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NORTHERN INSTITUTIONAL FUNDS
Fixed Income and Equity Portfolios
Supplement dated August 15, 2000
To Prospectus dated April 1, 2000
The name of Northern Trust Quantitative Advisors, Inc. was changed to
Northern Trust Investments, Inc. on May 1, 2000.
The following replaces the fourth paragraph under "Portfolio Management" on
page 53:
The management team leaders for the International Growth Portfolio are
Robert A. LaFleur, Senior Vice President of Northern, and Andrew Parry, Vice
President of Northern and Chief Investment Officer (Equities) of Northern Trust
Global Investments (Europe) Ltd. Mr. LaFleur has had such responsibility since
1994. Mr. LaFleur joined Northern in 1982 and during the past five years has
managed various international equity portfolios. Mr. Parry has had such
responsibility since August 14, 2000, when he joined Northern. Mr. Parry was
the head of global equities for Julius Baer from 1997 to July 2000. From 1995
to 1997, he was the chief investment officer for Lazard Brothers Asset
Management.
The following replaces the ninth paragraph under "Portfolio Management" on
page 53:
The management team leaders for the Balanced Portfolio are John J. Zielinski
and Eric M. Bergson, Vice President of Northern. Mr. Zielinski has had such
responsibility since 1999. Mr. Bergson has had such responsibility since August
2000. Mr. Bergson joined Northern in 1986 and during the past five years has
managed various fixed income portfolios.
The following replaces the section under "Additional Description of
Securities and Common Investment Techniques--Interest Rate Swaps, Floors and
Caps and Currency Swaps" on page 75:
Interest Rate Swaps, Currency Swaps, Total Rate of Return Swaps, Credit
Swaps, and Interest Rate Floors, Caps and Collars. Interest rate and currency
swaps are contracts that obligate a Portfolio and another party to exchange
their rights to pay or receive interest or specified amounts of currency,
respectively. Interest rate floors entitle the purchasers to receive interest
payments if a specified index falls below a predetermined interest rate.
Interest rate caps entitle the purchasers to receive interest payments if a
specified index exceeds a predetermined interest rate. An interest rate collar
is a combination of a cap and a floor that preserves a certain return within a
predetermined range of interest rates. Total rate of return swaps are contracts
that obligate a party to pay or receive interest in exchange for the payment by
the other party of the total return generated by a security, a basket of
securities, an index or an index component. Credit swaps are contracts
involving the receipt of floating or fixed rate payments in exchange for
assuming potential credit losses of an underlying security. Credit swaps give
one party to a transaction the right to dispose of or acquire an asset (or
group of assets), or the right to receive or make a payment from the other
party, upon the occurrence of specific credit events.
Investment strategy. The Portfolios may enter into swap transactions and
transactions involving interest rate floors, caps and collars for hedging
purposes or to seek to increase total return.
Special risks. The use of swaps and interest rate floors, caps and
collars is a highly specialized activity which involves investment
techniques and risks different from those associated with ordinary
portfolio securities transactions. Like other derivative securities, the
instruments can be highly volatile. If the Investment Adviser is incorrect
in its forecasts of market values, interest rates and currency exchange
rates, the investment performance of a Portfolio would be less favorable
than it would have been if these instruments were not used. Because these
instruments are normally illiquid, a Portfolio may not be able to terminate
its obligations when desired. In addition, if a Portfolio is obligated to
pay the return under the terms of a total rate of return swap, Portfolio
losses due to unanticipated market movements are potentially unlimited. A
Portfolio may also suffer a loss if the other party to a transaction
defaults.
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PART B
STATEMENT OF ADDITIONAL INFORMATION
NORTHERN INSTITUTIONAL FUNDS
U.S. GOVERNMENT SECURITIES PORTFOLIO
SHORT-INTERMEDIATE BOND PORTFOLIO
INTERMEDIATE BOND PORTFOLIO
U.S. TREASURY INDEX PORTFOLIO
BOND PORTFOLIO
INTERNATIONAL BOND PORTFOLIO
This Statement of Additional Information dated April 1, 2000, revised as of
August 15, 2000 (the "Additional Statement") is not a prospectus. Copies of the
prospectus dated April 1, 2000 for the U.S. Government Securities, Short-
Intermediate Bond, Intermediate Bond, U.S. Treasury Index, Bond, and
International Bond Portfolios (the "Portfolios") of Northern Institutional Funds
(the "Prospectus") may be obtained without charge by calling 1-800-637-1380
(toll-free). Capitalized terms not otherwise defined have the same meaning as in
the Prospectus.
The audited financial statements and related report of Ernst & Young LLP,
independent auditors, contained in the annual report to the Portfolios'
shareholders for the fiscal year ended November 30, 1999 are incorporated herein
by reference in the section entitled "Financial Statements." No other parts of
the annual report are incorporated herein by reference. Copies of the annual
report may be obtained upon request and without charge by calling 1-800-637-1380
(toll-free).
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<TABLE>
<CAPTION>
INDEX
Page
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<S> <C>
ADDITIONAL INVESTMENT INFORMATION...................... 3
Classification and History......................... 3
Investment Objectives, Strategies and Risks........ 3
Investment Restrictions............................ 14
ADDITIONAL TRUST INFORMATION........................... 16
Trustees and Officers.............................. 16
Investment Advisers, Transfer Agent and Custodian.. 21
Portfolio Transactions............................. 24
Portfolio Valuation................................ 25
Co-Administrators and Distributor.................. 25
Shareholder Servicing Plan......................... 28
Counsel and Auditors............................... 30
In-Kind Purchases and Redemptions.................. 30
PERFORMANCE INFORMATION................................ 30
TAXES.................................................. 37
Federal - General Information...................... 37
Foreign Investors.................................. 38
DESCRIPTION OF SHARES.................................. 38
OTHER INFORMATION...................................... 42
FINANCIAL STATEMENTS................................... 43
APPENDIX A............................................. A-1
APPENDIX B............................................. B-1
</TABLE>
No person has been authorized to give any information or to make any
representations not contained in this Additional Statement or in the Prospectus
in connection with the offering made by the Prospectus and, if given or made,
such information or representations must not be relied upon as having been
authorized by the Trust or its distributor. The Prospectus does not constitute
an offering by the Trust or by the distributor in any jurisdiction in which such
offering may not lawfully be made.
An investment in a Portfolio is not a deposit of any bank and is not insured or
guaranteed by the Federal Deposit Insurance Corporation or any other government
agency. An investment in a Portfolio involves investment risks, including
possible loss of principal.
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ADDITIONAL INVESTMENT INFORMATION
Classification and History
Northern Institutional Funds (the "Trust") is an open-end, management
investment company. Each Portfolio (other than the International Bond Portfolio)
is classified as diversified under the Investment Company Act of 1940, as
amended (the "1940 Act"). The International Bond Portfolio is classified as non-
diversified under the 1940 Act.
Each Portfolio is a series of the Trust, which was formed as a Delaware
business trust on July 1, 1997 under an Agreement and Declaration of Trust (the
"Trust Agreement"). The Trust is the result of a reorganization of a
Massachusetts business trust formerly known as The Benchmark Funds on March 31,
1998. The Trust's name was changed from The Benchmark Funds to the Northern
Institutional Funds on July 15, 1998. The Trust also offers five money market,
one balanced, and nine equity portfolios, which are not described in this
document.
Investment Objectives, Strategies and Risks
The following supplements the investment objectives, strategies and risks
of the Portfolios as set forth in the Prospectus. The investment objective of
the Intermediate Bond Portfolio may be changed without shareholder approval. The
investment objective of each other Portfolio may not be changed without the vote
of the majority of the Portfolio's outstanding shares. Except as expressly noted
below, however, each Portfolio's investment policies may be changed without
shareholder approval.
U.S. Government Obligations. Examples of the types of U.S. Government
---------------------------
obligations that may be acquired by the Portfolios include U.S. Treasury Bills,
Treasury Notes and Treasury Bonds and the obligations of Federal Home Loan
Banks, Federal Farm Credit Banks, Federal Land Banks, the Federal Housing
Administration, Farmers Home Administration, Export-Import Bank of the United
States, Small Business Administration, Federal National Mortgage Association
("FNMA"), Government National Mortgage Association ("GNMA"), General Services
Administration, Central Bank for Cooperatives, Federal Home Loan Mortgage
Corporation ("FHLMC"), Federal Intermediate Credit Banks and the Maritime
Administration.
Securities guaranteed as to principal and interest by the U.S. Government,
its agencies or instrumentalities are also deemed to include (a) securities for
which the payment of principal and interest is backed by an irrevocable letter
of credit issued by the U.S. Government or any agency or instrumentality
thereof, and (b) participations in loans made to foreign governments or their
agencies that are so guaranteed.
To the extent consistent with their respective investment objectives, the
Portfolios may invest in a variety of US. Treasury obligations and obligations
issued by or guaranteed by the U.S. Government or its agencies and
instrumentalities. Not all U.S. Government obligations carry the same credit
support. No assurance can be given that the U.S. Government would provide
financial support to its agencies or instrumentalities if it is not obligated to
do so by law. There is no assurance that these commitments will be undertaken or
complied with in the future. In addition, the secondary market for certain
participations in loans made to foreign governments or their agencies may be
limited.
Supranational Bank Obligations. Each Portfolio (other than the U.S.
-------------------------------
Treasury Index Portfolio) may invest in obligations of supranational banks.
Supranational banks are international banking institutions designed or supported
by national governments to promote economic reconstruction, development or trade
between nations (e.g., the World Bank). Obligations of supranational banks may
be supported by appropriated but unpaid commitments of their member countries
and there is no assurance that these commitments will be undertaken or met in
the future.
Stripped Securities. Each Portfolio may purchase stripped securities. The
--------------------
Treasury Department has facilitated transfers of ownership of zero coupon
securities by accounting separately for the beneficial ownership of particular
interest coupon and principal payments on Treasury securities through the
Federal Reserve book-entry record-keeping system. The Federal Reserve program as
established by the Treasury Department is known as "STRIPS" or "Separate Trading
of Registered Interest and Principal of Securities." Each Portfolio may purchase
securities registered in the STRIPS program. Under the STRIPS program, a
Portfolio will be able to have its beneficial ownership of zero coupon
securities recorded directly in the book-entry record-keeping system in lieu of
having to hold certificates or other evidences of ownership of the underlying
U.S. Treasury securities.
In addition, each Portfolio (other than the U.S. Treasury Index Portfolio)
may acquire U.S. Government obligations
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and their unmatured interest coupons that have been separated ("stripped") by
their holder, typically a custodian bank or investment brokerage firm. Having
separated the interest coupons from the underlying principal of the U.S.
Government obligations, the holder will resell the stripped securities in
custodial receipt programs with a number of different names, including "Treasury
Income Growth Receipts" ("TIGRs") and "Certificate of Accrual on Treasury
Securities" ("CATS"). The stripped coupons are sold separately from the
underlying principal, which is usually sold at a deep discount because the buyer
receives only the right to receive a future fixed payment on the security and
does not receive any rights to periodic interest (cash) payments. The underlying
U.S. Treasury bonds and notes themselves are held in book-entry form at the
Federal Reserve Bank or, in the case of bearer securities (i.e., unregistered
securities which are ostensibly owned by the bearer or holder), in trust on
behalf of the owners. Counsel to the underwriters of these certificates or other
evidences of ownership of U.S. Treasury securities have stated that, in their
opinion, purchasers of the stripped securities most likely will be deemed the
beneficial holders of the underlying U.S. Government obligations for Federal tax
purposes. The Trust is not aware of any binding legislative, judicial or
administrative authority on this issue.
To the extent consistent with its investment objectives, each Portfolio may
purchase stripped mortgage-backed securities ("SMBS"). SMBS are usually
structured with two or more classes that receive different proportions of the
interest and principal distributions from a pool of mortgage-backed obligations.
A common type of SMBS will have one class receiving all of the interest, while
the other class receives all of the principal. However, in some instances, one
class will receive some of the interest and most of the principal while the
other class will receive most of the interest and the remainder of the
principal. If the underlying obligations experience greater than anticipated
prepayments of principal, the Portfolio may fail to fully recoup its initial
investment in these securities. The market value of the class consisting
entirely of principal payments generally is extremely volatile in response to
changes in interest rates. The yields on a class of SMBS that receives all or
most of the interest are generally higher than prevailing market yields on other
mortgage-backed obligations because their cash flow patterns are also volatile
and there is a risk that the initial investment will not be fully recouped. SMBS
issued by the U.S. Government (or a U.S. Government agency or instrumentality)
may be considered liquid under guidelines established by the Trust's Board of
Trustees if they can be disposed of promptly in the ordinary course of business
at a value reasonably close to that used in the calculation of the net asset
value per share.
Asset-Backed Securities. The U.S. Government Securities Portfolio may
------------------------
purchase asset-backed securities that are secured or backed by mortgages and
issued by an agency of the U.S. Government, and the Short-Intermediate Bond,
Bond, Intermediate Bond and International Bond Portfolios may purchase asset-
backed securities, which are securities backed by mortgages, installment
contracts, credit card receivables or other assets. Asset-backed securities
represent interests in "pools" of assets in which payments of both interest and
principal on the securities are made monthly, thus in effect "passing through"
monthly payments made by the individual borrowers on the assets that underlie
the securities, net of any fees paid to the issuer or guarantor of the
securities. The average life of asset-backed securities varies with the
maturities of the underlying instruments, and the average life of a mortgage-
backed instrument, in particular, is likely to be substantially less than the
original maturity of the mortgage pools underlying the securities as a result of
mortgage prepayments. For this and other reasons, an asset-backed security's
stated maturity may be shortened, and the security's total return may be
difficult to predict precisely.
If an asset-backed security is purchased at a premium, a prepayment rate
that is faster than expected will reduce yield to maturity, while a prepayment
rate that is slower than expected will have the opposite effect of increasing
yield to maturity. Conversely, if an asset-backed security is purchased at a
discount, faster than expected prepayments will increase, while slower than
expected prepayments will decrease, yield to maturity. In calculating the
average weighted maturity of the U.S. Government Securities, Short-Intermediate
Bond, Bond, Intermediate Bond and International Bond Portfolios, the maturity of
asset-backed securities will be based on estimates of average life.
Prepayments on asset-backed securities generally increase with falling
interest rates and decrease with rising interest rates; furthermore, prepayment
rates are influenced by a variety of economic and social factors. In general,
the collateral supporting non-mortgage asset-backed securities is of shorter
maturity than mortgage loans and is less likely to experience substantial
prepayments.
Asset-backed securities acquired by a Portfolio may include collateralized
mortgage obligations ("CMOs") issued by private companies. CMOs provide the
holder with a specified interest in the cash flow of a pool of underlying
mortgages or other mortgage-backed securities. Issuers of CMOs ordinarily elect
to be taxed as pass-through entities known as real estate mortgage investment
conduits ("REMICs"). CMOs are issued in multiple classes, each with a specified
fixed or floating interest rate and a final distribution date. The relative
payment rights of the various CMO classes may be structured in a variety of
ways. The Portfolios will not purchase "residual" CMO interests, which normally
exhibit greater price volatility.
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There are a number of important differences among the agencies and
instrumentalities of the U.S. Government that issue mortgage-related securities
and among the securities that they issue. Mortgage-related securities guaranteed
by the Government National Mortgage Association ("GNMA") include GNMA Mortgage
Pass-Through Certificates (also known as "Ginnie Maes") which are guaranteed as
to the timely payment of principal and interest by GNMA and such guarantee is
backed by the full faith and credit of the United States. GNMA is a wholly-owned
U.S. Government corporation within the Department of Housing and Urban
Development. GNMA certificates also are supported by the authority of GNMA to
borrow funds from the U.S. Treasury to make payments under its guarantee.
Mortgage-backed securities issued by the Federal National Mortgage
Association ("FNMA") include FNMA Guaranteed Mortgage Pass-Through Certificates
(also known as "Fannie Maes") which are solely the obligations of the FNMA and
are not backed by or entitled to the full faith and credit of the United States,
but are supported by the right of the issuer to borrow from the U.S. Treasury.
FNMA is a government-sponsored organization owned entirely by private
stockholders. Fannie Maes are guaranteed as to timely payment of the principal
and interest by FNMA. Mortgage-related securities issued by the Federal Home
Loan Mortgage Corporation ("FHLMC") include FHLMC Mortgage Participation
Certificates (also known as "Freddie Macs" or "PCs"). FHLMC is a corporate
instrumentality of the United States, created pursuant to an Act of Congress,
which is owned entirely by Federal Home Loan Banks. Freddie Macs are not
guaranteed by the United States or by any Federal Home Loan Banks and do not
constitute a debt or obligation of the United States or of any Federal Home Loan
Bank. Freddie Macs entitle the holder to timely payment of interest, which is
guaranteed by the FHLMC. The FHLMC guarantees either ultimate collection or
timely payment of all principal payments on the underlying mortgage loans. When
the FHLMC does not guarantee timely payment of principal, the FHLMC may remit
the amount due on account of its guarantee of ultimate payment of principal at
any time after default on an underlying mortgage, but in no event later than one
year after it becomes payable.
Non-mortgage asset-backed securities involve certain risks that are not
presented by mortgage-backed securities. Primarily, these securities do not have
the benefit of the same security interest in the underlying collateral. Credit
card receivables are generally unsecured and the debtors are entitled to the
protection of a number of state and federal consumer credit laws, many of which
have given debtors the right to set off certain amounts owed on the credit
cards, thereby reducing the balance due. Most issuers of automobile receivables
permit the servicers to retain possession of the underlying obligations. If the
servicer were to sell these obligations to another party, there is a risk that
the purchaser would acquire an interest superior to that of the holders of the
related automobile receivables. In addition, because of the large number of
vehicles involved in a typical issuance and technical requirements under state
laws, the trustee for the holders of the automobile receivables may not have an
effective security interest in all of the obligations backing such receivables.
Therefore, there is a possibility that recoveries on repossessed collateral may
not, in some cases, be able to support payments on these securities.
Foreign Securities. Each Portfolio other than the U.S. Government
------------------
Securities and U.S. Treasury Index Portfolios may invest in bonds and other
fixed income securities of foreign issuers. Investment in foreign securities
involves special risks. These include market risk, interest rate risk and the
risks of investing in securities of foreign issuers and of companies whose
securities are principally traded outside the United States and in investments
denominated in foreign currencies. The holdings of the Portfolios will be
sensitive to changes in interest rates and the interest rate environment. In
addition, the performance of investments in securities denominated in a foreign
currency will depend on the strength of the foreign currency against the U.S.
dollar and the interest rate environment in the country issuing the currency.
Absent other events which could otherwise affect the value of a foreign security
(such as a change in the political climate or an issuer's credit quality),
appreciation in the value of the foreign currency generally can be expected to
increase the value of a foreign currency-denominated security in terms of U.S.
dollars. A rise in foreign interest rates or decline in the value of the foreign
currency relative to the U.S. dollar generally can be expected to depress the
value of a foreign currency-denominated security.
There are other risks and costs involved in investing in foreign securities
which are in addition to the usual risks inherent in domestic investments.
Investment in foreign securities involves higher costs than investment in U.S.
securities, including higher transaction and custody costs as well as the
imposition of additional taxes by foreign governments. Foreign investments also
involve risks associated with the level of currency exchange rates, less
complete financial information about the issuers, less market liquidity, more
market volatility and political instability. Future political and economic
developments, the possible imposition of withholding taxes on dividend income,
the possible seizure or nationalization of foreign holdings, the possible
establishment of exchange controls, or the adoption of other governmental
restrictions might adversely affect an investment in foreign securities.
Additionally, foreign banks and foreign branches of domestic banks are subject
to less stringent reserve requirements, and to different accounting, auditing
and recordkeeping requirements.
Although a Portfolio may invest in securities denominated in foreign
currencies, its portfolio securities and other
5
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assets are valued in U.S. dollars. Currency exchange rates may fluctuate
significantly over short periods of time causing, together with other factors, a
Portfolio's net asset value to fluctuate as well. Currency exchange rates can be
affected unpredictably by the intervention or the failure to intervene by U.S.
or foreign governments or central banks, or by currency controls or political
developments in the U.S. or abroad. To the extent that a Portfolio's total
assets, adjusted to reflect a Portfolio's net position after giving effect to
currency transactions, are denominated in the currencies or foreign countries, a
Portfolio will be more susceptible to the risk of adverse economic and political
developments within those countries. A Portfolio is also subject to the possible
imposition of exchange control regulations or freezes on the convertibility of
currency.
Dividends and interest payable on a Portfolio's foreign portfolio
securities may be subject to foreign withholding taxes. To the extent such taxes
are not offset by credits or deductions allowed to investors under U.S. federal
income tax law, they may reduce the net return to the shareholders. See "Taxes."
To the extent consistent with its investment objective, a Portfolio may
also invest in obligations of the International Bank for Reconstruction and
Development (also known as the World Bank) which are supported by subscribed,
but unpaid, commitments of its member countries. There is no assurance that
these commitments will be undertaken or complied with in the future.
Investors should understand that the expense ratio of the International
Bond Portfolio can be expected to be higher than those of Portfolios investing
primarily in domestic securities. The costs attributable to investing abroad are
usually higher for several reasons, such as the higher cost of investment
research, higher cost of custody of foreign securities, higher commissions paid
on comparable transactions on foreign markets and additional costs arising from
delays in settlements of transactions involving foreign securities. Countries in
which the Short-Intermediate Bond, Bond, Intermediate Bond and International
Bond Portfolios may invest include, but are not limited to: Argentina,
Australia, Austria, Belgium, Brazil, Canada, Chile, Colombia, Denmark, Finland,
France, Germany, Greece, Hong Kong, Hungary, Indonesia, Ireland, Israel, Italy,
Japan, Luxembourg, Malaysia, Mexico, the Netherlands, New Zealand, Norway, Peru,
the Philippines, Poland, Portugal, Singapore, South Africa, South Korea, Spain,
Sweden, Switzerland, Taiwan, Thailand, Turkey, the United Kingdom and Venezuela.
The end of the Cold War, the reunification of Germany, the accession of new
Western European members to the European Economic and Monetary Union and the
aspirations of Eastern European states to join and other political and social
events in Europe have caused considerable economic, social and political
dislocation. In addition, events in the Japanese economy, as well as political
and social developments there have affected Japanese securities and currency
markets, and the relationship of the Japanese yen with other currencies and with
the U.S. dollar. Future political, economic and social developments in Japan and
in the Asia/Pacific regional context can be expected to produce continuing
effects on securities and currency markets.
Foreign Currency Transactions. In order to protect against a possible loss
-----------------------------
on investments resulting from a decline or appreciation in the value of a
particular foreign currency against the U.S. dollar or another foreign currency
or for other reasons, the Short-Intermediate Bond, Bond, Intermediate Bond and
International Bond Portfolios are authorized to enter into forward foreign
currency exchange contracts. These contracts involve an obligation to purchase
or sell a specified currency at a future date at a price set at the time of the
contract. Forward currency contracts do not eliminate fluctuations in the values
of portfolio securities but rather allow a Portfolio to establish a rate of
exchange for a future point in time.
When entering into a contract for the purchase or sale of a security, a
Portfolio may enter into a forward foreign currency exchange contract for the
amount of the purchase or sale price to protect against variations, between the
date the security is purchased or sold and the date on which payment is made or
received, in the value of the foreign currency relative to the U.S. dollar or
other foreign currency.
When the investment management team anticipates that a particular foreign
currency may decline substantially relative to the U.S. dollar or other leading
currencies, in order to reduce risk, a Portfolio may enter into a forward
contract to sell, for a fixed amount, the amount of foreign currency
approximating the value of some or all of the Portfolio's securities denominated
in such foreign currency. Similarly, when the obligations held by a Portfolio
create a short position in a foreign currency, the Portfolio may enter into a
forward contract to buy, for a fixed amount, an amount of foreign currency
approximating the short position. A Portfolio's net long and short foreign
currency exposure will not exceed its total asset value. With respect to any
forward foreign currency contract, it will not generally be possible to match
precisely the amount covered by that contract and the value of the securities
involved due to the changes in the values of such securities resulting from
market movements between the date the forward contract is entered into and the
date it matures. In addition, while forward contracts may offer protection from
losses resulting from declines or appreciation in the value of a particular
foreign
6
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currency, they also limit potential gains which might result from changes in the
value of such currency. A Portfolio may also incur costs in connection with
forward foreign currency exchange contracts and conversions of foreign
currencies and U.S. dollars.
In addition, the International Bond Portfolio may purchase or sell forward
foreign currency exchange contracts to seek to increase total return or for
cross-hedging purposes. The Portfolio may engage in cross-hedging by using
forward contracts in one currency to hedge against fluctuations in the value of
securities denominated in a different currency if the investment management team
believes that there is a pattern of correlation between the two currencies.
Liquid assets equal to the amount of a Portfolio's assets that could be
required to consummate forward contracts will be segregated except to the extent
the contracts are otherwise "covered." The segregated assets will be valued at
market or fair value. If the market or fair value of such assets declines,
additional liquid assets will be segregated daily so that the value of the
segregated assets will equal the amount of such commitments by the Portfolio. A
forward contract to sell a foreign currency is "covered" if a Portfolio owns the
currency (or securities denominated in the currency) underlying the contract, or
holds a forward contract (or call option) permitting the Portfolio to buy the
same currency at a price that is (i) no higher than the Portfolio's price to
sell the currency or (ii) greater than the Portfolio's price to sell the
currency provided the Portfolio segregates liquid assets in the amount of the
difference. A forward contract to buy a foreign currency is "covered" if a
Portfolio holds a forward contract (or call option) permitting the Portfolio to
sell the same currency at a price that is (i) as high as or higher than the
Portfolio's price to buy the currency or (ii) lower than the Portfolio's price
to buy the currency provided the Portfolio segregates liquid assets in the
amount of the difference.
Interest Rate Swaps, Currency Swaps, Total Rate of Return Swaps, Credit
-----------------------------------------------------------------------
Swaps, Interest Rate Floors and Caps and Currency Swaps. The Portfolios may
--------------------------------------------------------
enter into swap transactions and transactions involving interest rate floors,
caps and collars for hedging purposes or to seek to increase total return. These
instruments are privately negotiated over-the-counter derivative products. A
great deal of flexibility is possible in the way these instruments are
structured. Interest rate swaps involve the exchange by a Portfolio with another
party of their respective commitments to pay or receive interest, such as an
exchange of fixed rate payments for floating rate payments. The purchase of an
interest rate floor or cap entitles the purchaser to receive payments of
interest on a notional principal amount from the seller, to the extent the
specified index falls below (floor) or exceeds (cap) a predetermined interest
rate. An interest rate collar is a combination of a cap and a floor that
preserves a certain return within a predetermined range of interest rates. Total
rate of return swaps are contracts that obligate a party to pay or receive
interest in exchange for the payment by the other party of the total return
generated by a security, a basket of securities, an index or an index component.
Credit swaps are contracts involving the receipt of floating or fixed rate
payments in exchange for assuming potential credit losses of an underlying
security. Credit swaps give one party to a transaction the right to dispose of
or acquire an asset (or group of assets), or the right to receive or make a
payment from the other party, upon the occurrence of specific credit events. The
Portfolios may also enter into currency swaps, which involve the exchange of the
rights of a Portfolio and another party to make or receive payments in specific
currencies.
Some transactions, such as interest rate swaps and total rate of return
swaps are entered into on a net basis; i.e., the two payment streams are netted
out, with the Portfolio receiving or paying, as the case may be, only the net
amount of the two payments. If the other party to such a transaction defaults, a
Portfolio's risk of loss consists of the net amount of payments that the
Portfolio is contractually entitled to receive, if any. In contrast, other
transactions involve the payment of the gross amount owed. For example, currency
swaps usually involve the delivery of the entire principal amount of one
designated currency in exchange for the other designated currency. Therefore,
the entire principal value of a currency swap is subject to the risk that the
other party to the swap will default on its contractual delivery obligations. To
the extent that the amount payable by a Portfolio under a swap or an interest
rate floor, cap or collar is covered by segregated cash or liquid assets, the
Portfolio and its Investment Adviser believes that transactions do not
constitute senior securities under the 1940 Act and, accordingly, will not treat
them as being subject to a Portfolio's borrowing restrictions.
The Portfolios will not enter into a currency or interest rate swap or
interest rate floor, cap or collar transaction unless the unsecured commercial
paper, senior debt or the claims-paying ability of the other party thereto is
rated either A or A-l or better by Standard & Poor's Ratings Group, Inc. ("S&P")
or Fitch IBCA ("Fitch"), or A or P-1 or better by Moody's Investors Service,
Inc. ("Moody's") or, if unrated by such rating organization, is determined to be
of comparable quality by the Investment Advisers. If there is a default by the
other party to such transaction, a Portfolio will have contractual remedies
pursuant to the agreements related to the transaction. The swap market has grown
substantially in recent years with a large number of banks and investment
banking firms acting both as principals and as agents utilizing standardized
swap documentation. As a result, the swap market has become relatively liquid in
comparison with markets for other similar instruments which are traded in the
interbank market.
The use of interest rate, total rate of return, credit and currency swaps,
as well as interest rate caps, floors and
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collars, is a highly specialized activity which involves investment techniques
and risks different from those associated with ordinary portfolio securities
transactions. If the Investment Adviser is incorrect in its forecasts of market
values, interest rates and currency exchange rates, the investment performance
of a Portfolio would be less favorable than it would have been if this
investment technique were not used.
Options. Each Portfolio may buy put options and buy call options and write
--------
covered call and secured put options. Such options may relate to particular
securities, financial instruments, foreign currencies, foreign or domestic
securities indices or the yield differential between two securities ("yield
curve options") and may or may not be listed on a domestic or foreign securities
exchange (an "Exchange") or issued by the Options Clearing Corporation. A call
option for a particular security or currency gives the purchaser of the option
the right to buy, and a writer the obligation to sell, the underlying security
or currency at the stated exercise price at any time prior to the expiration of
the option, regardless of the market price of the security or currency. The
premium paid to the writer is in consideration for undertaking the obligation
under the option contract. A put option for a particular security or currency
gives the purchaser the right to sell the security or currency at the stated
exercise price to the expiration date of the option, regardless of the market
price of the security or currency. In contrast to an option on a particular
security, an option on an index provides the holder with the right to make or
receive a cash settlement upon exercise of the option. The amount of this
settlement will be equal to the difference between the closing price of the
index at the time of exercise and the exercise price of the option expressed in
dollars, times a specified multiple.
Options trading is a highly specialized activity which entails greater than
ordinary investment risk. Options on particular securities may be more volatile
than the underlying instruments and, therefore, on a percentage basis, an
investment in options may be subject to greater fluctuation than an investment
in the underlying instruments themselves.
The Portfolios will write call options only if they are "covered." In the
case of a call option on a security or currency, the option is "covered" if a
Portfolio owns the security or currency underlying the call or has an absolute
and immediate right to acquire that security or currency without additional cash
consideration (or, if additional cash consideration is required, liquid assets
in such amount are segregated) upon conversion or exchange of other securities
or instruments held by it. For a call option on an index, the option is covered
if a Portfolio maintains with its custodian, a portfolio of securities
substantially replicating the movement of the index, or liquid assets equal to
the contract value. A call option is also covered if a Portfolio holds a call on
the same security, currency or index as the call written where the exercise
price of the call held is (i) equal to or less than the exercise price of the
call written, or (ii) greater than the exercise price of the call written
provided the Portfolio segregates liquid assets in the amount of the difference.
The Portfolios will write put options only if they are "secured" by segregated
liquid assets in an amount not less than the exercise price of the option at all
times during the option period.
With respect to yield curve options, a call (or put) option is covered if a
Portfolio holds another call (or put) option on the spread between the same two
securities and segregates liquid assets sufficient to cover the Portfolio's net
liability under the two options. Therefore, the Portfolio's liability for such a
covered option is generally limited to the difference between the amount of the
Portfolio's liability under the option written by the Portfolio less the value
of the option held by the Portfolio. Yield curve options may also be covered in
such other manner as may be in accordance with the requirements of the
counterparty with which the option is traded and applicable laws and
regulations.
A Portfolio's obligation to sell a security or currency subject to a
covered call option written by it, or to purchase a security or currency subject
to a secured put option written by it, may be terminated prior to the expiration
date of the option by the Portfolio's execution of a closing purchase
transaction, which is effected by purchasing on an exchange an option of the
same series (i.e., same underlying security or currency, exercise price and
expiration date) as the option previously written. Such a purchase does not
result in the ownership of an option. A closing purchase transaction will
ordinarily be effected to realize a profit on an outstanding option, to prevent
an underlying security or currency from being called, to permit the sale of the
underlying security or currency or to permit the writing of a new option
containing different terms on such underlying security. The cost of such a
liquidation purchase plus transaction costs may be greater than the premium
received upon the original option, in which event the Portfolio will have
incurred a loss in the transaction. There is no assurance that a liquid
secondary market will exist for any particular option. An option writer, unable
to effect a closing purchase transaction, will not be able to sell the
underlying security or currency (in the case of a covered call option) or
liquidate the segregated assets (in the case of a secured put option) until the
option expires or the optioned security or currency is delivered upon exercise
with the result that the writer in such circumstances will be subject to the
risk of market decline or appreciation in the security or currency during such
period.
When a Portfolio purchases an option, the premium paid by it is recorded as
an asset of the Portfolio. When the Portfolio writes an option, an amount equal
to the net premium (the premium less the commission) received by the Portfolio
is included in the liability section of the Portfolio's statement of assets and
liabilities as a deferred credit. The amount of this
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asset or deferred credit will be subsequently marked-to-market to reflect the
current value of the option purchased or written. The current value of the
traded option is the last sale price or, in the absence of a sale, the current
bid price. If an option purchased by the Portfolio expires unexercised, the
Portfolio realizes a loss equal to the premium paid. If the Portfolio enters
into a closing sale transaction on an option purchased by it, the Portfolio will
realize a gain if the premium received by the Portfolio on the closing
transaction is more than the premium paid to purchase the option, or a loss if
it is less. If an option written by the Portfolio expires on the stipulated
expiration date or if the Portfolio enters into a closing purchase transaction,
it will realize a gain (or loss if the cost of a closing purchase transaction
exceeds the net premium received when the option is sold) and the deferred
credit related to such option will be eliminated. If an option written by the
Portfolio is exercised, the proceeds of the sale will be increased by the net
premium originally received and the Portfolio will realize a gain or loss.
There are several risks associated with transactions in certain options.
For example, there are significant differences between the securities, currency
and options markets that could result in an imperfect correlation between these
markets, causing a given transaction not to achieve its objectives. In addition,
a liquid secondary market for particular options, whether traded over-the-
counter or on a national securities exchange (an "Exchange"), may be absent for
reasons which include the following: there may be insufficient trading interest
in certain options; restrictions may be imposed by an Exchange on opening
transactions or closing transactions or both; trading halts, suspensions or
other restrictions may be imposed with respect to particular classes or series
of options or underlying securities or currencies; unusual or unforeseen
circumstances may interrupt normal operations on an Exchange; the facilities of
an Exchange or the Options Clearing Corporation may not at all times be adequate
to handle current trading value; or one or more Exchanges could, for economic or
other reasons, decide or be compelled at some future date to discontinue the
trading of options (or a particular class or series of options), in which event
the secondary market on that Exchange (or in that class or series of options)
would cease to exist, although outstanding options that had been issued by the
Options Clearing Corporation as a result of trades on that Exchange would
continue to be exercisable in accordance with their terms.
Futures Contracts and Related Options. Each Portfolio may invest in
--------------------------------------
futures contracts and interest rate futures contracts and may purchase and sell
call and put options on futures contracts for hedging purposes, for speculative
purposes (to seek to increase total return), or for liquidity management
purposes. When used as a hedge, a Portfolio may sell a futures contract in order
to offset a decrease in the market value of its portfolio securities that might
otherwise result from a market decline or currency exchange fluctuations. A
Portfolio may do so either to hedge the value of its portfolio of securities as
a whole, or to protect against declines, occurring prior to sales of securities,
in the value of the securities to be sold. Conversely, a Portfolio may purchase
a futures contract as a hedge in anticipation of purchases of securities. In
addition, a Portfolio may utilize futures contracts in anticipation of changes
in the composition of its portfolio holdings. For a detailed description of
futures contracts and related options, see Appendix B to this Additional
Statement.
Securities Lending. Collateral for loans of portfolio securities made by a
-------------------
Portfolio may consist of cash, cash equivalents, securities issued or guaranteed
by the U.S. Government or its agencies or irrevocable bank letters of credit (or
any combination thereof). The borrower of securities will be required to
maintain the market value of the collateral at not less than the market value of
the loaned securities, and such value will be monitored on a daily basis. When a
Portfolio lends its securities, it continues to receive dividends and interest
on the securities loaned and may simultaneously earn interest on the investment
of the cash collateral. Although voting rights, or rights to consent, attendant
to securities on loan pass to the borrower, such loans will be called so that
the securities may be voted by a Portfolio if a material event affecting the
investment is to occur.
Forward Commitments, When-Issued Securities and Delayed Delivery
----------------------------------------------------------------
Transactions. Each Portfolio may purchase securities on a when-issued basis or
-------------
purchase or sell securities on a forward commitment (sometimes called delayed
delivery) basis. These transactions involve a commitment by the Portfolio to
purchase or sell securities at a future date. The price of the underlying
securities (usually expressed in terms of yield) and the date when the
securities will be delivered and paid for (the settlement date) are fixed at the
time the transaction is negotiated. When-issued purchases and forward commitment
transactions are normally negotiated directly with the other party.
A Portfolio will purchase securities on a when-issued basis or purchase or
sell securities on a forward commitment basis only with the intention of
completing the transaction and actually purchasing or selling the securities. If
deemed advisable as a matter of investment strategy, however, a Portfolio may
dispose of or negotiate a commitment after entering into it. A Portfolio also
may sell securities it has committed to purchase before those securities are
delivered to the Portfolio on the settlement date. The Portfolio may realize a
capital gain or loss in connection with these transactions.
When a Portfolio purchases securities on a when-issued or forward
commitment basis, the Portfolio will segregate liquid assets having a value
(determined daily) at least equal to the amount of the Portfolio's purchase
commitments until three days prior to the settlement date, or otherwise cover
its position. These procedures are designed to ensure that the
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<PAGE>
Portfolio will maintain sufficient assets at all times to cover its obligations
under when-issued purchases, forward commitments and delayed-delivery
transactions. For purposes of determining a Portfolio's average dollar-weighted
maturity, the maturity of when-issued or forward commitment securities will be
calculated from the commitment date.
Commercial Paper, Bankers' Acceptances, Certificates of Deposit, Time
---------------------------------------------------------------------
Deposits and Bank Notes. Commercial paper represents short-term unsecured
------------------------
promissory notes issued in bearer form by banks or bank holding companies,
corporations and finance companies. Certificates of deposit are negotiable
certificates issued against funds deposited in a commercial bank for a definite
period of time and earning a specified return. Bankers' acceptances are
negotiable drafts or bills of exchange, normally drawn by an importer or
exporter to pay for specific merchandise, which are "accepted" by a bank,
meaning, in effect, that the bank unconditionally agrees to pay the face value
of the instrument on maturity. Fixed time deposits are bank obligations payable
at a stated maturity date and bearing interest at a fixed rate. Fixed time
deposits may be withdrawn on demand by the investor, but may be subject to early
withdrawal penalties that vary depending upon market conditions and the
remaining maturity of the obligation. There are no contractual restrictions on
the right to transfer a beneficial interest in a fixed time deposit to a third
party. Bank notes rank junior to deposit liabilities of banks and pari passu
----------
with other senior, unsecured obligations of the bank. Bank notes are classified
as "other borrowings" on a bank's balance sheet, while deposit notes and
certificates of deposit are classified as deposits. Bank notes are not insured
by the Federal Deposit Insurance Corporation or any other insurer. Deposit notes
are insured by the Federal Deposit Insurance Corporation only to the extent of
$100,000 per depositor per bank.
A Portfolio may invest a portion of its assets in the obligations of
foreign banks and foreign branches of domestic banks. Such obligations include
Eurodollar Certificates of Deposit ("ECDs") which are U.S. dollar-denominated
certificates of deposit issued by offices of foreign and domestic banks located
outside the United States; Eurodollar Time Deposits ("ETDs") which are U.S.
dollar-denominated deposits in a foreign branch of a U.S. bank or a foreign
bank; Canadian Time Deposits ("CTDs") which are essentially the same as ETDs
except they are issued by Canadian offices of major Canadian banks; Schedule Bs,
which are obligations issued by Canadian branches of foreign or domestic banks;
Yankee Certificates of Deposit ("Yankee CDs") which are U.S. dollar-denominated
certificates of deposit issued by a U.S. branch of a foreign bank and held in
the United States; and Yankee Bankers' Acceptances ("Yankee BAs") which are U.S.
dollar-denominated bankers' acceptances issued by a U.S. branch of a foreign
bank and held in the United States.
Commercial paper and other short-term obligations acquired by a Portfolio
will be rated A-2 or higher by S&P, P-2 or higher by Moody's, or F-2 or higher
by Fitch at the time of purchase or, if unrated, determined to be of comparable
quality by the Investment Advisers.
Insurance Funding Agreements. The Short-Intermediate Bond, Bond and
-----------------------------
Intermediate Bond Portfolios may invest in insurance funding agreements
("IFAs"). An IFA is normally a general obligation of the issuing insurance
company and not a separate account. The purchase price paid for an IFA becomes
part of the general assets of the insurance company, and the contract is paid
from the company's general assets. Generally, IFAs are not assignable or
transferable without the permission of the issuing insurance companies, and an
active secondary market in IFAs may not exist.
Zero Coupon, Pay-in-Kind and Capital Appreciation Bonds. To the extent
--------------------------------------------------------
consistent with their respective investment objectives, each Portfolio may
invest in zero coupon bonds, capital appreciation bonds and pay-in-kind ("PIK")
securities. Zero coupon and capital appreciation bonds are debt securities
issued or sold at a discount from their face value and which do not entitle the
holder to any periodic payment of interest prior to maturity or a specified
date. The original issue discount varies depending on the time remaining until
maturity or cash payment date, prevailing interest rates, the liquidity of the
security and the perceived credit quality of the issuer. These securities also
may take the form of debt securities that have been stripped of their unmatured
interest coupons, the coupons themselves or receipts or certificates
representing interests in such stripped debt obligations or coupons. The market
prices of zero coupon bonds, capital appreciation bonds and PIK securities
generally are more volatile than the market prices of interest bearing
securities and are likely to respond to a greater degree to changes in interest
rates than interest bearing securities having similar maturities and credit
quality.
