanced Government
Income Fund." The Diversified Fund was organized as a business trust under the
laws of Massachusetts on October 24, 1985. Effective January 31, 1986, that Fund
pursuant to a reorganization succeeded to the assets and liabilities of Kemper
Option Income Fund, Inc., a Maryland corporation organized in 1977. Prior to
February 1, 1989, the Fund was known as "Kemper Option Income Fund." The
Government Fund was organized as a business trust under the laws of
Massachusetts on October 24, 1985. Effective January 31, 1986, that Fund
pursuant to a reorganization succeeded to the assets and liabilities of Kemper
U.S. Government Securities Fund, Inc., a Maryland corporation (formerly known as
Kemper Fund For Government Guaranteed Securities, Inc.) organized in 1980 as
successor to a Pennsylvania business trust organized in 1977. The High Yield
Fund was organized as a business trust under the laws of Massachusetts on
October 24, 1985. Effective January 31, 1986, that Fund pursuant to a
reorganization succeeded to the assets and liabilities of Kemper High Yield
Fund, Inc., a Maryland corporation organized in 1977. The Income and Capital
Fund was organized as a business trust under the laws of Massachusetts on
October 24, 1985. Effective January 31, 1986, that Fund pursuant to a
reorganization succeeded to
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the assets and liabilities of Kemper Income and Capital Preservation Fund, Inc.,
a Maryland corporation organized in 1972. The Cash Reserves, Mortgage and
Short-Intermediate Government Funds are separate series, or "Portfolios", of
Kemper Portfolios ("KP"), an open-end management investment company organized as
a business trust under the laws of Massachusetts on August 9, 1985. Effective
November 20, 1987, KP pursuant to a reorganization succeeded to the assets and
liabilities of Investment Portfolios, Inc., a Maryland corporation organized on
March 26, 1982. After such reorganization, KP was known as Investment Portfolios
until February 1, 1991, and thereafter until May 28, 1994, as Kemper Investment
Portfolios, when the name of KP became "Kemper Portfolios." Until December 1,
1989, the Mortgage Fund was known as the "Government Plus Portfolio" and prior
to May 28, 1994, the Mortgage Fund was known as the "Government Portfolio."
Prior to May 28, 1994, the Cash Reserves Fund was known as the Money Market
Portfolio, and the Short-Intermediate Government Fund was known as the
Short-Intermediate Government Portfolio.
Each Fund may issue an unlimited number of shares of beneficial interest in one
or more series or "Portfolios," all having no par value, which may be divided by
the Board of Trustees into classes of shares. While only shares of a single
Portfolio are presently being offered by each Fund (other than those Funds that
are Portfolios of Kemper Portfolios), the Board of Trustees of each Fund may
authorize the issuance of additional classes and additional Portfolios if deemed
desirable, each with its own investment objective, policies and restrictions.
Since the Funds may offer multiple Portfolios, each is known as a "series
company." Shares of a Portfolio have equal noncumulative voting rights and equal
rights with respect to dividends, assets and liquidation of such Portfolio and
are subject to any preferences, rights or privileges of any classes of shares of
the Portfolio. Currently, each Fund offers four classes of shares. These are
Class A, Class B and Class C shares, as well as Class I shares, which are
available for purchase exclusively by the following investors: (a) tax-exempt
retirement plans of KFS and its affiliates; and (b) the following investment
advisory clients of KFS and its investment advisory affiliates that invest at
least $1 million in a Fund: (1) unaffiliated benefit plans, such as qualified
retirement plans (other than individual retirement accounts and self-directed
retirement plans); (2) unaffiliated banks and insurance companies purchasing for
their own accounts; and (3) endowment funds of unaffiliated non-profit
organizations. Shares of each Fund have equal noncumulative voting rights except
that Class B and Class C shares have separate and exclusive voting rights with
respect to each Fund's Rule 12b-1 Plan. Shares of each class also have equal
rights with respect to dividends, assets and liquidation of such Fund subject to
any preferences (such as resulting from different Rule 12b-1 distribution fees),
rights or privileges of any classes of shares of a Fund. Shares of each Fund are
fully paid and nonassessable when issued, are transferable without restriction
and have no preemptive or conversion rights. The Funds are not required to hold
annual shareholder meetings and do not intend to do so. However, they will hold
special meetings as required or deemed desirable for such purposes as electing
trustees, changing fundamental policies or approving an investment management
agreement. Subject to the Agreement and Declaration of Trust of each Fund,
shareholders may remove trustees. If shares of more than one Portfolio for any
Fund are outstanding, shareholders will vote by Portfolio and not in the
aggregate or by class except when voting in the aggregate is required under the
1940 Act, such as for the election of trustees, or when voting by class is
appropriate.