PIK securities may be debt obligations or preferred shares that provide the
issuer with the option of paying interest or dividends on such obligations in
cash or in the form of additional securities rather than cash. Similar to zero
coupon bonds, PIK securities are designed to give an issuer flexibility in
managing cash flow. PIK securities that are debt securities can either be senior
or subordinated debt and generally trade flat (i.e., without accrued interest).
The trading price of PIK debt securities generally reflects the market value of
the underlying debt plus an amount representing accrued interest since the last
interest payment.
Zero coupon bonds, capital appreciation bonds and PIK securities involve
the additional risk that, unlike securities that periodically pay interest to
maturity, a Portfolio will realize no cash until a specified future payment date
unless a
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<PAGE>
portion of such securities is sold and, if the issuer of such securities
defaults, a Portfolio may obtain no return at all on its investment. In
addition, even though such securities do not provide for the payment of current
interest in cash, the Portfolios are nonetheless required to accrue income on
such investments for each taxable year and generally are required to distribute
such accrued amounts (net of deductible expenses, if any) to avoid being subject
to tax. Because no cash is generally received at the time of the accrual, a
Portfolio may be required to liquidate other portfolio securities to obtain
sufficient cash to satisfy Federal tax distribution requirements applicable to
the Portfolio.
Variable and Floating Rate Instruments. With respect to the variable and
--------------------------------------
floating rate instruments that may be acquired by the Portfolios, the investment
management team will consider the earning power, cash flows and other liquidity
ratios of the issuers and guarantors of such instruments and, if the instruments
are subject to demand features, will monitor their financial status and ability
to meet payment on demand. Where necessary to ensure that a variable or floating
rate instrument meets the Portfolios' quality requirements, the issuer's
obligation to pay the principal of the instrument will be backed by an
unconditional bank letter or line of credit, guarantee or commitment to lend.
Variable and floating rate instruments eligible for purchase by the
Portfolios include variable amount master demand notes, which permit the
indebtedness thereunder to vary in addition to providing for periodic
adjustments in the interest rate, and leveraged inverse floating rate debt
instruments ("inverse floaters"). The interest rate on an inverse floater resets
in the opposite direction from the market rate of interest to which the inverse
floater is indexed. An inverse floater may be considered to be leveraged to the
extent that its interest rate varies by a magnitude that exceeds the magnitude
of the change in the index rate of interest. The higher degree of leverage
inherent in inverse floaters is associated with greater volatility in their
market values. Accordingly, the duration of an inverse floater may exceed its
stated final maturity. The Portfolios may deem the maturity of variable and
floating rate instruments to be less than their stated maturities based on their
variable and floating rate features and/or their put features. Unrated variable
and floating rate instruments will be determined by Northern and Northern Trust
Quantitative Advisors, Inc. ("NTQA" and collectively with Northern, the
"Investment Advisers") to be of comparable quality at the time of purchase to
rated instruments which may be purchased by the Portfolios.
Variable and floating rate instruments including inverse floaters held by a
Portfolio will be subject to the Portfolio's 15% limitation on illiquid
investments when the Portfolio may not demand payment of the principal amount
within seven days absent a reliable trading market.
Investment Companies. With respect to the investments of the Portfolios in
---------------------
the securities of other investment companies, such investments will be limited
so that, as determined after a purchase is made, either (a) not more than 3% of
the total outstanding stock of such investment company will be owned by a
Portfolio, the Trust as a whole and their affiliated persons (as defined in the
1940 Act); or (b)(i) not more than 5% of the value of the total assets of a
Portfolio will be invested in the securities of any one investment company, (ii)
not more than 10% of the value of its total assets will be invested in the
aggregate in securities of investment companies as a group, and (iii) not more
than 3% of the outstanding voting stock of any one investment company will be
owned by the Portfolio.
Certain investment companies whose securities are purchased by the
Portfolios may not be obligated to redeem such securities in an amount exceeding
1% of the investment company's total outstanding securities during any period of
less than 30 days. Therefore, such securities that exceed this amount may be
illiquid.
If required by the 1940 Act, each Portfolio expects to vote the shares of
other investment companies that are held by it in the same proportion as the
vote of all other holders of such securities.
A Portfolio may invest all or substantially all of its assets in a single
open-end investment company or series thereof with substantially the same
investment objective, policies and restrictions as the Portfolio. However, each
Portfolio currently intends to limit its investments in securities issued by
other investment companies to the extent described above. A Portfolio may adhere
to more restrictive limitations with respect to its investments in securities
issued by other investment companies if required by the SEC or deemed to be in
the best interests of the Trust.
Repurchase Agreements. Each Portfolio may agree to purchase portfolio
----------------------
securities from financial institutions subject to the seller's agreement to
repurchase them at a mutually agreed upon date and price ("repurchase
agreements"). Repurchase agreements are considered loans under the 1940 Act.
Securities subject to repurchase agreements are held either by the Trust's
custodian (or subcustodian, if any), or in the Federal Reserve/Treasury Book-
Entry System. The seller under a repurchase agreement will be required to
maintain the value of the securities subject to the agreement in an amount
exceeding the repurchase price (including accrued interest). Default by the
seller would, however, expose the Portfolio to possible loss because of adverse
market action or delay in connection with the disposition of the underlying
obligations.
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Reverse Repurchase Agreements. Each Portfolio may borrow funds by selling
-----------------------------
portfolio securities to financial institutions such as banks and broker/dealers
and agreeing to repurchase them at a mutually specified date and price ("reverse
repurchase agreements"). The Portfolios may use the proceeds of reverse
repurchase agreements to purchase other securities either maturing, or under an
agreement to resell, at a date simultaneous with or prior to the expiration of
the reverse repurchase agreement. Reverse repurchase agreements involve the risk
that the market value of the securities sold by a Portfolio may decline below
the repurchase price. The Portfolios will pay interest on amounts obtained
pursuant to a reverse repurchase agreement. While reverse repurchase agreements
are outstanding, a Portfolio will segregate liquid assets in an amount at least
equal to the market value of the securities, plus accrued interest, subject to
the agreement. Reverse repurchase agreements are considered to be borrowings
under the 1940 Act.
Risks Related to Lower-Rated Securities. While any investment carries some
---------------------------------------
risk, certain risks associated with lower-rated securities are different than
those for investment-grade securities. The risk of loss through default is
greater because lower-rated securities are usually unsecured and are often
subordinate to an issuer's other obligations. Additionally, the issuers of these
securities frequently have high debt levels and are thus more sensitive to
difficult economic conditions, individual corporate developments and rising
interest rates. Consequently, the market price of these securities may be quite
volatile and may result in wider fluctuations of a Portfolio's net asset value
per share.
There remains some uncertainty about the performance level of the market
for lower-rated securities under adverse market and economic environments. An
economic downturn or increase in interest rates could have a negative impact on
both the market for lower-rated securities (resulting in a greater number of
bond defaults) and the value of lower-rated securities held in a portfolio of
investments.
The economy and interest rates can affect lower-rated securities
differently than other securities. For example, the prices of lower-rated
securities are more sensitive to adverse economic changes or individual
corporate developments than are the prices of higher-rated investments. In
addition, during an economic downturn or period in which interest rates are
rising significantly, highly leveraged issuers may experience financial
difficulties, which, in turn, would adversely affect their ability to service
their principal and interest payment obligations, meet projected business goals
and obtain additional financing.
If an issuer of a security defaults, a Portfolio may incur additional
expenses to seek recovery. In addition, periods of economic uncertainty would
likely result in increased volatility for the market prices of lower-rated
securities as well as a Portfolio's net asset value. In general, both the prices
and yields of lower-rated securities will fluctuate.
In certain circumstances it may be difficult to determine a security's fair
value due to a lack of reliable objective information. Such instances occur
where there is not an established secondary market for the security or the
security is lightly traded. As a result, a Portfolio's valuation of a security
and the price it is actually able to obtain when it sells the security could
differ.
Adverse publicity and investor perceptions, whether or not based on
fundamental analysis, may decrease the value and liquidity of lower-rated
securities held by a Portfolio, especially in a thinly traded market. Illiquid
or restricted securities held by the Portfolio may involve special registration
responsibilities, liabilities and costs, and could involve other liquidity and
valuation difficulties.
The ratings of S&P, Moody's, Fitch and Thompson Bank Watch, Inc. ("TBW")
evaluate the safety of a lower-rated security's principal and interest payments,
but do not address market value risk. Because the ratings of the rating agencies
may not always reflect current conditions and events, in addition to using
recognized rating agencies and other sources, the Investment Advisers perform
their own analysis of the issuers whose lower-rated securities the Portfolios
purchase. Because of this, a Portfolio's performance may depend more on the
Investment Adviser credit analysis than is the case of mutual funds investing in
higher-rated securities.
In selecting lower-rated securities, the Investment Advisers consider
factors such as those relating to the creditworthiness of issuers, the ratings
and performance of the securities, the protections afforded the securities and
the diversity of a Portfolio's investment portfolio. The Investment Advisers
monitor the issuers of lower-rated securities held by a Portfolio for their
ability to make required principal and interest payments, as well as in an
effort to control the liquidity of the Portfolio so that it can meet redemption
requests.
Yields and Ratings. The yields on certain obligations, including the
------------------
instruments in which the Portfolios may invest, are dependent on a variety of
factors, including general market economic conditions, conditions in the
particular market for
12
<PAGE>
the obligation, financial condition of the issuer, size of the offering,
maturity of the obligation and ratings of the issue. The ratings of S&P,
Moody's, Fitch and TBW represent their respective opinions as to the quality of
the obligations they undertake to rate. Ratings, however, are general and are
not absolute standards of quality. Consequently, obligations with the same
rating, maturity and interest rate may have different market prices. For a more
complete discussion of ratings, see Appendix A to this Additional Statement.
Subject to the limitations stated in the Prospectus, if a security held by
a Portfolio undergoes a rating revision, the Portfolio may continue to hold the
security if the Investment Advisers determine such retention is warranted.
Relative Value Approach. In buying and selling securities for the
-----------------------
Portfolios, the investment management team uses a relative value approach. This
approach involves an analysis of economic and market information, including
economic growth rates, interest and inflation rates, deficit levels, the shape
of the yield curve, sector and quality spreads and risk premiums. It also
involves the use of proprietary valuation models to analyze and compare expected
returns and assumed risks. Under the relative value approach, the investment
management team will emphasize particular securities and particular types of
securities that the team believes will provide a favorable return in light of
these risks.
Tracking Variance. As discussed in the Prospectus, the U.S. Treasury Index
------------------
Portfolio is subject to the risk of tracking variance. Tracking variance may
result from share purchases and redemptions, transaction costs, expenses and
other factors. Share purchases and redemptions may necessitate the purchase and
sale of securities by the Portfolio and the resulting transaction costs which
may be substantial because of the number and the characteristics of the
securities held. In addition, transaction costs are incurred because sales of
securities received in connection with spin-offs and other corporate
reorganizations are made to conform the Portfolio's holdings with its investment
objective. Tracking variance may also occur due to factors such as the size of
the Portfolio, the maintenance of a cash reserve pending investment or to meet
expected redemptions, changes made in the Portfolio's designated Index or the
manner in which the Index is calculated or because the indexing and investment
approach of the Investment Adviser does not produce the intended goal of the
Portfolio. Tracking variance is monitored by the Investment Adviser at least
quarterly. In the event the performance of the Portfolio is not comparable to
the performance of its designated Index, the Board of Trustees will evaluate the
reasons for the deviation and the availability of corrective measures. If
substantial deviation in the Portfolio's performance were to continue for
extended periods, it is expected that the Board of Trustees would consider
recommending to shareholders possible changes to the Portfolio's investment
objective.
Calculation of Portfolio Turnover Rate. The portfolio turnover rate for
---------------------------------------
the Portfolios is calculated by dividing the lesser of purchases or sales of
portfolio investments for the reporting period by the monthly average value of
the portfolio investments owned during the reporting period. The calculation
excludes all securities, including options, whose maturities or expiration dates
at the time of acquisition are one year or less. Portfolio turnover may vary
greatly from year to year as well as within a particular year, and may be
affected by cash requirements for redemption of shares and by requirements which
enable the Portfolios to receive favorable tax treatment.
Mortgage Dollar Rolls. The Portfolios may enter into mortgage "dollar
---------------------
rolls" in which a Portfolio sells securities for delivery in the future
(generally within 30 days) and simultaneously contracts with the same
counterparty to repurchase similar (same type, coupon and maturity), but not
identical securities on a specified future date. During the roll period, a
Portfolio loses the right to receive principal and interest paid on the
securities sold. However, a Portfolio would benefit to the extent of any
difference between the price received for the securities sold and the lower
forward price for the future purchase (often referred to as the "drop") or fee
income plus the interest earned on the cash proceeds of the securities sold
until the settlement date of the forward purchase. Unless such benefits exceed
the income, capital appreciation and gain or loss due to mortgage prepayments
that would have been realized on the securities sold as part of the mortgage
dollar roll, the use of this technique will diminish the investment performance
of a Portfolio compared with what such performance would have been without the
use of mortgage dollar rolls. All cash proceeds will be invested in instruments
that are permissible investments for the applicable Portfolio. Each Portfolio
will hold and maintain in a segregated account until the settlement date cash or
liquid assets, as permitted by applicable law, in an amount equal to its forward
purchase price.
For financial reporting and tax purposes, the Portfolios treat mortgage
dollar rolls as two separate transactions; one involving the purchase of a
security and a separate transaction involving a sale. The Portfolios do not
currently intend to enter into mortgage dollar rolls that are accounted for as a
financing.
Mortgage dollar rolls involve certain risks including the following. If the
broker-dealer to whom a Portfolio sells the security becomes insolvent, a
Portfolio's right to purchase or repurchase the mortgage-related securities
subject to the mortgage dollar roll may be restricted and the instrument which a
Portfolio is required to repurchase may be worth less than an instrument which a
Portfolio originally held. Successful use of mortgage dollar rolls will depend
upon an Investment
13
<PAGE>
Adviser's ability to manage a Portfolio's interest rate and mortgage prepayments
exposure. For these reasons, there is no assurance that mortgage dollar rolls
can be successfully employed.
Investment Restrictions
Each Portfolio is subject to the fundamental investment restrictions enumerated
below which may be changed with respect to a particular Portfolio only by a vote
of the holders of a majority of such Portfolio's outstanding shares.
No Portfolio may:
(1) Make loans, except through (a) the purchase of debt obligations in
accordance with the Portfolio's investment objective and policies, (b)
repurchase agreements with banks, brokers, dealers and other financial
institutions, (c) loans of securities, and (d) loans to affiliates of the
Portfolio to the extent permitted by law.
(2) Purchase or sell real estate, but this restriction shall not prevent a
Portfolio from investing directly or indirectly in portfolio instruments
secured by real estate or interests therein or acquiring securities of real
estate investment trusts or other issuers that deal in real estate.
(3) Invest in commodities or commodity contracts, except that each Portfolio
may invest in currency and financial instruments and contracts that are
commodities or commodity contracts.
(4) Invest in companies for the purpose of exercising control.
(5) Act as underwriter of securities, except as a Portfolio may be deemed to
be an underwriter under the Securities Act of 1933 in connection with the
purchase and sale of portfolio instruments in accordance with its investment
objective and portfolio management policies.
(6) Purchase securities (other than obligations issued or guaranteed by the
U.S. Government, its agencies or instrumentalities) if such purchase would
cause more than 25% in the aggregate of the market value of the total assets
of a Portfolio to be invested in the securities of one or more issuers having
their principal business activities in the same industry.
For the purposes of this restriction, as to utility companies, the gas,
electric, water and telephone businesses are considered separate industries;
personal credit finance companies and business credit finance companies are
deemed to be separate industries; and wholly-owned finance companies are
considered to be in the industries of their parents if their activities are
primarily related to financing the activities of their parents.
(7) Borrow money, except that to the extent permitted by applicable law (a)
a Portfolio may borrow from banks, other affiliated investment companies and
other persons, and may engage in reverse repurchase agreements and other
transactions which involve borrowings, in amounts up to 33 1/3% of its total
assets (including the amount borrowed) or such other percentage permitted by
law, (b) a Portfolio may borrow up to an additional 5% of its total assets
for temporary purposes, (c) a Portfolio may obtain such short-term credits as
may be necessary for the clearance of purchases and sales of portfolio
securities, and (d) a Portfolio may purchase securities on margin. If due to
market fluctuations or other reasons a Portfolio's borrowings exceed the
limitations stated above, the Trust will promptly reduce the borrowings of
such Portfolio in accordance with the 1940 Act. In addition, as a matter of
fundamental policy, a Portfolio will not issue senior securities to the
extent such issuance would violate applicable law.
(8) Notwithstanding any of the Trust's other fundamental investment
restrictions (including, without limitation, those restrictions relating to
issuer diversification, industry concentration and control), each Portfolio
may (a) purchase securities of other investment companies to the full extent
permitted under Section 12 of the 1940 Act (or any successor provision
thereto) or under any regulation or order of the Securities and Exchange
Commission; and (b) invest all or substantially all of its assets in a single
open-end investment company or series thereof with substantially the same
investment objective, policies and fundamental restrictions as the Portfolio.
(9) The Portfolio may not make any investment inconsistent with the
Portfolio's classification as a diversified investment company under the 1940
Act, provided that this restriction does not apply to the International Bond
Portfolio.
For the purposes of Restriction Nos. 1 and 7 above, the Portfolios expect
that they would be required to file an
14
<PAGE>
exemptive application with the SEC and receive the SEC's approval of that
application prior to entering into lending or borrowing arrangements with
affiliates. As of April 1, 2000, the Portfolios had not filed such an
exemptive application.
In applying Restriction No. 6 above, a security is considered to be
issued by the entity, or entities, whose assets and revenues back the security.
A guarantee of a security is not deemed to be a security issued by the guarantor
when the value of all securities issued and guaranteed by the guarantor, and
owned by the Portfolio, does not exceed 10% of the value of the Portfolio's
total assets.
Except to the extent otherwise provided in Investment Restriction No. 8
for the purpose of such restriction, in determining industry classification the
Trust intends to use the industry classification titles in the Bloomberg
Industry Group Classifications (except that the International Bond Portfolio
will use the Morgan Stanley Capital International industry classification
titles).
As a non-fundamental investment restriction that can be changed without
shareholder approval, the International Bond Portfolio may not, at the end of
any tax quarter, hold more than 10% of the outstanding voting securities of any
one issuer, except that up to 50% of the total value of the assets of the
Portfolio may be invested in any securities without regard to this 10%
limitation so long as no more than 25% of the total value of its assets is
invested in the securities of any one issuer (except the U.S. Government, its
agencies and instrumentalities). In addition, as a non-fundamental investment
restriction, the International Bond Portfolio may not, at the end of any tax
quarter, hold more than 5% of the total value of its assets in the securities of
any one issuer (except U.S. Government securities), except that up to 50% of the
total value of the Portfolio's assets may be invested in any securities without
regard to this 5% limitation so long as no more than 25% of the total value of
its assets is invested in the securities of any one issuer (except the U.S.
Government, its agencies and instrumentalities).
Any restriction which involves a maximum percentage will not be
considered violated unless an excess over the percentage occurs immediately
after, and is caused by, an acquisition of securities or assets of, or
borrowings by, a Portfolio.
15
<PAGE>
ADDITIONAL TRUST INFORMATION
Trustees and Officers
The business and affairs of the Trust and each Portfolio are managed under the
direction of the Trust's Board of Trustees. Information pertaining to the
Trustees and officers of the Trust is set forth below.
<TABLE>
<CAPTION>
Position(s) Principal Occupation(s)
Name and Address Age with Trust During the Past 5 Years
----------------- --- ----------- -----------------------
<S> <C> <C> <C>
Richard G. Cline 65 Trustee Chairman, Hawthorne Investors, Inc. (a management
4200 Commerce Court advisory services and private investment company)
Suite 300 since January 1996; Chairman, Hussman International,
Lisle, IL 60532 Inc. (a refrigeration company) since 1998, Chairman and
CEO of NICOR Inc. (a diversified public utility holding
company) from 1986 to 1995, and President, 1992-1993;
Chairman, Federal Reserve Bank of Chicago from 1992 to
1995; and Deputy Chairman from 1995 to 1996. Director:
Whitman Corporation (a diversified holding company);
Kmart Corporation (a retailing company); Ryerson Tull,
Inc. (a metals distribution company) and University of
Illinois Foundation. Trustee: Northern Funds.
Edward J. Condon, Jr. 60 Trustee Chairman of The Paradigm Group, Ltd. (a financial
Sears Tower, Suite 9650 advisor) since July 1993; Vice President and
233 S. Wacker Drive Treasurer of Sears, Roebuck and Co. (a retail
Chicago, IL 60606 corporation) from February 1989 to July 1993;
Member of Advisory Board of Real-Time USA, Inc. (a
software development company); Member of the Board of
Managers of The Liberty Hampshire Company, LLC (a
receivable securitization company); Vice Chairman and
Director of Energenics L.L.C. (a waste to energy
recycling company). Director: University Eldercare,
Inc. (an Alzheimer's disease research and treatment
company); Financial Pacific Company (a small business
leasing company). Trustee: Dominican University.
Trustee: Northern Funds.
Mr. Wesley M. Dixon, Jr. 72 Trustee Director of Kinship Capital Corporation (a
400 Skokie Blvd., Suite 300 financial services company) since 1985 to 1996,
Northbrook, IL 60062 Vice Chairman and Director of G.D. Searle & Co.
(manufacture and sale of food products and
pharmaceuticals) from 1977 to 1985 and President of
G.D. Searle & Co. prior thereto. Trustee: Northern
Funds.
Mr. William J. Dolan, Jr. 67 Trustee Partner of Arthur Andersen & Co. S.C. (an accounting
1534 Basswood Circle firm) from 1966 to 1989. Financial Consultant, Ernst &
Glenview, IL 60025 Young (an accounting firm) from 1992 to 1993 and 1997.
Trustee: Northern Funds.
</TABLE>
16
<PAGE>
<TABLE>
<CAPTION>
Position(s) Principal Occupation(s)
Name and Address Age with Trust During the Past 5 Years
---------------- --- ----------- -----------------------
<S> <C> <C> <C>
John W. English 67 Trustee Private Investor; Vice President and Chief Investment
50-H New England Ave. Officer of The Ford Foundation (a charitable trust)
P.O. Box 640 from 1981 to 1993. Trustee: The China Fund, Inc.,
Summit, NJ 07902-0640 Select Sector SPDR Trust; WM Funds; American Red Cross
in Greater New York; Mote Marine Laboratory (a non-
profit marine research facility); and United Board for
Christian Higher Education in Asia. Trustee: Northern
Funds.
Mr. Raymond E. George, Jr. * 69 Trustee Senior Vice President and Senior Fiduciary Officer of
703 Prospect Avenue The Northern Trust Company from 1990 to 1993. Trustee:
Winnetka, IL 60093 Northern Funds.
Sandra Polk Guthman 56 Trustee President and CEO of Polk Bros. Foundation (an
420 N. Wabash Avenue Illinois not-for-profit corporation) from 1993 to
Suite 204 present; Director of Business Transformation from
Chicago, IL 60611 1992-1993, and Midwestern Director of Marketing
from 1988-1992, IBM (a technology company);
Director: MBIA Insurance Corporation of Illinois
(a municipal bond insurance company). Trustee:
Northern Funds.
Mr. Michael E. Murphy** 63 Trustee President of Sara Lee Foundation (philanthropic
Suite 2222 organization) since November 1997. Vice Chairman
20 South Clark Street and Chief Administrative Officer of Sara Lee
Chicago, IL 60603 Corporation (a consumer product company) from
November 1994 to October 1997; Vice Chairman and
Chief Financial and Administrative Officer of
Sara Lee Corporation from July 1993 to November
1994. Director: Payless Shoe Source, Inc., (a
retail shoe store business); True North
Communications, Inc. (a global advertising and
communications holding company); American General
Corporation (a diversified financial services
company); GATX Corporation (a railroad holding
company); Bassett Furniture Industries, Inc. (a
furniture manufacturer) Trustee: Northern Funds.
Mary Jacobs Skinner, Esq.*** 42 Trustee Partner in the law firm of Sidley & Austin.
One First National Plaza Trustee: Northern Funds.
Chicago, IL 06063
</TABLE>
17
<PAGE>
<TABLE>
<CAPTION>
Position(s) Principal Occupation(s)
Name and Address Age with Trust During the Past 5 Years
---------------- --- ---------- -----------------------
<S> <C> <C> <C>
William H. Springer 71 Chairman and Trustee Vice Chairman of Ameritech (a telecommunications
701 Morningside Drive holding company) from February 1987 to August
Lake Forest, IL 60045 1992; Vice Chairman, Chief Financial and
Administrative Officer of Ameritech prior to
1987. Director: Walgreen Co. (a retail drug store
business); Baker, Fentress & Co. (a closed-end,
non-diversified management investment company).
Trustee: Goldman Sachs Trust; Goldman Sachs
Variable Insurance Trust. Trustee: Northern Funds.
Richard P. Strubel 61 Trustee President and Chief Operating Officer, UNext.com
737 N. Michigan Avenue (a provider of educational services via the
Suite 1405 internet) since 1999; Managing Director of Tandem
Chicago, IL 60611 Partners, Inc. (a privately held management
services firm) from 1990 to 1999; President and Chief
Executive Officer, Microdot, Inc. (a privately held
manufacturing firm) from 1984 to 1994; Director:
Gildan Activewear, Inc. (an athletic clothing
marketing and manufacturing company); Children's
Memorial Medical Center. Trustee: University of
Chicago; Goldman Sachs Trust; Goldman Sachs Variable
Insurance Trust. Trustee: Northern Funds.
Stephen Timbers**** 55 Trustee President of Northern Trust Global Investments, a
50 South LaSalle Street division of Northern Trust Corporation and
Chicago, IL 60675 Executive Vice President, The Northern Trust
Company since 1998; President, Chief Executive
Officer and Director of Zurich Kemper Investments (a
financial services company) from 1996 to 1998;
President, Chief Operating Officer and Director of
Kemper Corporation (a financial services company)
from 1992 to 1996; President and Director of Kemper
Funds (a registered investment company) from 1990 to
1998. Director: LTV Corporation (a steel producer).
Trustee: Northern Funds.
Jylanne M. Dunne 40 President Senior Vice President for Distribution Services
4400 Computer Drive at PFPC Inc. ("PFPC") (formerly First Data
Westborough, MA 01581 Investor Services Group, Inc. ("FDISG")) (since
1988).
Archibald E. King 42 Vice President Senior Vice President and other positions at The
50 South LaSalle Street Northern Trust Company (since 1979).
Chicago, IL 60675
</TABLE>
18
<PAGE>
<TABLE>
<CAPTION>
Position(s) Principal Occupation(s)
Name and Address Age with Trust During the Past 5 Years
---------------- --- ----------- -----------------------
<S> <C> <C> <C>
Lloyd A. Wennlund 42 Vice President Senior Vice President and other positions at The
50 South LaSalle Street Northern Trust Company, President of Northern
Chicago, IL 60675 Trust Securities, Inc., and Managing Executive,
Mutual Funds for Northern Trust Global
Investments (since 1989).
Brian R. Curran 32 Vice President and Director of Fund Administration at PFPC (formerly
4400 Computer Drive Treasurer FDISG) (since 1997); Director of Fund
Westborough, MA 01581 Administration at State Street Bank & Trust
Company (February 1997 to October 1997); Senior
Auditor at Price Waterhouse L.L.P. (an accounting
firm) (February 1994 to February 1997).
Judith E. Clear 33 Assistant Treasurer Client Treasury Manager of Mutual Fund
4400 Computer Drive Administration at PFPC (since 1997); Compliance
Westborough, MA 01581 Manager at Citizens Trust (1994 to 1996).
Suzanne E. Anderson 27 Assistant Treasurer Client Treasury Manager of Mutual Fund
4400 Computer Drive Administration at PFPC Inc. (since August 1998);
Westborough, MA 01581 Manager of Fund Administration at State Street
Bank & Trust Company (October 1996 to August
1998); Fund Administrator at State Street Bank &
Trust Company (October 1995 to October 1996);
Mutual Fund Accountant at The Boston Company
(prior thereto).
Jeffrey A. Dalke 49 Secretary Partner in the law firm of Drinker Biddle & Reath
One Logan Square LLP.
18th and Cherry Streets
Philadelphia, PA 19103-6996
Linda J. Hoard 52 Assistant Secretary Vice President at PFPC (formerly FDISG) (since
4400 Computer Drive 1998); Attorney Consultant for Fidelity
Westborough, MA 01581 Management & Research (a financial service
company); Investors Bank & Trust Company (a
financial service provider) and FDISG (September
1994 to June 1998).
Therese Hogan 37 Assistant Secretary Director of the State Regulation Department at
4400 Computer Drive PFPC (formerly FDISG) (since 1994).
Westborough, MA 01581
</TABLE>
* Mr. George is deemed to be an "interested" Trustee because he owns
shares of Northern Trust Corporation.
** Mr. Murphy is deemed to be an "interested" Trustee because he owns
shares of Northern Trust Corporation.
*** Ms. Skinner is deemed to be an "interested" Trustee because her law
firm provides legal services to Northern.
**** Mr. Timbers is deemed to be an "interested" Trustee because he is an
officer, director, employee and shareholder of Northern Trust
Corporation and/or Northern and NTQA.
Certain of the Trustees and officers and the organizations with which they
are associated have had in the past, and may have in the future, transactions
with the Investment Advisers, PFPC (formerly FDISG), Northern Funds
Distributors, LLC ("NFD") and their respective affiliates. The Trust has been
advised by such Trustees and officers that all such transactions have been and
are expected to be in the ordinary course of business and the terms of such
transactions, including all loans and loan commitments by such persons, have
been and are expected to be substantially the same as the prevailing
19
<PAGE>
terms for comparable transactions for other customers. As a result of the
responsibilities assumed by the Investment Advisers under the Advisory Agreement
with the Trust, by Northern under its Transfer Agency Agreement, Custodian
Agreement, Foreign Custody Agreement and Co-Administration Agreement with the
Trust, by PFPC under its Co-Administration Agreement with the Trust and by PFPC
under its Distribution Agreement with the Trust, the Trust itself requires no
employees.
Each officer holds comparable positions with certain other investment
companies of which NFD, PFPC or an affiliate thereof is the investment adviser,
administrator and/or distributor.
Each Trustee, except Mr. Timbers, earns a quarterly retainer of $6,750 and
the Chairman of the Board earns a quarterly retainer of $10,125. Each Trustee,
including the Chairman of the Board, earns an additional fee of $2,500 for each
meeting attended, plus reimbursement of expenses incurred as a Trustee.
In addition, the Trustees established an Audit Committee consisting of two
members, including a Chairman of the Committee. The Audit Committee members are
Messrs. Condon and Strubel (Chairman). Each member earns a fee of $2,500 for
each meeting attended and the Chairman earns a quarterly retainer of $1,500.
Each Trustee will hold office for an indefinite term until the earliest of
(i) the next meeting of shareholders if any, called for the purpose of
considering the election or re-election of such Trustee and until the election
and qualification of his or her successor, if any, elected at such meeting; (ii)
the date a Trustee resigns or retires, or a Trustee is removed by the Board of
Trustees or shareholders, in accordance with the Trust's Agreement and
Declaration of Trust; or (iii) effective December 31, 2001, in accordance with
the current resolutions of the Board of Trustees (which may be changed without
shareholder vote), on the last day of the fiscal year of the Trust in which he
or she attains the age of 72 years.
The Trust's officers do not receive fees from the Trust for services in
such capacities, although PFPC, of which certain of the Trust's officers are
also officers (except Mr. Dalke, Mr. King and Mr. Wennlund), receives fees from
the Trust for administrative services.
Drinker Biddle & Reath LLP, of which Mr. Dalke is a partner, receives fees
from the Trust for legal services.
Northern Trust Company, of which Mr. King and Mr. Wennlund are officers,
receives fees from the Trust as investment adviser, custodian, transfer agent
and co-administrator.
The following table sets forth certain information with respect to the
compensation of each Trustee of the Trust for the one-year period ended November
30, 1999:
<TABLE>
<CAPTION>
U.S. Short- U.S. Total
Government Intermediate Treasury Intermediate International Compensation
Securities Bond Index Bond Bond Bond from Fund
Portfolio Portfolio Portfolio Portfolio Portfolio Portfolio Complex***
--------- --------- --------- --------- --------- --------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Steven Timbers** $ 0 $ 0 0 $ 0 $ 0 $ 0 $ 0
William H. Springer 530 1,060 530 3,710 530 530 53,000
Richard G. Cline 395 790 395 2,765 395 395 39,500
Edward J. Condon, Jr. 445 890 445 3,115 445 445 44,500
John W. English 395 790 395 2,765 395 395 39,500
Sandra Polk Guthman 395 790 395 2,765 395 395 39,500
Frederick T. Kelsey* 445 890 445 3,115 445 445 44,500
Richard P. Strubel 505 1,010 505 3,535 505 505 50,500
Wesley M. Dixon, Jr.** 0 0 0 0 0 0 22,500
William J. Dolan, Jr.** 0 0 0 0 0 0 22,500
Raymond E. George, Jr.** 0 0 0 0 0 0 21,250
Michael E. Murphy** 0 0 0 0 0 0 22,500
Mary Jacobs Skinner** 0 0 0 0 0 0 22,500
</TABLE>
* Frederick Kelsey retired from the Board of Trustees on November 30, 1999.
** Not a Trustee of the Northern Institutional Funds during the period ended
November 30, 1999.
*** Fund complex includes twenty-one investment portfolios of the Trust and
thirty-one portfolios of Northern Funds, a separately registered
investment company.
The Trust does not provide pension or retirement benefits to its Trustees.
The Trust, its investment adviser and principal underwriter have adopted
codes of ethics (the "Codes of Ethics") under rule 17j-1 of the 1940 Act. The
Codes of Ethics permit personnel, subject to the Codes of Ethics and their
provisions, to invest in securities, including securities that may be purchased
or held by the Trust.
20
<PAGE>
Investment Advisers, Transfer Agent and Custodian
Northern, a wholly-owned subsidiary of Northern Trust Corporation, a bank
holding company, is one of the nation's leading providers of trust and
investment management services. Northern is one of the strongest banking
organizations in the United States. Northern believes it has built its
organization by serving clients with integrity, a commitment to quality, and
personal attention. Its stated mission with respect to all its financial
products and services is to achieve unrivaled client satisfaction. With respect
to such clients, the Trust is designed to assist (i) defined contribution plan
sponsors and their employees by offering a range of diverse investment options
to help comply with 404(c) regulation and may also provide educational material
to their employees, (ii) employers who provide post-retirement Employees'
Beneficiary Associations ("VEBA") and require investments that respond to the
impact of Federal regulations, (iii) insurance companies with the day-to-day
management of uninvested cash balances as well as with longer-term investment
needs, and (iv) charitable and not-for-profit organizations, such as endowments
and foundations, demanding investment management solutions that balance the
requirement for sufficient current income to meet operating expenses and the
need for capital appreciation to meet future investment objectives. NTQA, also a
wholly-owned subsidiary of Northern Trust Corporation, serves as investment
adviser principally to defined benefit and defined contribution plans and
manages over 60 equity and bond commingled and common trust funds. As of
February 29, 2000, the Investment Advisers and their affiliates had
approximately $299.1 billion in assets under management for clients including
public and private retirement funds, endowments, foundations, trusts,
corporations, other investment companies and individuals.
Under the Advisory Agreement with the Trust, the Investment Advisers,
subject to the general supervision of the Trust's Board of Trustees, are
responsible for making investment decisions for each Portfolio and placing
purchase and sale orders for portfolio transactions of the Portfolios. The
Advisory Agreement with the Trust provides that in selecting brokers or dealers
to place orders for transactions, the Investment Advisers shall attempt to
obtain best net price and execution or, with respect to the International Bond
and Intermediate Bond Portfolios, their best judgment to obtain the best overall
terms available. In assessing the best overall terms available for any
transaction, the Investment Advisers are to consider all factors they deem
relevant, including the breadth of the market in the security, the price of the
security, the financial condition and execution capability of the broker or
dealer, and the reasonableness of the commission, if any, both for the specific
transaction and on a continuing basis. In evaluating the best overall terms
available and in selecting the broker or dealer to execute a particular
transaction, the Investment Advisers may consider the brokerage and research
services provided to the Portfolios and/or other accounts over which the
Investment Advisers or an affiliate of Northern exercise investment discretion.
A broker or dealer providing brokerage and/or research services may receive a
higher commission than another broker or dealer would receive for the same
transaction. These brokerage and research services may include industry and
company analyses, portfolio services, quantitative data, market information
systems and economic and political consulting and analytical services.
Transactions on U.S. stock exchanges involve the payment of negotiated
brokerage commissions. On exchanges on which commissions are negotiated, the
cost of transactions may vary among different brokers. Transactions on foreign
stock exchanges involve payment for brokerage commissions which are generally
fixed. Over-the-counter issues, including corporate debt and government
securities, are normally traded on a "net" basis (i.e., without commission)
through dealers, or otherwise involve transactions directly with the issuer of
an instrument. With respect to over-the-counter transactions, the Investment
Advisers will normally deal directly with dealers who make a market in the
instruments involved except in those circumstances where more favorable prices
and execution are available elsewhere. The cost of foreign and domestic
securities purchased from underwriters includes an underwriting commission or
concession, and the prices at which securities are purchased from and sold to
dealers include a dealer's mark-up or mark-down.
The Portfolios may participate, if and when practicable, in bidding for the
purchase of portfolio securities directly from an issuer in order to take
advantage of the lower purchase price available to members of a bidding group.
The Portfolios will engage in this practice, however, only when the Investment
Advisers believe such practice to be in the Portfolios' interests.
21
<PAGE>
On occasions when the Investment Advisers deem the purchase or sale of a
security to be in the best interests of a Portfolio as well as other fiduciary
or agency accounts managed by them (including any other Portfolio, investment
company or account for which an Investment Adviser acts as adviser), the
Advisory Agreement provides that the Investment Advisers, to the extent
permitted by applicable laws and regulations, may aggregate the securities to be
sold or purchased for such Portfolio with those to be sold or purchased for such
other accounts in order to obtain the best net price and execution. In such
event, allocation of the securities so purchased or sold, as well as the
expenses incurred in the transaction, will be made by the Investment Advisers in
the manner they consider to be most equitable and consistent with their
fiduciary obligations to the Portfolio and other accounts involved. In some
instances, this procedure may adversely affect the size of the position
obtainable for a Portfolio or the amount of the securities that are able to be
sold for a Portfolio.
The Advisory Agreement provides that the Investment Advisers may render
similar services to others so long as their services under such Agreements are
not impaired thereby. The Advisory Agreement also provides that the Trust will
indemnify the Investment Advisers against certain liabilities (including
liabilities under the Federal securities laws relating to untrue statements or
omissions of material fact and actions that are in accordance with the terms of
the Agreements) or, in lieu thereof, contribute to resulting losses.
Under its Transfer Agency Agreement with the Trust, with respect to shares
held by Institutions, Northern has undertaken to perform some or all of the
following services: (i) establish and maintain an omnibus account in the name of
each Institution; (ii) process purchase orders and redemption requests from an
Institution, and furnish confirmations and disburse redemption proceeds; (iii)
act as the income disbursing agent of the Trust; (iv) answer inquiries from
Institutions; (v) provide periodic statements of account to each Institution;
(vi) process and record the issuance and redemption of shares in accordance with
instructions from the Trust or its administrator; (vii) if required by law,
prepare and forward to Institutions shareholder communications (such as proxy
statements and proxies, annual and semi-annual financial statements, and
dividend, distribution and tax notices); (viii) preserve records; and (ix)
furnish necessary office space, facilities and personnel. Under the Transfer
Agency Agreement, with respect to shares held by investors, Northern has also
undertaken to perform some or all of the following services: (i) establish and
maintain separate accounts in the name of the investors; (ii) process purchase
orders and redemption requests, and furnish confirmations in accordance with
applicable law; (iii) disburse redemption proceeds; (iv) process and record the
issuance and redemption of shares in accordance with instructions from the Trust
or its administrator; (v) act as income disbursing agent of the Trust in
accordance with the terms of the Prospectus and instructions from the Trust or
its administrator; (vi) provide periodic statements of account; (vii) answer
inquiries (including requests for prospectuses and statements of additional
information, and assistance in the completion of new account applications) from
investors and respond to all requests for information regarding the Trust (such
as current price, recent performance, and yield data) and questions relating to
accounts of investors (such as possible errors in statements, and transactions);
(viii) respond to and seek to resolve all complaints of investors with respect
to the Trust or their accounts; (ix) furnish proxy statements and proxies,
annual and semi-annual financial statements, and dividend, distribution and tax
notices to investors; (x) furnish the Trust with all pertinent Blue Sky
information; (xi) perform all required tax withholding; (xii) preserve records;
and (xiii) furnish necessary office space, facilities and personnel. Northern
may appoint one or more sub-transfer agents in the performance of its services.
As compensation for the services rendered by Northern under the Transfer
Agency Agreement and the assumption by Northern of related expenses, Northern is
entitled to a fee from the Trust, payable monthly, at an annual rate of .01%,
.10% and .15% of the average daily net asset value of the Class A, C and D
Shares, respectively, of the Portfolios.
Under its Custodian Agreement (and in the case of the International Bond
Portfolio, its Foreign Custody Agreement) with the Trust, Northern (i) holds
each Portfolio's cash and securities, (ii) maintains such cash and securities in
separate accounts in the name of the Portfolio, (iii) makes receipts and
disbursements of funds on behalf of the Portfolio, (iv) receives, delivers and
releases securities on behalf of the Portfolio, (v) collects and receives all
income, principal and other payments in respect of the Portfolio's investments
held by Northern under the Agreement, and (vi) maintains the accounting records
of the Trust. Northern may employ one or more subcustodians, provided that
Northern, subject to certain monitoring responsibilities, shall have no more
responsibility or liability to the Trust on account of any action or omission of
any subcustodian so employed than such subcustodian has to Northern and that the
responsibility or liability of the subcustodian to Northern shall conform to the
resolution of the Trustees of the Trust authorizing the appointment of the
particular subcustodian (or, in the case of foreign securities, to the terms of
any agreement entered into between Northern and such subcustodian to which such
resolution relates). In addition, the Trust's custodial arrangements provide,
with respect to foreign securities, that Northern shall not be: (i) responsible
for the solvency of any subcustodian appointed by it with reasonable care; (ii)
responsible for any act, omission, default or for the solvency of any eligible
foreign securities depository; and (iii) liable for any loss, damage, cost,
expense, liability or claim resulting from nationalization, expropriation,
currency restrictions, or acts of war or terrorism or any loss where the
subcustodian has otherwise exercised reasonable care. Northern may also appoint
agents to carry out such of the provisions of the Custodian Agreement and the
Foreign Custody
22
<PAGE>
Agreement as Northern may from time to time direct, provided that the
appointment of an agent shall not relieve Northern of any of its
responsibilities under either Agreement. Northern has entered into agreements
with financial institutions and depositories located in foreign countries with
respect to the custody of the Portfolios' foreign securities.
As compensation for the services rendered to the Trust by Northern as
custodian to the U.S. Government Securities, Short-Intermediate Bond, U.S.
Treasury Index, Bond and Intermediate Bond Portfolios, and the assumption by
Northern of certain related expenses, Northern is entitled to payment from the
Trust as follows: (i) $18,000 annually for each Portfolio, plus (ii) 1/100/th/
of 1% annually of each Portfolio's average daily net assets to the extent they
exceed $100 million, plus (iii) a fixed dollar fee for each trade in portfolio
securities, plus (iv) a fixed dollar fee for each time that Northern as
Custodian receives or transmits funds via wire, plus (v) reimbursement of
expenses incurred by Northern as custodian for telephone, postage, courier fees,
office supplies and duplicating. The fees referred to in clauses (iii) and (iv)
are subject to annual upward adjustments based on increases in the Consumer
Price Index for All Urban Consumers, provided that Northern may permanently or
temporarily waive all or any portion of any upward adjustment.
As compensation for the services rendered to the Trust under the Foreign
Custody Agreement with respect to the International Bond Portfolio, and the
assumption by Northern of certain related expenses, Northern is entitled to
payment from the Trust as follows: (i) $35,000 annually for the International
Bond Portfolio, plus (ii) 9/100/th/ of 1% annually of the Portfolio's average
daily net assets, plus (iii) reimbursement for fees incurred by Northern as
foreign custodian for telephone, postage, courier fees, office supplies and
duplicating.
Northern's fees under the Custodian Agreement and Foreign Custody Agreement
are subject to reduction based on the Portfolios' daily uninvested cash balances
(if any).
Unless sooner terminated, the Advisory Agreement, the Custodian Agreement
(or, in the case of the International Bond Portfolio, the Foreign Custody
Agreement) and the Transfer Agency Agreement will continue in effect with
respect to a particular Portfolio until April 30, 2001 and thereafter for
successive 12-month periods, provided that the continuance is approved at least
annually (i) by the vote of a majority of the Trustees who are not parties to
the agreement or "interested persons" (as such term is defined in the 1940 Act)
of any party thereto, cast in person at a meeting called for the purpose of
voting on such approval, and (ii) by the Trustees or by the vote of a majority
of the outstanding shares of such Portfolio (as defined below under "Other
Information"). Each agreement is terminable at any time without penalty by the
Trust (by specified Trustee or shareholder action) on 60 days' written notice to
Northern or NTQA and by Northern or NTQA on 60 days' written notice to the
Trust.
Prior to April 1, 1998, Northern served as investment adviser to the U.S.
Treasury Index Portfolio on the same terms as those described above. For the
fiscal years or periods ended November 30 as indicated, the amount of advisory
fees incurred by each Portfolio (after fee waivers) was as follows:
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
U.S. Government Securities Portfolio $ 199,929 $ 123,385 $ 214,637
Short-Intermediate Bond Portfolio 468,003 498,090 428,876
U.S. Treasury Index Portfolio 34,779 37,969 43,880
Bond Portfolio 2,051,219 1,454,684 1,086,221
Intermediate Bond Portfolio (1) 178,297 55,413 8,743
International Bond Portfolio 198,243 185,420 200,976
</TABLE>
(1) Commenced investment operations on July 31, 1997.
23
<PAGE>
For the fiscal years or periods ended November 30 as indicated, the
Investment Advisers waived advisory fees as follows:
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
U.S. Government Securities Portfolio $ 279,902 $ 172,740 $ 300,491
Short-Intermediate Bond Portfolio 655,206 697,327 600,427
U.S. Treasury Index Portfolio 57,965 63,282 73,133
Bond Portfolio 2,871,713 2,036,562 1,520,709
Intermediate Bond Portfolio (1) 249,615 77,578 12,240
International Bond Portfolio 56,641 52,977 57,422
</TABLE>
(1) Commenced investment operations on July 31, 1997.
For the fiscal years or periods ended November 30 as indicated, the amount
of transfer agency fees incurred by each Portfolio was as follows:
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
U.S. Government Securities Portfolio $ 9,552 $ 9,110 $12,116
Short-Intermediate Bond Portfolio 19,199 21,373 17,908
U.S. Treasury Index Portfolio 3,342 5,260 4,802
Bond Portfolio 138,870 112,476 74,971
Intermediate Bond Portfolio (1) 7,181 2,226 347
International Bond Portfolio 2,865 2,837 2,957
</TABLE>
(1) Commenced investment operations on July 31, 1997.
For the fiscal years or periods ended November 30 as indicated, the amount
of custodian fees (and, in the case of the International Bond Portfolio, the
foreign custodian fees) incurred by each Portfolio was as follows:
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
U.S. Government Securities Portfolio $18,609 $21,756 $21,569
Short-Intermediate Bond Portfolio 25,659 28,255 29,972
U.S. Treasury Index Portfolio 22,105 21,321 21,465
Bond Portfolio 85,855 76,339 48,245
Intermediate Bond Portfolio (1) 23,114 17,589 7,200
International Bond Portfolio 59,184 54,780 67,525
</TABLE>
(1) Commenced investment operations on July 31, 1997.
Under a Service Mark License Agreement (the "Agreement") with the Trust,
Northern Trust Corporation has agreed that the name "Northern Institutional
Funds" may be used in connection with the Trust's business on a royalty-free
basis. Northern Trust Corporation has reserved to itself the right to grant the
non-exclusive right to use the name "Northern Institutional Funds" to any other
person. The Agreement provides that at such time as the Agreement is no longer
in effect, the Trust will cease using the name "Northern Institutional Funds."
Portfolio Transactions
To the extent that a Portfolio effects brokerage transactions with NFD or
PFPC or any broker/dealer affiliated directly or indirectly with the Investment
Advisers, such transactions, including the frequency thereof, the receipt of any
commissions payable in connection therewith, and the selection of the affiliated
broker/dealer effecting such transactions, will be fair and reasonable to the
shareholders of the Portfolio.
For the fiscal years ended November 30, 1999, 1998 and 1997, all portfolio
transactions for the Portfolios were executed on a principal basis and,
therefore, no brokerage commissions were paid by the Portfolios. Purchases by
the Portfolios from underwriters of portfolio securities, however, normally
include a commission or concession paid by the issuer to the underwriter, and
purchases from dealers include the spread between the dealer's cost for a given
security and the resale price of the security.
24
<PAGE>
During the fiscal year ended November 30, 1999, the Bond Portfolio acquired
and sold securities of Lehman Brothers, Inc. and Morgan Stanley Dean Witter &
Co., each a regular broker/dealer. At November 30, 1999, the Bond Portfolio
owned the following amounts of securities of its regular broker/dealers, as
defined in Rule 10b-1 under the 1940 Act, or their parents: Lehman Brothers,
Inc., with an approximate aggregate market value of $11,316,000; and Morgan
Stanley Dean Witter & Co., with an approximate aggregate market value of
$33,060,000.
During the fiscal year ended November 30, 1999, the Intermediate Bond
Portfolio did not acquire or sell any securities of its regular broker/dealers
or their parents. At November 30, 1999, the Intermediate Bond Portfolio owned
the following amounts of securities of its regular broker/dealers, as defined in
Rule 10b-1 under the 1940 Act, or their parents: Morgan Stanley Dean Witter &
Co., with an approximate aggregate market value of $343,000.
During the fiscal year ended November 30, 1999, the International Bond
Portfolio acquired and sold securities of Banque Brussels Lambert, Deutsche
Bank, and Credit Suisse, each a regular broker/dealer. At November 30, 1999,
the International Bond Portfolio did not own securities of its regular
broker/dealers, as defined in Rule 10b-1 under the 1940 Act, or their parents.
During the fiscal year ended November 30, 1999, the Short-Intermediate Bond
Portfolio did acquired and sold securities of Lehman Brothers, Inc., a regular
broker/dealer. At November 30, 1999, the Short-Intermediate Bond Portfolio owned
the following amounts of securities of its regular broker/dealers, as defined in
Rule 10b-1 under the 1940 Act, or their parents: Lehman Brothers, Inc., with an
approximate aggregate market value of $5,318,000; and Prudential Securities,
with an approximate aggregate market value of $4,461,000.
During the fiscal year ended November 30, 1999, the U.S. Government
Securities Portfolio did not acquire, sell or own any securities of its regular
broker/dealers or their parents.
During the fiscal year ended November 30, 1999, the U.S. Treasury Index
Portfolio did not acquire, sell or own any securities of its regular
broker/dealers or their parents.
Portfolio Valuation
U.S. and foreign investments held by a Portfolio are valued at the last
quoted sales price on the exchange on which such securities are primarily
traded, except that securities listed on an exchange in the United Kingdom are
valued at the average of the closing bid and ask prices. If any securities
listed on a U.S. securities exchange are not traded on a valuation date, they
will be valued at the last quoted bid price. If securities listed on a foreign
securities exchange are not traded on a valuation date, they will be valued at
the most recent quoted trade price. Securities which are traded in the U.S.
over-the-counter markets are valued at the last quoted bid price. Securities
which are traded in the foreign over-the-counter markets are valued at the last
sales price, except that such securities traded in the United Kingdom are valued
at the average of the closing bid and ask prices. Shares of investment companies
held by the Portfolios will be valued at their respective net asset values. Any
securities, including restricted securities, for which current quotations are
not readily available are valued at fair value as determined in good faith by
the Investment Adviser under the supervision of the Board of Trustees. Short-
term investments are valued at amortized cost which the Investment Advisers have
determined, pursuant to Board authorization, approximates market value.
Securities may be valued on the basis of prices provided by independent pricing
services when such prices are believed to reflect the fair market value of such
securities.
Co-Administrators and Distributor
Effective May 1, 1999, Northern and PFPC (formerly FDISG), 4400 Computer
Drive, Westborough, Massachusetts 01581, act as co-administrators for the
Portfolios under a Co-Administration Agreement with the Trust. Subject to the
general supervision of the Trust's Board of Trustees, Northern and PFPC (the
"Co-Administrators") provide supervision of all aspects of the Trust's non-
investment advisory operations and perform various corporate secretarial,
treasury and blue sky services, including but not limited to: (i) maintaining
office facilities and furnishing corporate officers for the Trust; (ii)
furnishing data processing services, clerical services, and executive and
administrative services and standard stationery and office supplies; (iii)
performing all functions ordinarily performed by the office of a corporate
treasurer, and furnishing the services and facilities ordinarily incident
thereto, such as expense accrual monitoring and payment of the Trust's bills,
preparing monthly reconciliation of the Trust's expense records, updating
projections of annual expenses, preparing materials for review by the Board of
Trustees and compliance testing; (iv) preparing and submitting reports to the
Trust's shareholders and the SEC; (v) preparing and printing financial
statements; (vi) preparing monthly Portfolio profile reports; (vii) preparing
and filing the Trust's federal and state tax returns (other than those required
to be filed by the Trust's custodian and transfer agent) and providing
shareholder tax information to the Trust's transfer agent; (viii) assisting in
marketing strategy and
25
<PAGE>
product development; (ix) performing oversight/management responsibilities, such
as the supervision and coordination of certain of the Trust's service providers;
(x) effecting and maintaining, as the case may be, the registration of shares of
the Trust for sale under the securities laws of various jurisdictions; (xi)
assisting in maintaining corporate records and good standing status of the Trust
in its state of organization; and (xii) monitoring the Trust's arrangements with
respect to services provided by Servicing Agents to their customers who are the
beneficial owners of shares, pursuant to servicing agreements between the Trust
and such Servicing Agents.
Subject to the limitations described below, as compensation for their
administrative services and the assumption of related expenses, the Co-
Administrators are entitled to a fee from each Portfolio, computed daily and
payable monthly, at an annual rate of .15% of the average daily net assets of
the International Bond Portfolio, and .10% of the average daily net assets of
each other Portfolio. The Co-Administrators will reimburse each Portfolio for
its expenses (including administration fees payable to the Co-Administrators,
but excluding advisory fees, transfer agency fees, servicing fees and
extraordinary expenses) which exceed on an annualized basis .25% of the
International Bond Portfolio's average daily net assets and .10% of each other
Portfolio's average daily net assets.
For the period May 1, 1999 through the fiscal year ended November 30, 1999,
the Co-Administrators received fees under the Co-Administration Agreement with
the Trust in the amount of:
U.S. Government Securities Portfolio $ 50,136
Short-Intermediate Bond Portfolio 112,931
U.S. Treasury Index Portfolio 13,232
Bond Portfolio 524,623
Intermediate Bond Portfolio 36,974
International Bond Portfolio 24,567
Additionally, for the period May 1, 1999 through the fiscal year ended
November 30, 1999, the Co-Administrators voluntarily reimbursed each Portfolio
for its expenses reducing administration fees in the following amounts for the
period May 1, 1999 through the fiscal year ended November 30, 1999:
U.S. Government Securities Portfolio $ 34,540
Short-Intermediate Bond Portfolio 49,829
U.S. Treasury Index Portfolio 37,242
Bond Portfolio 159,362
Intermediate Bond Portfolio 40,640
International Bond Portfolio 42,941
Prior to May 1, 1999, Goldman, Sachs & Co. ("Goldman Sachs"), 85 Broad
Street, New York, New York 10004, acted as the Trust's administrator pursuant to
an administration agreement similar to the Co-Administration Agreement currently
in effect with Northern and PFPC. For the fiscal years or periods ended November
30 as indicated, Goldman Sachs received fees under its administration agreement
with the Trust in the amount of:
<TABLE>
<CAPTION>
December 1, 1998
through
April 30, 1999 1998 1997
---------------- ---- ----
<S> <C> <C> <C>
U.S. Government Securities Portfolio $ 29,835 $ 49,354 $ 85,432
Short-Intermediate Bond Portfolio 74,269 199,235 171,514
U.S. Treasury Index Portfolio 9,954 25,313 29,247
Bond Portfolio 295,859 581,869 434,500
Intermediate Bond Portfolio (1) 34,344 22,165 3,470
International Bond Portfolio 17,914 39,733 36,801
</TABLE>
(1) Commenced investment operations on July 31, 1997.
26
<PAGE>
Prior to May 1, 1997, Goldman Sachs voluntarily agreed to waive a portion
of its administration fee for each Portfolio then in existence resulting in an
effective fee of .10% of the average daily net assets for each Portfolio. The
effect of these waivers by Goldman Sachs was to reduce administration fees by
the following amounts for the fiscal years or periods ended November 30 as
indicated:
<TABLE>
<CAPTION>
December 1, 1998
through
April 30, 1999 1998 1997
-------------- ---- ----
<S> <C> <C> <C>
U.S. Government Securities Portfolio $0 $0 $52,820
Short-Intermediate Bond Portfolio 0 0 72,454
U.S. Treasury Index Portfolio 0 0 17,382
Bond Portfolio 0 0 94,064
Intermediate Bond Portfolio (1) 0 0 N/A
International Bond Portfolio 0 0 18,779
</TABLE>
(1) Commenced investment operations on July 31, 1997.
In addition, pursuant to an undertaking that commenced August 1, 1992,
Goldman Sachs agreed that, if its administration fees (less expense
reimbursements paid by Goldman Sachs to the Trust and less certain marketing
expenses paid by Goldman Sachs) exceeded a specified amount ($1 million for the
Trust's first twelve investment portfolios plus $50,000 for each additional
portfolio) during a fiscal year, Goldman Sachs would waive a portion of its
administration fees during the following fiscal year. There were no waivers
pursuant to this agreement during the last three fiscal years.
Goldman Sachs had also agreed each year to reimburse each Portfolio for its
expenses (including fees payable to Goldman Sachs as administrator, but
excluding advisory fees, transfer agency fees, servicing fees and extraordinary
expenses) which exceeded on an annualized basis .25% of the International Bond
Portfolio's average daily net assets and .10% of each other Portfolio's average
daily net assets. Prior to May 1, 1997, this undertaking was voluntary with
respect to the Portfolios. As of May 1, 1997, this undertaking was contractual
with respect to all Portfolios. The effect of these reimbursements by Goldman
Sachs for the fiscal years or periods ended November 30 as indicated was to
reduce the expenses of each Portfolio by:
<TABLE>
<CAPTION>
December 1, 1998
through
April 30, 1999 1998 1997
-------------- ---- ----
<S> <C> <C> <C>
U.S. Government Securities Portfolio $ 24,893 $ 72,267 $ 70,879
Short-Intermediate Bond Portfolio 48,092 103,011 102,005
U.S. Treasury Index Portfolio 23,710 66,821 71,652
Bond Portfolio 121,707 222,213 165,969
Intermediate Bond Portfolio (1) 23,301 83,211 54,096
International Bond Portfolio 35,599 95,507 82,249
(1) Commenced investment operations on July 31, 1997.
</TABLE>
Unless sooner terminated, the Co-Administration Agreement among Northern,
PFPC and the Trust will continue in effect until April 30, 2001, and thereafter
for successive one-year terms with respect to each Portfolio, provided that the
Agreement is approved annually (1) by the Board of Trustees or (2) by the vote
of a majority of the outstanding shares of such Portfolio (as defined below
under "Other Information"), provided that in either event the continuance is
also approved by a majority of the Trustees who are not parties to the Agreement
and who are not interested persons (as defined in the 1940 Act) of any party
thereto, by vote cast in person at a meeting called for the purpose of voting on
such approval. The Co-Administration Agreement is terminable at any time after
April 30, 2001 without penalty by the Trust on at least 60 days written notice
to the Co-Administrators. Each Co-Administrator may terminate the Co-
Administration Agreement with respect to itself at any time after April 30, 2001
without penalty on at least 60 days written notice to the Trust and the other
Co-Administrator.
The Trust may terminate the Co-Administration Agreement prior to April 30,
2001 in the event that the Trust or its shareholders incur damages in excess of
$100,000 as a result of the willful misfeasance, bad faith or negligence of the
Co-Administrators, or the reckless disregard of their duties under the
Agreement. The Trust may also terminate the Co-
27
<PAGE>
Administration Agreement prior to April 30, 2001 in the event that the Co-
Administrators fail to meet one of the performance standards set forth in the
Agreement.
The Trust has entered into a Distribution Agreement with NFD under which
NFD, as agent, sells shares of each Portfolio on a continuous basis. NFD pays
the cost of printing and distributing prospectuses to persons who are not
shareholders of the Trust (excluding preparation and typesetting expenses) and
of certain other distribution efforts. NFD is a wholly-owned subsidiary of
Provident Distributors, Inc. ("PDI"). PDI, based in West Conshohocken,
Pennsylvania, is an independently owned and operated broker-dealer. Between May
1, 1999 and November 30, 1999, First Data Distributors, Inc. ("FDDI") acted as
the Trust's distributor pursuant to a distribution agreement similar to the
Distribution Agreement currently in effect with NFD. No compensation is payable
by the Trust to NFD for such distribution services. Prior to May 1, 1999,
Goldman Sachs acted as the Trust's distributor pursuant to a distribution
agreement similar to the Distribution Agreement currently in effect with NFD.
The Co-Administration Agreement provides that the Co-Administrators may
render similar services to others so long as their services under such Agreement
are not impaired thereby. The Co-Administration Agreement also provides that the
Trust will indemnify each Co-Administrator against all claims except those
resulting from the willful misfeasance, bad faith or negligence of such Co-
Administrator, or the Co-Administrator's breach of confidentiality. The
Distribution Agreement provides that the Trust will indemnify NFD against
certain liabilities relating to untrue statements or omissions of material fact
except those resulting from the reliance on information furnished to the Trust
by NFD, or those resulting from the willful misfeasance, bad faith or negligence
of NFD, or NFD's breach of confidentiality.
Under a Service Mark License Agreement (the "License Agreement") with NFD,
Northern Trust Corporation agrees that the name "Northern Institutional Funds"
may be used in connection with Northern Institutional Funds' business on a
royalty-free basis. Northern Trust Corporation has reserved to itself the right
to grant the non-exclusive right to use the name ("Northern Institutional
Funds") to any other person. The License Agreement provides that at such time as
the License Agreement is no longer in effect NFD will cease using the name
"Northern Institutional Funds."
Shareholder Servicing Plan
As stated in the Portfolios' Prospectus, Servicing Agents may enter into
servicing agreements with the Trust under which they provide (or arrange to have
provided) support services to their Customers or other investors who
beneficially own such shares in consideration of the Portfolios' payment of not
more than .15% and .25% (on an annualized basis) of the average daily net asset
value of the Class C and D Shares, respectively, beneficially owned by such
Customers or investors.
28
<PAGE>
For the fiscal years or periods ended November 30 as indicated, the
aggregate amount of the Shareholder Service Fee incurred by each class of each
Portfolio then in existence was as follows:
<TABLE>
<CAPTION>
1999 1998 1997
------- ------- -------
<S> <C> <C> <C>
U.S. Government Securities Portfolio
Class C (1) $ 560 $ 5,132 $ 5,225
Class D 2,175 1,955 710
Short-Intermediate Bond Portfolio
Class D 852 2,584 1,349
U.S. Treasury Index Portfolio
Class C (2) 251 25 N/A
Class D 1,558 4,846 3,353
Bond Portfolio
Class C 90,790 86,693 51,720
Class D 4,179 4,050 887
Intermediate Bond Portfolio
Class D (3) 86 17 N/A
International Bond Portfolio
Class D 59 334 154
(1) Class C Shares were issued on December 29, 1995.
(2) Class C Shares were issued on October 7, 1998.
(3) Class D Shares were issued on October 5, 1998.
</TABLE>
Services provided by or arranged to be provided by Servicing Agents under
their servicing agreements may include: (i) establishing and maintaining
separate account records of Customers or other investors; (ii) providing
Customers or other investors with a service that invests their assets in shares
of certain classes pursuant to specific or pre-authorized instructions, and
assistance with new account applications; (iii) aggregating and processing
purchase and redemption requests for shares of certain classes from Customers or
other investors, and placing purchase and redemption orders with the Transfer
Agent; (iv) issuing confirmations to Customers or other investors in accordance
with applicable law; (v) arranging for the timely transmission of funds
representing the net purchase price or redemption proceeds; (vi) processing
dividend payments on behalf of Customers or other investors; (vii) providing
information periodically to Customers or other investors showing their positions
in shares; (viii) responding to Customer or other investor inquiries (including
requests for prospectuses), and complaints relating to the services performed by
the Servicing Agents; (ix) acting as liaison with respect to all inquiries and
complaints from Customers and other investors relating to errors committed by
the Trust or its agents, and other matters pertaining to the Trust; (x)
providing or arranging for another person to provide subaccounting with respect
to shares of certain classes beneficially owned by Customers or other investors;
(xi) if required by law, forwarding shareholder communications from the Trust
(such as proxy statements and proxies, shareholder reports, annual and semi-
annual financial statements and dividend, distribution and tax notices) to
Customers and other investors; (xii) providing such office space, facilities and
personnel as may be required to perform their services under the servicing
agreements; (xiv) maintaining appropriate management reporting and statistical
information; (xiii) paying expenses related to the preparation of educational
and other explanatory materials in connection with the development of investor
services; (xv) developing and monitoring investment programs; and (xvi)
providing such other similar services as the Trust may reasonably request to the
extent the Servicing Agents are permitted to do so under applicable statutes,
rules and regulations.
The Trust's agreements with Servicing Agents are governed by a Plan (called
the "Shareholder Servicing Plan") which has been adopted by the Board of
Trustees. Pursuant to the Shareholder Servicing Plan, the Board of Trustees will
review, at least quarterly, a written report of the amounts expended under the
Trust's agreements with Servicing Agents and the purposes for which the
expenditures were made. In addition, the arrangements with Servicing Agents must
be approved annually by a majority of the Board of Trustees, including a
majority of the Trustees who are not "interested persons" of the Trust, as
defined in the 1940 Act, and have no direct or indirect financial interest in
such arrangements.
The Board of Trustees has approved the arrangements with Servicing Agents
based on information provided by the Trust's service contractors that there is a
reasonable likelihood that the arrangements will benefit the Portfolios and
their shareholders by affording the Portfolios greater flexibility in connection
with the servicing of the accounts of the beneficial owners of their shares in
an efficient manner.
29
<PAGE>
Counsel and Auditors
Drinker Biddle & Reath LLP, with offices at One Logan Square, 18th and
Cherry Streets, Philadelphia, Pennsylvania 19103-6996, serve as counsel to the
Trust.
Ernst & Young LLP, independent auditors, 233 S. Wacker Drive, Chicago,
Illinois 60606, have been selected as auditors of the Trust. In addition to
audit services, Ernst & Young LLP reviews the Trust's Federal and state tax
returns, and provides consultation and assistance on accounting, internal
control and related matters.
In-Kind Purchases and Redemptions
Payment for shares of a Portfolio may, in the discretion of Northern, be
made in the form of securities that are permissible investments for the
Portfolio as described in the Prospectus. For further information about this
form of payment, contact Northern. In connection with an in-kind securities
payment, a Portfolio will require, among other things, that the securities be
valued on the day of purchase in accordance with the pricing methods used by the
Portfolio and that the Portfolio receive satisfactory assurances that it will
have good and marketable title to the securities received by it; that the
securities be in proper form for transfer to the Portfolio; and that adequate
information be provided concerning the basis and other tax matters relating to
the securities.
Although each Portfolio generally will redeem shares in cash, each
Portfolio reserves the right to pay redemptions by a distribution in kind of
securities (instead of cash) from such Portfolio. The securities distributed in
kind would be readily marketable and would be valued for this purpose using the
same method employed in calculating the Portfolio's net asset value per share.
If a shareholder receives redemption proceeds in kind, the shareholder should
expect to incur transaction costs upon the disposition of the securities
received in the redemption.
PERFORMANCE INFORMATION
The performance of a class of shares of a Portfolio may be compared to
those of other mutual funds with similar investment objectives and to bond,
stock and other relevant indices or to rankings prepared by independent services
or other financial or industry publications that monitor the performance of
mutual funds. For example, the performance of a class of shares may be compared
to data prepared by Lipper Analytical Services, Inc. or other independent mutual
fund reporting services. In addition, the performance of a class may be compared
to the Lehman Brothers Government/Corporate Bond Index (or its components,
including the Treasury Bond Index), the Lehman Mutual Fund Intermediate Tax
Exempt Index, S&P 500 Index, S&P/Barra Growth Index, the Russell 2000 Index, the
Europe and Australia Far East Equity Index ("EAFE Index") or other unmanaged
stock and bond indices, including, but not limited to, the Merrill Lynch 1-5
Year Government Bond Index, the Merrill Lynch 1-5 Year Corporate/Government Bond
Index, the 3-month LIBOR Index, the 91-day Treasury Bill Rate, the Composite
Index, the J.P. Morgan Non-U.S. Government Bond Index, and the Dow Jones
Industrial Average, a recognized unmanaged index of common stocks of 30 industry
companies listed on the New York Stock Exchange. Performance data as reported in
national financial publications such as Money Magazine, Morningstar, Forbes,
Barron's, The Wall Street Journal and The New York Times, or in publications of
a local or regional nature, may also be used in comparing the performance of a
class of shares of a Portfolio.
The Portfolios calculate their total returns for each class of shares
separately on an "annual total return" basis for various periods as permitted
under the rules of the SEC. Average annual total return reflects the average
annual percentage change in value of an investment in the class over the
measuring period. Total returns for each class of shares may also be calculated
on an "aggregate total return" basis for various periods. Aggregate total return
reflects the total percentage change in value over the measuring period. Both
methods of calculating total return reflect changes in the price of the shares
and assume that any dividends and capital gain distributions made by the
Portfolio with respect to a class during the period are reinvested in the shares
of that class. When considering average total return figures for periods longer
than one year, it is important to note that the annual total return of a class
for any one year in the period might have been more or less than the average for
the entire period. The Portfolios may also advertise from time to time the total
return of one or more classes of shares on a year-by-year or other basis for
various specified periods by means of quotations, charts, graphs or schedules.
Each Portfolio that advertises an "average annual total return" for a class
of shares computes such return by determining the average annual compounded rate
of return during specified periods that equates the initial amount invested to
the ending redeemable value of such investment according to the following
formula:
P (1+T)/n/ = ERV
30
<PAGE>
Where: T = average annual total return;
ERV = ending redeemable value at the end of the applicable period
(or fractional portion thereof) of a hypothetical $1,000
payment made at the beginning of the 1, 5 or 10 year (or
other) period;
P = hypothetical initial payment of $1,000; and
n = period covered by the computation, expressed in terms of
years.
Each Portfolio that advertises an "aggregate total return" for a class of
shares computes such return by determining the aggregate compounded rates of
return during specified periods that likewise equate the initial amount invested
to the ending redeemable value of such investment. The formula for calculating
aggregate total return is as follows:
T = [(ERV/P)] - 1
The calculations set forth below are made assuming that (1) all dividends
and capital gain distributions are reinvested on the reinvestment dates at the
price per share existing on the reinvestment date and (2) all recurring fees
charged to all shareholder accounts are included. The ending redeemable value
(variable "ERV" in the formula) is determined by assuming complete redemption of
the hypothetical investment after deduction of all nonrecurring charges at the
end of the measuring period.
The average annual total returns and aggregate total returns shown below
for the Short-Intermediate Bond, U.S. Treasury Index and Bond Portfolios
include, for periods prior to the commencement of the Portfolios' operations,
the performance of predecessor collective funds adjusted to reflect the higher
estimated fees and expenses applicable to such Portfolios' Class A Shares at the
time of their inception. Although all such predecessor collective funds were
managed by Northern for the periods stated in a manner and pursuant to
investment objectives that were equivalent in all material respects to the
management and investment objectives of the corresponding Portfolios, such
predecessor collective funds were not registered under the 1940 Act and were not
subject to certain investment restrictions imposed by the 1940 Act. If they had
been registered under the 1940 Act, performance might have been adversely
affected. The average annual total returns and aggregate total returns shown for
the Portfolios for their Class C and/or Class D Shares also include, for the
periods prior to the inception of such classes, the performance of the
Portfolios' Class A Shares. Because the fees and expenses of Class C and Class D
Shares are, respectively, 0.24% and 0.39% higher than those of Class A Shares,
actual performance for periods prior to the inception of Class C and Class D
Shares would have been lower if such higher fees and expenses had been taken
into account.
Following commencement of operations of the Portfolios, the Portfolios'
administrator (Goldman Sachs) or Co-administrators (Northern and PFPC)
reimbursed expenses to the Portfolios and voluntarily agreed to reduce a portion
of their administration fees for each Portfolio pursuant to the undertaking
described above under "Additional Trust Information - Co-Administrators and
Distributor" and "- Investment Advisers, Transfer Agent and Custodian," and
Northern waived a portion of its investment advisory fees with respect to the
Portfolios. The average annual total returns and aggregate total returns of each
Portfolio with respect to Class A, Class C and Class D Shares, as applicable,
are shown below with and without such fee waivers and expense reimbursements.
31
<PAGE>
<TABLE>
<CAPTION>
For Periods Ended November 30, 1999
Average Annual Total Returns (%) Aggregate Total Returns (%)
Since Since
1 Year 5 Year 10 year Inception 1 Year 5 Year 10 Year Inception
------ ------ ------- --------- ------ ------ ------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Bond/1/
Class A
with fee waivers and (1.35%) 8.60% 8.57% --- (1.35%) 51.05% 127.53% ---
expense reimbursements
without fee waivers and (1.81%) 8.12% 8.02% --- (1.81%) 47.74% 116.26% ---
expense reimbursements
Class C
with fee waivers and (1.59%) 8.37% 8.45% --- (1.59%) 49.44% 125.10% ---
expense reimbursements
without fee waivers and (1.98%) 7.90% 7.91% --- (1.98%) 46.26% 114.09% ---
expense reimbursements
Class D
with fee waivers and (1.74%) 8.17% 8.35% --- (1.74%) 48.10% 122.93% ---
expense reimbursements
without fee waivers and (2.14%) 7.71% 7.81% --- (2.14%) 44.94% 112.03% ---
expense reimbursements
Intermediate Bond/2/
Class A
with fee waivers and 0.25% --- --- 3.79% 0.25% --- --- 9.07%
expense reimbursements
without fee waivers and (0.17%) --- --- 3.05% (0.17%) --- --- (7.10%)
expense reimbursements
Class D
with fee waivers and (0.21%) --- --- 3.52% (0.21%) --- --- 8.41%
expense reimbursements
without fee waivers and (0.64%) --- --- 2.82% (0.64%) --- --- 6.45%
expense reimbursements
</TABLE>
32
<PAGE>
<TABLE>
<CAPTION>
For Periods Ended November 30, 1999
Average Annual Total Returns (%) Aggregate Total Returns (%)
Since Since
1 Year 5 Year 10 year Inception 1 Year 5 Year 10 Year Inception
------ ------ ------- --------- ------ ------ ------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Short-Intermediate Bond/3/
Class A
with fee waivers and 2.25% 6.55% 6.91% --- 2.25% 37.31% 94.99% ---
expense reimbursements
without fee waivers and 1.84% 6.90% 6.75% --- 1.84% 39.57% 92.10% ---
expense reimbursements
Class D
with fee waivers and 1.84% 6.11% 6.69% --- 1.84% 34.54% 91.01% ---
expense reimbursements
without fee waivers and 1.44% 5.62% 6.10% --- 1.44% 31.42% 80.73% ---
expense reimbursements
U.S. Treasury Index/4/
Class A
with fee waivers and (2.10%) 7.48% 7.37% --- (2.10%) 43.42% 103.68% ---
expense reimbursements
without fee waivers and (2.59%) 6.84% 6.71% --- (2.59%) 39.24% 91.44% ---
expense reimbursements
Class C
with fee waivers and (1.85%) 7.39% 7.33% --- (1.85%) 42.83% 102.84% ---
expense reimbursements
without fee waivers and (2.34%) 6.90% 6.74% --- (2.34%) 39.63% 91.98% ---
expense reimbursements
Class D
with fee waivers and
expense reimbursements (1.86%) 7.01% 7.15% --- (1.86%) 40.35% 99.43% ---
without fee waivers and (2.31%) 6.57% 6.57% --- (2.31%) 37.49% 89.03% ---
expense reimbursements
</TABLE>
33
<PAGE>
<TABLE>
<CAPTION>
For Periods Ended November 30,1999
Average Annual Total Returns(%) Aggregate Total Returns(%)
Since Since
1 Year 5 Year 10 Year Inception 1 Year 5 Year 10 Year Inception
------ ------ ------- --------- ------ ------ ------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. Government Securities/5/
Class A
with fee waivers and 2.46% 6.38% --- 5.13% 2.46% 36.21% --- 39.51%
expense reimbursements
without fee waivers and 2.03% 5.80% --- 4.50% 2.03% 32.54% --- 34.06%
expense reimbursements
Class C/6/
with fee waivers and
expense reimbursements See Footnote 7 See Footnote 7
without fee waivers and
expense reimbursements See Footnote 7 See Footnote 7
Class D
with fee waivers and 2.06% 5.95% --- 4.79% 2.06% 33.51% --- 36.58%
expense reimbursements
without fee waivers and 1.62% 5.37% --- 4.17% 1.62% 29.92% --- 31.23%
expense reimbursements
International Bond
Class A
with fee waivers and (5.76%) 5.75% --- 5.78% (5.76%) 32.23% --- 37.59%
expense reimbursements
without fee waivers and (6.24%) 5.16% --- 5.19% (6.24%) 28.61% --- 33.31%
expense reimbursements
Class D/7/
with fee waivers and
expense reimbursements See Footnote 8 See Footnote 8
without fee waivers and
expense reimbursements See Footnote 8 See Footnote 8
</TABLE>
1. For Class A, C and D Shares, performance information prior to January 11,
1993 (commencement of Portfolio) is that of a predecessor collective fund.
For Class C and D Shares, performance information from January 11, 1993 to
July 3, 1995 (commencement of Class C Shares) and September 14, 1994
(commencement of Class D Shares), respectively, is that of Class A Shares.
Because the fees and expenses of Class C and Class D Shares are .24% and
.39%, respectively, higher than those of Class A Shares, actual performance
would have been lower had such fees and expenses been taken into account.
The predecessor collective fund has been managed in a manner and pursuant
to investment objectives equivalent in all material respects to the
management and investment objective of the Portfolio for the periods shown.
The performance information of the predecessor collective fund is adjusted
to reflect the higher fees and expenses applicable to Class A Shares at the
time of their inception.
2. For Class D Shares, performance information from August 1, 1997 to October
5, 1998 (commencement of Class D Shares) is that of Class A Shares. Class A
Shares commenced operations on August 1, 1997. Because the fees and
expenses of Class D Shares are .39% higher than those of Class A Shares,
actual performance would have been lower had such higher fees and expenses
been taken into account.
3. For Class A and D Shares, performance information prior to January 11, 1993
(commencement of Portfolio) is that of a predecessor collective fund. For
Class D Shares, performance information from January 11, 1993 to September
14, 1994 (commencement of Class D Shares) is that of Class A Shares.
Because the fees and expenses of Class D Shares are .39% higher than those
of Class A Shares, actual performance would have been lower had such higher
fees and expenses been taken into account. The predecessor collective fund
has been managed in a manner and pursuant to investment objectives
equivalent in all material respects to the management and investment
objective of the Portfolio for the periods shown. The performance
information of the predecessor collective fund is adjusted to reflect the
higher fees and expenses applicable to Class A Shares at the time of their
inception.
4. For Class A, C and D Shares, performance information prior to January 11,
1993 (commencement of Portfolio) is that
34
<PAGE>
of a predecessor collective fund. For Class C and D Shares, performance
information from January 11, 1993 to October 7, 1998 (commencement of Class
C Shares) and November 16, 1994 (commencement of Class D Shares),
respectively, is that of Class A Shares. Because the fees and expenses of
Class C and Class D Shares are .24% and .39%, respectively, higher than
those of Class A Shares, actual performance would have been lower had such
higher fees and expenses been taken into account. Performance information
of the predecessor collective fund is shown from January 1, 1987, the date
from which the predecessor fund has been managed in a manner and pursuant
to investment objectives equivalent in all material respects to the
management and investment objective of the Portfolio. The performance
information of the predecessor collective fund is adjusted to reflect the
higher fees and expenses applicable to Class A Shares at the time of their
inception.
5. For Class D Shares, performance information prior to September 15, 1994
(commencement of Class D Shares) is that of Class A Shares. Class A Shares
commenced operations April 5, 1993. Because fees and expenses of Class D
Shares are .39%, higher than those of Class A Shares, actual performance
would have been lower had such higher fees and expenses been taken into
account.
6. From February 10, 1999 to the date of the Prospectus, no Class C shares of
the U.S. Government Securities Portfolio were held by shareholders. Class C
shares of the U.S. Government Securities Portfolio will have substantially
similar annual returns when compared with Class A shares of the U.S.
Government Securities Portfolio because shares of both Class A and Class C
are invested in the same portfolio of securities. The annual returns of
Class A and Class C shares will differ only to the extent that the share
classes do not have the same expenses. Annual returns reflected since
inception will also differ as the classes do not have the same inception
date.
7. From August 22, 1999 to the date of the Prospectus, no Class D shares of
the International Bond Portfolio were held by shareholders. Class D shares
of the International Bond Portfolio will have substantially similar annual
returns when compared with Class A shares of the International Bond
Portfolio because shares of both Class A and Class D are invested in the
same portfolio of securities. The annual returns of Class A and Class D
shares will differ only to the extent that the share classes do not have
the same expenses. Annual returns reflected since inception will also
differ as the classes do not have the same inception date.
The yield of a class of shares in the Portfolios is computed based on the
net income of such class during a 30-day (or one month) period (which period
will be identified in connection with the particular yield quotation). More
specifically, a Portfolio's yield for a class of shares is computed by dividing
the per share net income for the class during a 30-day (or one month) period by
the net asset value per share on the last day of the period and annualizing the
result on a semi-annual basis.
The Portfolios' 30-day (or one month) standard yield is calculated for each
class of the Portfolios in accordance with the method prescribed by the SEC for
mutual funds:
Yield = 2[{(a-b/cd) + 1}/6/ - 1]
Where: a = dividends and interest earned by a Portfolio during the
period;
b = expenses accrued for the period (net of reimbursements);
c = average daily number of shares outstanding during the
period entitled to receive dividends; and
d = net asset value per share on the last day of the period.
35
<PAGE>
For the 30-day period ended November 30, 1999, the annualized yields for the
outstanding Class A, Class C and Class D Shares of the Portfolios were as
follows:
30-Day Yield
------------
U.S. Government Securities Portfolio
Class A 5.75%
Class D 5.36%
Short-Intermediate Bond Portfolio
Class A 6.08%
Class D 5.69%
U.S. Treasury Index Portfolio
Class A 6.06%
Class C 5.83%
Class D 5.68%
Bond Portfolio
Class A 6.73%
Class C 6.49%
Class D 6.33%
Intermediate Bond Portfolio
Class A 6.39%
Class D 5.99%
International Bond Portfolio
Class A 3.43%
The information set forth in the foregoing table reflects certain fee
reductions and expense limitations. See "Investment Advisers, Transfer Agent and
Custodian" and "Co-Administrators and Distributor" under "Additional Trust
Information." In the absence of such fee reductions and expense limitations, the
annualized 30-day yields of each Portfolio with respect to Class A, Class C and
Class D Shares would have been as follows:
30-Day Yield
------------
U.S. Government Securities Portfolio
Class A 5.34%
Class D 4.95%
Short-Intermediate Bond Portfolio
Class A 5.68%
Class D 5.29%
U.S. Treasury Index Portfolio
Class A 5.55%
Class C 5.32%
Class D 5.17%
Bond Portfolio
Class A 6.35%
Class C 6.11%
Class D 5.95%
36
<PAGE>
30-Day Yield
------------
Intermediate Bond Portfolio
Class A 5.95%
Class D 5.55%
International Bond Portfolio
Class A 2.95%
Because of the different servicing fees and transfer agency fees payable
with respect to Class A, C and D Shares in a Portfolio, performance quotations
for shares of Class C and D of the Portfolio will be lower than the quotations
for Class A Shares of the Portfolio, which will not bear any fees for
shareholder support services and will bear minimal transfer agency fees.