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APPENDIX A--PORTFOLIO COMPOSITION OF HIGH YIELD BONDS
The table below reflects the composition by quality rating of the portfolios of
the Diversified and High Yield Funds. Percentages for each Fund reflect the net
asset weighted average of the percentage for each category on the last day of
each month in the twelve month period ended October 31, 1995. The table reflects
the percentage of total net assets represented by fixed income securities rated
by Moody's Investors Service, Inc. ("Moody's") or Standard & Poor's Corporation
("S&P"), by unrated fixed income securities and by other assets. The percentage
shown reflects the higher of the Moody's or S&P rating. U.S. Government
securities, whether or not rated, are reflected as Aaa and AAA (highest
quality). Cash equivalents include money market instruments, repurchase
agreements, net payables and receivables, treasuries with a maturity of less
than one year and cash. Other assets include options, financial futures
contracts and equity securities. As noted under "Investment Objectives, Policies
and Risk Factors" the Diversified and High Yield Funds invest in high yielding,
fixed income securities without relying upon published ratings. The allocations
in the table are not necessarily representative of the composition of the
portfolios at other times. Portfolio composition will change over time.
END OF THE MONTH COMPOSITION OF PORTFOLIO BY QUALITY AS AN AVERAGE PERCENTAGE OF
NET ASSETS (NOVEMBER 1, 1994-OCTOBER 31, 1995)
<TABLE>
<CAPTION>
HIGH
MOODY'S/S&P RATING DIVERSIFIED YIELD GENERAL DEFINITION OF
CATEGORY FUND FUND BOND QUALITY
- ------------------------------- ---- ---- -----------------------------
<S> <C> <C> <C>
Cash Equivalents............... 12% 6%
Aaa/AAA........................ 44 2 Highest quality
Aa/AA.......................... 1 0 High quality
A/A............................ 0 0 Upper medium grade
Baa/BBB........................ 3 0 Medium grade
Ba/BB.......................... 11 21 Some speculative elements
B/B............................ 18 60 Speculative
Caa/CCC........................ 2 6 More speculative
Ca/CC, C/C..................... 0 0 Very speculative
D.............................. 0 0 In default
Not Rated, Not in Default...... 6 1
Not Rated, In Default.......... 1 1
Other Assets................... 2 3
---- ----
Net Assets..................... 100% 100%
</TABLE>
The description of each bond quality category set forth in the table above is
intended to be a general guide and not a definitive statement as to how Moody's
and S&P define such rating category. A more complete description of the rating
categories is set forth under "Appendix B--Ratings of Investments." The ratings
of Moody's and S&P represent their opinions as to the quality of the securities
that they undertake to rate. It should be emphasized, however, that ratings are
relative and subjective and are not absolute standards of quality.
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APPENDIX B--RATINGS OF INVESTMENTS
COMMERCIAL PAPER RATINGS
Commercial paper rated by Standard & Poor's Corporation ("S&P") has the
following characteristics: Liquidity ratios are adequate to meet cash
requirements. Long-term senior debt is rated "A" or better. The issuer has
access to at least two additional channels of borrowing. Basic earnings and cash
flow have an upward trend with allowance made for unusual circumstances.