The performance of each class of shares of the Portfolios is based on
historical earnings, will fluctuate and is not intended to indicate future
performance. The investment return and principal value of an investment in a
class will fluctuate so that when redeemed, shares may be worth more or less
than their original cost. Performance information may not provide a basis for
comparison with bank deposits and other investments which provide a fixed yield
for a stated period of time. Total return data should also be considered in
light of the risks associated with a Portfolio's composition, quality, maturity,
operating expenses and market conditions. Any fees charged by Institutions
directly to their Customer accounts in connection with investments in a
Portfolio will not be included in the Portfolios' calculations of performance
information.
TAXES
The following summarizes certain additional tax considerations generally
affecting the Portfolios and their shareholders that are not described in the
Portfolios' Prospectus. No attempt is made to present a detailed explanation of
the tax treatment of the Portfolios or their shareholders, and the discussion
here and in the applicable Prospectus is not intended as a substitute for
careful tax planning. Potential investors should consult their tax advisers with
specific reference to their own tax situations.
The discussions of tax consequences in the Prospectus and this Additional
Statement are based on the Internal Revenue Code of 1986, as amended (the
"Code"), and the laws and regulations issued thereunder as in effect on the date
of this Additional Statement. Future legislative or administrative changes or
court decisions may significantly change the conclusions expressed herein, and
any such changes or decisions may have a retroactive effect with respect to the
transactions contemplated herein.
Federal - General Information
Each Portfolio intends to qualify as a regulated investment company under
Part I of Subchapter M of Subtitle A, Chapter 1, of Code. As a regulated
investment company, each Portfolio is generally exempt from federal income tax
on its net investment income and realized capital gains which it distributes to
shareholders, provided that it distributes an amount equal to at least the sum
of 90% of its tax-exempt income and 90% of its investment company taxable income
(net investment income and the excess of net short-term capital gain over net
long-term capital loss), if any, for the year (the "Distribution Requirement")
and satisfies certain other requirements of the Code that are described below.
In addition to satisfaction of the Distribution Requirement, each Portfolio
must derive with respect to a taxable year at least 90% of its gross income from
dividends, interest, certain payments with respect to securities, loans and
gains from the sale or other disposition of stock or securities, loans and gains
from the sale or other disposition of stock or securities or foreign currencies,
or from income derived with respect to its business of investing in such stock,
securities, or currencies (the "Income Requirement").
In addition to the foregoing requirements, at the close of each quarter of
its taxable year, at least 50% of the value of each Portfolio's assets must
generally consist of cash and cash items, U.S. Government Securities, securities
of other regulated investment companies, and securities of other issuers (as to
which as Portfolio has not invested more than 5% of the value of its total
assets in securities of such issuer and as to which a Portfolio does not hold
more that 10% of the outstanding voting securities of such issuer), and no more
than 25% of the value of each Portfolio's total assets may be invested in the
securities of any one issuer (other than U.S. Government Securities and
securities of other regulated
37
<PAGE>
investment companies), or in two or more issuers which such Portfolio controls
and which are engaged in the same or similar trades or businesses.
None of the Portfolios expects to pay dividends that qualify for the
dividends-received deduction for corporations.
If for any taxable year any Portfolio were not to qualify as a regulated
investment company, all of its taxable income would be subject to tax at regular
corporate rates without any deduction for distributions to shareholders. In such
event, all distributions would be taxable as ordinary income to the extent of
the Portfolio's current and accumulated earnings and profits, and would be
eligible for the dividends-received deduction in the case of corporate
shareholders.
The Code imposes a non-deductible 4% excise tax on regulated investment
companies that fail currently to distribute an amount equal to specified
percentages of their ordinary taxable income and capital gain net income (excess
of capital gains over capital losses). Each Portfolio intends to make sufficient
distributions or deemed distributions of its ordinary taxable income and capital
gain net income each calendar year to avoid liability for this excise tax.
Although each Portfolio expects to qualify as a RIC and to be relieved of
all or substantially all Federal taxes, depending upon the extent of its
activities in states and localities in which its offices are maintained, in
which its agents or independent contractors are located or in which it is
otherwise deemed to be conducting business, each Portfolio may be subject to the
tax laws of such states or localities.
The Trust will be required in certain cases to withhold and remit to the
United States Treasury 31% of taxable dividends or 31% of gross sale proceeds
paid to any shareholder (i) who has provided either an incorrect tax
identification number or no number at all, (ii) who is subject to backup
withholding by the Internal Revenue Service for prior failure to report the
receipt of taxable interest or dividend income properly, or (iii) who has failed
to certify to the Trust, when required to do so, that he is not subject to
backup withholding or that he is an "exempt recipient."
Foreign Investors
Foreign shareholders generally will be subject to U.S. withholding tax at a
rate of 30% (or a lower treaty rate, if applicable) on distributions by a
Portfolio of net investment income, other ordinary income, and the excess, if
any, of net short-term capital gain over net long-term capital loss for the
year, regardless of the extent, if any, to which the income or gain is derived
from non-U.S. investments of the Portfolio. For this purpose, foreign
shareholders include individuals other than U.S. citizens, residents and
certain nonresident aliens, and foreign corporations, partnerships, trusts and
estates. A foreign shareholder generally will not be subject to U.S. income or
withholding tax in respect of proceeds from or gain on the redemption of shares
or in respect of capital gain dividends (i.e., dividends attributable to long-
term capital gains of a Portfolio), provided such shareholder submits a
statement, signed under penalties of perjury, attesting to such shareholder's
exempt status. Different tax consequences apply to a foreign shareholder engaged
in a U.S. trade or business or present in the U.S. for 183 days or more in a
year. Foreign shareholders should consult their tax advisers regarding the U.S.
and foreign tax consequences of investing in a Portfolio.
DESCRIPTION OF SHARES
The Trust Agreement permits the Trust's Board of Trustees to issue an
unlimited number of full and fractional shares of beneficial interest of one or
more separate series representing interests in one or more investment
portfolios. The Trustees may hereafter create series in addition to the Trust's
twenty-one existing series, which represent interests in the Trust's twenty-one
respective portfolios, six of which are discussed in this Additional Statement.
The Trust Agreement also permits the Board of Trustees to classify or reclassify
any unissued shares into classes within a series. Pursuant to such authority,
the Trustees have authorized the issuance of an unlimited number of shares of
beneficial interest in three separate classes of shares in each of the Trust's
non-money market portfolios: Class A, C and D Shares.
Under the terms of the Trust Agreement, each share of each Portfolio is
without par value, represents an equal proportionate interest in the particular
Portfolio with each other share of its class in the same Portfolio and is
entitled to such dividends and distributions out of the income belonging to the
Portfolio as are declared by the Trustees. Upon any liquidation of a Portfolio,
shareholders of each class of a Portfolio are entitled to share pro rata in the
net assets belonging to that class available for distribution. Shares do not
have any preemptive or conversion rights. The right of redemption is described
under "About Your Account -- Selling Shares" in the Prospectus. In addition,
pursuant to the terms of the 1940 Act, the right of a shareholder to redeem
shares and the date of payment by a Portfolio may be suspended for more than
seven days (i) for any period during which the New York Stock Exchange is
closed, other than the customary weekends or holidays, or trading in the markets
the Portfolio normally utilizes is closed or is restricted as determined by the
SEC, (ii)
38
<PAGE>
during any emergency, as determined by the SEC, as a result of which it is not
reasonably practicable for the Portfolio to dispose of instruments owned by it
or fairly to determine the value of its net assets, or (iii) for such other
period as the SEC may by order permit for the protection of the shareholders of
the Portfolio. The Trust may also suspend or postpone the recordation of the
transfer of its shares upon the occurrence of any of the foregoing conditions.
In addition, shares of each Portfolio are redeemable at the unilateral option of
the Trust if the Trustees determine in their sole discretion that failure to so
redeem may have material adverse consequences to the shareholders of the
Portfolio. Shares when issued as described in the Prospectus are validly issued,
fully paid and nonassessable, except as stated below. In the interests of
economy and convenience, certificates representing shares of the Portfolios are
not issued.
The proceeds received by each Portfolio for each issue or sale of its
shares, and all net investment income, realized and unrealized gain and proceeds
thereof, subject only to the rights of creditors, will be specifically allocated
to and constitute the underlying assets of that Portfolio. The underlying assets
of each Portfolio will be segregated on the books of account, and will be
charged with the liabilities in respect to that Portfolio and with a share of
the general liabilities of the Trust. Expenses with respect to the Portfolios
are normally allocated in proportion to the net asset value of the respective
Portfolios except where allocations of direct expenses can otherwise be fairly
made.
Rule 18f-2 under the 1940 Act provides that any matter required by the
provisions of the 1940 Act or applicable state law, or otherwise, to be
submitted to the holders of the outstanding voting securities of an investment
company such as the Trust shall not be deemed to have been effectively acted
upon unless approved by the holders of a majority of the outstanding shares of
each investment portfolio affected by such matter. Rule 18f-2 further provides
that an investment portfolio shall be deemed to be affected by a matter unless
the interests of each investment portfolio in the matter are substantially
identical or the matter does not affect any interest of the investment
portfolio. Under the Rule, the approval of an investment advisory agreement or
any change in a fundamental investment policy would be effectively acted upon
with respect to an investment portfolio only if approved by a majority of the
outstanding shares of such investment portfolio. However, the Rule also provides
that the ratification of the appointment of independent accountants, the
approval of principal underwriting contracts and the election of Trustees are
exempt from the separate voting requirements stated above. In addition,
shareholders of each of the classes in a particular investment portfolio have
equal voting rights except that only shares of a particular class of an
investment portfolio will be entitled to vote on matters submitted to a vote of
shareholders (if any) relating to shareholder servicing expenses and transfer
agency fees that are payable by that class.
The Trust is not required to hold annual meetings of shareholders and does
not intend to hold such meetings. In the event that a meeting of shareholders is
held, each share of the Trust will be entitled, as determined by the Trustees
without the vote or consent of shareholders, either to one vote for each share
or to one vote for each dollar of net asset value represented by such shares on
all matters presented to shareholders, including the election of Trustees (this
method of voting being referred to as "dollar-based voting"). However, to the
extent required by the 1940 Act or otherwise determined by the Trustees, series
and classes of the Trust will vote separately from each other. Shareholders of
the Trust do not have cumulative voting rights in the election of Trustees and,
accordingly, the holders of more than 50% of the aggregate voting power of the
Trust may elect all of the Trustees, irrespective of the vote of the other
shareholders. Meetings of shareholders of the Trust, or any series or class
thereof, may be called by the Trustees, certain officers or upon the written
request of holders of 10% or more of the shares entitled to vote at such
meeting. To the extent required by law, the Trust will assist in shareholder
communications in connection with a meeting called by shareholders. The
shareholders of the Trust will have voting rights only with respect to the
limited number of matters specified in the Trust Agreement and such other
matters as the Trustees may determine or may be required by law.
The Trust Agreement authorizes the Trustees, without shareholder approval
(except as stated in the next paragraph), to cause the Trust, or any series
thereof, to merge or consolidate with any corporation, association, trust or
other organization or sell or exchange all or substantially all of the property
belonging to the Trust, or any series thereof. In addition, the Trustees,
without shareholder approval, may adopt a "master-feeder" structure by investing
substantially all of the assets of a series of the Trust in the securities of
another open-end investment company or pooled portfolio.
The Trust Agreement also authorizes the Trustees, in connection with the
merger, consolidation, termination or other reorganization of the Trust or any
series or class, to classify the shareholders of any class into one or more
separate groups and to provide for the different treatment of shares held by the
different groups, provided that such merger, consolidation, termination or other
reorganization is approved by a majority of the outstanding voting securities
(as defined in the 1940 Act) of each group of shareholders that are so
classified.
The Trust Agreement permits the Trustees to amend the Trust Agreement
without a shareholder vote. However, shareholders of the Trust have the right to
vote on any amendment (i) that would adversely affect the voting rights of
shareholders; (ii) that is required by law to be approved by shareholders; (iii)
that would amend the voting provisions of the
39
<PAGE>
Trust Agreement; or (iv) that the Trustees determine to submit to shareholders.
The Trust Agreement permits the termination of the Trust or of any series
or class of the Trust (i) by a majority of the affected shareholders at a
meeting of shareholders of the Trust, series or class; or (ii) by a majority of
the Trustees without shareholder approval if the Trustees determine that such
action is in the best interest of the Trust or its shareholders. The factors and
events that the Trustees may take into account in making such determination
include (i) the inability of the Trust or any series or class to maintain its
assets at an appropriate size; (ii) changes in laws or regulations governing the
Trust, or any series or class thereof, or affecting assets of the type in which
it invests; or (iii) economic developments or trends having a significant
adverse impact on their business or operations.
Under the Delaware Business Trust Act (the "Delaware Act"), shareholders
are not personally liable for obligations of the Trust. The Delaware Act
entitles shareholders of the Trust to the same limitation of liability as is
available to shareholders of private for-profit corporations. However, no
similar statutory or other authority limiting business trust shareholder
liability exists in many other states. As a result, to the extent that the Trust
or a shareholder is subject to the jurisdiction of courts in such other states,
those courts may not apply Delaware law and may subject the shareholders to
liability. To offset this risk, the Trust Agreement (i) contains an express
disclaimer of shareholder liability for acts or obligations of the Trust and
requires that notice of such disclaimer be given in each agreement, obligation
and instrument entered into or executed by the Trust or its Trustees and (ii)
provides for indemnification out of the property of the applicable series of the
Trust of any shareholder held personally liable for the obligations of the Trust
solely by reason of being or having been a shareholder and not because of the
shareholder's acts or omissions or for some other reason. Thus, the risk of a
shareholder incurring financial loss beyond his or her investment because of
shareholder liability is limited to circumstances in which all of the following
factors are present: (i) a court refuses to apply Delaware law; (ii) the
liability arises under tort law or, if not, no contractual limitation of
liability is in effect; and (iii) the applicable series of the Trust is unable
to meet its obligations.
The Trust Agreement provides that the Trustees will not be liable to any
person other than the Trust or a shareholder and that a Trustee will not be
liable for any act as a Trustee. However, nothing in the Trust Agreement
protects a Trustee against any liability to which he or she would otherwise be
subject by reason of willful misfeasance, bad faith, gross negligence or
reckless disregard of the duties involved in the conduct of his or her office.
The Trust Agreement provides for indemnification of Trustees, officers and
agents of the Trust unless the recipient is liable by reason of willful
misfeasance, bad faith, gross negligence or reckless disregard of the duties
involved in the conduct of such person's office.
The Trust Agreement provides that each shareholder, by virtue of becoming
such, will be held to have expressly assented and agreed to the terms of the
Trust Agreement and to have become a party thereto.
In addition to the requirements of Delaware law, the Trust Agreement
provides that a shareholder of the Trust may bring a derivative action on behalf
of the Trust only if the following conditions are met: (i) shareholders eligible
to bring such derivative action under Delaware law who hold at least 10% of the
outstanding shares of the Trust, or 10% of the outstanding shares of the series
or class to which such action relates, must join in the request for the Trustees
to commence such action; and (ii) the Trustees must be afforded a reasonable
amount of time to consider such shareholder request and to investigate the basis
of such claim. The Trust Agreement also provides that no person, other than the
Trustees, who is not a shareholder of a particular series or class shall be
entitled to bring any derivative action, suit or other proceeding on behalf of
or with respect to such series or class. The Trustees will be entitled to retain
counsel or other advisers in considering the merits of the request and may
require an undertaking by the shareholders making such request to reimburse the
Trust for the expense of any such advisers in the event that the Trustees
determine not to bring such action.
40
<PAGE>
The Trustees may appoint separate Trustees with respect to one or more
series or classes of the Trust's shares (the "Series Trustees"). To the extent
provided by the Trustees in the appointment of Series Trustees, Series Trustees
(i) may, but are not required to, serve as Trustees of the Trust or any other
series or class of the Trust; (ii) may have, to the exclusion of any other
Trustee of the Trust, all the powers and authorities of Trustees under the Trust
Agreement with respect to such series or class; and/or (iii) may have no power
or authority with respect to any other series or class. The Trustees are not
currently considering the appointment of Series Trustees for the Trust.
As of February 29, 2000, substantially all of the Portfolios' outstanding
shares were held of record by Northern for the benefit of its customers and the
customers of its affiliates and correspondent banks that have invested in the
Portfolios. As of the same date, Northern possessed sole or shared voting and/or
investment power for its customer accounts with respect to less than 10% of the
Trust's outstanding shares. As of the same date, the Trust's Trustees and
officers as a group owned beneficially less than 1% of the outstanding shares of
each class of each Portfolio. Northern has advised the Trust that the following
persons (whose mailing address is: c/o The Northern Trust Company, 50 South
LaSalle, Chicago, IL 60675) beneficially owned five percent or more of the
outstanding shares of the Portfolios' classes as of February 29, 2000:
<TABLE>
<CAPTION>
Number Percentage
of Shares of Shares
------------ ---------
<S> <C> <C>
BOND PORTFOLIO
Class A
Lannan Foundation 2,665,481.75 5.3%
Northern Trust Co. Pension Plan 2,628,042.33 5.3%
PWC Group Investment Savings Plan 3,188,817.76 6.4%
Class C
Phycor, Inc. 2,411,113.39 81.9%
Tuthill Corp. Supplement Investment 181,286.95 6.2%
Retirement Plan
Kitch Drutchas Wagner Kenney PC 218,389.11 7.4%
Class D
Bank of Illinois Trust Company 68,385.05 92.1%
First National Bank of La Grange 5,876.73 7.9%
INTERMEDIATE BOND PORTFOLIO
Class A
Illinois Masonic Medical Center - Board Designated Fund 226,527.36 8.7%
Illinois Masonic Medical Center - Restricted Investment Fund 355,426.73 13.6%
Illinois Masonic Medical Center - Warren Barr Pavillion 148,018.42 5.7%
HEB Savings & Retirement Trust 186,094.74 7.1%
Marshfield ERP 841,385.61 32.2%
Cavalcade Pension Trust 156,756.52 6.0%
Class D
Peoples National Bank & Trust 1,369.10 100%
INTERNATIONAL BOND PORTFOLIO
Class A
Northern Trust Pension Plan 947,008.94 57.1%
Doe Run Resources Corp. Retirement Plan 249,055.58 15.0%
SHORT-INTERMEDIATE BOND PORTFOLIO
Class A
Emerson Electric Co. Savings Plans Trust 821,852.49 8.2%
Northern Illinois Medical Center 530,043.31 5.3%
Class D
BankIllinois Trust Co. 5,349.91 78.9%
Dacotah Co. 1,431.21 21.1%
</TABLE>
41
<PAGE>
<TABLE>
<CAPTION>
Number Percentage
of Shares of Shares
--------- ---------
<S> <C> <C>
U.S. TREASURY INDEX PORTFOLIO
Class A
Belvediere National Bank & Trust 78,006.14 5.8%
Herget National Bank of Pekin 90,994.85 6.8%
Hubbell Defined Contribution Trust 118,357.60 8.8%
Old Second National Bank 201,001.14 14.9%
The Accreditation Council for Graduate Medical Education 84,894.97 6.3%
Henkel Rabbi Trust 395,100.72 29.4%
Class C
Wilson Sporting Goods 401K Plan 6,924.88 100.0%
Class D
First National Bank of LaGrange 5,106.16 100.0%
U.S. GOVERNMENT SECURITIES PORTFOLIO
Class A
Electrical Insurance Trust 611,708.59 11.6%
Sheet Metal Workers' Health & Welfare Plan 675,477.84 12.8%
Schlumberger Ltd. Master Health Care Trust 323,327.11 6.1%
Illinois State Partners Welfare Fund 311,930.68 5.9%
Mafco 420,634.70 8.0%
CTA 1,428,327.64 27.0%
Lifeway Christian Resources Master Retirement Fund 521,335.75 9.9%
Class D
First Bankers Trust Co. 39,978.98 87.0%
Enjayco Company 4,215.51 9.2%
</TABLE>
OTHER INFORMATION
The Prospectus and this Additional Statement do not contain all the
information included in the Registration Statement filed with the SEC under the
Securities Act of 1933 with respect to the securities offered by the Trust's
Prospectus. Certain portions of the Registration Statement have been omitted
from the Prospectus and this Additional Statement pursuant to the rules and
regulations of the SEC. The Registration Statement including the exhibits filed
therewith may be examined at the office of the SEC in Washington, D.C.
Each Portfolio is responsible for the payment of its expenses. Such
expenses include, without limitation, the fees and expenses payable to Northern,
NTQA and PFPC, brokerage fees and commissions, fees for the registration or
qualification of Portfolio shares under Federal or state securities laws,
expenses of the organization of the Portfolio, taxes, interest, costs of
liability insurance, fidelity bonds, indemnification or contribution, any costs,
expenses or losses arising out of any liability of, or claim for damages or
other relief asserted against, the Trust for violation of any law, legal, tax
and auditing fees and expenses, servicing fees, expenses of preparing and
printing prospectuses, statements of additional information, proxy materials,
reports and notices and the printing and distributing of the same to the Trust's
shareholders and regulatory authorities, compensation and expenses of its
Trustees, expenses for industry organizations such as the Investment Company
Institute, miscellaneous expenses and extraordinary expenses incurred by the
Trust.
The term "majority of the outstanding shares" of either the Trust or a
particular Portfolio means, with respect to the approval of an investment
advisory agreement or a change in a fundamental investment policy, the vote of
the lesser of (i) 67% or more of the shares of the Trust or such Portfolio
present at a meeting, if the holders of more than 50% of the outstanding shares
of the Trust or such Portfolio are present or represented by proxy, or (ii) more
than 50% of the outstanding shares of the Trust or such Portfolio.
Statements contained in the Prospectus or in this Additional Statement as
to the contents of any contract or other documents referred to are not
necessarily complete, and in each instance reference is made to the copy of such
contract or other document filed as an exhibit to the Registration Statement of
which the Prospectus and this Additional Statement form a part, each such
statement being qualified in all respects by such reference.
42
<PAGE>
FINANCIAL STATEMENTS
The audited financial statements and related report of Ernst & Young LLP,
independent auditors, contained in the annual report to the Portfolios'
shareholders for the fiscal year ended November 30, 1999 (the "Annual Report")
are hereby incorporated herein by reference and attached hereto. No other parts
of the Annual Report, including without limitation, "Management's Discussion of
Portfolio Performance," are incorporated by reference herein. Copies of the
Annual Report may be obtained upon request and without charge by calling 1-800-
637-1380 (toll-free).
43
<PAGE>
APPENDIX A
Description of Bond Ratings
The following summarizes the highest six ratings used by Standard & Poor's
Ratings Group, Inc., a division of McGraw Hill ("S&P") for corporate and
municipal debt:
AAA: Debt rated AAA has the highest rating assigned by S&P. The obligor's
capacity to meet its financial commitment on the obligation is extremely
strong.
AA: Debt rated AA differs from the highest rated obligations only in a small
degree. The obligor's capacity to meet its financial commitment on the
obligation is very strong.
A: Debt rated A is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than debt in higher-rated
categories. However, the obligor's capacity to meet its financial commitment
on the obligation is still strong.
BBB: Debt rated BBB exhibits adequate protection parameters. However,
adverse economic conditions or changing circumstances are more likely to lead
to a weakened capacity of the obligor to meet its financial commitment on the
obligation.
BB and B: Debt rated BB and B is regarded as having significant speculative
characteristics. Debt rated BB is less vulnerable to non-payment than other
speculative issues. However, it faces major ongoing uncertainties or exposure
to adverse business, financial, or economic conditions which could lead to
the obligor's inadequate capacity to meet its financial commitment on the
obligation. Debt rated B is more vulnerable to non-payment than debt rated
BB, but the obligor currently has the capacity to meet its financial
commitment on the obligation. Adverse business, financial, or economic
conditions will likely impair the obligor's capacity or willingness to meet
its financial commitment on the obligation.
Obligations rated BB, B, CCC, CC and C are regarded as having significant
speculative characteristics. BB indicates the least degree of speculation and C
the highest. While such obligations will likely have some quality and protective
characteristics, these may be outweighed by large uncertainties or major
exposures to adverse conditions.
BB - An obligation rated BB is less vulnerable to nonpayment than other
speculative issues. However, it faces major ongoing uncertainties or exposure
to adverse business, financial or economic conditions which could lead to the
obligor's inadequate capacity to meet its financial commitment on the
obligation.
B - An obligation rated B is more vulnerable to nonpayment than obligations
rated BB, but the obligor currently has the capacity to meet its financial
commitment on the obligation. Adverse business, financial or economic
conditions will likely impair the obligor's capacity or willingness to meet
its financial commitment on the obligation.
CCC - An obligation rated CCC is currently vulnerable to nonpayment, and is
dependent upon favorable business, financial and economic conditions for the
obligor to meet its financial commitment on the obligation. In the event of
adverse business, financial, or economic conditions, the obligor is not
likely to have the capacity to meet its financial commitment on the
obligation.
CC - An obligation rated CC is currently highly vulnerable to nonpayment.
C - The C rating may be used to cover a situation where a bankruptcy petition
has been filed or similar action has been taken, but payments on this
obligation are being continued.
D - An obligation rated D is in payment default. The D rating category is
used when payments on an obligation are not made on the date due even if the
applicable grace period has not expired, unless S&P believes that such
payments will be made during such grace period. The D rating also will be
used upon the filing of a bankruptcy petition or the taking of a similar
action if payments on an obligation are jeopardized.
PLUS (+) OR MINUS (-) - The ratings from AA through CCC may be modified by the
addition of a plus or minus sign to show relative standing within the major
rating categories.
A-1
<PAGE>
r - This symbol is attached to the ratings of instruments with significant
noncredit risks. It highlights risks to principal or volatility of expected
returns which are not addressed in the credit rating. Examples include:
obligations linked or indexed to equities, currencies, or commodities;
obligations exposed to severe prepayment risk - such as interest-only or
principal-only mortgage securities; and obligations with unusually risky
interest terms, such as inverse floaters.
To provide more detailed indications of credit quality, the ratings AA and lower
may be modified by the addition of a plus or minus sign to show relative
standing within these major rating categories.
S&P may attach the rating r to highlight risks to principal or volatility of
expected returns which are not addressed in the credit rating.
The following summarizes the highest six ratings used by Moody's Investors
Service, Inc. ("Moody's") for corporate and municipal long-term debt:
Aaa: Bonds that are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred to as
"gilt edged." Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized
are most unlikely to impair the fundamentally strong position of such issues.
Aa: Bonds that are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known
as high grade bonds. They are rated lower than the best bonds because margins
of protection may not be as large as in Aaa securities or fluctuation of
protective elements may be of greater amplitude or there may be other
elements present which make the long-term risk appear somewhat larger than in
Aaa securities.
A: Bonds that 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 that 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 and B: Bonds that possess one of these ratings provide questionable
protection of interest and principal. Ba indicates some speculative
elements. B indicates a general lack of characteristics of desirable
investment.
The foregoing ratings for corporate and municipal long-term debt are sometimes
presented in parenthesis preceded with a "con", indicating the bonds are rated
conditionally. Such parenthetical rating denotes the probable credit stature
upon completion of some act or the fulfillment of some condition.
The following summarizes the highest six ratings used by Duff & Phelps Credit
Rating Co. ("D&P") for corporate and municipal long-term debt:
AAA: Debt rated AAA is of the highest credit quality. The risk factors are
considered to be negligible, being only slightly more than for risk-free U.S.
Treasury debt.
AA: Debt rated AA is of high credit quality. Protection factors are strong.
Risk is modest but may vary slightly from time to time because of economic
conditions.
A: Debt rated A has protection factors which are average but adequate.
However risk factors are more variable and greater in periods of economic
stress.
BBB: Debt rated BBB has below-average protection factors but such protection
factors are still considered sufficient for prudent investment. Considerable
variability in risk is present during economic cycles.
BB and B: Debt rated BB or B is considered to be below investment grade. Debt
rated BB is deemed likely to meet obligations when due. Debt rated B
possesses the risk that obligations will not be met when due.
A-2
<PAGE>
To provide more detailed indications of credit quality, the ratings AA and lower
may be modified by the addition of a plus (+) or minus (-) sign to show relative
standing within these major categories.
The following summarizes the highest six ratings used by Fitch IBCA, Inc.
("Fitch") for corporate and municipal bonds:
AAA: Bonds considered to be investment grade and of the highest credit
quality. These ratings denote the lowest expectation of investment risk and
are assigned only in case of exceptionally strong capacity for timely payment
of financial commitments. This capacity is highly unlikely to be affected by
reasonably foreseeable events.
AA: Bonds considered to be investment grade and of very high credit quality.
These ratings denote a very low expectation of credit risk and indicate very
strong capacity for timely payment of financial commitments. This capacity is
not significantly vulnerable to foreseeable events.
A: Bonds considered to be investment grade and of high credit quality. These
ratings denote a low expectation of credit risk and indicate strong capacity
for timely payment of financial commitments. This capacity may, nevertheless,
be more vulnerable to changes in circumstances or in economic conditions than
is the case for higher ratings.
BBB: Bonds considered to be investment grade and of good credit quality.
These ratings denote that there is currently a low expectation of credit
risk. The capacity for timely payment of financial commitments is considered
adequate, but adverse changes in circumstances and in economic conditions are
more likely to impair this category.
BB: Bonds considered to be speculative. These ratings indicate that there is
a possibility of credit risk developing, particularly as the result of
adverse economic changes over time; however, business or financial
alternatives may be available to allow financial commitments to be met.
Securities rated in this category are not investment grade.
B: Bonds are considered highly speculative. These ratings indicate that
significant credit risk is present, but a limited margin of safety remains.
Financial commitments are currently being met; however, capacity for
continued payment is contingent upon a sustained, favorable business and
economic environment.
To provide more detailed indications of credit quality, the Fitch ratings "AA"
and lower may be modified by the addition of a plus (+) or minus (-) sign to
show relative standing within these major rating categories.
Description of Municipal Note Ratings
The following summarizes the two highest ratings by S&P for short-term municipal
notes:
SP-1: Strong capacity to pay principal and interest. Those issues determined
to possess very strong characteristics are given a plus (+) designation.
SP-2: Satisfactory capacity to pay principal and interest, with some
vulnerability to adverse financial and economic changes over the term of the
notes.
The following summarizes the two highest ratings used by Moody's for short-term
municipal notes and variable rate demand obligations:
MIG-1/VMIG-1: Obligations bearing these designations are of the best quality,
enjoying strong protection by established cash flows, superior liquidity
support or demonstrated broad-based access to the market for refinancing.
MIG-2/VMIG-2: Obligations bearing these designations are of high quality with
margins of protection ample although not as large as in the preceding group.
The two highest rating categories of D&P for short-term debt are D-1 and D-2.
D&P employs three designations, D-1+, D-1 and D-1-, within the highest rating
category. D-1+ indicates the highest certainty of timely payment. Short-term
liquidity, including internal operating factors and/or access to alternative
sources of funds, is outstanding, and safety is just below risk-free U.S.
Treasury short-term obligations. D-1 indicates very high certainty of timely
payment. Liquidity factors are excellent and supported by good fundamental
protection factors. Risk factors are minor. D-1- indicates high certainty of
timely payment. Liquidity factors are strong and supported by good fundamental
protection factors. Risk factors are very small. D-2 indicates good certainty of
timely payment. Liquidity factors and company fundamentals are sound. Although
ongoing funding needs may enlarge total financing requirements, access to
capital markets is good. Risk factors are small.
A-3
<PAGE>
D&P uses the fixed-income ratings described above under "Description of Bond
Ratings" for tax-exempt notes and other short-term obligations. Fitch uses the
short-term ratings described below under "Description of Commercial Paper
Ratings" for municipal notes.
Description of Commercial Paper Ratings
Commercial paper rated A-1 by S&P indicates that the obligor's capacity to meet
its financial commitment is strong. Those issues for which the obligor's
capacity to meet its financial commitment on the obligation is extremely strong
are denoted in A-1+. The obligor's capacity to meet its financial commitment on
commercial paper rated A-2 is satisfactory but these obligations are somewhat
more susceptible to the adverse effects of changes in circumstances and economic
conditions than obligations in higher rating categories.
The rating Prime-1 is the highest commercial paper rating assigned by Moody's.
Issuers or supporting institutions rated Prime-1 are considered to have a
superior capacity for repayment of short-term debt obligations. Prime-1
repayment ability will often be evidenced by the following characteristics:
leading market positions in well-established industries; high rates of return on
funds employed; conservative capitalization structures with moderate reliance on
debt and ample asset protection; broad margins in earning coverage of fixed
financial charges and high internal cash generation; and well-established access
to a range of financial markets and assured sources of alternate liquidity.
Issuers or supporting institutions rated Prime-2 are considered to have a strong
ability for repayment of senior short-term debt obligations. This will normally
be evidenced by many of the characteristics cited above but to a lesser degree.
Earnings trends and coverage ratios, while sound, will be more subject to
variation. Capitalization characteristics, while still appropriate, may be more
affected by external conditions. Ample alternate liquidity is maintained.
The following summarizes the highest ratings used by Fitch for short-term
obligations:
F1 securities possess exceptionally strong credit quality. Issues assigned
this rating are regarded as having the strongest capacity for timely payment
of financial commitments and may have an added + to denote any exceptionally
strong credit feature.
F2 securities possess good credit quality. Issues assigned this rating have a
satisfactory capacity for timely payment of financial commitments, but the
margin of safety is not as great as in the case of the higher ratings.
D&P uses the short-term ratings described above under "Description of Note
Ratings" for commercial paper.
A-4
<PAGE>
APPENDIX B
As stated in their Prospectus, the Portfolios may enter into futures
transactions and options thereon. Such transactions are described more fully in
this Appendix.
I. Interest Rate Futures Contracts
Use of Interest Rate Futures Contracts. Bond prices are established in
---------------------------------------
both the cash market and the futures market. In the cash market, bonds are
purchased and sold with payment for the full purchase price of the bond being
made in cash, generally within three business days after the trade. In the
futures market, only a contract is made to purchase or sell a bond in the future
for a set price on a certain date. Historically, the prices for bonds
established in the futures markets have tended to move generally in the
aggregate in concert with the cash market prices and have maintained fairly
predictable relationships. Accordingly, a Portfolio could use interest rate
futures contracts as a defense, or hedge, against anticipated interest rate
changes. As described below, this could include the use of futures contract
sales to protect against expected increases in interest rates and the use of
futures contract purchases to offset the impact of interest rate declines.
A Portfolio presently could accomplish a similar result to that which
it hopes to achieve through the use of futures contracts by selling bonds with
long maturities and investing in bonds with short maturities when interest rates
are expected to increase, or conversely, selling short-term bonds and investing
in long-term bonds when interest rates are expected to decline. However, because
of the liquidity that is often available in the futures market, the protection
is more likely to be achieved, perhaps at a lower cost and without changing the
rate of interest being earned by a Portfolio, through using futures contracts.
Interest rate futures contracts can also be used by a Portfolio for
non-hedging (speculative) purposes to increase total return.
Description of Interest Rate Futures Contracts. An interest rate
----------------------------------------------
futures contract sale would create an obligation by a Portfolio, as seller, to
deliver the specific type of financial instrument called for in the contract at
a specific future time for a specified price. A futures contract purchase would
create an obligation by a Portfolio, as purchaser, to take delivery of the
specific type of financial instrument at a specific future time at a specific
price. The specific securities delivered or taken, respectively, at settlement
date, would not be determined until at or near that date. The determination
would be in accordance with the rules of the exchange on which the futures
contract sale or purchase was made.
Although interest rate futures contracts by their terms call for
actual delivery or acceptance of securities, in most cases the contracts are
closed out before a settlement date without the making or taking of delivery of
securities. Closing out a futures contract sale is effected by a Portfolio's
entering into a futures contract purchase for the same aggregate amount of the
specific type of financial instrument and the same delivery date. If the price
of a sale exceeds the price of the offsetting purchase, a Portfolio is
immediately paid the difference and thus realizes a gain. If the offsetting
purchase price exceeds the sale price, a Portfolio pays the difference and
realizes a loss. Similarly, the closing out of a futures contract purchase is
effected by a Portfolio entering into a futures contract sale. If the offsetting
sale price exceeds the purchase price, a Portfolio realizes a gain, and if the
purchase price exceeds the offsetting sale price, a Portfolio realizes a loss.
Interest rate futures contracts are traded in an auction environment
on the floors of several exchanges--principally, the Chicago Board of Trade, the
Chicago Mercantile Exchange and the -New York Futures Exchange. A Portfolio
would deal only in standardized contracts on recognized exchanges. Each exchange
guarantees performance under contract provisions through a clearing corporation,
a nonprofit organization managed by the exchange membership.
A public market now exists in futures contracts covering various
financial instruments including long-term United States Treasury Bonds and
Notes; Government National Mortgage Association (GNMA) modified pass-through
mortgage backed securities; three-month United States Treasury Bills; and
ninety-day commercial paper. A Portfolio may trade in any interest rate futures
contracts for which there exists a public market, including, without limitation,
the foregoing instruments.
B-1
<PAGE>
II. Index Futures Contracts
General. A bond index assigns relative values to the bonds included in
the index which fluctuates with changes in the market values of the bonds
included.
A Portfolio may sell index futures contracts in order to offset a
decrease in market value of its portfolio securities that might otherwise result
from a market decline. A Portfolio may do so either to hedge the value of its
portfolio as a whole, or to protect against declines, occurring prior to sales
of securities, in the value of the securities to be sold. Conversely, a
Portfolio may purchase index futures contracts in anticipation of purchases of
securities. A long futures position may be terminated without a corresponding
purchase of securities.
In addition, a Portfolio may utilize index futures contracts in
anticipation of changes in the composition of its portfolio holdings. For
example, in the event that a Portfolio expects to narrow the range of industry
groups represented in its holdings it may, prior to making purchases of the
actual securities, establish a long futures position based on a more restricted
index, such as an index comprised of securities of a particular industry group.
A Portfolio may also sell futures contracts in connection with this strategy, in
order to protect against the possibility that the value of the securities to be
sold as part of the restructuring of the portfolio will decline prior to the
time of sale.
Index futures contracts may also be used by a Portfolio for non-
hedging (speculative) purposes, to increase total return.
III. Futures Contracts on Foreign Currencies
A futures contract on foreign currency creates a binding obligation on
one party to deliver, and a corresponding obligation on another party to accept
delivery of, a stated quantity of foreign currency, for an amount fixed in U.S.
dollars. Foreign currency futures may be used by a Portfolio for hedging
purposes in anticipation of fluctuations in exchange rates between the U.S.
dollars and other currencies arising from multinational transactions.
A Portfolio may also use futures contracts on foreign currencies for
non-hedging (speculative) purposes to increase total return.
IV. Margin Payments
Unlike purchases or sales of portfolio securities, no price is paid or
received by a Portfolio upon the purchase or sale of a futures contract.
Initially, the Portfolio will be required to deposit with the broker or in a
segregated account with the Custodian or a sub-custodian an amount of liquid
assets, known as initial margin, based on the value of the contract. The nature
of initial margin in futures transactions is different from that of margin in
security transactions in that futures contract margin does not involve the
borrowing of funds by the customer to finance the transactions. Rather, the
initial margin is in the nature of a performance bond or good faith deposit on
the contract which is returned to the Portfolio upon termination of the futures
contract assuming all contractual obligations have been satisfied. Subsequent
payments, called variation margin, to and from the broker, will be made on a
daily basis as the price of the underlying instruments fluctuates making the
long and short positions in the futures contract more or less valuable, a
process known as marking-to-the-market. For example, when a particular Portfolio
has purchased a futures contract and the price of the contract has risen in
response to a rise in the underlying instruments, that position will have
increased in value and the Portfolio will be entitled to receive from the broker
a variation margin payment equal to that increase in value. Conversely, where
the Portfolio has purchased a futures contract and the price of the future
contract has declined in response to a decrease in the underlying instruments,
the position would be less valuable and the Portfolio would be required to make
a variation margin payment to the broker. At any time prior to expiration of the
futures contract, the Portfolio's adviser may elect to close the position by
taking an opposite position, subject to the availability of a secondary market,
which will operate to terminate the Portfolio's position in the futures
contract. A final determination of variation margin is then made, additional
cash is required to be paid by or released to the Portfolio, and the Portfolio
realizes a loss or gain.
V. Risks of Transactions in Futures Contracts
There are several risks in connection with the use of futures by the
Portfolios, even when futures are used for hedging (non-speculative) purposes.
In connection with the use of futures for hedging purposes, one risk arises
because of the imperfect correlation between movements in the price of the
futures and movements in the price of the instruments which are the subject of a
hedge. The price of the future may move more than or less than the price of the
instruments being hedged. If the price of the futures moves less than the price
of the instruments which are the subject of the hedge, the hedge
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<PAGE>
will not be fully effective but, if the price of the instruments being hedged
has moved in an unfavorable direction, the Portfolio would be in a better
position than if it had not hedged at all. If the price of the instruments being
hedged has moved in a favorable direction, this advantage will be partially
offset by the loss on the futures. If the price of the futures moves more than
the price of the hedged instruments, the Portfolio involved will experience
either a loss or gain on the futures which will not be completely offset by
movements in the price of the instruments which are the subject of the hedge. To
compensate for the imperfect correlation of movements in the price of
instruments being hedged and movements in the price of futures contracts, the
Portfolio may buy or sell futures contracts in a greater dollar amount than the
dollar amount of instruments being hedged if the volatility over a particular
time period of the prices of such instruments has been greater than the
volatility over such time period of the futures, or if otherwise deemed to be
appropriate by the Investment Advisers. Conversely, the Portfolios may buy or
sell fewer futures contracts if the volatility over a particular time period of
the prices of the instruments being hedged is less than the volatility over such
time period of the futures contract being used, or if otherwise deemed to be
appropriate by the Investment Advisers. It is also possible that, where a
Portfolio had sold futures to hedge its portfolio against a decline in the
market, the market may advance and the value of instruments held in the
Portfolio may decline. If this occurred, the Portfolio would lose money on the
futures and also experience a decline in value in its portfolio securities.
When futures are purchased to hedge against a possible increase in the
price of securities before a Portfolio is able to invest its cash (or cash
equivalents) in an orderly fashion, it is possible that the market may decline
instead; if the Portfolio then concludes not to invest its cash at that time
because of concern as to possible further market decline or for other reasons,
the Portfolio will realize a loss on the futures contract that is not offset by
a reduction in the price of the instruments that were to be purchased.
In addition to the possibility that there may be an imperfect correlation,
or no correlation at all, between movements in the futures and the instruments
being hedged, the price of futures may not correlate perfectly with movement in
the cash market due to certain market distortions. First, rather than meeting
additional margin deposit requirements, investors may close futures contracts
through off-setting transactions which could distort the normal relationship
between the cash and futures markets. Second, with respect to financial futures
contracts, the liquidity of the futures market depends on participants entering
into off-setting transactions rather than making or taking delivery. To the
extent participants decide to make or take delivery, liquidity in the futures
market could be reduced thus producing distortions. Third, from the point of
view of speculators, the deposit requirements in the futures market are less
onerous than margin requirements in the securities market. Therefore, increased
participation by speculators in the futures market may also cause temporary
price distortions. Due to the possibility of price distortion in the futures
market, and because of the imperfect correlation between the movements in the
cash market and movements in the price of futures, a correct forecast of general
market trends or interest rate movements by the Investment Advisers may still
not result in a successful hedging transaction over a short time frame.
Positions in futures may be closed out only on an exchange or board of
trade which provides a secondary market for such futures. Although the
Portfolios intend to purchase or sell futures only on exchanges or boards of
trade where there appear to be active secondary markets, there is no assurance
that a liquid secondary market on any exchange or board of trade will exist for
any particular contract or at any particular time. In such event, it may not be
possible to close a futures investment position, and in the event of adverse
price movements, the Portfolios would continue to be required to make daily cash
payments of variation margin. However, in the event futures contracts have been
used to hedge portfolio securities, such securities will generally not be sold
until the futures contract can be terminated. In such circumstances, an increase
in the price of the securities, if any, may partially or completely offset
losses on the futures contract. However, as described above, there is no
guarantee that the price of the securities will in fact correlate with the price
movements in the futures contract and thus provide an offset on a futures
contract.
Further, it should be noted that the liquidity of a secondary market in a
futures contract may be adversely affected by "daily price fluctuation limits"
established by commodity exchanges which limit the amount of fluctuation in a
futures contract price during a single trading day. Once the daily limit has
been reached in the contract, no trades may be entered into at a price beyond
the limit, thus preventing the liquidation of open futures positions. The
trading of futures contracts is also subject to the risk of trading halts,
suspensions, exchange or clearing house equipment failures, government
intervention, insolvency of a brokerage firm or clearing house or other
disruptions of normal activity, which could at times make it difficult or
impossible to liquidate existing positions or to recover excess variation margin
payments.
Successful use of futures by the Portfolios is also subject to the
Investment Advisers' ability to predict correctly movements in the direction of
the market. For example, if a particular Portfolio has hedged against the
possibility of a decline in the market adversely affecting securities held by it
and securities prices increase instead, the Portfolio will lose part or all of
the benefit to the increased value of its securities which it has hedged because
it will have offsetting losses in its
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futures positions. In addition, in such situations, if the Portfolio has
insufficient cash, it may have to sell securities to meet daily variation margin
requirements. Such sales of securities may be, but will not necessarily be, at
increased prices which reflect the rising market. The Portfolios may have to
sell securities at a time when they may be disadvantageous to do so.
Futures purchased or sold by the International Bond Portfolio (and related
options) may be traded on foreign exchanges. Participation in foreign futures
and foreign options transactions involves the execution and clearing of trades
on or subject to the rules of a foreign board of trade. Neither the National
Futures Association nor any domestic exchange regulates activities of any
foreign boards of trade, including the execution, delivery and clearing of
transactions, or has the power to compel enforcement of the rules of a foreign
board of trade or any applicable foreign law. This is true even if the exchange
is formally linked to a domestic market so that a position taken on the market
may be liquidated by a transaction on another market. Moreover, such laws or
regulations will vary depending on the foreign country in which the foreign
futures or foreign options transaction occurs. For these reasons, customers who
trade foreign futures of foreign options contracts may not be afforded certain
of the protective measures provided by the Commodity Exchange Act, the Commodity
Futures Trading Commission's ("CFTC") regulations and the rules of the National
Futures Association and any domestic exchange, including the right to use
reparations proceedings before the CFTC and arbitration proceedings provided by
the National Futures Association or any domestic futures exchange. In
particular, the investments of the International Bond Portfolio in foreign
futures or foreign options transactions may not be provided the same protections
in respect of transactions on United States futures exchanges. In addition, the
price of any foreign futures or foreign options contract and, therefore the
potential profit and loss thereon may be affected by any variance in the foreign
exchange rate between the time an order is placed and the time it is liquidated,
offset or exercised.
VI. Options on Futures Contracts
The Portfolios may purchase and write (sell) call and put options on the
futures contracts described above. A futures option gives the holder, in return
for the premium paid, the right to buy (call) from or sell (put) to the writer
of the option a futures contract at a specified price at any time during the
period of the option. Upon exercise, the writer of the option is obligated to
pay the difference between the cash value of the futures contract and the
exercise price. Like the buyer or seller of a futures contract, the holder, or
writer, of an option has the right to terminate its position prior to the
scheduled expiration of the option by selling, or purchasing an option of the
same series, at which time the person entering into the closing transaction will
realize a gain or loss. A Portfolio will be required to deposit initial margin
and variation margin with respect to put and call options on futures contracts
written by it pursuant to brokers' requirements similar to those described
above. Net option premiums received will be included as initial margin
deposits.
Investments in futures options involve some of the same considerations that
are involved in connection with investments in futures contracts (for example,
the existence of a liquid secondary market). See "Risks of Transactions in
Futures Contracts" above. In addition, the purchase or sale of an option also
entails the risk that changes in the value of the underlying futures contract
will not correspond to changes in the value of the option purchased. Depending
on the pricing of the option compared to either the futures contract upon which
it is based, or upon the price of any underlying instruments, an option may or
may not be less risky than ownership of the futures contract or such
instruments. In general, the market prices of options can be expected to be more
volatile than the market prices on the underlying futures contract. Compared to
the purchase or sale of futures contracts, however, the purchase of call or put
options on futures contracts may, unlike futures contracts where the risk of
loss is potentially unlimited, frequently involve less potential risk to the
Portfolio because the maximum amount at risk is the premium paid for the options
(plus transaction costs). The writing of an option on a futures contract
involves risks similar to those risks relating to the sale of futures contracts.
VII. Other Matters
Each Portfolio intends to comply with the regulations of the CFTC exempting
it from registration as a "commodity pool operator." Accounting for futures
contracts will be in accordance with generally accepted accounting principles.
B-4
<PAGE>
PART B
STATEMENT OF ADDITIONAL INFORMATION
NORTHERN INSTITUTIONAL FUNDS
BALANCED PORTFOLIO
EQUITY INDEX PORTFOLIO
DIVERSIFIED GROWTH PORTFOLIO
FOCUSED GROWTH PORTFOLIO
SMALL COMPANY INDEX PORTFOLIO
SMALL COMPANY GROWTH PORTFOLIO
MID CAP GROWTH PORTFOLIO
INTERNATIONAL EQUITY INDEX PORTFOLIO
INTERNATIONAL GROWTH PORTFOLIO
This Statement of Additional Information dated April 1, 2000, revised as of
August 15, 2000 (the "Additional Statement") is not a prospectus. Copies of the
prospectus dated April 1, 2000 for the Balanced, Equity Index, Diversified
Growth, Focused Growth, Small Company Index, Small Company Growth, Mid Cap
Growth, International Equity Index and International Growth Portfolios (the
"Portfolios") of Northern Institutional Funds (the "Prospectus") may be obtained
without charge by calling 1-800-637-1380 (toll-free). Capitalized terms not
otherwise defined have the same meaning as in the Prospectus.
The audited financial statements and related report of Ernst & Young LLP,
independent auditors, contained in the Annual Report to the Portfolio's
shareholders for the fiscal year ended November 30, 1999 (except for Small
Company Growth and Mid Cap Portfolios, which did not commence operations during
the period) are incorporated herein by reference in the section "Financial
Statements." No other portions of the Fund's Annual Reports are incorporated by
reference.
<PAGE>
INDEX
<TABLE>
<CAPTION>
Page
----
<S> <C>
ADDITIONAL INVESTMENT INFORMATION....................................... 3
Classification and History............................................ 3
Investment Objectives, Strategies and Risks........................... 3
Investment Restrictions............................................... 19
ADDITIONAL TRUST INFORMATION............................................ 20
Trustees and Officers................................................. 20
Investment Advisers, Transfer Agent and Custodian..................... 26
Portfolio Transactions................................................ 30
Portfolio Valuation................................................... 34
Co-Administrators and Distributor..................................... 35
Shareholder Servicing Plan............................................ 38
Counsel and Auditors.................................................. 39
In-Kind Purchases and Redemptions..................................... 39
PERFORMANCE INFORMATION................................................. 40
TAXES................................................................... 48
Federal--General Information.......................................... 49
Taxation of Certain Financial Instruments............................. 50
Foreign Investors..................................................... 50
DESCRIPTION OF SHARES................................................... 50
OTHER INFORMATION....................................................... 55
FINANCIAL STATEMENTS.................................................... 56
APPENDIX A.............................................................. A-1
APPENDIX B.............................................................. B-1
</TABLE>
No person has been authorized to give any information or to make any
representations not contained in this Additional Statement or in the Prospectus
in connection with the offering made by the Prospectus and, if given or made,
such information or representations must not be relied upon as having been
authorized by the Trust or its distributor. The Prospectus does not constitute
an offering by the Trust or by the distributor in any jurisdiction in which such
offering may not lawfully be made.
An investment in a Portfolio is not a deposit of any bank and is not insured or
guaranteed by the Federal Deposit Insurance Corporation or any other government
agency. An investment in a Portfolio involves investment risks, including
possible loss of principal.
2
<PAGE>
ADDITIONAL INVESTMENT INFORMATION
Classification and History
Northern Institutional Funds (the "Trust") is an open-end, management
investment company. Each Portfolio is classified as diversified under the
Investment Company Act of 1940, as amended (the "1940 Act").
Each Portfolio is a series of the Trust, which was formed as a Delaware
business trust on July 1, 1997 under an Agreement and Declaration of Trust (the
"Trust Agreement"). The Trust is the result of a reorganization of a
Massachusetts business trust formerly known as The Benchmark Funds on March 31,
1998. The Trust's name was changed from The Benchmark Funds to Northern
Institutional Funds on July 15, 1998. The Trust also offers six fixed income and
five money market portfolios, which are not described in this document.
Investment Objectives, Strategies and Risks
The following supplements the investment objectives, strategies and risks
of the Portfolios as set forth in the Prospectus. The investment objectives of
the Mid Cap Growth and Small Company Growth Portfolios may be changed without
shareholder approval. The investment objective of each other Portfolio may not
be changed without the vote of the majority of the Portfolio's outstanding
shares. Except as expressly noted below, however, each Portfolio's investment
policies may be changed without shareholder approval.
Warrants. The Balanced, Diversified Growth, Focused Growth, Small Company
---------
Index, Small Company Growth, Mid Cap Growth, International Equity Index and
International Growth Portfolios may purchase warrants and similar rights, which
are privileges issued by corporations enabling the owners to subscribe to and
purchase a specified number of shares of the corporation at a specified price
during a specified period of time. The prices of warrants do not necessarily
correlate with the prices of the underlying shares. The purchase of warrants
involves the risk that a Portfolio could lose the purchase value of a warrant if
the right to subscribe to additional shares is not exercised prior to the
warrant's expiration. Also, the purchase of warrants involves the risk that the
effective price paid for the warrant added to the subscription price of the
related security may exceed the value of the subscribed security's market price
such as when there is no movement in the level of the underlying security. A
Portfolio will not invest more than 5% of its total assets, taken at market
value, in warrants. Warrants acquired by a Portfolio in shares or attached to
other securities are not subject to this restriction.
U.S. Government Obligations. Examples of the types of U.S. Government
----------------------------
obligations that may be acquired by the Portfolios include U.S. Treasury Bills,
Treasury Notes and Treasury Bonds and the obligations of Federal Home Loan
Banks, Federal Farm Credit Banks, Federal Land Banks, the Federal Housing
Administration, Farmers Home Administration, Export-Import Bank of the United
States, Small Business Administration, Federal National Mortgage Association,
Government National Mortgage Association, General Services Administration,
Central Bank for Cooperatives, Federal Home Loan Mortgage Corporation, Federal
Intermediate Credit Banks and the Maritime Administration.
Securities guaranteed as to principal and interest by the U.S. Government,
its agencies or instrumentalities are also deemed to include (i) securities for
which the payment of principal and interest is backed by an irrevocable letter
of credit issued by the U.S. Government or any agency or instrumentality
thereof, and (ii) participations in loans made to foreign government; or their
agencies that are so guaranteed.
To the extent consistent with their respective investment objectives, the
Portfolios may invest in a variety of U.S. Treasury obligations and obligations
issued by or guaranteed by the U.S. Government or its agencies and
instrumentalities. Not all U.S. Government obligations carry the same credit
support. No assurance can be given that the U.S. Government would provide
financial support to its agencies or instrumentalities if it is not obligated to
do so by law. There is no assurance that these commitments will be undertaken or
complied with in the future. In addition, the secondary market for certain
participations in loans made to foreign governments or their agencies may be
limited.
American Depository Receipts ("ADRs"). The Portfolios may invest in ADRs.
--------------------------------------
ADRs are receipts typically issued by a United States bank or trust company
evidencing ownership of the underlying foreign securities and are denominated in
U.S. dollars. Some institutions issuing ADRs may not be sponsored by the
issuer.
3
<PAGE>
A non-sponsored depository may not provide the same shareholder information
that a sponsored depository is required to provide under its contractual
arrangement with the issuer.
European Depository Receipts ("EDRs"). The Portfolios may also invest in
--------------------------------------
EDRs and GDRs. EDRs and GDRs are receipts issued by a non-U.S. financial
institution evidencing ownership of underlying foreign or U.S. securities and
are usually denominated in foreign currencies. EDRs and GDRs may not be
denominated in the same currency as the securities they represent. Generally,
EDRs and GDRs are designed for use in the foreign securities markets.
Foreign Securities. Investment in foreign securities involves special
-------------------
risks. These include market risk, interest rate risk and the risks of investing
in securities of foreign issuers and of companies whose securities are
principally traded outside the United States and in investments denominated in
foreign currencies. Market risk involves the possibility that stock prices will
decline over short or even extended periods. The stock markets tend to be
cyclical, with periods of generally rising prices and periods of generally
declining prices. These cycles will affect the value of the Portfolio to the
extent that it invests in foreign stocks. The holdings of the Portfolios, to the
extent that they invest in fixed income securities, will be sensitive to changes
in interest rates and the interest rate environment. In addition, the
performance of investments in securities denominated in a foreign currency will
depend on the strength of the foreign currency against the U.S. dollar and the
interest rate environment in the country issuing the currency. Absent other
events which could otherwise affect the value of a foreign security (such as a
change in the political climate or an issuer's credit quality), appreciation in
the value of the foreign currency generally can be expected to increase the
value of a foreign currency-denominated security in terms of U.S. dollars. A
rise in foreign interest rates or decline in the value of the foreign currency
relative to the U.S. dollar generally can be expected to depress the value of a
foreign currency-denominated security.
There are other risks and costs involved in investing in foreign securities
which are in addition to the usual risks inherent in domestic investments.
Investment in foreign securities involves higher costs than investment in U.S.
securities, including higher transaction and custody costs as well as the
imposition of additional taxes by foreign governments. Foreign investments also
involve risks associated with the level of currency exchange rates, less
complete financial information about the issuers, less market liquidity, more
market volatility and political instability. Future political and economic
developments, the possible imposition of withholding taxes on dividend income,
the possible seizure or nationalization of foreign holdings, the possible
establishment of exchange controls, or the adoption of other governmental
restrictions might adversely affect an investment in foreign securities.
Additionally, foreign banks and foreign branches of domestic banks are subject
to less stringent reserve requirements, and to different accounting, auditing
and recordkeeping requirements.
Unanticipated political, economic or social developments may affect the
value of a Portfolio's investments in emerging market countries and the
availability to a Portfolio of additional investments in these countries. Some
of these countries may have in the past failed to recognize private property
rights and may have at times nationalized or expropriated the assets of private
companies. The small size and inexperience of the securities markets in certain
of such countries and the limited volume of trading in securities in those
countries may make a Portfolio's investments in such countries illiquid and more
volatile than investments in Japan or most Western European countries, and a
Portfolio may be required to establish special custodial or other arrangements
before making certain investments in those countries. There may be little
financial or accounting information available with respect to issuers located in
certain of such countries, and it may be difficult as a result to assess the
value or prospects of an investment in such issuers.
Although a Portfolio may invest in securities denominated in foreign
currencies, its portfolio securities and other assets are valued in U.S.
dollars. Currency exchange rates may fluctuate significantly over short periods
of time causing, together with other factors, a Portfolio's net asset value to
fluctuate as well. Currency exchange rates can be affected unpredictably by the
intervention or the failure to intervene by U.S. or foreign governments or
central banks, or by currency controls or political developments in the U.S. or
abroad. To the extent that a Portfolio's total assets, adjusted to reflect a
Portfolio's net position after giving effect to currency transactions, are
denominated in the currencies of foreign countries, a Portfolio will be more
susceptible to the risk of adverse economic and political developments within
those countries. A Portfolio is also subject to the possible imposition of
exchange control regulations or freezes on the convertibility of currency.
Dividends and interest payable on a Portfolio's foreign portfolio
securities may be subject to foreign withholding taxes. To the extent such taxes
are not offset by credits or deductions allowed to investors under U.S. federal
income tax law, they may reduce the net return to the shareholders. See "Taxes."
4
<PAGE>
To the extent consistent with its investment objective, a Portfolio may
also invest in obligations of the International Bank for Reconstruction and
Development (also known as the World Bank) which are supported by subscribed,
but unpaid, commitments of its member countries. There is no assurance that
these commitments will be undertaken or complied with in the future.
Investors should understand that the expense ratios of the International
Equity Index and International Growth Portfolios can be expected to be higher
than those funds investing primarily in domestic securities. The costs
attributable to investing abroad are usually higher for several reasons, such as
the higher cost of investment research, higher cost of custody of foreign
securities, higher commissions paid on comparable transactions on foreign
markets and additional costs arising from delays in settlements of transactions
involving foreign securities.
As noted in the Prospectus, the International Equity Index Portfolio
invests primarily in the equity securities included in the Europe and Australia
for East Equity Index ("EAFE Index"). As of November 30, 1999, fourteen
European countries (Austria, Belgium, Denmark, Finland, France, Germany,
Ireland, Italy, the Netherlands, Norway, Spain, Sweden, Switzerland and the
United Kingdom) constitute approximately 73% of the EAFE Index. Six
Asian/Pacific countries (Australia, Hong Kong, Japan, Malaysia, New Zealand and
Singapore) account for the remaining 27%.
Countries in which the other Portfolios may invest (to the extent permitted
by their investment policies) include, but are not limited to: Argentina,
Australia, Austria, Belgium, Brazil, Canada, Chile, Colombia, Czech Republic,
Denmark, Finland, France, Germany, Greece, Hong Kong, Hungary, Indonesia,
Ireland, Israel, Italy, Japan, Luxembourg, Malaysia, Mexico, the Netherlands,
New Zealand, Norway, Peru, the Philippines, Poland, Portugal, Singapore, South
Africa, South Korea, Spain, Sweden, Switzerland, Taiwan, Thailand, Turkey, the
United Kingdom and Venezuela.
The end of the Cold War, the reunification of Germany, the accession of new
Western European members to the European Economic and Monetary Union and the
aspirations of Eastern European states to join and other political and social
events in Europe have caused considerable economic, social and political
dislocation. In addition, events in the Japanese economy, as well as political
and social developments there have affected Japanese securities and currency
markets, and the relationship of the Japanese yen with other currencies and with
the U.S. dollar. Future political, economic and social developments in Japan and
in the Asia/Pacific regional context can be expected to produce continuing
effects on securities and currency markets.
Foreign Currency Transactions. In order to protect against a possible loss
------------------------------
on investments resulting from a decline or appreciation in the value of a
particular foreign currency against the U.S. dollar or another foreign currency
or for other reasons, the Balanced, Diversified Growth, Focused Growth, Small
Company Growth, Mid Cap Growth, International Equity Index and International
Growth Portfolios are authorized to enter into forward foreign currency exchange
contracts. These contracts involve an obligation to purchase or sell a specified
currency at a future date at a price set at the time of the contract. Forward
currency contracts do not eliminate fluctuations in the values of portfolio
securities but rather allow a Portfolio to establish a rate of exchange for a
future point in time.
When entering into a contract for the purchase or sale of a security, a
Portfolio may enter into a forward foreign currency exchange contract for the
amount of the purchase or sale price to protect against variations, between the
date the security is purchased or sold and the date on which payment is made or
received, in the value of the foreign currency relative to the U.S. dollar or
other foreign currency.
When the investment management team anticipates that a particular foreign
currency may decline substantially relative to the U.S. dollar or other leading
currencies, in order to reduce risk, a Portfolio may enter into a forward
contract to sell, for a fixed amount, the amount of foreign currency
approximating the value of some or all of the Portfolio's securities denominated
in such foreign currency. Similarly, when the securities held by a Portfolio
create a short position in a foreign currency, the Portfolio may enter into a
forward contract to buy, for a fixed amount, an amount of foreign currency
approximating the short position. A Portfolio's net long and short foreign
currency exposure will not exceed its total asset value. With respect to any
forward foreign currency contract, it will not generally be possible to match
precisely the amount covered by that contract and the value of the securities
involved due to the changes in the values of such securities resulting from
market movements between the date the forward contract is entered into and the
date it matures. In addition, while forward contracts may offer protection from
losses resulting from declines or appreciation in the value of a particular
foreign currency, they also limit potential gains which might result from
changes in the value of such currency. A Portfolio may also incur costs in
connection with forward foreign currency exchange contracts and conversions of
foreign currencies and U.S.
5
<PAGE>
dollars.
In addition, the International Growth Portfolio may purchase or sell
forward foreign currency exchange contracts to seek to increase total return or
for cross-hedging purposes. The Portfolio may engage in cross-hedging by using
forward contracts in one currency to hedge against fluctuations in the value of
securities denominated in a different currency if the investment management team
believes that there is a pattern of correlation between the two currencies.
Liquid assets equal to the amount of a Portfolio's assets that could be
required to consummate forward contracts will be segregated except to the extent
the contracts are otherwise "covered." The segregated assets will be valued at
market or fair value. If the market or fair value of such assets declines,
additional liquid assets will be segregated daily so that the value of the
segregated assets will equal the amount of such commitments by the Portfolio. A
forward contract to sell a foreign currency is "covered" if a Portfolio owns the
currency (or securities denominated in the currency) underlying the contract, or
holds a forward contract (or call option) permitting the Portfolio to buy the
same currency at a price that is (i) no higher than the Portfolio's price to
sell the currency or (ii) greater than the Portfolio's price to sell the
currency provided the Portfolio segregates liquid assets in the amount of the
difference. A forward contract to buy a foreign currency is "covered" if a
Portfolio holds a forward contract (or call option) permitting the Portfolio to
sell the same currency at a price that is (i) as high as or higher than the
Portfolio's price to buy the currency or (ii) lower than the Portfolio's price
to buy the currency provided the Portfolio segregates liquid assets in the
amount of the difference.
Options. Each Portfolio may buy put options and buy call options and write
--------
covered call and secured put options. Such options may relate to particular
securities, foreign and domestic stock indices, financial instruments, foreign
currencies or the yield differential between the securities ("yield curve
options") and may or may not be listed on a domestic or foreign securities
exchange or issued by the Options Clearing Corporation. A call option for a
particular security or currency gives the purchaser of the option the right to
buy, and a writer the obligation to sell, the underlying security or currency at
the stated exercise price at any time prior to the expiration of the option,
regardless of the market price of the security or currency. The premium paid to
the writer is in consideration for undertaking the obligation under the option
contract. A put option for a particular security or currency gives the purchaser
the right to sell the security or currency at the stated exercise price to the
expiration date of the option, regardless of the market price of the security or
currency. In contrast to an option on a particular security, an option on an
index provides the holder with the right to make or receive a cash settlement
upon exercise of the option. The amount of this settlement will be equal to the
difference between the closing price of the index at the time of exercise and
the exercise price of the option expressed in dollars, times a specified
multiple.
Options trading is a highly specialized activity which entails greater than
ordinary investment risk. Options on particular securities may be more volatile
than the underlying instruments, and therefore, on a percentage basis, an
investment in options may be subject to greater fluctuation than an investment
in the underlying instruments themselves.
The Portfolios will write call options only if they are "covered." In the
case of a call option on a security or currency, the option is "covered" if a
Portfolio owns the security or currency underlying the call or has an absolute
and immediate right to acquire that security or currency without additional cash
consideration (or, if additional cash consideration is required, liquid assets
in such amount are segregated) upon conversion or exchange of other securities
held by it. For a call option on an index, the option is covered if a Portfolio
maintains with its custodian a portfolio of securities substantially replicating
the movement of the index, or liquid assets equal to the contract value. A call
option is also covered if a Portfolio holds a call on the same security,
currency or index as the call written where the exercise price of the call held
is (i) equal to or less than the exercise price of the call written, or (ii)
greater than the exercise price of the call written provided the Portfolio
segregates liquid assets in the amount of the difference. The Portfolios will
write put options only if they are "secured" by segregated liquid assets in an
amount not less than the exercise price of the option at all times during the
option period.
A Portfolio's obligation to sell a security subject to a covered call
option written by it, or to purchase a security or currency subject to a secured
put option written by it, may be terminated prior to the expiration date of the
option by the Portfolio's execution of a closing purchase transaction, which is
effected by purchasing on an exchange an option of the same series (i.e., same
underlying security or currency, exercise price and expiration date) as the
option previously written. Such a purchase does not result in the ownership of
an option. A closing purchase transaction will ordinarily be effected to realize
a profit on an outstanding option, to prevent an underlying security or currency
from being called, to permit the sale of the underlying security or currency or
to permit the writing of a new option containing different terms on such
underlying security. The cost of such a liquidation purchase plus transaction
costs may be greater than the premium received upon the
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original option, in which event the Portfolio will have incurred a loss in the
transaction. There is no assurance that a liquid secondary market will exist for
any particular option. An option writer, unable to effect a closing purchase
transaction, will not be able to sell the underlying security or currency (in
the case of a covered call option) or liquidate the segregated assets (in the
case of a secured put option) until the option expires or the optioned security
or currency is delivered upon exercise with the result that the writer in such
circumstances will be subject to the risk of market decline or appreciation in
the security or currency during such period.
When a Portfolio purchases an option, the premium paid by it is recorded as
an asset of the Portfolio. When the Portfolio writes an option, an amount equal
to the net premium (the premium less the commission) received by the Portfolio
is included in the liability section of the Portfolio's statement of assets and
liabilities as a deferred credit. The amount of this asset or deferred credit
will be subsequently marked-to-market to reflect the current value of the option
purchased or written. The current value of the traded option is the last sale
price or, in the absence of a sale, the current bid price. If an option
purchased by the Portfolio expires unexercised, the Portfolio realizes a loss
equal to the premium paid. If the Portfolio enters into a closing sale
transaction on an option purchased by it, the Portfolio will realize a gain if
the premium received by the Portfolio on the closing transaction is more than
the premium paid to purchase the option, or a loss if it is less. If an option
written by the Portfolio expires on the stipulated expiration date or if the
Portfolio enters into a closing purchase transaction, it will realize a gain (or
loss if the cost of a closing purchase transaction exceeds the net premium
received when the option is sold) and the deferred credit related to such option
will be eliminated. If an option written by the Portfolio is exercised, the
proceeds of the sale will be increased by the net premium originally received
and the Portfolio will realize a gain or loss.
There are several risks associated with transactions in certain options.
For example, there are significant differences between the securities, currency
and options markets that could result in an imperfect correlation between these
markets, causing a given transaction not to achieve its objectives. In addition,
a liquid secondary market for particular options, whether traded over-the-
counter or on a national securities exchange (an "Exchange"), may be absent for
reasons which include the following: there may be insufficient trading interest
in certain options; restrictions may be imposed by an Exchange on opening
transactions or closing transactions or both; trading halts, suspensions or
other restrictions may be imposed with respect to particular classes or series
of options or underlying securities or currencies; unusual or unforeseen
circumstances may interrupt normal operations on an Exchange; the facilities of
an Exchange or the Options Clearing Corporation may not at all times be adequate
to handle current trading value; or one or more Exchanges could, for economic or
other reasons, decide or be compelled at some future date to discontinue the
trading of options (or a particular class or series of options), in which event
the secondary market on that Exchange (or in that class or series of options)
would cease to exist, although outstanding options that had been issued by the
Options Clearing Corporation as a result of trades on that Exchange would
continue to be exercisable in accordance with their terms.
Supranational Bank Obligations. The Balanced Portfolio may invest in
-------------------------------
obligations of supranational banks. Supranational banks are international
banking institutions designed or supported by national governments to promote
economic reconstruction, development or trade between nations (e.g., the World
Bank). Obligations of supranational banks may be supported by appropriated but
unpaid commitments of their member countries and there is no assurance that
these commitments will be undertaken or met in the future.
Stripped Securities. The Balanced Portfolio may purchase stripped
--------------------
securities. The Treasury Department has facilitated transfers of ownership of
zero coupon securities by accounting separately for the beneficial ownership of
particular interest coupon and principal payments on Treasury securities through
the Federal Reserve book-entry record-keeping system. The Federal Reserve
program as established by the Treasury Department is known as "STRIPS" or
"Separate Trading of Registered Interest and Principal of Securities." The
Portfolio may purchase securities registered in the STRIPS program. Under the
STRIPS program, the Portfolio will be able to have its beneficial ownership of
zero coupon securities recorded directly in the book-entry record-keeping system
in lieu of having to hold certificates or other evidences of ownership of the
underlying U.S. Treasury securities.
In addition, the Balanced Portfolio may acquire U.S. Government obligations
and their unmatured interest coupons that have been separated ("stripped") by
their holder, typically a custodian bank or investment brokerage firm. Having
separated the interest coupons from the underlying principal of the U.S.
Government obligations, the holder will resell the stripped securities in
custodial receipt programs with a number of different names, including "Treasury
Income Growth Receipts" ("TIGRs") and "Certificate of Accrual on Treasury
Securities" ("CATS"). The stripped coupons are sold separately from the
underlying principal, which is usually sold at a deep discount because the buyer
receives only the right to receive a future fixed payment on the security and
does not receive any rights to periodic interest (cash) payments. The underlying
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U.S. Treasury bonds and notes themselves are held in book-entry form at the
Federal Reserve Bank or, in the case of bearer securities (i.e., unregistered
securities which are ostensibly owned by the bearer or holder), in trust on
behalf of the owners. Counsel to the underwriters of these certificates or other
evidences of ownership of U.S. Treasury securities have stated that, in their
opinion, purchasers of the stripped securities most likely will be deemed the
beneficial holders of the underlying U.S. Government obligations for Federal tax
purposes. The Trust is not aware of any binding legislative, judicial or
administrative authority on this issue.
The Prospectus discusses other types of stripped securities that may be
purchased by the Balanced Portfolio, including stripped mortgage-backed
securities ("SMBS"). SMBS are usually structured with two or more classes that
receive different proportions of the interest and principal distributions from a
pool of mortgage-backed obligations. A common type of SMBS will have one class
receiving all of the interest, while the other class receives all of the
principal. However, in some instances, one class will receive some of the
interest and most of the principal while the other class will receive most of
the interest and the remainder of the principal. If the underlying obligations
experience greater than anticipated prepayments of principal, the Portfolio may
fail to fully recoup its initial investment in these securities. The market
value of the class consisting entirely of principal payments generally is
extremely volatile in response to changes in interest rates. The yields on a
class of SMBS that receives all or most of the interest are generally higher
than prevailing market yields on other mortgage-backed obligations because their
cash flow patterns are also volatile and there is a risk that the initial
investment will not be fully recouped. SMBS issued by the U.S. Government (or a
U.S. Government agency or instrumentality) may be considered liquid under
guidelines established by the Trust's Board of Trustees if they can be disposed
of promptly in the ordinary course of business at a value reasonably close to
that used in the calculation of the net asset value per share.
Asset-Backed Securities. The Balanced Portfolio may purchase asset backed
------------------------
securities, which are securities backed by mortgages, installment contracts,
credit card receivables or other assets. Asset-backed securities represent
interests in "pools" of assets in which payments of both interest and principal
on the securities are made monthly, thus in effect "passing through" monthly
payments made by the individual borrowers on the assets that underlie the
securities, net of any fees paid to the issuer or guarantor of the securities.
The average life of asset-backed securities varies with the maturities of the
underlying instruments, and the average life of a mortgage-backed instrument, in
particular, is likely to be substantially less than the original maturity of the
mortgage pools underlying the securities as a result of mortgage prepayments.
For this and other reasons, an asset-backed security's stated maturity may be
shortened, and the security's total return may be difficult to predict
precisely.
If an asset-backed security is purchased at a premium, a prepayment rate
that is faster than expected will reduce yield to maturity, while a prepayment
rate that is slower than expected will have the opposite effect of increasing
yield to maturity. Conversely, if an asset-backed security is purchased at a
discount, faster than expected prepayments will increase, while slower than
expected prepayments will decrease, yield to maturity. In calculating the
average weighted maturity of the fixed income portion of the Balanced Portfolio,
the maturity of asset-backed securities will be based on estimates of average
life.
Prepayments on asset-backed securities generally increase with falling
interest rates and decrease with rising interest rates; furthermore, prepayment
rates are influenced by a variety of economic and social factors. In general,
the collateral supporting non-mortgage asset-backed securities is of shorter
maturity than mortgage loans and is less likely to experience substantial
prepayments.
Asset-backed securities acquired by the Balanced Portfolio may include
collateralized mortgage obligations ("CMOs") issued by private companies. CMOs
provide the holder with a specified interest in the cash flow of a pool of
underlying mortgages or other mortgage-backed securities. Issuers of CMOs
ordinarily elect to be taxed as pass-through entities known as real estate
mortgage investment conduits ("REMICs"). CMOs are issued in multiple classes,
each with a specified fixed or floating interest rate and a final distribution
date. The relative payment rights of the various CMO classes may be structured
in a variety of ways. The Portfolio will not purchase "residual" CMO interests,
which normally exhibit greater price volatility.
There are a number of important differences among the agencies and
instrumentalities of the U.S. Government that issue mortgage-related securities
and among the securities that they issue. Mortgage-related securities guaranteed
by the Government National Mortgage Association ("GNMA") include GNMA Mortgage
Pass-Through Certificates (also known as "Ginnie Maes") which are guaranteed as
to the timely payment of principal and interest by GNMA and such guarantee is
backed by the full faith and credit of the United States. GNMA is a wholly-owned
U.S. Government corporation within the
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Department of Housing and Urban Development. GNMA certificates also are
supported by the authority of GNMA to borrow funds from the U.S. Treasury to
make payments under its guarantee. Mortgage-backed securities issued by the
Federal National Mortgage Association ("FNMA") include FNMA Guaranteed Mortgage
Pass-Through Certificates (also known as "Fannie Maes") which are solely the
obligations of the FNMA and are not backed by or entitled to the full faith and
credit of the United States, but are supported by the right of the issuer to
borrow from the Treasury. FNMA is a government-sponsored organization owned
entirely by private stockholders. Fannie Maes are guaranteed as to timely
payment of the principal and interest by FNMA. Mortgage-related securities
issued by the Federal Home Loan Mortgage Corporation ("FHLMC") include FHLMC
Mortgage Participation Certificates (also known as "Freddie Macs" or "PCs").
FHLMC is a corporate instrumentality of the United States, created pursuant to
an Act of Congress, which is owned entirely by Federal Home Loan Banks. Freddie
Macs are not guaranteed by the United States or by any Federal Home Loan Banks
and do not constitute a debt or obligation of the United States or of any
Federal Home Loan Bank. Freddie Macs entitle the holder to timely payment of
interest, which is guaranteed by the FHLMC. The FHLMC guarantees either ultimate
collection or timely payment of all principal payments on the underlying
mortgage loans. When the FHLMC does not guarantee timely payment of principal,
the FHLMC may remit the amount due on account of its guarantee of ultimate
payment of principal at any time after default on an underlying mortgage, but in
no event later than one year after it becomes payable.
Non-mortgage asset-backed securities involve certain risks that are not
presented by mortgage-backed securities. Primarily, these securities do not have
the benefit of the same security interest in the underlying collateral. Credit
card receivables are generally unsecured and the debtors are entitled to the
protection of a number of state and federal consumer credit laws, many of which
have given debtors the right to set off certain amounts owed on the credit
cards, thereby reducing the balance due. Most issuers of automobile receivables
permit the servicers to retain possession of the underlying obligations. If the
servicer were to sell these obligations to another party, there is a risk that
the purchaser would acquire an interest superior to that of the holders of the
related automobile receivables. In addition, because of the large number of
vehicles involved in a typical issuance and technical requirements under state
laws, the trustee for the holders of the automobile receivables may not have an
effective security interest in all of the obligations backing such receivables.
Therefore, there is a possibility that recoveries on repossessed collateral may
not, in some cases, be able to support payments on these securities.
Interest Rate Swaps, Currency Swaps, Total Rate of Return Swaps, Credit
-----------------------------------------------------------------------
Swaps, Interest Rate Floors and Caps and Currency Swaps. The Portfolios may
--------------------------------------------------------
enter into swap transactions and transactions involving interest rate floors,
caps and collars for hedging purposes or to seek to increase total return. These
instruments are privately negotiated over-the-counter derivative products. A
great deal of flexibility is possible in the way these instruments are
structured. Interest rate swaps involve the exchange by a Portfolio with another
party of their respective commitments to pay or receive interest, such as an
exchange of fixed rate payments for floating rate payments. The purchase of an
interest rate floor or cap entitles the purchaser to receive payments of
interest on a notional principal amount from the seller, to the extent the
specified index falls below (floor) or exceeds (cap) a predetermined interest
rate. An interest rate collar is a combination of a cap and a floor that
preserves a certain return within a predetermined range of interest rates. Total
rate of return swaps are contracts that obligate a party to pay or receive
interest in exchange for the payment by the other party of the total return
generated by a security, a basket of securities, an index or an index component.
Credit swaps are contracts involving the receipt of floating or fixed rate
payments in exchange for assuming potential credit losses of an underlying
security. Credit swaps give one party to a transaction the right to dispose of
or acquire an asset (or group of assets), or the right to receive or make a
payment from the other party, upon the occurrence of specific credit events. The
Portfolios may also enter into currency swaps, which involve the exchange of the
rights of a Portfolio and another party to make or receive payments in specific
currencies.
Some transactions, such as interest rate swaps and total rate of return
swaps are entered into on a net basis; i.e., the two payment streams are netted
out, with the Portfolio receiving or paying, as the case may be, only the net
amount of the two payments. If the other party to such a transaction defaults, a
Portfolio's risk of loss consists of the net amount of payments that the
Portfolio is contractually entitled to receive, if any. In contrast, other
transactions involve the payment of the gross amount owed. For example, currency
swaps usually involve the delivery of the entire principal amount of one
designated currency in exchange for the other designated currency. Therefore,
the entire principal value of a currency swap is subject to the risk that the
other party to the swap will default on its contractual delivery obligations. To
the extent that the amount payable by a Portfolio under a swap or an interest
rate floor, cap or collar is covered by segregated cash or liquid assets, the
Portfolio and its Investment Adviser believes that transactions do not
constitute senior securities under the 1940 Act and, accordingly, will not treat
them as being subject to a Portfolio's borrowing restrictions.
The Portfolios will not enter into a currency or interest rate swap or
interest rate floor, cap or collar transaction
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unless the unsecured commercial paper, senior debt or the claims-paying ability
of the other party thereto is rated either A or A-1 or better by Standard &
Poor's Ratings Group, Inc. ("S&P") or Fitch IBCA ("Fitch"), or A or P-1 or
better by Moody's Investors Service, Inc. ("Moody's") or, if unrated by such
rating organization, is determined to be of comparable quality by the Investment
Advisers. If there is a default by the other party to such transaction, a
Portfolio will have contractual remedies pursuant to the agreements related to
the transaction. The swap market has grown substantially in recent years with a
large number of banks and investment banking firms acting both as principals and
as agents utilizing standardized swap documentation. As a result, the swap
market has become relatively liquid in comparison with markets for other similar
instruments which are traded in the interbank market.
The use of interest rate, total rate of return, credit and currency swaps,
as well as interest rate caps, floors and collars, is a highly specialized
activity which involves investment techniques and risks different from those
associated with ordinary portfolio securities transactions. If the Investment
Adviser is incorrect in its forecasts of market values, interest rates and
currency exchange rates, the investment performance of a Portfolio would be less
favorable than it would have been if this investment technique were not used.
Equity Swaps. Each Portfolio may enter into equity swap contracts to
-------------
invest in a market without owning or taking physical custody of securities in
circumstances in which direct investment is restricted for legal reasons or is
otherwise impracticable. Equity swaps may also be used for hedging purposes or
to seek to increase total return. The counterparty to an equity swap contract
will typically be a bank, investment banking firm or broker/dealer. Equity swap
contracts may be structured in different ways. For example, a counterparty may
agree to pay the Portfolio the amount, if any, by which the notional amount of
the equity swap contract would have increased in value had it been invested in
particular stocks (or an index of stocks), plus the dividends that would have
been received on those stocks. In these cases, the Portfolio may agree to pay to
the counterparty the amount, if any, by which that notional amount would have
decreased in value had it been invested in the stocks. Therefore, the return to
the Portfolio on any equity swap contract should be the gain or loss on the
notional amount plus dividends on the stocks less the interest paid by the
Portfolio on the notional amount. In other cases, the counterparty and the
Portfolio may each agree to pay the other the difference between the relative
investment performances that would have been achieved if the notional amount of
the equity swap contract had been invested in different stocks (or indices of
stocks).