Typically, the issuer's industry is well established and the issuer has a strong
position within the industry. The reliability and quality of management are
unquestioned. Relative strength or weakness of the above factors determine
whether the issuer's commercial paper is rated A-1 or A-2.
The ratings Prime-1 and Prime-2 are the two highest commercial paper ratings
assigned by Moody's Investors Service, Inc. ("Moody's"). Among the factors
considered by it in assigning ratings are the following: (1) evaluation of the
management of the issuer; (2) economic evaluation of the issuer's industry or
industries and an appraisal of speculative-type risks which may be inherent in
certain areas; (3) evaluation of the issuer's products in relation to
competition and customer acceptance; (4) liquidity; (5) amount and quality of
long-term debt; (6) trend of earnings over a period of ten years; (7) financial
strength of a parent company and the relationships which exist with the issuer;
and (8) recognition by the management of obligations which may be present or may
arise as a result of public interest questions and preparations to meet such
obligations. Relative strength or weakness of the above factors determines
whether the issuer's commercial paper is rated Prime-1 or 2.
CORPORATE BONDS
STANDARD & POOR'S CORPORATION BOND RATINGS
AAA. Debt rated AAA has the highest rating assigned by S&P. Capacity to pay
interest and repay principal is extremely strong.
AA. Debt rated AA has a very strong capacity to pay interest and repay principal
and differs from the higher rated issues only in small degree.
A. Debt rated A has a strong capacity to pay interest and repay principal
although it is somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions than debt in higher rated categories.
BBB. Debt rated BBB is regarded as having an adequate capacity to pay interest
and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than in higher rated categories.
BB, B, CCC, CC, C. Debt rated BB, B, CCC, CC and C is regarded, on balance, as
predominantly speculative with respect to capacity to pay interest and repay
principal in accordance with the terms of the obligation. BB indicates the
lowest degree of speculation and C the highest degree of speculation. While such
debt will likely have some quality and protective characteristics, these are
outweighed by large uncertainties or major risk exposures to adverse conditions.
CI. The rating CI is reserved for income bonds on which no interest is being
paid.
D. Debt rated D is in default, and payment of interest and/or repayment of
principal is in arrears.
MOODY'S INVESTORS SERVICE, INC. BOND RATINGS
AAA. Bonds which are rated Aaa are judged to be of the best quality. They carry
the smallest degree of investment risk and are generally referred to as
"gilt-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
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<PAGE> 59
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 as medium grade obligations, i.e.,
they are neither highly protected nor poorly secured. Interest payments and
principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
BA. Bonds which are rated Ba are judged to have speculative elements; their
future cannot be considered as well assured. Often the protection of interest
and principal payments may be very moderate and thereby not well safeguarded
during both good and bad times over the future. Uncertainty of position
characterizes bonds in this class.
B. Bonds which are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
CAA. Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to principal or
interest.
CA. Bonds which are rated Ca represent obligations which are speculative in a
high degree. Such issues are often in default or have other marked shortcomings.
C. Bonds which are rated C are the lowest rated class of bonds and issues so
rated can be regarded as having extremely poor prospects of ever attaining any
real investment standing.
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PROSPECTUS
KEMPER FIXED
INCOME FUNDS
DECEMBER 1, 1995
--------------
KEMPER ADJUSTABLE RATE
U.S. GOVERNMENT FUND
KEMPER CASH RESERVES FUND
KEMPER DIVERSIFIED INCOME FUND
KEMPER U.S. GOVERNMENT
SECURITIES FUND
KEMPER HIGH YIELD FUND
KEMPER INCOME AND CAPITAL
PRESERVATION FUND
KEMPER U.S. MORTGAGE FUND
KEMPER SHORT-INTERMEDIATE
GOVERNMENT FUND
--------------
KEMPER
[KEMPER LOGO]
[KEMPER LOGO] INVESTMENT MANAGER
Kemper Financial Services, Inc.
PRINCIPAL UNDERWRITER:
Kemper Distributors, Inc.
120 South LaSalle Street
Chicago, IL 60603
KFIF-1 (12/95) [RECYCLED PAPER LOGO]