A Portfolio will enter into equity swaps only on a net basis, which means
that the two payment streams are netted out, with the Portfolio receiving or
paying, as the case may be, only the net amount of the two payments. Payments
may be made at the conclusion of an equity swap contract or periodically during
its term. Equity swaps do not involve the delivery of securities or other
underlying assets. Accordingly, the risk of loss with respect to equity swaps is
limited to the net amount of payments that a Portfolio is contractually
obligated to make. If the other party to an equity swap defaults, a Portfolio's
risk of loss consists of the net amount of payments that such Portfolio is
contractually entitled to receive, if any. Inasmuch as these transactions are
entered into for hedging purposes or are offset by segregated cash or liquid
assets to cover the Portfolios' potential exposure, the Portfolios and the
Investment Advisers believe that such transactions do not constitute senior
securities under the 1940 Act and, accordingly, will not treat them as being
subject to a Portfolio's borrowing restrictions.
The Portfolios will not enter into any swap transactions unless the
unsecured commercial paper, senior debt or claims-paying ability of the other
party is rated either A or A-1 or better by S&P or Fitch, or A or P-1 or better
by Moody's. If there is a default by the other party to such a transaction, a
Portfolio will have contractual remedies pursuant to the agreements related to
the transaction.
The use of equity swaps is a highly specialized activity which involves
investment techniques and risks different from those associated with ordinary
portfolio securities transactions. If the Investment Advisers are incorrect in
their forecasts of market values, the investment performance of a Portfolio
would be less favorable than it would have been if this investment technique
were not used.
Futures Contracts and Related Options. Each Portfolio may invest in
--------------------------------------
futures contracts and may purchase and sell call and put options on futures
contracts for hedging purposes, for speculative purposes (to seek to increase
total return), or for liquidity management purposes. When used as a hedge, a
Portfolio may sell a futures contract in order to offset a decrease in the
market value of its portfolio securities that might otherwise result from a
market decline or currency exchange fluctuations. A Portfolio may do so either
to hedge the value of its portfolio of securities as a whole, or to protect
against declines, occurring prior to sales of securities, in the value of the
securities to be sold. Conversely, a Portfolio may purchase a futures contract
as a hedge in anticipation of purchases of securities. In addition, a Portfolio
may utilize futures contracts in
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anticipation of changes in the composition of its portfolio holdings. For a
detailed description of futures contracts and related options, see Appendix B to
this Additional Statement.
Real Estate Investment Trusts. The Small Company Index and the Small
------------------------------
Company Growth Portfolios may invest in equity real estate investment trusts
("REITs") that constitute a part of the Russell 2000 Small Stock Index. REITs
pool investors' funds for investment primarily in commercial real estate
properties. Investments in REITs may subject a Portfolio to certain risks. REITs
may be affected by changes in the value of the underlying property owned by the
trust. REITs are dependent upon specialized management skill, may not be
diversified and are subject to the risks of financing projects. REITs are also
subject to heavy cash flow dependency, defaults by borrowers, self liquidation
and the possibility of failing to qualify for the beneficial tax treatment
available to REITs under the Internal Revenue Code of 1986, as amended, and to
maintain exemption from the 1940 Act. As a shareholder in a REIT, a Portfolio
would bear, along with other shareholders, its pro rata portion of the REIT's
operating expenses. These expenses would be in addition to the advisory and
other expenses a Portfolio bears directly in connection with its own operations.
Securities Lending. Collateral for loans of portfolio securities made by a
-------------------
Portfolio may consist of cash, cash equivalents, securities issued or guaranteed
by the U.S. Government or its agencies or irrevocable bank letters of credit (or
any combination thereof). The borrower of securities will be required to
maintain the market value of the collateral at not less than the market value of
the loaned securities, and such value will be monitored on a daily basis. When a
Portfolio lends its securities, it continues to receive dividends and interest
on the securities loaned and may simultaneously earn interest on the investment
of the cash collateral. Although voting rights, or rights to consent, attendant
to securities on loan pass to the borrower, such loans will be called so that
the securities may be voted by a Portfolio if a material event affecting the
investment is to occur.
Forward Commitments, When-Issued Securities and Delayed Delivery
----------------------------------------------------------------
Transactions. When a Portfolio purchases securities on a when-issued, delayed
-------------
delivery or forward commitment basis, the Portfolio will segregate liquid assets
until three days prior to the settlement date having a value (determined daily)
at least equal to the amount of the Portfolio's purchase commitments, or will
otherwise cover its position. In the case of a forward commitment to sell
portfolio securities, the Portfolio will segregate the portfolio securities
themselves. These procedures are designed to ensure that the Portfolio will
maintain sufficient assets at all times to cover its obligations under when-
issued purchases, forward commitments and delayed delivery transactions.
Commercial Paper, Bankers' Acceptances, Certificates of Deposit, Time
---------------------------------------------------------------------
Deposits and Bank Notes. Commercial paper represents short-term unsecured
------------------------
promissory notes issued in bearer form by banks or bank holding companies,
corporations and finance companies. Certificates of deposit are negotiable
certificates issued against funds deposited in a commercial bank for a definite
period of time and earning a specified return. Bankers' acceptances are
negotiable drafts or bills of exchange, normally drawn by an importer or
exporter to pay for specific merchandise, which are "accepted" by a bank,
meaning, in effect, that the bank unconditionally agrees to pay the face value
of the instrument on maturity. Fixed time deposits are bank obligations payable
at a stated maturity date and bearing interest at a fixed rate. Fixed time
deposits may be withdrawn on demand by the investor, but may be subject to early
withdrawal penalties that vary depending upon market conditions and the
remaining maturity of the obligation. There are no contractual restrictions on
the right to transfer a beneficial interest in a fixed time deposit to a third
party. Bank notes rank junior to deposit liabilities of banks and pari passu
----------
with other senior, unsecured obligations of the bank. Bank notes are classified
as "other borrowings" on a bank's balance sheet, while deposit notes and
certificates of deposit are classified as deposits. Bank notes are not insured
by the Federal Deposit Insurance Corporation or any other insurer. Deposit notes
are insured by the Federal Deposit Insurance Corporation only to the extent of
$100,000 per depositor per bank.
Each Portfolio may invest a portion of its assets in the obligations of
foreign banks and foreign branches of domestic banks. Such obligations include
Eurodollar Certificates of Deposit ("ECDs") which are U.S. dollar-denominated
certificates of deposit issued by offices of foreign and domestic banks located
outside the United States; Eurodollar Time Deposits ("ETDs") which are U.S.
dollar-denominated deposits in a foreign branch of a U.S. bank or a foreign
bank; Canadian Time Deposits ("CTDs") which are essentially the same as ETDs
except they are issued by Canadian offices of major Canadian banks; Schedule Bs,
which are obligations issued by Canadian branches of foreign or domestic banks;
Yankee Certificates of Deposit ("Yankee CDs") which are U.S. dollar-denominated
certificates of deposit issued by a U.S. branch of a foreign bank and held in
the United States; and Yankee Bankers' Acceptances ("Yankee Bas") which are U.S.
dollar-denominated bankers' acceptances issued by a U.S. branch of a foreign
bank and held in the United States.
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Convertible Securities. Convertible securities entitle the holder to
-----------------------
receive interest paid or accrued on debt or the dividend paid on preferred stock
until the convertible securities mature or are redeemed, converted or exchanged.
Prior to conversion, convertible securities have characteristics similar to
ordinary debt securities in that they normally provide a stable stream of income
with generally higher yields than those of common stock of the same or similar
issuers. Convertible securities rank senior to common stock in a corporation's
capital structure and therefore generally entail less risk than the
corporation's common stock, although the extent to which such risk is reduced
depends in large measure upon the degree to which the convertible security sells
above its value as a fixed income security.
In selecting convertible securities, the investment management team will
consider, among other factors: an evaluation of the creditworthiness of the
issuers of the securities; the interest or dividend income generated by the
securities; the potential for capital appreciation of the securities and the
underlying common stocks; the prices of the securities relative to other
comparable securities and to the underlying common stocks; whether the
securities are entitled to the benefits of sinking funds or other protective
conditions; diversification of Portfolio securities as to issuers; and whether
the securities are rated by a rating agency and, if so, the ratings assigned.
The value of convertible securities is a function of their investment value
(determined by yield in comparison with the yields of other securities of
comparable maturity and quality that do not have a conversion privilege) and
their conversion value (their worth, at market value, if converted into the
underlying common stock). The investment value of convertible securities is
influenced by changes in interest rates, with investment value declining as
interest rates increase and increasing as interest rates decline, and by the
credit standing of the issuer and other factors. The conversion value of
convertible securities is determined by the market price of the underlying
common stock. If the conversion value is low relative to the investment value,
the price of the convertible securities is governed principally by their
investment value. To the extent the market price of the underlying common stock
approaches or exceeds the conversion price, the price of the convertible
securities will be increasingly influenced by their conversion value. In
addition, convertible securities generally sell at a premium over their
conversion value determined by the extent to which investors place value on the
right to acquire the underlying common stock while holding fixed income
securities.
Capital appreciation for the Portfolios may result from an improvement in
the credit standing of an issuer whose securities are held in the Portfolio or
from a general lowering of interest rates, or a combination of both. Conversely,
a reduction in the credit standing of an issuer whose securities are held by the
Portfolio or a general increase in interest rates may be expected to result in
capital depreciation to the Portfolio.
In general, investments in lower quality convertible securities are subject
to a significant risk of a change in the credit rating or financial condition of
the issuing entity. Investments in convertible securities of medium or lower
quality are also likely to be subject to greater market fluctuation and to
greater risk of loss of income and principal due to default than investments of
higher quality fixed-income securities. Such lower quality securities generally
tend to reflect short-term corporate and market developments to a greater extent
than higher quality securities, which react more to fluctuations in the general
level of interest rates. A Portfolio that invests in convertible securities will
generally reduce risk to the investor by diversification, credit analysis and
attention to current developments in trends of both the economy and financial
markets. However, while diversification reduces the effect on a Portfolio of any
single investment, it does not reduce the overall risk of investing in lower
quality securities.
Risks Related to Small Company Securities. While the Investment Advisers
------------------------------------------
believe that smaller companies can provide greater growth potential than larger,
more mature firms, investing in the securities of such companies also involves
greater risk, portfolio price volatility and cost. Historically, small
capitalization stocks, which will be the Small Company Index and Small Company
Growth Portfolios' primary investments, and stocks of recently organized
companies, in which the Portfolios may also invest, have been more volatile in
price than the larger capitalization stocks included in the Standard & Poor's
500(R) Composite Stock Price Index (the "S&P 500 Index"). Among the reasons for
this greater price volatility are the lower degree of market liquidity (the
securities of companies with small stock market capitalizations may trade less
frequently and in limited volume) and the greater sensitivity of small companies
to changing economic conditions. For example, these companies are associated
with higher investment risk due to the greater business risks of small size and
limited product lines, markets, distribution channels and financial and
managerial resources.
The values of small company stocks will frequently fluctuate independently
of the values of larger company stocks. Small company stocks may decline in
price as large company stock prices rise, or rise in price as large company
stock prices decline. You should, therefore, expect that the net asset value of
the Small Company Index and Small Company Growth
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Portfolios' shares will be more volatile than, and may fluctuate independently
of, broad stock market indices such as the S&P 500 Index.
The additional costs associated with the acquisition of small company
stocks include brokerage costs, market impact costs (that is, the increase in
market prices which may result when the Small Company Index Portfolio or Small
Company Growth Portfolio purchases thinly traded stock) and the effect of the
"bid-ask" spread in small company stocks. These costs will be borne by all
shareholders and may negatively impact investment performance.
Insurance Funding Agreements. The Balanced Portfolio may invest in
-----------------------------
insurance funding agreements ("IFAs"). An IFA is normally a general obligation
of the issuing insurance company and not a separate account. The purchase price
paid for an IFA becomes part of the general assets of the insurance company, and
the contract is paid from the company's general assets. Generally, IFAs are not
assignable or transferable without the permission of the issuing insurance
companies, and an active secondary market in IFAs may not exist. IFAs therefore
will be subject to the Portfolio's limitation on illiquid investments when the
Portfolio may not demand payment of the principal amount within seven days and a
reliable trading market is absent.
Zero Coupon, Pay-in-Kind and Capital Appreciation Bonds. To the extent
--------------------------------------------------------
consistent with their respective investment objectives, the Portfolios may
invest in zero coupon bonds, capital appreciation bonds and pay-in-kind ("PIK")
securities. Zero coupon and capital appreciation bonds are debt securities
issued or sold at a discount from their face value and which do not entitle the
holder to any periodic payment of interest prior to maturity or a specified
date. The original issue discount varies depending on the time remaining until
maturity or cash payment date, prevailing interest rates, the liquidity of the
security and the perceived credit quality of the issuer. These securities also
may take the form of debt securities that have been stripped of their unmatured
interest coupons, the coupons themselves or receipts or certificates
representing interests in such stripped debt obligations or coupons. The market
prices of zero coupon bonds, capital appreciation bonds and PIK securities
generally are more volatile than the market prices of interest bearing
securities and are likely to respond to a greater degree to changes in interest
rates than interest bearing securities having similar maturities and credit
quality.
PIK securities may be debt obligations or preferred shares that provide the
issuer with the option of paying interest or dividends on such obligations in
cash or in the form of additional securities rather than cash. Similar to zero
coupon bonds, PIK securities are designed to give an issuer flexibility in
managing cash flow. PIK securities that are debt securities can either be senior
or subordinated debt and generally trade flat (i.e., without accrued interest).
The trading price of PIK debt securities generally reflects the market value of
the underlying debt plus an amount representing accrued interest since the last
interest payment.
Zero coupon bonds, capital appreciation bonds and PIK securities involve
the additional risk that, unlike securities that periodically pay interest to
maturity, the Portfolio will realize no cash until a specified future payment
date unless a portion of such securities is sold and, if the issuer of such
securities defaults, the Portfolio may obtain no return at all on its
investment. In addition, even though such securities do not provide for the
payment of current interest in cash, the Portfolio is nonetheless required to
accrue income on such investments for each taxable year and generally is
required to distribute such accrued amounts (net of deductible expenses, if any)
to avoid being subject to tax. Because no cash is generally received at the time
of the accrual, the Portfolio may be required to liquidate other portfolio
securities to obtain sufficient cash to satisfy Federal tax distribution
requirements applicable to the Portfolio.
Variable and Floating Rate Instruments. With respect to the variable and
---------------------------------------
floating rate instruments that may be acquired by the Portfolios, the investment
management team will consider the earning power, cash flows and other liquidity
ratios of the issuers and guarantors of such instruments and, if the instruments
are subject to demand features, will monitor their financial status and ability
to meet payment on demand. Where necessary to ensure that a variable or floating
rate instrument meets the Portfolios' quality requirements, the issuer's
obligation to pay the principal of the instrument will be backed by an
unconditional bank letter or line of credit, guarantee or commitment to lend.
Variable and floating rate instruments eligible for purchase by the
Portfolios include variable amount master demand notes, which permit the
indebtedness thereunder to vary in addition to providing for periodic
adjustments in the interest rate, and leveraged inverse floating rate debt
instruments ("inverse floaters"). The interest rate on an inverse floater resets
in the opposite direction from the market rate of interest to which the inverse
floater is indexed. An inverse floater may be considered to be leveraged to the
extent that its interest rate varies by a magnitude that exceeds the magnitude
of the
13
<PAGE>
change in the index rate of interest. The higher degree of leverage inherent in
inverse floaters is associated with greater volatility in their market values.
Accordingly, the duration of an inverse floater may exceed its stated final
maturity. The Portfolios may deem the maturity of variable and floating rate
instruments to be less than their stated maturities based on their variable and
floating rate features and/or their put features. Unrated variable and floating
rate instruments will be determined by the Investment Advisers to be of
comparable quality at the time of purchase to rated instruments which may be
purchased by the Portfolios.
Variable and floating rate instruments including inverse floaters held by a
Portfolio will be subject to the Portfolio's 15% limitation on illiquid
investments, absent a reliable trading market, when the Portfolio may not demand
payment of the principal amount within seven days.
Repurchase Agreements. Each Portfolio may agree to purchase portfolio
----------------------
securities from financial institutions subject to the seller's agreement to
repurchase them at a mutually agreed upon date and price ("repurchase
agreements"). Repurchase agreements are considered to be loans under the 1940
Act. Securities subject to repurchase agreements are held either by the Trust's
custodian or subcustodian (if any), or in the Federal Reserve/Treasury Book-
Entry System. The seller under a repurchase agreement will be required to
maintain the value of the securities subject to the agreement in an amount
exceeding the repurchase price (including accrued interest). Default by the
seller would, however, expose the Portfolio to possible loss because of adverse
market action or delay in connection with the disposition of the underlying
obligations.
Reverse Repurchase Agreements. Each Portfolio may borrow funds by selling
------------------------------
portfolio securities to financial institutions such as banks and broker/dealers
and agreeing to repurchase them at a mutually specified date and price ("reverse
repurchase agreements"). The Portfolios may use the proceeds of reverse
repurchase agreements to purchase other securities either maturing, or under an
agreement to resell, on a date simultaneous with or prior to the expiration of
the reverse repurchase agreement. Reverse repurchase agreements are considered
to be borrowings under the 1940 Act. Reverse repurchase agreements involve the
risk that the market value of the securities sold by the Portfolios may decline
below the repurchase price. The Portfolios will pay interest on amounts obtained
pursuant to a reverse repurchase agreement. While reverse repurchase agreements
are outstanding, the Portfolios will segregate liquid assets in an amount at
least equal to the market value of the securities, plus accrued interest,
subject to the agreement.
Investment Companies. With respect to the investments of the Portfolios in
---------------------
the securities of other investment companies, such investments will be limited
so that, as determined after a purchase is made, either (a) not more than 3% of
the total outstanding stock of such investment company will be owned by a
Portfolio, the Trust as a whole and their affiliated persons (as defined in the
1940 Act); or (b) (i) not more than 5% of the value the total assets of a
Portfolio will be invested in the securities of any one investment company, (ii)
not more than 10% of the value of its total assets will be invested in the
aggregate in securities of investment companies as a group, and (iii) not more
than 3% of the outstanding voting stock of any one investment company will be
owned by the Portfolio.
Certain investment companies whose securities are purchased by the
Portfolios may not be obligated to redeem such securities in an amount exceeding
1% of the investment company's total outstanding securities during any period of
less than 30 days. Therefore, such securities that exceed this amount may be
illiquid.
If required by the 1940 Act, each Portfolio expects to vote the shares of
other investment companies that are held by it in the same proportion as the
vote of all other holders of such securities.
A Portfolio may invest all or substantially all of its assets in a single
open-end investment company or series thereof with substantially the same
investment objective, policy and restrictions as the Portfolio. However, each
Portfolio currently intends to limit its investments in securities issued by
other investment companies to the extent described above. A Portfolio may adhere
to more restrictive limitations with respect to its investments in securities
issued by other investment companies if required by the SEC or deemed to be in
the best interests of the Trust.
As noted in the Prospectus, a Portfolio may invest in World Equity
Benchmark Shares ("WEBS"), Standard & Poor's Depository Receipts ("SPDRs") and
similar securities of other investment companies, subject to the restrictions
set forth above.
WEBS are shares of an investment company that invests substantially all of
its assets in securities included in the Morgan Stanley Capital International
Index ("MSCI") indices for specified countries. WEBS are listed on the American
14
<PAGE>
Stock Exchange (the "AMEX"), and were initially offered to the public in 1996.
The market prices of WEBS are expected to fluctuate in accordance with both
changes in the net asset values of their underlying indices and supply and
demand of WEBS on the AMEX. To date WEBS have traded at relatively modest
discounts and premiums to their net asset values. However, WEBS have a limited
operating history, and information is lacking regarding the actual performance
and trading liquidity of WEBS for extended periods or over complete market
cycles. In addition, there is no assurance that the requirements of the AMEX
necessary to maintain the listing of WEBS will continue to be met or will remain
unchanged. In the event substantial market or other disruptions affecting WEBS
should occur in the future, the liquidity and value of a Portfolio's shares
could also be substantially and adversely affected, and a Portfolio's ability to
provide investment results approximating the performance of securities in the
EAFE Index could be impaired. If such disruptions were to occur, a Portfolio
could be required to reconsider the use of WEBS as part of its investment
strategy.
SPDRs are interests in a unit investment trust ("UIT") that may be obtained
from the UIT or purchased in the secondary market (SPDRs are listed on the
AMEX). The UIT will issue SPDRs in aggregations known as "Creation Units" in
exchange for a "Portfolio Deposit" consisting of (i) a portfolio of securities
substantially similar to the component securities ("Index Securities") of the
S&P 500 Index, (ii) a cash payment equal to a pro rata portion of the dividends
accrued on the UIT's portfolio securities since the last dividend payment by the
UIT, net of expenses and liabilities, and (iii) a cash payment or credit
("Balancing Amount") designed to equalize the net asset value of the S&P Index
and the net asset value of a Portfolio Deposit.
SPDRs are not individually redeemable, except upon termination of the UIT.
To redeem, a Portfolio must accumulate enough SPDRs to reconstitute a Creation
Unit. The liquidity of small holdings of SPDRs, therefore, will depend upon the
existence of a secondary market. Upon redemption of a Creation Unit, a Portfolio
will receive Index Securities and cash identical to the Portfolio Deposit
required of an investor wishing to purchase a Creation Unit that day.
The price of SPDRs is derived from and based upon the securities held by
the UIT. Accordingly, the level of risk involved in the purchase or sale of a
SPDR is similar to the risk involved in the purchase or sale of traditional
common stock, with the exception that the pricing mechanism for SPDRs is based
on a basket of stocks. Disruptions in the markets for the securities underlying
SPDRs purchased or sold by a Portfolio could result in losses on SPDRs. Trading
in SPDRs involves risks similar to those risks involved in the writing of
options on securities.
Risks Related to Lower-Rated Securities. While any investment carries some
----------------------------------------
risk, certain risks associated with lower-rated securities are different than
those for investment-grade securities. The risk of loss through default is
greater because lower-rated securities are usually unsecured and are often
subordinate to an issuer's other obligations. Additionally, the issuers of these
securities frequently have high debt levels and are thus more sensitive to
difficult economic conditions, individual corporate developments and rising
interest rates. Consequently, the market price of these securities may be quite
volatile and may result in wider fluctuations of a Portfolio's net asset value
per share.
There remains some uncertainty about the performance level of the market
for lower-rated securities under adverse market and economic environments. An
economic downturn or increase in interest rates could have a negative impact on
both the market for lower-rated securities (resulting in a greater number of
bond defaults) and the value of lower-rated securities held in the portfolio of
investments.
The economy and interest rates can affect lower-rated securities
differently than other securities. For example, the prices of lower-rated
securities are more sensitive to adverse economic changes or individual
corporate developments than are the prices of higher-rated investments. In
addition, during an economic downturn or period in which interest rates are
rising significantly, highly leveraged issuers may experience financial
difficulties, which, in turn, would adversely affect their ability to service
their principal and interest payment obligations, meet projected business goals
and obtain additional financing.
If an issuer of a security defaults, a Portfolio may incur additional
expenses to seek recovery. In addition, periods of economic uncertainty would
likely result in increased volatility for the market prices of lower-rated
securities as well as a Portfolio's net asset value. In general, both the prices
and yields of lower-rated securities will fluctuate.
In certain circumstances it may be difficult to determine a security's fair
value due to a lack of reliable objective information. Such instances occur
where there is not an established secondary market for the security or the
security is lightly traded. As a result, a Portfolio's valuation of a security
and the price it is actually able to obtain when it sells the security
15
<PAGE>
could differ.
Adverse publicity and investor perceptions, whether or not based on
fundamental analysis, may decrease the value and liquidity of lower-rated
securities held by a Portfolio, especially in a thinly traded market. Illiquid
or restricted securities held by a Portfolio may involve special registration
responsibilities, liabilities and costs, and could involve other liquidity and
valuation difficulties.
The ratings of S&P, Moody's and Fitch evaluate the safety of a lower-rated
security's principal and interest payments, but do not address market value
risk. Because the ratings of the rating agencies may not always reflect current
conditions and events, in addition to using recognized rating agencies and other
sources, the Investment Advisers perform their own analysis of the issuers whose
lower-rated securities the Portfolios purchase. Because of this, a Portfolio's
performance may depend more on the Investment Adviser own credit analysis than
is the case of mutual funds investing in higher-rated securities.
In selecting lower-rated securities, the Investment Advisers consider
factors such as those relating to the creditworthiness of issuers, the ratings
and performance of the securities, the protections afforded the securities and
the diversity of a Portfolio's investment portfolio. The Investment Advisers
monitor the issuers of lower-rated securities held by a Portfolio for their
ability to make required principal and interest payments, as well as in an
effort to control the liquidity of the Portfolio so that it can meet redemption
requests.
Yields and Ratings. The yields on certain obligations, including the
------------------
instruments in which the Portfolios may invest, are dependent on a variety of
factors, including general market conditions, conditions in the particular
market for the obligation, financial condition of the issuer, size of the
offering, maturity of the obligation and ratings of the issue. The ratings of
S&P, Moody's, Fitch and Thomson Bank Watch ("TBW") represent their respective
opinions as to the quality of the obligations they undertake to rate. Ratings,
however, are general and are not absolute standards of quality. Consequently,
obligations with the same rating, maturity and interest rate may have different
market prices. For a more complete discussion of ratings, see Appendix A to
this Additional Statement.
Subject to the limitations stated in the Prospectus, if a security held by
a Portfolio undergoes a rating revision, the Portfolio may continue to hold the
security if the Investment Advisers determine such retention is warranted.
Stock Indices. The S&P 500 Index is a market value-weighted index
--------------
consisting of 500 common stocks which are traded on the New York Stock Exchange,
AMEX and the Nasdaq National Market System and selected by Standard & Poor's
Corporation ("Standard & Poor's") through a detailed screening process starting
on a macro-economic level and working toward a micro-economic level dealing with
company-specific information such as market value, industry group
classification, capitalization and trading activity. Standard & Poor's primary
objective for the S&P 500 Index is to be the performance benchmark for the U.S.
equity markets. The companies chosen for inclusion in the S&P 500 Index tend to
be leaders in important industries within the U.S. economy. However, companies
are not selected by Standard & Poor's for inclusion because they are expected to
have superior stock price performance relative to the market in general or other
stocks in particular. Standard & Poor's makes no representation or warranty,
implied or express, to purchasers of Stock Index Fund shares or any member of
the public regarding the advisability of investing in the Equity Index Portfolio
or the ability of the S&P 500 Index to track general stock market performance.
As of November 30, 1999, the approximate market capitalization range of the
companies included in the S&P 500 Index was between $395 million and $464.69
billion.
The Standard & Poor's Midcap 400 Stock Index ("S&P MidCap 400 Index") is a
market-weighted index composed of 400 common stocks chosen by Standard & Poor's
for market size, liquidity and industry group representation. The purpose of
the S&P MidCap 400 Index is to represent the performance of the medium-
capitalization sector of the U.S. securities market. Medium capitalized stocks
which are included in the S&P 500 Index are excluded from the S&P MidCap 400
Index. Except for a limited number of Canadian securities, the S&P MidCap 400
does not include foreign securities. As of November 30, 1999, the approximate
market capitalization range of the companies included in the S&P MidCap 400
Index was between $195 million and $23.394 billion.
The Russell 2000 Index is a market value-weighted index composed of the
stocks of the smallest 2000 companies in the Russell 3000 Index, which is
composed of the stocks of 3000 large U.S. domiciled companies (based on market
capitalization) that represent approximately 98% of the investable U.S. equity
markets. Because of its emphasis on the smallest 2000 companies, the Russell
2000 Index represents approximately 8% of the total market capitalization of the
16
<PAGE>
Russell 3000 Index. As of November 30, 1999, the average market capitalization
of the companies included in the Russell 2000 Index was approximately $570.0
million. The Russell 2000 Index is reconstituted annually to reflect changes in
market capitalization. The primary criteria used by Frank Russell & Company
("Russell") to determine the initial list of securities eligible for inclusion
in the Russell 3000 Index (and accordingly, the Russell 2000 Index) is total
market capitalization adjusted for large private holdings and cross-ownership.
However, companies are not selected by Russell for inclusion in the Russell 2000
Index because they are expected to have superior stock price performance
relative to the market in general or other stocks in particular. Russell makes
no representation or warranty, implied or express, to purchasers of Small Cap
Index or Small Cap Growth Fund shares or any member of the public regarding the
advisability of investing in the Fund or the ability of the Russell 2000 Index
to track general market performance of small capitalization stocks.
Relative Value Approach. In buying and selling securities for the fixed
------------------------
income portion of the Balanced Portfolio, the investment management team uses a
relative value approach. This approach involves an analysis of economic and
market information, including economic growth rates, interest and inflation
rates, deficit levels, the shape of the yield curve, sector and quality spreads
and risk premiums. It also involves the use of proprietary valuation models to
analyze and compare expected returns and assumed risks. Under the relative value
approach, the investment management team will emphasize particular securities
and particular types of securities that the team believes will provide a
favorable return in light of these risks.
Tracking Variance. As discussed in the Prospectus, the Equity Index, Small
------------------
Company Index and International Equity Index Portfolios are subject to the risk
of tracking variance. Tracking variance may result from share purchases and
redemptions, transaction costs, expenses and other factors. Share purchases and
redemptions may necessitate the purchase and sale of securities by a Portfolio
and the resulting transaction costs which may be substantial because of the
number and the characteristics of the securities held. In addition, transaction
costs are incurred because sales of securities received in connection with spin-
offs and other corporate reorganizations are made to conform a Portfolio's
holdings with its investment objective. Tracking variance may also occur due to
factors such as the size of a Portfolio, the maintenance of a cash reserve
pending investment or to meet expected redemptions, changes made in the
Portfolio's designated Index or the manner in which the Index is calculated or
because the indexing and investment approach of the Investment Adviser does not
produce the intended goal of the Portfolio. Tracking variance is monitored by
the Investment Adviser at least quarterly. In the event the performance of a
Portfolio is not comparable to the performance of its designated Index, the
Board of Trustees will evaluate the reasons for the deviation and the
availability of corrective measures. If substantial deviation in a Portfolio's
performance were to continue for extended periods, it is expected that the Board
of Trustees would consider recommending to shareholders possible changes to the
Portfolio's investment objective.
The Small Company Index and International Equity Index Portfolios require
the payment of an additional transaction fee on purchases of shares of the
Portfolios. The purpose of the fee is to indirectly allocate transaction costs
associated with new purchases to investors making those purchases, thus
protecting existing shareholders. These costs include: (i) brokerage costs; (ii)
market impact costs--i.e., the increase in market prices which may result when
the Portfolios purchase thinly traded stocks; (iii) sales charges relating to
the purchase of shares in certain unaffiliated investment companies; and, most
importantly (iv) the effect of the "bid-ask" spread in the over-the-counter
market. (Securities in the over-the-counter market are bought at the "ask" or
purchase price, but are valued in the Portfolios at the last quoted bid price).
The additional transaction fees represent the Investment Adviser's estimate of
the brokerage and other transaction costs which may be incurred by the Small
Company Index and International Equity Index Portfolios in acquiring stocks of
small capitalization or foreign companies. Without the additional transaction
fee, the Portfolios would generally be selling their shares at a price less than
the cost to the Portfolios of acquiring the portfolio securities necessary to
maintain their investment characteristics, thereby resulting in reduced
investment performance for all shareholders in the Portfolios. With the
additional transaction fee, the transaction costs of acquiring additional stocks
are not borne by all existing shareholders, but are defrayed by the transaction
fees paid by those investors making additional purchases of shares.
Calculation of Portfolio Turnover Rate. The portfolio turnover rate for
---------------------------------------
the Portfolios is calculated by dividing the lesser of purchases or sales of
portfolio investments for the reporting period by the monthly average value of
the portfolio investments owned during the reporting period. The calculation
excludes all securities, including options, whose maturities or expiration dates
at the time of acquisition are one year or less. Portfolio turnover may vary
greatly from year to year as well as within a particular year, and may be
affected by cash requirements for redemption of shares and by requirements which
enable the Portfolios to receive favorable tax treatment.
Mortgage Dollar Rolls. The Portfolios may enter into mortgage "dollar
----------------------
rolls" in which a Portfolio sells securities for
17
<PAGE>
delivery in the future (generally within 30 days) and simultaneously contracts
with the same counterparty to repurchase similar (same type, coupon and
maturity), but not identical securities on a specified future date. During the
roll period, a Portfolio loses the right to receive principal and interest paid
on the securities sold. However, a Portfolio would benefit to the extent of any
difference between the price received for the securities sold and the lower
forward price for the future purchase (often referred to as the "drop") or fee
income plus the interest earned on the cash proceeds of the securities sold
until the settlement date of the forward purchase. Unless such benefits exceed
the income, capital appreciation and gain or loss due to mortgage prepayments
that would have been realized on the securities sold as part of the mortgage
dollar roll, the use of this technique will diminish the investment performance
of a Portfolio compared with what such performance would have been without the
use of mortgage dollar rolls. All cash proceeds will be invested in instruments
that are permissible investments for the applicable Portfolio. Each Portfolio
will hold and maintain in a segregated account until the settlement date cash or
liquid assets, as permitted by applicable law, in an amount equal to its forward
purchase price.
For financial reporting and tax purposes, the Portfolios treat mortgage
dollar rolls as two separate transactions; one involving the purchase of a
security and a separate transaction involving a sale. The Portfolios do not
currently intend to enter into mortgage dollar rolls that are accounted for as a
financing.
Mortgage dollar rolls involve certain risks including the following. If the
broker-dealer to whom a Portfolio sells the security becomes insolvent, a
Portfolio's right to purchase or repurchase the mortgage-related securities
subject to the mortgage dollar roll may be restricted and the instrument which a
Portfolio is required to repurchase may be worth less than an instrument which a
Portfolio originally held. Successful use of mortgage dollar rolls will depend
upon the Investment Adviser's ability to manage a Portfolio's interest rate and
mortgage prepayments exposure. For these reasons, there is no assurance that
mortgage dollar rolls can be successfully employed.
18
<PAGE>
Investment Restrictions
Each Portfolio is subject to the fundamental investment restrictions
enumerated below which may be changed with respect to a particular Portfolio
only by a vote of the holders of a majority of such Portfolio's outstanding
shares.
No Portfolio may:
(1) Make loans, except through (a) the purchase of debt obligations in
accordance with the Portfolio's investment objective and policies, (b)
repurchase agreements with banks, brokers, dealers and other financial
institutions, (c) loans of securities, and (d) loans to affiliates of the
Portfolio to the extent permitted by law.
(2) Purchase or sell real estate, but this restriction shall not prevent a
Portfolio from investing directly or indirectly in portfolio instruments
secured by real estate or interests therein or acquiring securities of real
estate investment trusts or other issuers that deal in real estate.
(3) Invest in commodities or commodity contracts, except that each Portfolio
may invest in currency and financial instruments and contracts that are
commodities or commodity contracts.
(4) Invest in companies for the purpose of exercising control.
(5) Act as underwriter of securities, except as a Portfolio may be deemed to
be an underwriter under the Securities Act of 1933 in connection with the
purchase and sale of portfolio instruments in accordance with its investment
objective and portfolio management policies.
(6) Make any investment inconsistent with the Portfolio's classification as
a diversified investment company under the 1940 Act.
(7) Purchase securities (other than obligations issued or guaranteed by the
U.S. Government, its agencies or instrumentalities if such purchase would
cause more than 25% in the aggregate of the market value of the total assets
of a Portfolio to be invested in the securities of one or more issuers having
their principal business activities in the same industry. For the purposes of
this restriction, as to utility companies, the gas, electric, water and
telephone businesses are considered separate industries; personal credit
finance companies and business credit finance companies are deemed to be
separate industries; and wholly-owned finance companies are considered to be
in the industries of their parents if their activities are primarily related
to financing the activities of their parents.
(8) Borrow money, except that to the extent permitted by applicable law (a)
a Portfolio may borrow from banks, other affiliated investment companies and
other persons, and may engage in reverse repurchase agreements and other
transactions which involve borrowings, in amounts up to 33-1/3% of its total
assets (including the amount borrowed) or such other percentage permitted by
law, (b) a Portfolio may borrow up to an additional 5% of its total assets
for temporary purposes, (c) a Portfolio may obtain such short-term credits as
may be necessary for the clearance of purchases and sales of portfolio
securities, and (d) a Portfolio may purchase securities on margin. If due to
market fluctuations or other reasons a Portfolio's borrowings exceed the
limitations stated above, the Trust will promptly reduce the borrowings of
such Portfolio in accordance with the 1940 Act. In addition, as a matter of
fundamental policy, a Portfolio will not issue senior securities to the
extent such issuance would violate applicable law.
(9) Notwithstanding any of the Trust's other fundamental investment
restrictions (including, without limitation, those restrictions relating to
issuer diversification, industry concentration and control), each Portfolio
may (a) purchase securities of other investment companies to the full extent
permitted under Section 12 of the 1940 Act (or any successor provision
thereto) or under any regulation or order of the Securities and Exchange
Commission; and (b) may invest all or substantially all of its assets in a
single open-end investment company or series thereof with substantially the
same investment objective, policies and fundamental restrictions as the
Portfolio.
* * *
For the purposes of Restriction Nos. 1 and 8 above, the Portfolios expect
that they would be required to file an exemptive application with the SEC and
receive the SEC's approval of that application prior to entering into lending or
borrowing arrangements with affiliates. As of April 1, 2000, the Portfolios had
not filed such an exemptive application.
19
<PAGE>
In applying Restriction No. 7 above, a security is considered to be issued
by the entity, or entities, whose assets and revenues back the security. A
guarantee of a security is not deemed to be a security issued by the guarantor
when the value of all securities issued and guaranteed by the guarantor, and
owned by a Portfolio, does not exceed 10% of the value of the Portfolio's total
assets.
Except to the extent otherwise provided in Investment Restriction No. 7 for
the purpose of such restriction, in determining industry classification the
Trust intends to use the industry classification titles in the Bloomberg
Industry Group Classifications (except that the International Growth Portfolio
and the International Equity Index Portfolio will use the Morgan Stanley Capital
International industry classification titles).
Any restriction which involves a maximum percentage will not be considered
violated unless an excess over the percentage occurs immediately after, and is
caused by, an acquisition of securities or assets of, or borrowings by, a
Portfolio.
ADDITIONAL TRUST INFORMATION
Trustees and Officers
The business and affairs of the Trust and each Portfolio are managed under
the direction of the Trust's Board of Trustees. Information pertaining to the
Trustees and officers of the Trust is set forth below.
<TABLE>
<CAPTION>
Position(s) Principal Occupation(s)
Name and Address Age with Trust During the Past 5 Years
---------------- --- ----------- -----------------------
<S> <C> <C> <C>
Richard G. Cline 65 Trustee Chairman, Hawthorne Investors, Inc. (a management advisory services
4200 Commerce Court and private investment company) since January 1996; Chairman, Hussman
Suite 300 International, Inc. (a refrigeration company) since 1998, Chairman and
Lisle, IL 60532 CEO of NICOR Inc. (a diversified public utility holding company) from
1986 to 1995, and President, 1992-1993; Chairman, Federal Reserve Bank
of Chicago from 1992 to 1995; and Deputy Chairman from 1995 to 1996.
Director: Whitman Corporation (a diversified holding company); Kmart
Corporation (a retailing company); Ryerson Tull, Inc. (a metals
distribution company) and University of Illinois Foundation. Trustee:
Northern Funds.
</TABLE>
20
<PAGE>
<TABLE>
<CAPTION>
Position(s) Principal Occupation(s)
Name and Address Age with Trust During the Past 5 Years
---------------- --- ----------- -----------------------
<S> <C> <C> <C>
Edward J. Condon, Jr. 60 Trustee Chairman of The Paradigm Group, Ltd. (a financial advisor) since
Sears Tower, Suite 9650 July 1993; Vice President and Treasurer of Sears, Roebuck and Co.
233 S. Wacker Drive (a retail corporation) from February 1989 to July 1993; Member of
Chicago, IL 60606 Advisory Board of Real-Time USA, Inc. (a software development
company); Member of the Board of Managers of The Liberty Hampshire
Company, LLC (a receivable securitization company); Vice Chairman
and Director of Energenics L.L.C. (a waste to energy recycling
company). Director: University Eldercare, Inc. (an Alzheimer's
disease research and treatment company); Financial Pacific Company
(a small business leasing company). Trustee: Dominican University.
Trustee: Northern Funds.
Mr. Wesley M. Dixon, Jr. 72 Trustee Director of Kinship Capital Corporation (a financial services
400 Skokie Blvd., Suite 300 company) since 1985 to 1996, Vice Chairman and Director of G.D.
Northbrook, IL 60062 Searle & Co. (manufacture and sale of food products and
pharmaceuticals) from 1977 to 1985 and President of G.D. Searle &
Co. prior thereto. Trustee: Northern Funds.
Mr. William J. Dolan, Jr. 67 Trustee Partner of Arthur Andersen & Co. S.C. (an accounting firm) from
1534 Basswood Circle 1966 to 1989. Financial Consultant, Ernst & Young (an accounting
Glenview, IL 60025 firm) from 1992 to 1993 and 1997. Trustee: Northern Funds.
John W. English 67 Trustee Private Investor; Vice President and Chief Investment Officer of
50-H New England Ave. The Ford Foundation (a charitable trust) from 1981 to 1993.
P.O. Box 640 Trustee: The China Fund, Inc., Select Sector SPDR Trust; WM Funds;
Summit, NJ 07902-0640 American Red Cross in Greater New York; Mote Marine Laboratory (a
non-profit marine research facility); and United Board for
Christian Higher Education in Asia. Trustee: Northern Funds.
Mr. Raymond E. George, Jr. * 69 Trustee Senior Vice President and Senior Fiduciary Officer of The Northern
703 Prospect Avenue Trust Company from 1990 to 1993. Trustee: Northern Funds.
Winnetka, IL 60093
</TABLE>
21
<PAGE>
<TABLE>
<CAPTION>
Position(s) Principal Occupation(s)
Name and Address Age with Trust During the Past 5 Years
---------------- --- ----------- -----------------------
<S> <C>
Sandra Polk Guthman 56 Trustee President and CEO of Polk Bros. Foundation (an Illinois not-for-
420 N. Wabash Avenue profit corporation) from 1993 to present; Director of Business
Suite 204 Transformation from 1992-1993, and Midwestern Director of
Chicago, IL 60611 Marketing from 1988-1992, IBM (a technology company); Director:
MBIA Insurance Corporation of Illinois (a municipal bond insurance
company). Trustee: Northern Funds.
Mr. Michael E. Murphy** 63 Trustee President of Sara Lee Foundation (philanthropic organization)
Suite 2222 since November 1997. Vice Chairman and Chief Administrative
20 South Clark Street Officer of Sara Lee Corporation (a consumer product company) from
Chicago, IL 60603 November 1994 to October 1997; Vice Chairman and Chief Financial
and Administrative Officer of Sara Lee Corporation from July 1993
to November 1994. Director: Payless Shoe Source, Inc., (a retail
shoe store business); True North Communications, Inc. (a global
advertising and communications holding company); American General
Corporation (a diversified financial services company); GATX
Corporation (a railroad holding company); Bassett Furniture
Industries, Inc. (a furniture manufacturer) Trustee: Northern
Funds.
Mary Jacobs Skinner, Esq.*** 42 Trustee Partner in the law firm of Sidley & Austin. Trustee: Northern
One First National Plaza Funds.
Chicago, IL 06063
William H. Springer 71 Chairman and Vice Chairman of Ameritech (a telecommunications holding company)
701 Morningside Drive Trustee from February 1987 to August 1992; Vice Chairman, Chief Financial
Lake Forest, IL 60045 and Administrative Officer of Ameritech prior to 1987. Director:
Walgreen Co. (a retail drug store business); Baker, Fentress & Co.
(a closed-end, non-diversified management investment company).
Trustee: Goldman Sachs Trust; Goldman Sachs Variable Insurance
Trust. Trustee: Northern Funds.
</TABLE>
22
<PAGE>
<TABLE>
<CAPTION>
Position(s) Principal Occupation(s)
Name and Address Age with Trust During the Past 5 Years
---------------- --- ----------- -----------------------
<S> <C> <C> <C>
Richard P. Strubel 61 Trustee President and Chief Operating Officer, UNext.com (a provider
737 N. Michigan Avenue of educational services via the internet) since 1999; Managing
Suite 1405 Director of Tandem Partners, Inc. (a privately held management
Chicago, IL 60611 services firm) from 1990 to 1999; President and Chief
Executive Officer, Microdot, Inc. (a privately held
manufacturing firm) from 1984 to 1994; Director: Gildan
Activewear, Inc. (an athletic clothing marketing and
manufacturing company); Children's Memorial Medical Center.
Trustee: University of Chicago; Goldman Sachs Trust; Goldman
Sachs Variable Insurance Trust. Trustee: Northern Funds.
Stephen Timbers**** 55 Trustee President of Northern Trust Global Investments, a division of
50 South LaSalle Street Northern Trust Corporation and Executive Vice President, The
Chicago, IL 60675 Northern Trust Company since 1998; President, Chief Executive
Officer and Director of Zurich Kemper Investments (a financial
services company) from 1996 to 1998; President, Chief
Operating Officer and Director of Kemper Corporation (a
financial services company) from 1992 to 1996; President and
Director of Kemper Funds (a registered investment company)
from 1990 to 1998. Director: LTV Corporation (a steel
producer). Trustee: Northern Funds.
Jylanne M. Dunne 40 President Senior Vice President for Distribution Services at PFPC Inc.
4400 Computer Drive ("PFPC") (formerly First Data Investor Services Group, Inc.
Westborough, MA 01581 ("FDISG")) (since 1988).
Archibald E. King 42 Vice President Senior Vice President and other positions at The Northern
50 South LaSalle Street Trust Company (since 1979).
Chicago, IL 60675
Lloyd A. Wennlund 42 Vice President Senior Vice President and other positions at The Northern
50 South LaSalle Street Trust Company, President of Northern Trust Securities, Inc.,
Chicago, IL 60675 and Managing Executive, Mutual Funds for Northern Trust
Global Investments (since 1989).
</TABLE>
23
<PAGE>
<TABLE>
<CAPTION>
Position(s) Principal Occupation(s)
Name and Address Age with Trust During the Past 5 Years
---------------- --- ---------- -----------------------
<S> <C> <C> <C>
Brian R. Curran 32 Vice President and Director of Fund Administration at PFPC (formerly FDISG)
4400 Computer Drive Treasurer (since 1997); Director of Fund Administration at State Street
Westborough, MA 01581 Bank & Trust Company (February 1997 to October 1997); Senior
Auditor at Price Waterhouse L.L.P. (an accounting firm)
(February 1994 to February 1997).
Judith E. Clear 33 Assistant Treasurer Client Treasury Manager of Mutual Fund Administration
4400 Computer Drive at PFPC (since 1997); Compliance Manager at Citizens Trust
Westborough, MA 01581 (1994 to 1996).
Suzanne E. Anderson 27 Assistant Treasurer Client Treasury Manager of Mutual Fund Administration at PFPC
4400 Computer Drive Inc. (since August 1998); Manager of Fund Administration at
Westborough, MA 01581 State Street Bank & Trust Company (October 1996 to August
1998); Fund Administrator at State Street Bank & Trust Company
(October 1995 to October 1996); Mutual Fund Accountant at The
Boston Company (prior thereto).
Jeffrey A. Dalke 49 Secretary Partner in the law firm of Drinker Biddle & Reath LLP.
One Logan Square
18/th/ and Cherry Streets
Philadelphia, PA 19103-6996
Linda J. Hoard 52 Assistant Secretary Vice President at PFPC (formerly FDISG) (since 1998); Attorney
4400 Computer Drive Consultant for Fidelity Management & Research (a financial
Westborough, MA 01581 service company); Investors Bank & Trust Company (a financial
service provider) and FDISG (September 1994 to June 1998).
Therese Hogan 37 Assistant Secretary Director of the State Regulation Department at PFPC (formerly
4400 Computer Drive FDISG) (since 1994).
Westborough, MA 01581
</TABLE>
* Mr. George is deemed to be an "interested" Trustee because he owns
shares of Northern Trust Corporation.
** Mr. Murphy is deemed to be an "interested" Trustee because he owns
shares of Northern Trust Corporation.
*** Ms. Skinner is deemed to be an "interested" Trustee because her law firm
provides legal services to Northern.
**** Mr. Timbers is deemed to be an "interested" Trustee because he is an
officer, director, employee and shareholder of Northern Trust
Corporation and/or Northern and NTQA.
Certain of the Trustees and officers and the organizations with which they
are associated have had in the past, and may have in the future, transactions
with the Investment Advisers, PFPC (formerly FDISG), Northern Funds
Distributors, LLC ("NFD") and their respective affiliates. The Trust has been
advised by such Trustees and officers that all such transactions have been and
are expected to be in the ordinary course of business and the terms of such
transactions, including all loans and loan commitments by such persons, have
been and are expected to be substantially the same as the prevailing terms for
comparable transactions for other customers. As a result of the responsibilities
assumed by the Trust's service providers, the Trust itself requires no
employees.
24
<PAGE>
Each officer holds comparable positions with certain other investment
companies for which NFD, PFPC or an affiliate thereof is the investment adviser,
administrator and/or distributor.
Each Trustee, except Mr. Timbers, earns a quarterly retainer of $6,750 and
the Chairman of the Board earns a quarterly retainer of $10,125. Each Trustee,
including the Chairman of the Board, earns an additional fee of $2,500 for each
meeting attended, plus reimbursement of expenses incurred as a Trustee.
In addition, the Trustees have established an Audit Committee consisting of
two members, including a Chairman of the Committee. The Audit Committee members
are Messrs. Condon and Strubel (Chairman). Each member earns a fee of $2,500 for
each meeting attended and the Chairman earns a quarterly retainer of $1,500.
Each Trustee will hold office for an indefinite term until the earliest of
(i) the next meeting of shareholders if any, called for the purpose of
considering the election or re-election of such Trustee and until the election
and qualification of his or her successor, if any, elected at such meeting; (ii)
the date a Trustee resigns or retires, or a Trustee is removed by the Board of
Trustees or shareholders, in accordance with the Trust's Agreement and
Declaration of Trust, or (iii) effective December 31, 2001, in accordance with
the current resolutions of the Board of Trustees (which may be changed without
shareholder vote), on the last day of the fiscal year of the Trust in which he
or she attains the age of 72 years.
The Trust's officers do not receive fees from the Trust for services in such
capacities, although PFPC, of which certain of the Trusts Officers are also
officers (except Mr. Dalke, Mr. King and Mr. Wennlund), receives fees from the
Trust for co-administrative services.
Drinker Biddle & Realth LLP, of which Mr. Dalke is a partner, receives fees
from the Trust for legal services.
Northern Trust Company, of which Mr. King and Mr. Wennlund are officers,
receives fees from the Trust as investment adviser, custodian, transfer agent
and co-administrator.
The following table sets forth certain information with respect to the
compensation of each Trustee of the Trust for the one-year period ended November
30, 1999:
<TABLE>
<CAPTION>
Small Small Total
Equity Diversified Focused Company Company Mid Cap International International Compensation
Balanced Index Growth Growth Index Growth Growth Equity Index Growth from Fund
Portfolio Portfolio Portfolio Portfolio Portfolio Portfolio Portfolio Portfolio Portfolio Complex
--------- --------- ----------- --------- --------- --------- --------- ------------- ------------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Steven Timbers** $ 0 $ 0 $ 0 $ 0 $ 0 n/a n/a $ 0 $ 0 $ 0
William H. Springer 530 5,300 530 530 530 n/a n/a 530 530 53,000
Richard G. Cline 395 3,950 395 395 395 n/a n/a 395 395 39,500
Edward J. Condon, 445 4,450 450 450 450 n/a n/a 450 450 44,500
Jr.
John W. English 395 3,950 395 395 395 n/a n/a 395 395 39,500
Sandra Polk Guthman 395 3,950 395 395 395 n/a n/a 395 395 39,500
Frederick T. 445 4,450 445 445 445 n/a n/a 445 445 44,500
Kelsey*
Richard P. Strubel 505 5,050 505 505 505 n/a n/a 505 505 50,500
Wesley M. Dixon, 0 0 0 0 0 n/a n/a 0 0 22,500
Jr.**
William J. Dolan, 0 0 0 0 0 n/a n/a 0 0 22,500
Jr.**
Raymond E. George, 0 0 0 0 0 n/a n/a 0 0 21,250
Jr.**
Michael E. Murphy** 0 0 0 0 0 n/a n/a 0 0 22,500
Mary Jacobs 0 0 0 0 0 n/a n/a 0 0 22,500
Skinner**
</TABLE>
* Frederick Kelsey retired from the Board of Trustees on November
30, 1999.
** Not a Trustee of the Northern Institutional Funds during the period
ended November 30, 1999.
*** Fund Complex includes twenty-one investment portfolios of the Trust
and thirty-one investment Portfolios of Northern Funds, a separately
registered investment company.
+ Small Company Growth and Mid Cap Portfolios did not commence
operations during the period.
The Trust does not provide pension or retirement benefits to its
Trustees.
The Trust, its investment adviser and principal underwriter have
adopted codes of ethics (the "Codes of Ethics") under rule 17j-1 of the 1940
Act. The Codes of Ethics permit personnel, subject to the Codes of Ethics
and their provisions, to invest in securities, including securities that may
be purchased or held by the Trust.
25
<PAGE>
Investment Advisers, Transfer Agent and Custodian
Northern, a wholly-owned subsidiary of Northern Trust Corporation, a bank
holding company, is one of the nation's leading providers of trust and
investment management services. Northern is one of the strongest banking
organizations in the United States. Northern believes it has built its
organization by serving clients with integrity, a commitment to quality, and
personal attention. Its stated mission with respect to all its financial
products and services is to achieve unrivaled client satisfaction. With respect
to such clients, the Trust is designed to assist (i) defined contribution plan
sponsors and their employees by offering a range of diverse investment options
to help comply with 404(c) regulation and may also provide educational material
to their employees, (ii) employers who provide post-retirement Employees'
Beneficiary Associations ("VEBA") and require investments that respond to the
impact of federal regulations, (iii) insurance companies with the day-to-day
management of uninvested cash balances as well as with longer-term investment
needs, and (iv) charitable and not-for-profit organizations, such as endowments
and foundations, demanding investment management solutions that balance the
requirement for sufficient current income to meet operating expenses and the
need for capital appreciation to meet future investment objectives. NTQA, also a
wholly-owned subsidiary of Northern Trust Corporation, serves as investment
adviser principally to defined benefit and defined contribution plans and
manages over 60 equity and bond commingled and common trust funds. As of
December 31, 1999, the Investment Advisers and their affiliates had
approximately $299.1 billion in assets under management for clients including
public and private retirement funds, endowments, foundations, trusts,
corporations, other investment companies and individuals.
Under the Advisory Agreement with the Trust, the Investment Advisers make
decisions with respect to, and place orders for, all purchases and sales of
portfolio securities for each Portfolio. The Advisory Agreement with the Trust
provides that in selecting brokers or dealers to place orders for transactions
(i) on common and preferred stocks, the Investment Advisers shall use their best
judgment to obtain the best overall terms available, and (ii) on bonds and other
fixed income obligations, the Investment Advisers shall attempt to obtain best
net price and execution. In assessing the best overall terms available for any
transaction, the Investment Advisers are to consider all factors they deem
relevant, including the breadth of the market in the security, the price of the
security, the financial condition and execution capability of the broker or
dealer, and the reasonableness of the commission, if any, both for the specific
transaction and on a continuing basis. In evaluating the best overall terms
available and in selecting the broker or dealer to execute a particular
transaction, the Investment Advisers may consider the brokerage and research
services provided to the Portfolios and/or other accounts over which the
Investment Advisers or an affiliate of Northern exercise investment discretion.
A broker or dealer providing brokerage and/or research services may receive a
higher commission than another broker or dealer would receive for the same
transaction. These brokerage and research services may include industry and
company analyses, portfolio services, quantitative data, market information
systems and economic and political consulting and analytical services.
Transactions on U.S. stock exchanges involve the payment of negotiated
brokerage commissions. On exchanges on which commissions are negotiated, the
cost of transactions may vary among different brokers. Transactions on foreign
stock exchanges involve payment for brokerage commissions which are generally
fixed. Over-the-counter issues, including corporate debt and government
securities, are normally traded on a "net" basis (i.e., without commission)
through dealers, or otherwise involve transactions directly with the issuer of
an instrument. With respect to over-the-counter transactions, the Investment
Advisers will normally deal directly with dealers who make a market in the
instruments involved except in those circumstances where more favorable prices
and execution are available elsewhere. The cost of foreign and domestic
securities purchased from underwriters includes an underwriting commission or
concession, and the prices at which securities are purchased from and sold to
dealers include a dealer's mark-up or mark-down.
The Portfolios may participate, if and when practicable, in bidding for
the purchase of portfolio securities directly from an issuer in order to take
advantage of the lower purchase price available to members of a bidding group.
The Portfolios will engage in this practice, however, only when the Investment
Advisers believe such practice to be in the Portfolios' interests.
On occasions when the Investment Advisers deem the purchase or sale of a
security to be in the best interests of a Portfolio as well as other fiduciary
or agency accounts managed by them (including any other Portfolio, investment
company or account for which an Investment Adviser acts as adviser), the
Advisory Agreement provides that the Investment Advisers, to the extent
permitted by applicable laws and regulations, may aggregate the securities to be
sold or purchased for such Portfolio with those to be sold or purchased for such
other accounts in order to obtain best overall terms available with respect to
common and preferred stock, and best net price and execution with respect to
bonds and other fixed income obligations. In such event, allocation of the
securities so purchased or sold, as well as the expenses incurred in the
26
<PAGE>
transaction, will be made by the Investment Advisers in the manner they consider
to be most equitable and consistent with their fiduciary obligations to the
Portfolio and other accounts involved. In some instances, this procedure may
adversely affect the size of the position obtainable for a Portfolio or the
amount of the securities that are able to be sold for a Portfolio.
The Advisory Agreement provides that the Investment Advisers may render
similar services to others so long as their services under such Agreements are
not impaired thereby. The Advisory Agreement also provides that the Trust will
indemnify the Investment Advisers against certain liabilities (including
liabilities under the Federal securities laws relating to untrue statements or
omissions of material fact and actions that are in accordance with the terms of
the Agreements) or, in lieu thereof, contribute to resulting losses.
At a meeting held on September 2, 1997, shareholders of the International
Growth Portfolio approved a new advisory agreement with Northern and another
wholly-owned subsidiary of Northern Trust Corporation (The Northern Trust
Company of Connecticut, formerly, RCB Trust Company, which has principal offices
at 300 Atlantic Street, Stamford, Connecticut 06901) that would permit the
Portfolio to implement a "manager-of-managers" structure. The new advisory
agreement would be identical in all material respects to the current Advisory
Agreement for the International Growth Portfolio, except that the new agreement
would appoint both Northern and The Northern Trust Company of Connecticut as the
advisers of the Portfolio and would allow the advisers to (i) delegate their
duties to sub-advisers, (ii) implement a manager-of-managers structure and (iii)
enter into sub-advisory agreements in the future without further shareholder
approval. Fees payable to the sub-advisers would be payable by Northern and The
Northern Trust Company of Connecticut and not by the Portfolio, and the current
investment advisory fee rate payable by the Portfolio would not change. Although
the Securities and Exchange Commission (the "SEC") has granted an exemption
permitting the Portfolio to implement a manager-of-managers structure, the new
advisory agreement will not become effective until the Trust's Board of Trustees
acts to effectuate the structure with respect to the Portfolio. At present, it
is uncertain when, or if, the manager-of-managers structure will become
effective.
Under its Transfer Agency Agreement with the Trust, with respect to
shares held by Institutions, Northern has undertaken to perform some or all of
the following services: (i) establish and maintain an omnibus account in the
name of each Institution; (ii) process purchase orders and redemption requests
from an Institution, and furnish confirmations and disburse redemption proceeds;
(iii) act as the income disbursing agent of the Trust; (iv) answer inquiries
from Institutions; (v) provide periodic statements of account to each
Institution; (vi) process and record the issuance and redemption of shares in
accordance with instructions from the Trust or its administrator; (vii) if
required by law, prepare and forward to Institutions shareholder communications
(such as proxy statements and proxies, annual and semi-annual financial
statements, and dividend, distribution and tax notices); (viii) preserve all
records; and (ix) furnish necessary office space, facilities and personnel.
Under the Transfer Agency Agreement, with respect to shares held by investors,
Northern has also undertaken to perform some or all of the following services:
(i) establish and maintain separate accounts in the name of the investors; (ii)
process purchase orders and redemption requests, and furnish confirmations in
accordance with applicable law; (iii) disburse redemption proceeds; (iv) process
and record the issuance and redemption of shares in accordance with instructions
from the Trust or its administrator; (v) act as income disbursing agent of the
Trust in accordance with the terms of the Prospectus and instructions from the
Trust or its administrator; (vi) provide periodic statements of account; (vii)
answer inquiries (including requests for prospectuses and statements of
additional information, and assistance in the completion of new account
applications) from investors and respond to all requests for information
regarding the Trust (such as current price, recent performance, and yield data)
and questions relating to accounts of investors (such as possible errors in
statements, and transactions); (viii) respond to and seek to resolve all
complaints of investors with respect to the Trust or their accounts; (ix)
furnish proxy statements and proxies, annual and semi-annual financial
statements, and dividend, distribution and tax notices to investors; (x) furnish
the Trust with all pertinent Blue Sky information; (xi) perform all required tax
withholding; (xii) preserve records; and (xiii) furnish necessary office space,
facilities and personnel. Northern may appoint one or more sub-transfer agents
in the performance of its services.
As compensation for the services rendered by Northern under the Transfer
Agency Agreement and the assumption by Northern of related expenses, Northern is
entitled to a fee from the Trust, payable monthly, at an annual rate of .01%,
.10% and .15% of the average daily net asset value of the Class A, C and D
Shares, respectively, of the Portfolios.
Under its Custodian Agreement (and in the case of the International
Growth Portfolio and International Equity Index Portfolio, its Foreign Custody
Agreement) with the Trust, Northern (i) holds each Portfolio's cash and
securities, (ii) maintains such cash and securities in separate accounts in the
name of the Portfolio, (iii) makes receipts and disbursements of funds on behalf
of the Portfolio, (iv) receives, delivers and releases securities on behalf of
the Portfolio, (v) collects and
27
<PAGE>
receives all income, principal and other payments in respect of the Portfolio's
investments held by Northern under the Agreement, and (vi) maintains the
accounting records of the Trust. Northern may employ one or more subcustodians,
provided that Northern, subject to certain monitoring responsibilities, shall
have no more responsibility or liability to the Trust on account of any action
or omission of any subcustodian so employed than such subcustodian has to
Northern and that the responsibility or liability of the subcustodian to
Northern shall conform to the resolution of the Trustees of the Trust
authorizing the appointment of the particular subcustodian (or, in the case of
foreign securities, to the terms of any agreement entered into between Northern
and such subcustodian to which such resolution relates). In addition, the
Trust's custodial arrangements provide, with respect to foreign securities, that
Northern shall not be: (i) responsible for the solvency of any subcustodian
appointed by it with reasonable care; (ii) responsible for any act, omission,
default or for the solvency of any eligible foreign securities depository; and
(iii) liable for any loss, damage, cost, expense, liability or claim resulting
from nationalization, expropriation, currency restrictions, or acts of war or
terrorism or any loss where the subcustodian has otherwise exercised reasonable
care. Northern may also appoint agents to carry out such of the provisions of
the Custodian Agreement and the Foreign Custody Agreement as Northern may from
time to time direct, provided that the appointment of an agent shall not relieve
Northern of any of its responsibilities under either Agreement. Northern has
entered into agreements with financial institutions and depositories located in
foreign countries with respect to the custody of the Portfolios' foreign
securities.
As compensation for the services rendered to the Trust by Northern as
custodian with respect to each Portfolio except the International Growth
Portfolio and International Equity Index Portfolio, and the assumption by
Northern of certain related expenses, Northern is entitled to payment from the
Trust as follows: (i) $18,000 annually for each Portfolio, plus (ii) 1/100th of
1% annually of each Portfolio's average daily net assets to the extent they
exceed $100 million, plus (iii) a fixed dollar fee for each trade in portfolio
securities, plus (iv) a fixed dollar fee for each time that Northern as
Custodian receives or transmits funds via wire, plus (v) reimbursement of
expenses incurred by Northern as custodian for telephone, postage, courier fees,
office supplies and duplicating. The fees referred to in clauses (iii) and (iv)
are subject to annual upward adjustments based on increases in the Consumer
Price Index for All Urban Consumers, provided that Northern may permanently or
temporarily waive all or any portion of any upward adjustment.
As compensation for the services rendered to the Trust under the Foreign
Custody Agreement with respect to the International Growth Portfolio and
International Equity Index Portfolio, and the assumption by Northern of certain
related expenses, Northern is entitled to payment from the Trust as follows: (i)
$35,000 annually for the International Growth Portfolio and International Equity
Index Portfolio, plus (ii) 9/100th of 1% annually of the Portfolios' average
daily net assets, plus (iii) reimbursement for fees incurred by Northern as
foreign custodian for telephone, postage, courier fees, office supplies and
duplicating.
Northern's fees under the Custodian Agreement and Foreign Custody
Agreement are subject to reduction based on the Portfolios' daily uninvested
cash balances (if any).
Unless sooner terminated, the Advisory Agreement, the Custodian Agreement
(or, in the case of the International Growth Portfolio and International Equity
Index Portfolio, the Foreign Custody Agreement) and the Transfer Agency
Agreement will continue in effect with respect to a particular Portfolio until
April 30, 2001 and thereafter for successive 12-month periods, provided that the
continuance is approved at least annually (i) by the vote of a majority of the
Trustees who are not parties to the agreement or "interested persons" (as such
term is defined in the 1940 Act) of any party thereto, cast in person at a
meeting called for the purpose of voting on such approval, and (ii) by the
Trustees or by the vote of a majority of the outstanding shares of such
Portfolio (as defined below under "Other Information"). Each agreement is
terminable at any time without penalty by the Trust (by specified Trustee or
shareholder action) on 60 days' written notice to Northern or NTQA and by
Northern or NTQA on 60 days' written notice to the Trust.
Prior to April 1, 1998, Northern served as investment adviser to the
Equity Index, Small Company Index and International Equity Index Portfolios on
the samae terms as those described above.
For the fiscal years or periods ended November 30 as indicated, the
amount of advisory fees incurred by each Portfolio (after fee waivers) (except
for Mid Cap Growth and Small Company Growth, which did not commence operations
during the fiscal year ended November 30, 1999) was as follows:
28
<PAGE>
<TABLE>
<CAPTION>
1999 1998 1997
---------- ---------- --------
<S> <C> <C> <C>
Balanced Portfolio $ 368,178 $ 297,879 $ 270,536
Equity Index Portfolio 1,453,598 1,136,850 830,952
Diversified Growth Portfolio 1,050,355 905,091 795,346
Focused Growth Portfolio 1,315,624 1,045,682 934,052
Small Company Index Portfolio 397,251 248,736 242,421
International Growth Portfolio 985,305 869,641 993,121
International Equity Index Portfolio/1/ 126,053 117,326 44,662
</TABLE>
/1/ Commenced investment operations on April 1, 1997.
For the fiscal years or periods ended November 30 as indicated, the
Investment Advisers waived advisory fees as follows:
<TABLE>
<CAPTION>
1999 1998 1997
---------- ---------- ----------
<S> <C> <C> <C>
Balanced Portfolio $ 220,907 $ 178,727 $ 162,322
Equity Index Portfolio 2,907,197 2,273,722 1,661,904
Diversified Growth Portfolio 477,434 411,405 361,521
Focused Growth Portfolio 493,359 392,131 350,269
Small Company Index Portfolio 397,250 248,733 242,421
International Growth Portfolio 246,326 217,410 248,280
International Equity Index Portfolio/1/ 126,053 117,319 44,662
</TABLE>
/1/ Commenced investment operations on April 1, 1997.
For the fiscal years or periods ended November 30 as indicated, the amount
of transfer agency fees incurred by each Portfolio was as follows:
<TABLE>
<CAPTION>
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
Balanced Portfolio $ 9,237 $ 11,754 $ 10,622
Equity Index Portfolio 274,756 249,731 172,360
Diversified Growth Portfolio 19,733 17,453 15,280
Focused Growth Portfolio 26,816 23,773 19,546
Small Company Index Portfolio 20,843 13,858 12,676
International Growth Portfolio 12,389 11,469 12,624
International Equity Index Portfolio/1/ 5,061 4,696 1,780
</TABLE>
/1/ Commenced investment operations on April 1, 1997.
29
<PAGE>
For the fiscal years or periods ended November 30 as indicated, the amount
of custodian fees (and, in the case of the International Growth Portfolio and
International Equity Index Portfolio, the foreign custodian fees) incurred by
each Portfolio was as follows:
<TABLE>
<CAPTION>
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
Balanced Portfolio $ 22,972 $ 22,993 $ 24,371
Equity Index Portfolio 200,973 268,057 142,960
Diversified Growth Portfolio 31,714 28,035 27,587
Focused Growth Portfolio 30,486 28,583 23,050
Small Company Index Portfolio 491,423 227,658 66,695
International Growth Portfolio 135,538 123,373 158,611
International Equity Index Portfolo /1/ 77,124 67,398 49,999
/1/ Commenced investment operations on April 1, 1997.
</TABLE>
Under a Service Mark License Agreement with the Trust, Northern Trust
Corporation has agreed that the name "Northern Institutional Funds" may be used
in connection with the Trust's business on a royalty-free basis. Northern Trust
Corporation has reserved to itself the right to grant the non-exclusive right to
use the name "Northern Institutional Funds" to any other person. The Agreement
provides that at such time as the Agreement is no longer in effect, the Trust
will cease using the name "Northern Institutional Funds."
Portfolio Transactions
To the extent that a Portfolio effects brokerage transactions with any
broker/dealer affiliated directly or indirectly with the Investment Advisers,
such transactions, including the frequency thereof, the receipt of any
commissions payable in connection therewith, and the selection of the affiliated
broker/dealer effecting such transactions, will be fair and reasonable to the
shareholders of the Portfolio.
During the fiscal year ended November 30, 1999, the Balanced Portfolio
acquired and sold securities of Bank of America, Goldman Sachs Group, Inc.,
Merrill Lynch & Co., Inc., Morgan Stanley Dean Witter & Co. Inc., and Lehman
Brothers, Inc., each a regular broker/dealer. At November 30, 1999, the Balanced
Portfolio owned the following amounts of securities of its regular
broker/dealers, as defined in Rule 10b-1 under the 1940 Act, or their parents:
Donaldson Lufkin & Jenrette Securities, Inc., with an approximate aggregate
market value of $131,000; Goldman Sachs Group, Inc., with an approximate
aggregate market value of $62,000; Merrill Lynch & Co., Inc., with an
approximate aggregate market value of $363,000; Morgan Stanley Dean Witter &
Co., with an approximate aggregate market value of $458,000; and Salomon Smith
Barney, Inc., with an approximate aggregate market value of $648,000.
During the fiscal year ended November 30, 1999, the Diversified Growth
Portfolio acquired and sold securities of Bank of America, Goldman Sachs Group,
Inc., Merrill Lynch & Co., Inc., Morgan Stanley Dean Witter & Co. Inc., each a
regular broker/dealer. At November 30, 1999, the Diversified Growth Portfolio
owned the following amounts of securities of its regular broker/dealers, as
defined in Rule 10b-1 under the 1940 Act, or their parents: Merrill Lynch & Co.,
Inc., with an approximate aggregate market value of $1,411,000; Goldman Sachs
Group, Inc., with an approximate aggregate market value of $287,000; and Morgan
Stanley Dean Witter & Co., with an approximate aggregate market value of
$2,256,000.
During the fiscal year ended November 30, 1999, the Equity Index
Portfolio acquired and sold securities of Bank of America, Bear Stearns & Co.,
Lehman Brothers, Inc., Merrill Lynch & Co., Inc. and Morgan Stanley Dean Witter
& Co., each a regular broker/dealer. At November 30, 1999, the Equity Index
Portfolio owned the following amounts of securities of its regular
broker/dealers, as defined in Rule 10b-1 under the 1940 Act, or their parents:
Merrill Lynch & Co., Inc., with an approximate aggregate market value of
$3,789,000.
During the fiscal year ended November 30, 1999, the Focused Growth
Portfolio acquired and sold securities of Goldman Sachs Group, Inc., Merrill
Lynch & Co., Inc., and Morgan Stanley Dean Witter & Co., each a regular
broker/dealer. At November 30, 1999, the Focused Growth Portfolio owned the
following amounts of securities of its regular broker/dealers, as defined in
Rule 10b-1 under the 1940 Act, or their parents: Morgan Stanley Dean Witter &
Co., with an approximate aggregate market value of $1,206,000.
30
<PAGE>
During the fiscal year ended November 30, 1999, the International Equity
Index Portfolio did not acquire, sell or own any securities of its regular
broker/d ealers or their parents.
During the fiscal year ended November 30, 1999, the International Growth
Portfolio acquired and sold securities of UBS Securities, a regular
broker/dealer. At November 30, 1999, the International Growth Portfolio owned
the following amounts of securities of its regular broker/dealers, as defined in
Rule 10b-1 under the 1940 Act, or their parents: UBS Securities, with an
approximate aggregate market value of $1,641,000.
During the fiscal year ended November 30, 1999, the Small Company Index
Portfolio acquired and sold securities of Investment Technology Group, a regular
broker/dealer. At November 30, 1999, the Small Company Index Portfolio did not
own any securities of its regular broker/dealers or their parents.
During the fiscal year ended November 30, 1999, the Mid Cap Growth and
Small Company Growth Portfolios had not yet commenced operations.
31
<PAGE>
For the fiscal years ended November 30 as indicated, each Portfolio paid
brokerage commissions as follows:
<TABLE>
<CAPTION>
Total Total Brokerage
Fiscal Brokerage Amount of Commissions
Year Total Commissions Transactions Paid
Ended Brokerage Paid to On Which to Brokers
November 30, Commissions Affiliated Commissions Providing
1999 Paid Brokers/1/ Paid Research/4/
----------------------- --------------------- --------------------- ----------------------- ---------------------
<S> <C> <C> <C> <C>
Balanced $ 60,846 $ 3,936 $ 49,709,379 $ 54,086
Portfolio (6.47%)/2/ (5.35%)/3/
Equity 162,116 0 362,402,193 130,118
Index
Portfolio
Focused 312,416 9,567 249,401,190 252,742
Growth (3.06%)/2/ (2.40%)/3/
Portfolio
Diversified 266,101 20,628 227,241,917 240,074
Growth (7.75%)/2/ (6.46%)/3/
Portfolio
Small Company 327,470 0 354,777,500 259,972
Index
Portfolio
International 334,816 8,997 259,424,703 144,240
Growth (2.69%)/2/ (3.12%)/3/
Portfolio
International 156,404 0 36,494,860 152,351
Equity Index
Portfolio
</TABLE>
------------------------
1 Goldman Sachs and Co., the Trust's distributor prior to May 1, 1999, was the
only affiliated broker utilized by the Trust during the fiscal year ending
November 30, 1999.
2 Percentage of total commissions paid.
3 Percentage of total amount of transactions involving the payment of
commissions effected through affiliated persons.
4 The amounts of the transactions involving commissions paid to brokers
providing research were $43,134,455, $300,137,797, $195,324,563,
$197,120,921, $274,938,914, $128,020,612 and $33,641,730 for the Balanced,
Equity Index, Focused Growth, Diversified Growth, Small Company Index,
International Growth and International Equity Index Portfolios, respectively.
32
<PAGE>
<TABLE>
<CAPTION>
Total Total Brokerage
Fiscal Brokerage Amount of Commissions
Year Total Commissions Transactions Paid
Ended Brokerage Paid to On Which to Brokers
November 30, Commissions Affiliated Commissions Providing
1998 Paid Brokers/1/ Paid Research/4/
------------ ----------- ----------- ------------ ------------
<S> <C> <C> <C> <C>
Balanced
Portfolio $ 33,693 $ 2,794 $ 24,707,706 $ 25,032
(8.29%)/2/ (1.91%)/3/
Equity
Index 148,670 0 590,431,860 125,498
Portfolio
Focused
Growth 257,630 12,648 178,606,124 208,872
Portfolio (4.91%)/2/ (0.12%)/3/
Diversified
Growth 148,788 19,748 116,674,485 122,744
Portfolio (13.27%)/2/ (2.23%)/3/
Small Company
Index 98,346 0 139,815,827 97,942
Portfolio
International
Growth 933,041 23,687 325,994,274 581,629
Portfolio (2.54%)/2/ (3.32%)/3/
International
Equity Index 72,801 0 43,852,342 61,732
Portfolio
</TABLE>
_________________________
/1/ Goldman, Sachs & Co., the Trust's distributor prior to May 1, 1999, was the
only affiliated broker utilized by the Trust during the fiscal year.
/2/ Percentage of total commissions paid.
/3/ Percentage of total amount of transactions involving the payment of
commissions effected through affiliated persons.
/4/ The amounts of the transactions involving commissions paid to brokers
providing research were $18,453,666, $537,682,036, $145,818,514,
$94,871,574, $139,042,814, $198,366,763 and $36,469,237 for the Balanced,
Equity Index, Focused Growth, Diversified Growth, Small Company Index,
International Growth and International Equity Index Portfolios,
respectively.
33
<PAGE>
<TABLE>
<CAPTION>
Total Total Brokerage
Fiscal Brokerage Amount of Commissions
Year Total Commissions Transactions Paid
Ended Brokerage Paid to On Which to Brokers
November 30, Commissions Affiliated Commissions Providing
1997 Paid Brokers/1/ Paid Research
------------ ----------- ------------ ------------ -----------
<S> <C> <C> <C> <C>
Balanced
Portfolio $ 32,642 $ 0 $ 20,396,168 $ 25,974
Equity
Index
Portfolio 131,385 0 254,772,161 121,495
Focused
Growth
Portfolio 300,436 1,484 226,791,529 260,384
(0.49%)/2/ (0.59%)/3/
Diversified
Growth
Portfolio 202,193 0 132,628,487 186,656
Small Company
Index
Portfolio 73,241 0 93,889,780 73,173
International
Growth
Portfolio 1,163,242 0 374,185,022 644,392
International
Equity Index
Portfolio 56,347 0 26,892,453 56,347
</TABLE>
-----------------------
/1/ Goldman, Sachs & Co., the Trust's distributor prior to May 1, 1999, was the
only affiliated broker utilized by the Trust during the fiscal year.
/2/ Percentage of total commissions paid.
/3/ Percentage of total amount of transactions involving the payment of
commissions effected through affiliated persons.
Portfolio Valuation
U.S. and foreign investments held by a Portfolio are valued at the last
quoted sales price on the exchange on which such securities are primarily
traded, except that securities listed on an exchange in the United Kingdom are
valued at the average of the closing bid and ask prices. If any securities
listed on a U.S. securities exchange are not traded on a valuation date, they
will be valued at the last quoted bid price. If securities listed on a foreign
securities exchange are not traded on a valuation date, they will be valued at
the most recent quoted trade price. Securities which are traded in the U.S.
over-the-counter markets are valued at the last quoted bid price. Securities
which are traded in the foreign over-the-counter markets are valued at the last
sales price, except that such securities traded in the United Kingdom are valued
at the average of the closing bid and ask prices. Shares of investment companies
held by the Portfolios will be valued at their respective net asset values. Any
securities, including restricted securities, for which current quotations are
not readily available are valued at fair value as determined in good faith by
the Investment Adviser under the supervision of the Board of Trustees. Short-
term investments are valued at amortized cost which the Investment Advisers have
determined, pursuant to Board authorization, approximates market value.
Securities may be valued on the basis of prices provided by independent pricing
services when
34
<PAGE>
such prices are believed to reflect the fair market value of such securities.
Co-Administrators and Distributor
Effective May 1, 1999, Northern and PFPC (formerly FDISG), 4400 Computer
Drive, Westborough, Massachusetts 01581, act as co-administrators for the
Portfolios under a Co-Administration Agreement with the Trust. Subject to the
general supervision of the Trust's Board of Trustees, Northern and PFPC (the
"Co-Administrators") provide supervision of all aspects of the Trust's non-
investment advisory operations and perform various corporate secretarial,
treasury and blue sky services, including but not limited to: (i) maintaining
office facilities and furnishing corporate officers for the Trust; (ii)
furnishing data processing services, clerical services, and executive and
administrative services and standard stationery and office supplies; (iii)
performing all functions ordinarily performed by the office of a corporate
treasurer, and furnishing the services and facilities ordinarily incident
thereto, such as expense accrual monitoring and payment of the Trust's bills,
preparing monthly reconciliation of the Trust's expense records, updating
projections of annual expenses, preparing materials for review by the Board of
Trustees and compliance testing; (iv) preparing and submitting reports to the
Trust's shareholders and the SEC; (v) preparing and printing financial
statements; (vi) preparing monthly Portfolio profile reports; (vii) preparing
and filing the Trust's federal and state tax returns (other than those required
to be filed by the Trust's custodian and transfer agent) and providing
shareholder tax information to the Trust's transfer agent; (viii) assisting in
marketing strategy and product development; (ix) performing oversight/management
responsibilities, such as the supervision and coordination of certain of the
Trust's service providers; (x) effecting and maintaining, as the case may be,
the registration of shares of the Trust for sale under the securities laws of
various jurisdictions; (xi) assisting in maintaining corporate records and good
standing status of the Trust in its state of organization; and (xii) monitoring
the Trust's arrangements with respect to services provided by Servicing Agents
to their customers who are the beneficial owners of shares.
Subject to the limitations described below, as compensation for their
administrative services and the assumption of related expenses, the Co-
Administrators are entitled to a fee from each Portfolio, computed daily and
payable monthly, at an annual rate of .15% of the average daily net assets of
each of the International Equity Index and International Growth Portfolios, and
.10% of the average daily net assets of each other Portfolio. The Co-
Administrators will reimburse each Portfolio for its expenses (including
administration fees payable to the Co-Administrators, but excluding advisory
fees, transfer agency fees, servicing fees and extraordinary expenses) which
exceed on an annualized basis .25% of the International Equity Index and
International Growth Portfolios' respective average daily net assets and .10% of
each other Portfolio's average daily net assets.
For the period May 1, 1999 through the fiscal year ended November 30,
1999, the Co-Administrators received fees under the Co-Administration Agreement
with the Trust (except for the Mid Cap Growth and Small Company Growth
Portfolios, which did not commence operations during the period) in the amount
of:
May 1, 1999
through
November 30, 1999
-----------------
Balanced Portfolio $ 44,254
Equity Index Portfolio 862,791
Diversified Growth Portfolio 110,735
Focused Growth Portfolio 101,915
Small Company Index Portfolio 115,702
International Equity Index Portfolio 46,855
International Growth Portfolio 114,770
35
<PAGE>
Additionally, for the period May 1, 1999 through the fiscal year ended
November 30, 1999, the Co-Administrators voluntarily reimbursed each Portfolio
(except for the Mid Cap Growth and Small Company Growth Portfolios, which did
not commence operations during the period) for its expenses reducing the
administration fees in the following amounts:
May 1, 1999
through
November 30, 1999
-----------------
Balanced Portfolio $ 35,435
Equity Index Portfolio 255,730
Diversified Growth Portfolio 48,664
Focused Growth Portfolio 44,091
Small Company Index Portfolio 325,512
International Equity Index Portfolio 36,849
International Growth Portfolio 26,024
Prior to May 1, 1999, Goldman, Sachs & Co. ("Goldman Sachs"), 85 Broad
Street, New York, New York 10004, acted as the Trust's administrator pursuant to
an administration agreement similar to the Co-Administration Agreement currently
in effect with Northern and PFPC. For the fiscal years or periods ended November
30 as indicated, Goldman Sachs received fees under its administration agreement
with the Trust in the amount of:
<TABLE>
<CAPTION>
December 1, 1998
through
April 30, 1999 1998 1997
-------------- ---------- ---------
<S> <C> <C> <C>
Balanced Portfolio $ 29,381 $ 59,575 $ 54,096
Equity Index Portfolio 590,794 1,136,850 830,785
Diversified Growth Portfolio 80,237 164,560 144,576
Focused Growth Portfolio 62,536 130,709 116,431
Small Company Index Portfolio 82,921 124,365 121,184
International Equity Index Portfolio1 28,777 70,396 26,233
International Growth Portfolio/1/ 69,975 163,058 159,139
/1/ Commenced investment operations on April 1, 1997.
</TABLE>
Prior to May 1, 1997, Goldman Sachs voluntarily agreed to waive a portion
of its administration fee for each Portfolio resulting in an effective fee of
.10% of the average daily net assets for each Portfolio. The effect of these
waivers by Goldman Sachs was to reduce administration fees by the following
amounts for the fiscal years or periods ended November 30 as indicated:
<TABLE>
<CAPTION>
December 1, 1998
through
April 30, 1999 1998 1997
-------------- ----- -------
<S> <C> <C> <C>
Balanced Portfolio $ $ 0 $32,260
Equity Index Portfolio 0 0 52,050
Diversified Growth Portfolio 0 0 68,234
Focused Growth Portfolio 0 0 63,979
Small Company Index Portfolio 0 0 65,061
International Equity Index Portfolio/1/ 0 0 1,460
International Growth Portfolio 0 0 68,541
/1/ Commenced investment operations on April 1, 1997.
</TABLE>
In addition, pursuant to an undertaking that commenced August 1, 1992,
Goldman Sachs agreed that, if its administration fees (less expense
reimbursements paid by Goldman Sachs to the Trust and less certain marketing
expenses paid by Goldman Sachs) exceeded a specified amount ($1 million for the
Trust's first twelve investment portfolios plus
36
<PAGE>
$50,000 for each additional portfolio) during a fiscal year, Goldman Sachs would
waive a portion of its administration fees during the following fiscal year.
There were no waivers pursuant to this agreement during the last three fiscal
years.
Goldman Sachs had also agreed each year to reimburse each Portfolio for
its expenses (including fees payable to Goldman Sachs as administrator, but
excluding advisory fees, transfer agency fees, servicing fees and extraordinary
expenses) which exceeded on an annualized basis .25% of the International Equity
Index and International Growth Portfolios' respective average daily net assets
and .10% of each other Portfolio's average daily net assets. Prior to May 1,
1997, this undertaking was voluntary with respect to the Portfolios. As of May
1, 1997, this undertaking was contractual with respect to all Portfolios. The
effect of these reimbursements by Goldman Sachs for the fiscal years or periods
ended November 30 as indicated was to reduce the expenses of each Portfolio by:
<TABLE>
<CAPTION>
December 1, 1998
through
April 30, 1999 1998 1997
---------------- -------- --------
<S> <C> <C>
Balanced Portfolio $ 25,110 $ 78,916 $ 74,341
Equity Index Portfolio 194,185 504,482 304,060
Diversified Growth Portfolio 33,095 82,995 89,069
Focused Growth Portfolio 28,925 83,616 79,410
Small Company Index Portfolio 217,923 282,541 128,881
International Equity Index Portfolio/1/ 31,559 98,328 56,393
International Growth Portfolio 30,874 49,890 67,398
</TABLE>
__________________
/1/ Commenced investment operations on April 1, 1997.
Unless sooner terminated, the Co-Administration Agreement will continue
in effect until April 30, 2001, and thereafter for successive one-year terms
with respect to each Portfolio, provided that the Agreement is approved annually
(i) by the Board of Trustees or (ii) by the vote of a majority of the
outstanding shares of such Portfolio (as defined below under "Other
Information"), provided that in either event the continuance is also approved by
a majority of the Trustees who are not parties to the Agreement and who are not
interested persons (as defined in the 1940 Act) of any party thereto, by vote
cast in person at a meeting called for the purpose of voting on such approval.
The Co-Administration Agreement is terminable at any time after April 30, 2001
without penalty by the Trust on at least 60 days written notice to the Co-
Administrators. Each Co-Administrator may terminate the Co-Administration
Agreement with respect to itself at any time after April 30, 2001 without
penalty on at least 60 days written notice to the Trust and the other Co-
Administrator.
The Trust may terminate the Co-Administration Agreement prior to April
30, 2001 in the event that the Trust or its shareholders incur damages in excess
of $100,000 as a result of the willful misfeasance, bad faith or negligence of
the Co-Administrators, or the reckless disregard of their duties under the
Agreement. The Trust may also terminate the Co-Administration Agreement prior to
April 30, 2001 in the event that the Co-Administrators fail to meet one of the
performance standards set forth in the Agreement.
The Trust has entered into a Distribution Agreement under which Northern
Funds Distributors, LLC, ("NFD") as agent, sells shares of each Portfolio on a
continuous basis. NFD pays the cost of printing and distributing prospectuses to
persons who are not shareholders of the Trust (excluding preparation and
typesetting expenses) and of certain other distribution efforts. No compensation
is payable by the Trust to NFD for such distribution services. NFD is a wholly-
owned subsidiary of Provident Distributors, Inc. ("PDI"). PDI, based in West
Conshohocken, Pennsylvania, is an independently owned and operated broker-
dealer. Between May 1, 1999 and November 30, 1999, First Data Distributors, Inc.
("FDDI") acted as the Trust's distributor pursuant to a distribution agreement
similar to the Distribution Agreement currently in effect with NFD. Prior to May
1, 1999, Goldman Sachs acted as the Trust's distributor pursuant to a
distribution agreement similar to the Distribution Agreement currently in effect
with NFD.
37
<PAGE>
The Co-Administration Agreement provides that the Co-Administrators may
render similar services to others so long as their services under such Agreement
are not impaired thereby. The Co-Administration Agreement also provides that the
Trust will indemnify each Co-Administrator against all claims except those
resulting from the willful misfeasance, bad faith or negligence of such Co-
Administrator, or the Co-Administrator's breach of confidentiality. The
Distribution Agreement provides that the Trust will indemnify NFD against
certain liabilities relating to untrue statements or omissions of material fact
except those resulting from the reliance on information furnished to the Trust
by NFD, or those resulting from the willful misfeasance, bad faith or negligence
of NFD's, or NFD's breach of confidentiality.
Under a Service Mark License Agreement (the "License Agreement") with NFD,
Northern Trust Corporation agrees that the name "Northern Institutional Funds"
may be used in connection with Northern Institutional Funds' business on a
royalty-free basis. Northern Trust Corporation has reserved to itself the right
to grant the non-exclusive right to use the name ("Northern Institutional
Funds") to any other person. The License Agreement provides that at such time as
the License Agreement is no longer in effect NFD will cease using the name
"Northern Institutional Funds."
Shareholder Servicing Plan
As stated in the Portfolios' Prospectus, Servicing Agents may enter into
servicing agreements with the Trust under which they provide (or arrange to have
provided) support services to their Customers or other investors who
beneficially own such shares in consideration of the Portfolios' payment of not
more than .15% and .25% (on an annualized basis) of the average daily net asset
value of the Class C and D Shares, respectively, beneficially owned by such
Customers or investors.
For the fiscal years or periods ended November 30 as indicated, the
aggregate amount of the Shareholder Service Fee incurred by each class of each
Portfolio then in existence was as follows:
<TABLE>
<CAPTION>
1999 1998 1997
---- ---- ----
<S> <C> <C> <C>
Balanced Portfolio
Class C $ 1,895 $ 7,927 $ 8,026
Class D 1,301 1,860 710
Equity Index Portfolio
Class C 167,443 148,096 99,924
Class D 51,644 84,248 52,360
Diversified Growth Portfolio
Class D 1,129 2,669 1,466
Focused Growth Portfolio
Class C 15,098 13,754 11,222
Class D 2,340 4,375 2,037
Small Company Index Portfolio
Class C/1/ 284 338 N/A
Class D 1,427 2,173 993
International Growth Portfolio
Class D 128 825 379
International Equity Index Portfolio
Class D/2/ 32 5 N/A
</TABLE>
_____________________________
/1/ Class C Shares were issued on January 8, 1998.
/2/ Class D Shares were issued on October 5, 1998.
Services provided by or arranged to be provided by Servicing Agents under
their servicing agreements may include: (i) establishing and maintaining
separate account records of Customers or other investors; (ii) providing
Customers or other investors with a service that invests their assets in shares
of certain classes pursuant to specific or pre-authorized instructions, and
assistance with new account applications; (iii) aggregating and processing
purchase and redemption requests for shares of certain classes from Customers or
other investors, and placing purchase and redemption orders with the Transfer
Agent; (iv) issuing confirmations to Customers or other investors in accordance
with applicable law; (v) arranging for the timely transmission of funds
representing the net purchase price or redemption proceeds; (vi) processing
dividend payments on behalf of Customers or other investors; (vii) providing
information periodically to Customers or other investors showing their positions
in shares; (viii) responding to Customer or other investor inquiries (including
requests for prospectuses), and
38
<PAGE>
complaints relating to the services performed by the Servicing Agents; (ix)
acting as liaison with respect to all inquiries and complaints from Customers
and other investors relating to errors committed by the Trust or its agents, and
other matters pertaining to the Trust; (x) providing or arranging for another
person to provide subaccounting with respect to shares of certain classes
beneficially owned by Customers or other investors; (xi) if required by law,
forwarding shareholder communications from the Trust (such as proxy statements
and proxies, shareholder reports, annual and semi-annual financial statements
and dividend, distribution and tax notices) to Customers and other investors;
(xii) providing such office space, facilities and personnel as may be required
to perform their services under the servicing agreements; (xiii) maintaining
appropriate management reporting and statistical information; (xiv) paying
expenses related to the preparation of educational and other explanatory
materials in connection with the development of investor services; (xv)
developing and monitoring investment programs; and (xvi) providing such other
similar services as the Trust may reasonably request to the extent the Servicing
Agents are permitted to do so under applicable statutes, rules and regulations.
The Trust's agreements with Servicing Agents are governed by a Plan (called
the "Shareholder Servicing Plan"), which has been adopted by the Board of
Trustees. Pursuant to the Shareholder Servicing Plan, the Board of Trustees will
review, at least quarterly, a written report of the amounts expended under the
Trust's agreements with Servicing Agents and the purposes for which the
expenditures were made. In addition, the arrangements with Servicing Agents must
be approved annually by a majority of the Board of Trustees, including a
majority of the Trustees who are not "interested persons" of the Trust, as
defined in the 1940 Act, and have no direct or indirect financial interest in
such arrangements.
The Board of Trustees has approved the arrangements with Servicing Agents
based on information provided by the Trust's service contractors that there is a
reasonable likelihood that the arrangements will benefit the Portfolios and
their shareholders by affording the Portfolios greater flexibility in connection
with the servicing of the accounts of the beneficial owners of their shares in
an efficient manner.
Counsel and Auditors
Drinker Biddle & Reath LLP, with offices at One Logan Square, 18th and
Cherry Streets, Philadelphia, Pennsylvania 19103-6996, serve as counsel to the
Trust.
Ernst & Young LLP, independent auditors, 233 S. Wacker Drive, Chicago,
Illinois 60606, have been selected as auditors of the Trust. In addition to
audit services, Ernst & Young LLP reviews the Trust's Federal and state tax
returns, and provides consultation and assistance on accounting, internal
control and related matters.
In-Kind Purchases and Redemptions
Payment for shares of a Portfolio may, in the discretion of Northern, be
made in the form of securities that are permissible investments for the
Portfolio as described in the Prospectus. For further information about this
form of payment, contact Northern. In connection with an in-kind securities
payment, a Portfolio will require, among other things, that the securities be
valued on the day of purchase in accordance with the pricing methods used by the
Portfolio and that the Portfolio receive satisfactory assurances that it will
have good and marketable title to the securities received by it; that the
securities be in proper form for transfer to the Portfolio; and that adequate
information be provided concerning the basis and other tax matters relating to
the securities.
The additional transaction fee described in the Prospectus with respect to
the Small Company Index Portfolio and the International Equity Index Portfolio
does not apply to in-kind purchases of shares that are structured to minimize
the related brokerage, market impact costs and other transaction costs to such
Portfolios as described in the Prospectus.
Although each Portfolio generally will redeem shares in cash, each
Portfolio reserves the right to pay redemptions by a distribution in kind of
securities (instead of cash) from such Portfolio. The securities distributed in
kind would be readily marketable and would be valued for this purpose using the
same method employed in calculating the Portfolio's net asset value per share.
If a shareholder receives redemption proceeds in kind, the shareholder should
expect to incur transaction costs upon the disposition of the securities
received in the redemption.
PERFORMANCE INFORMATION
The performance of a class of shares of a Portfolio may be compared to
those of other mutual funds with similar
39
<PAGE>
investment objectives and to bond, stock and other relevant indices or to
rankings prepared by independent services or other financial or industry
publications that monitor the performance of mutual funds. For example, the
performance of a class of shares may be compared to data prepared by Lipper
Analytical Services, Inc. or other independent mutual fund reporting services.
In addition, the performance of a class may be compared to the Lehman Brothers
Government/Corporate Bond Index (or its components, including the Treasury Bond
Index), S&P 500 Index, S&P/Barra Growth Index, the Russell 2000 Index, the EAFE
Index or other unmanaged stock and bond indices, including, but not limited to,
the Merrill Lynch 1-5 Year Government Bond Index, the Merrill Lynch 1-5 Year
Corporate/Government Bond Index, the 3-month LIBOR Index, the 91-day Treasury
Bill Rate, the Composite Index, the J.P. Morgan Non-U.S. Government Bond Index,
and the Dow Jones Industrial Average, a recognized unmanaged index of common
stocks of 30 industry companies listed on the New York Stock Exchange.
Performance data as reported in national financial publications such as Money
Magazine, Morningstar, Forbes, Barron's, The Wall Street Journal and The New
York Times, or in publications of a local or regional nature, may also be used
in comparing the performance of a class of shares of a Portfolio.
The Portfolios calculate their total returns for each class of shares
separately on an "average annual total return" basis for various periods.
Average annual total return reflects the average annual percentage change in
value of an investment in the class over the measuring period. Total returns for
each class of shares may also be calculated on an "aggregate total return" basis
for various periods. Aggregate total return reflects the total percentage change
in value over the measuring period. Both methods of calculating total return
reflect changes in the price of the shares and assume that any dividends and
capital gain distributions made by the Portfolio with respect to a class during
the period are reinvested in the shares of that class. When considering average
total return figures for periods longer than one year, it is important to note
that the annual total return of a class for any one year in the period might
have been more or less than the average for the entire period. The Portfolios
may also advertise from time to time the total return of one or more classes of
shares on a year-by-year or other basis for various specified periods by means
of quotations, charts, graphs or schedules.
Each Portfolio that advertises an "average annual total return" for a class
of shares computes such return by determining the average annual compounded rate
of return during specified periods that equates the initial amount invested to
the ending redeemable value of such investment according to the following
formula:
P(1 + T)/n/ = ERV
Where: T = average annual total return;
ERV = ending redeemable value at the end of the applicable period (or
fractional portion thereof) of a hypothetical $1,000 payment made
at the beginning of the 1, 5 or 10 year (or other) period;
P = hypothetical initial payment of $1,000; and
n = period covered by the computation, expressed in terms of years.
Each Portfolio that advertises an "aggregate total return" for a class of
shares computes such return by determining the aggregate compounded rates of
return during specified periods that likewise equate the initial amount invested
to the ending redeemable value of such investment. The formula for calculating
aggregate total return is as follows:
T = [(ERV/P)]-1
The Small Company Index and International Equity Index Portfolios may
advertise total return data without reflecting the .50% and 1.00% portfolio
transaction fee in accordance with the rules of the SEC. Quotations which do not
reflect the fee will, of course, be higher than quotations which do.
The calculations set forth below are made assuming that (i) all dividends
and capital gain distributions are reinvested on the reinvestment dates at the
price per share existing on the reinvestment date, (ii) all recurring fees
charged to all shareholder accounts are included, and (iii) the portfolio
transaction fee is taken into account for purchases of shares of the Small
Company Index Portfolio and the International Equity Index Portfolio. The ending
redeemable value (variable "ERV" in the formula) is determined by assuming
complete redemption of the hypothetical investment after deduction of all
40
<PAGE>
nonrecurring charges at the end of the measuring period. Total return
calculations excluding the transaction fee are also provided for the Small
Company Index Portfolio and the International Equity Index Portfolio.
The average annual total returns and aggregate total returns shown below
for the Diversified Growth, Equity Index, Small Company Index and International
Growth Portfolios include, for periods prior to the commencement of the
Portfolios' operations, the performance of predecessor collective funds adjusted
to reflect the higher estimated fees and expenses applicable to such Portfolios'
Class A Shares at the time of their inception. Although all such predecessor
collective funds were managed by Northern for the periods stated in a manner and
pursuant to investment objectives that were equivalent in all material respects
to the management and investment objectives of the corresponding Portfolios,
such predecessor collective funds were not registered under the 1940 Act and
were not subject to certain investment restrictions imposed by the 1940 Act. If
they had been registered under the 1940 Act, performance might have been
adversely affected. The average annual total returns and aggregate total returns
shown for the Portfolios for their Class C and/or Class D Shares also include,
for the periods prior to the inception of such classes, the performance of the
Portfolios' Class A Shares. Because the fees and expenses of Class C and Class D
Shares are, respectively, 0.24% and 0.39% higher than those of Class A Shares,
actual performance for periods prior to the inception of Class C and Class D
Shares would have been lower if such higher fees and expenses had been taken
into account.
Following commencement of operations of the Portfolios, the Portfolios'
prior administrator (Goldman Sachs) or co-administrators (Northern and PFPC)
reimbursed expenses to the Portfolios and voluntarily agreed to reduce a portion
of its administration fees for each Portfolio pursuant to the undertaking
described above under "Additional Trust Information -Co-Administrators and
Distributor" and "Investment Advisers, Transfer Agent and Custodian," and
Northern waived a portion of its investment advisory fees with respect to the
Portfolios. The average annual total returns and aggregate total returns of each
Portfolio with respect to Class A, Class C and Class D Shares, as applicable,
are shown below with and without such fee waivers and expense reimbursements.
41
<PAGE>
<TABLE>
<CAPTION>
For Periods Ended November 30, 1999
Average Annual Total Returns (%) Aggregate Total Returns (%)
Since Since
1 Year 5 Year 10 Year Inception 1 Year 5 Year 10 Year Inception
------ ------ ------- ---------- ------ ------ ------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Diversified Growth/1/
Class A
with fee waivers and 24.66% 24.45% 15.29% --- 24.66% 198.52% 314.75% ---
expense reimbursements
without fee waivers and 24.31% 24.00% 14.82% --- 24.31% 193.13% 298.42% ---
expense reimbursements
Class D
with fee waivers and 24.09% 23.99% 15.06% --- 24.09% 193.05% 306.74% ---
expense reimbursements
without fee waivers and 23.73% 23.53% 14.60% --- 23.73% 187.66% 290.54% ---
expense reimbursements
Focused Growth/2/
Class A
with fee waivers and 34.23% 26.18% --- 19.48% 34.23% 219.89% --- 213.37%
expense reimbursements
without fee waivers and 33.76% 25.41% --- 23.30% 33.76% 210.24% --- 283.81%
expense reimbursements
Class C
with fee waivers and 33.95% 25.98% --- 19.33% 33.95% 217.33% --- 210.86%
expense reimbursements
without fee waivers and 33.51% 25.44% --- 18.73% 33.51% 210.58% --- 201.19%
expense reimbursements
Class D
with fee waivers and 33.74% 25.70% --- 19.13% 33.74% 213.82% --- 207.42%
expense reimbursements
without fee waivers and 33.30% 25.17% --- 18.51% 33.30% 207.21% --- 197.66%
expense reimbursements
</TABLE>
42
<PAGE>
<TABLE>
<CAPTION>
For Periods Ended November 30, 1999
Average Annual Total Returns (%) Aggregate Total Returns (%)
Since Since
1 Year 5 Year 10 Year Inception 1 Year 5 Year 10 Year Inception
------ ------ ------- --------- ------- ------- -------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Equity Index/3/
Class A
with fee waivers and 20.53% 27.08% 17.48% --- 20.53% 231.48 400.69% ---
expense reimbursements
without fee waivers and 20.24% 26.75% 17.12% --- 20.24% 227.14% 385.61% ---
expense reimbursements
Class C
with fee waivers and 20.23% 26.84% 17.37% --- 20.23% 228.33% 395.94% ---
expense reimbursements
without fee waivers and 19.95% 26.31% 17.81% --- 19.95% 224.03% 380.98% ---
expense reimbursements
Class D
with fee waivers and 20.15% 26.66% 17.28% --- 20.15% 226.03% 392.44% ---
expense reimbursements
without fee waivers and 19.85% 26.33% 16.92% --- 19.85% 221.74% 377.59% ---
expense reimbursements
Small Company Index/4/
Class A
with fee waivers and 14.40% 14.16% 11.65% --- 14.40% 97.92% 200.92% ---
expense reimbursements
and portfolio transaction fee
with fee waivers and 14.97% 14.28% 11.70% --- 14.97% 94.88% 202.43% ---
expense reimbursements
but without portfolio
transaction fee
without fee waivers and 14.48% 13.78% 11.16% --- 14.48% 90.63% 188.06% ---
expense reimbursements
but with portfolio
transaction fee
without fee waivers and 13.48% 13.71% 11.13% --- 13.48% 84.68% 187.06% ---
expense reimbursements
and portfolio transaction fee
</TABLE>
43
<PAGE>
<TABLE>
<CAPTION>
For Periods Ended November 30, 1999
Average Annual Total Returns (%) Aggregate Total Returns (%)
Since Since
1 Year 5 Year 10 Year Inception 1 Year 5 Year 10 Year Inception
------ ------ ------- --------- ------ ------ ------- ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Small Company Index
Class C
with fee waivers and See footnote 8 See footnote 8
expense reimbursements and
portfolio transaction fee
with fee waivers and expense See footnote 8 See footnote 8
reimbursements but without
portfolio transaction fee
without fee waivers and See footnote 8 See footnote 8
expense reimbursements but
with portfolio transaction fee
without fee waivers and See footnote 8 See footnote 8
expense reimbursements and
portfolio transaction fee
Class D
with fee waivers and 13.51% 13.77% 11.45% --- 13.51% 90.61% 195.56% ---
expense reimbursements and
portfolio transaction fee
with fee waivers and expense 14.13% 13.88% 11.51% --- 14.13% 91.49% 242.08% ---
reimbursements but without
portfolio transaction fee
without fee waivers and 13.65% 13.78% 11.15% --- 13.65% 90.59% 187.86% ---
expense reimbursements but
with portfolio transaction fee
without fee waivers and 12.65% 13.09% 11.13% --- 12.65% 89.59% 186.86% ---
expense reimbursements and
portfolio transaction fee
</TABLE>
44
<PAGE>
<TABLE>
<CAPTION>
For Periods Ended November 30, 1999
Average Annual Total Returns (%) Aggregate Total Returns (%)
Since Since
1 Year 5 Year 10 Year Inception 1 Year 5 Year 10 Year Inception
------ ------ ------- --------- ------ ------ ------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
International Growth/5/
Class A
with fee waivers and 30.07% 11.90% --- 9.18% 30.07% 75.42% --- 128.74%
expense reimbursements
without fee waivers and 29.75% 11.57% --- 8.83% 29.75% 72.86% --- 122.01%
expense reimbursements
Class D
with fee waivers and See footnote 9 See footnote 9
expense reimbursements
without fee waivers and See footnote 9 See footnote 9
expense reimbursements
Balanced/6/
Class A
with fee waivers and 14.41% 16.51% --- 12.32% 14.11% 114.73% --- 110.79%
expense reimbursements
without fee waivers and 13.79% 15.93% --- 11.65% 13.79% 109.37% --- 102.95%
expense reimbursements
Class C
with fee waivers and 14.03% 16.25% --- 12.12% 14.03% 112.30% --- 108.46%
expense reimbursements
without fee waivers and 13.57% 15.71% --- 11.50% 13.57% 107.42% --- 101.22%
expense reimbursements
Class D
with fee waivers and 13.73% 16.18% --- 12.07% 13.73% 111.65% --- 107.76%
expense reimbursements
without fee waivers and 13.29% 15.58% --- 11.40% 13.29% 106.22% --- 100.06%
expense reimbursements
</TABLE>
45
<PAGE>
<TABLE>
<CAPTION>
For Periods Ended November 30, 1999
Average Annual Total Returns (%) Aggregate Total Returns (%)
Since Since
1 Year 5 Year 10 Year Inception 1 Year 5 Year 10 Year Inception
------ ------ ------- ---------- ------ ------ ------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
International Equity Index/7/
Class A
with fee waivers and 19.13% --- --- 14.99% 19.13% --- --- 45.13%
expense reimbursements
and portfolio transaction fee
with fee waivers and expense 20.32% --- --- 15.42% 20.32% --- --- 46.58%
reimbursements but without
portfolio transaction fee
without fee waivers and 19.83% --- --- 14.62% 19.83% --- --- 43.88%
expense reimbursements but with
portfolio transaction fee
without fee waivers and 18.83% --- --- 14.32% 18.83% --- --- 40.88%
expense reimbursements
and portfolio transaction fee
Class D
with fee waivers and 18.29% --- --- 14.65% 18.29% --- --- 43.99%
expense reimbursements
and portfolio transaction fee
with fee waivers and expense 19.48% --- --- 15.08% 19.48% --- --- 45.43%
reimbursements but without
portfolio transaction fee
without fee waivers and 19.00% --- --- 14.29% 19.00% --- --- 42.77%
expense reimbursements but with
portfolio transaction fee
without fee waivers and 18.00% --- --- 13.99% 18.00% --- --- 41.77%
expense reimbursements
and portfolio transaction fee
</TABLE>
46
<PAGE>
1. For Class A and D Shares, performance information prior to January 11, 1993
(commencement of Portfolio) is that of a predecessor collective fund. For
Class D Shares, performance information from January 11, 1993 to September
14, 1994 (commencement of Class D Shares) is that of Class A Shares.
Because the fees and expenses of Class D Shares are .39% higher than those
of Class A Shares, actual performance would have been lower had such higher
fees and expenses been taken into account. The predecessor collective fund
has been managed in a manner and pursuant to investment objectives
equivalent in all material respects to the management and investment
objective of the Portfolio for the periods shown. The performance
information of the predecessor collective fund is adjusted to reflect the
higher fees and expenses applicable to Class A Shares at the time of their
inception.
2. For Class C and Class D Shares, performance from July 1, 1993 to June 14,
1996 (commencement of Class C Shares) and December 8, 1994 (commencement of
Class D Shares), respectively, is that of Class A Shares. Class A Shares
commenced operations on July 1, 1993. Because the fees and expenses of
Class C and Class D Shares are .24% and .39%, respectively, higher than
those of Class A Shares, actual performance would have been lower had such
higher expenses been taken into account.
3. For Class A, C and D Shares, performance information prior to January 11,
1993 (commencement of Portfolio) is that of a predecessor collective fund.
For Class C and D Shares, performance information from January 11, 1993 to
September 28, 1995 (commencement of Class C Shares) and September 14, 1994
(commencement of Class D Shares), respectively, is that of Class A Shares.
Because the fees and expenses of Class C and Class D Shares are .24% and
.39%, respectively, higher than those of Class A Shares, actual performance
would have been lower had such higher fees and expenses been taken into
account. The predecessor collective fund has been managed in a manner and
pursuant to investment objectives equivalent in all material respects to
the management and investment objective of the Portfolio for the periods
shown. The performance information of the predecessor collective fund is
adjusted to reflect the higher fees and expenses applicable to Class A
Shares at the time of their inception.
4. For Class A and D Shares, performance information prior to January 11, 1993
(commencement of Portfolio) is that of a predecessor collective fund. For
Class D Shares, performance information from January 11, 1993 to December
8, 1994 (commencement of Class D Shares), is that of Class A Shares.
Because the fees and expenses of Class D Shares are .39%, higher than those
of Class A Shares, actual performance would have been lower had such higher
fees and expenses been taken into account. Performance information of the
predecessor collective fund is shown from August 1, 1988 (the date such
collective fund was first managed in a manner and pursuant to investment
objectives equivalent in all material respects to the management and
investment objective of the Portfolio) and is adjusted to reflect the
higher fees and expenses applicable to Class A Shares at the time of their
inception.
5. For Class A Shares, performance information prior to March 28, 1994
(commencement of Portfolio) is that of a predecessor collective fund.
Performance information of the predecessor collective fund is shown from
July 1, 1990 (the date such fund was first managed in a manner and pursuant
to investment objectives equivalent in all material respects to the
management and investment objective of the Portfolio) and is adjusted to
reflect the higher fees and expenses applicable to Class A Shares at the
time of their inception.
6. For Class C and Class D Shares, performance from July 1, 1993 to December
29, 1995 (commencement of Class C Shares) and February 20, 1996
(commencement of Class D Shares), respectively, is that of Class A Shares.
Class A Shares commenced operations on July 1, 1993. Because the fees and
expenses of Class C and Class D Shares are .24% and .39%, respectively,
higher than those of Class A Shares, actual performance would have been
lower had such higher fees and expenses been taken into account.
7. For Class D Shares, performance from April 1, 1997 to October 5, 1998
(commencement of Class D Shares) is that of Class A Shares. Class A Shares
commenced operations on April 1, 1997. Because the fees and expenses of
Class D Shares are .39% higher than those of Class A Shares, actual
performance would have been lower had such higher fees and expenses been
taken into account.
8. From July 27, 1999 to the date of the Prospectus, no Class C shares of the
Small Company Index Portfolio were held by shareholders. Class C shares of
the Small Company Index Portfolio will have substantially similar annual
returns when compared with Class A shares of the Small Company Index
Portfolio because shares of both Class A and Class C are invested in the
same portfolio of securities. The annual returns of Class A and Class C
shares will differ only to the extent that the share classes do not have
the same expenses. Annual returns reflected since inception will also
differ as the classes do not have the same inception date.
47
<PAGE>
9. From August 22, 1999 to the date of the Prospectus, no Class D shares of
the International Growth Portfolio were held by shareholders. Class C
shares of the International Growth Portfolio will have substantially
similar annual returns when compared with Class A shares of the
International Growth Portfolio because shares of both Class A and Class D
are invested in the same portfolio of securities. The annual returns of
Class A and Class D shares will differ only to the extent that the share
classes do not have the same expenses. Annual returns reflected since
inception will also differ as the classes do not have the same inception
date.
The yield of a class of shares in the Balanced Portfolio is computed based
on the net income of such class during a 30-day (or one month) period (which
period will be identified in connection with the particular yield quotation).
More specifically, the Portfolio's yield for a class of shares is computed by
dividing the per share net income for the class during a 30-day (or one month)
period by the net asset value per share on the last day of the period and
annualizing the result on a semi-annual basis.
The Balanced Portfolio calculates its 30-day (or one month) standard yield
for a class of shares in accordance with the method prescribed by the SEC for
mutual funds:
Yield = 2[{(a-b/cd) + 1}/6/ - 1]
Where: a = dividends and interest earned during the period;
b = expenses accrued for the period (net of reimbursements);
c = average daily number of shares outstanding during the period
entitled to receive dividends; and
d = net asset value per share on the last day of the period.
For the 30-day period ended November 30, 1999, the annualized yields
for the Class A, Class C and Class D Shares of the Balanced Portfolio were
2.78%, 2.54% and 2.41%, respectively. During such period, the Co-Administrators
reimbursed expenses to the Portfolio and voluntarily agreed to reduced a portion
of its administration fees under "Additional Trust Information - Co-
Administrators and Distributor," and Northern waived a portion of its investment
advisory fees with respect to the Portfolio. In the absence of such advisory and
administration fee reductions, the 30-day yield for Class A, Class C and Class D
Shares would have been 2.40%, 2.16% and 2.03%, respectively.
Because of the different servicing fees and transfer agency fees
payable with respect to Class A, C and D Shares in a Portfolio, performance
quotations for shares of Class C and D of the Portfolio will be lower than the
quotations for Class A Shares of the Portfolio, which will not bear any fees for
shareholder support services and will bear minimal transfer agency fees.
The performance of each class of shares of the Portfolios is based on
historical earnings, will fluctuate and is not intended to indicate future
performance. The investment return and principal value of an investment in a
class will fluctuate so that when redeemed, shares may be worth more or less
than their original cost. Performance information may not provide a basis for
comparison with bank deposits and other investments which provide a fixed yield
for a stated period of time. Total return data should also be considered in
light of the risks associated with a Portfolio's composition, quality, maturity,
operating expenses and market conditions. Any fees charged by Institutions
directly to their Customer accounts in connection with investments in a
Portfolio will not be included in calculations of performance information.
TAXES
The following summarizes certain additional tax considerations
generally affecting the Portfolios and their shareholders that are not described
in the Prospectus. No attempt is made to present a detailed explanation of the
tax treatment of the Portfolios or their shareholders, and the discussions here
and in the Prospectus are not intended as a substitute for careful tax planning.
Potential investors should consult their tax advisers with specific reference to
their own tax situations.
The discussions of tax consequences in the Prospectus and this
Additional Statement are based on the Internal Revenue Code of 1986, as amended
(the "Code") and the laws and regulations issued thereunder as in effect on the
date of this Additional Statement. Future legislative or administrative changes
or court decisions may significantly change the conclusions expressed herein,
and any such changes or decisions may have a retroactive effect with respect to
the
48
<PAGE>
transactions contemplated herein.
Federal - General Information
Each Portfolio intends to qualify as a regulated investment company under
Part I of Subchapter M of Subtitle A, Chapter 1, of the Code. As a regulated
investment company, each Portfolio is generally exempt from federal income tax
on its net investment income and realized capital gains which it distributes to
shareholders, provided that it distributes an amount equal to at least the sum
of 90% of its tax-exempt income and 90% of its investment company taxable income
(net investment income and the excess of net short-term capital gain over net
long-term capital loss), if any, for the year (the "Distribution Requirement")
and satisfies certain other requirements of the Code that are described below.
In addition to satisfaction of the Distribution Requirement, each Portfolio
must derive with respect to a taxable year at least 90% of its gross income from
dividends, interest, certain payments with respect to securities, loans and
gains from the sale or other disposition of stock or securities or foreign
currencies, or from income derived with respect to its business of investing in
such stock, securities, or currencies (the "Income Requirement").
In addition to the foregoing requirements, at the close of each quarter of
its taxable year, at least 50% of the value of each Portfolio's assets must
generally consist of cash and cash items, U.S. Government securities, securities
of other regulated investment companies, and securities of other issuers (as to
which as Portfolio has not invested more than 5% of the value of its total
assets in securities of such issuer and as to which a Portfolio does not hold
more than 10% of the outstanding voting securities of such issuer), and no more
than 25% of the value of each Portfolio's total assets may be invested in the
securities of any one issuer (other than U.S. Government securities and
securities of other regulated investment companies), or in two or more issuers
which such Portfolio controls and which are engaged in the same or similar
trades or businesses.
In the case of corporate shareholders, distributions of a Portfolio for any
taxable year generally qualify for the dividends received deduction to the
extent of the gross amount of "qualifying dividends" from domestic corporations
received by the Portfolio for the year. A dividend usually will be treated as a
"qualifying dividend" if it has been received from a domestic corporation. A
portion of the dividends paid by the Balanced, Equity Index, Diversified Growth,
Focused Growth, Small Company Growth, Mid Cap Growth, and potentially
International Growth Portfolios, may constitute "qualifying dividends." The
other Portfolios, however, are not expected to pay qualifying dividends.
If for any taxable year any Portfolio does not qualify as a regulated
investment company, all of its taxable income will be subject to tax at regular
corporate rates without any deduction for distributions to shareholders. In such
event, all distributions would be taxable as ordinary income to the extent of
such Portfolio's current and accumulated earnings and profits and would be
eligible for the dividends received deduction in the case of corporate
shareholders.
The Code imposes a non-deductible 4% excise tax on regulated investment
companies that fail to currently distribute an amount equal to specified
percentages of their ordinary taxable income and capital gain net income (excess
of capital gains over capital losses). Each Portfolio intends to make sufficient
distributions or deemed distributions of its ordinary taxable income and capital
gain net income each calendar year to avoid liability for this excise tax.
Although each Portfolio expects to qualify as a "regulated investment
company" and to be relieved of all or substantially all federal income taxes,
depending upon the extent of its activities in states and localities in which
its offices are maintained, in which its agents or independent contractors are
located or in which it is otherwise deemed to be conducting business, each
Portfolio may be subject to the tax laws of such states or localities.
The Trust will be required in certain cases to withhold and remit to the
U.S. Treasury 31% of taxable dividends and gross sale proceeds paid to any
shareholder (i) who has provided either an incorrect tax identification number
or no number at all, (ii) who is subject to backup withholding by the Internal
Revenue Service for failure to report the receipt of taxable interest or
dividend income properly, or (iii) who has failed to certify to the Trust, when
required to do so, that he or she is not subject to backup withholding or that
he or she is an "exempt recipient."
Taxation of Certain Financial Instruments
The tax principles applicable to transactions in financial instruments and
futures contracts and options that may be engaged in by a Portfolio, and
investments in passive foreign investment companies ("PFICs"), are complex and,
in some cases, uncertain. Such transactions and investments may cause a
Portfolio to recognize taxable income prior to the receipt of cash, thereby
requiring the Portfolio to liquidate other positions, or to borrow money, so as
to make sufficient distributions to shareholders to avoid corporate-level tax.
Moreover, some or all of the taxable income recognized may be ordinary income
49
<PAGE>
or short-term capital gain, so that the distributions may be taxable to
shareholders as ordinary income.
In addition, in the case of any shares of a PFIC in which a Portfolio
invests, the Portfolio may be liable for corporate-level tax on any ultimate
gain or distributions on the shares if the Portfolio fails to make an election
to recognize income annually during the period of its ownership of the shares.
Foreign Investors
Foreign shareholders generally will be subject to U.S. withholding tax at a
rate of 30% (or a lower treaty rate, if applicable) on distributions by a
Portfolio of net investment income, other ordinary income, and the excess, if
any, of net short-term capital gain over net long-term capital loss for the
year, regardless of the extent, if any, to which the income or gain is derived
from non-U.S. investments of the Portfolio. For this purpose, foreign
shareholders include individuals other than U.S. citizens, residents and certain
nonresident aliens, and foreign corporations, partnerships, trusts and estates.
A foreign shareholder generally will not be subject to U.S. income or
withholding tax in respect of proceeds from or gain on the redemption of shares
or in respect of capital gain dividends (i.e., dividends attributable to long-
term capital gains of a Portfolio), provided such shareholder submits a
statement, signed under penalties of perjury, attesting to such shareholder's
exempt status. Different tax consequences apply to a foreign shareholder engaged
in a U.S. trade or business or present in the U.S. for 183 days or more in a
year. Foreign shareholders should consult their tax advisers regarding the U.S.
and foreign tax consequences of investing in a Portfolio.
DESCRIPTION OF SHARES
The Trust Agreement permits the Trust's Board of Trustees to issue an
unlimited number of full and fractional shares of beneficial interest of one or
more separate series representing interests in one or more investment
portfolios. The Trustees may hereafter create series in addition to the Trust's
twenty-one existing series, which represent interests in the Trust's twenty-one
respective portfolios, ten of which are discussed in this Additional Statement.
The Trust Agreement also permits the Board of Trustees to classify or reclassify
any unissued shares into classes within a series. Pursuant to such authority,
the Trustees have authorized the issuance of an unlimited number of shares of
beneficial interest in three separate classes of shares in each of the Trust's
non-money market portfolios: Class A, C and D Shares.
Under the terms of the Trust Agreement, each share of each Portfolio is
without par value, represents an equal proportionate interest in the particular
Portfolio with each other share of its class in the same Portfolio and is
entitled to such dividends and distributions out of the income belonging to the
Portfolio as are declared by the Trustees. Upon any liquidation of a Portfolio,
shareholders of each class of a Portfolio are entitled to share pro rata in the
net assets belonging to that class available for distribution. Shares do not
have any preemptive or conversion rights. The right of redemption is described
under "About Your Account -- Selling Shares" in the Prospectus. In addition,
pursuant to the terms of the 1940 Act, the right of a shareholder to redeem
shares and the date of payment by a Portfolio may be suspended for more than
seven days (i) for any period during which the New York Stock Exchange is
closed, other than the customary weekends or holidays, or trading in the markets
the Portfolio normally utilizes is closed or is restricted as determined by the
SEC, (ii) during any emergency, as determined by the SEC, as a result of which
it is not reasonably practicable for the Portfolio to dispose of instruments
owned by it or fairly to determine the value of its net assets, or (iii) for
such other period as the SEC may by order permit for the protection of the
shareholders of the Portfolio. The Trust may also suspend or postpone the
recordation of the transfer of its shares upon the occurrence of any of the
foregoing conditions. In addition, shares of each Portfolio are redeemable at
the unilateral option of the Trust if the Trustees determine in their sole
discretion that failure to so redeem may have material adverse consequences to
the shareholders of the Portfolio. Shares when issued as described in the
Prospectus are validly issued, fully paid and nonassessable, except as stated
below. In the interests of economy and convenience, certificates representing
shares of the Portfolios are not issued.
The proceeds received by each Portfolio for each issue or sale of its
shares, and all net investment income, realized and unrealized gain and proceeds
thereof, subject only to the rights of creditors, will be specifically allocated
to and constitute the underlying assets of that Portfolio. The underlying assets
of each Portfolio will be segregated on the books of account, and will be
charged with the liabilities in respect to that Portfolio and with a share of
the general liabilities of the Trust. Expenses with respect to the Portfolios
are normally allocated in proportion to the net asset value of the respective
Portfolios except where allocations of direct expenses can otherwise be fairly
made.
Rule 18f-2 under the 1940 Act provides that any matter required by the
provisions of the 1940 Act or applicable state law, or otherwise, to be
submitted to the holders of the outstanding voting securities of an investment
company such as the Trust shall not be deemed to have been effectively acted
upon unless approved by the holders of a majority of the outstanding shares of
each investment portfolio affected by such matter. Rule 18f-2 further provides
that an investment portfolio shall be deemed to be affected by a matter unless
the interests of each investment portfolio in the matter are
50
<PAGE>
substantially identical or the matter does not affect any interest of the
investment portfolio. Under the Rule, the approval of an investment advisory
agreement or any change in a fundamental investment policy would be effectively
acted upon with respect to an investment portfolio only if approved by a
majority of the outstanding shares of such investment portfolio. However, the
Rule also provides that the ratification of the appointment of independent
accountants, the approval of principal underwriting contracts and the election
of Trustees are exempt from the separate voting requirements stated above. In
addition, shareholders of each of the classes in a particular investment
portfolio have equal voting rights except that only shares of a particular class
of an investment portfolio will be entitled to vote on matters submitted to a
vote of shareholders (if any) relating to shareholder servicing expenses and
transfer agency fees that are payable by that class.
The Trust is not required to hold annual meetings of shareholders and does
not intend to hold such meetings. In the event that a meeting of shareholders is
held, each share of the Trust will be entitled, as determined by the Trustees
without the vote or consent of shareholders, either to one vote for each share
or to one vote for each dollar of net asset value represented by such shares on
all matters presented to shareholders, including the election of Trustees (this
method of voting being referred to as "dollar-based voting"). However, to the
extent required by the 1940 Act or otherwise determined by the Trustees, series
and classes of the Trust will vote separately from each other. Shareholders of
the Trust do not have cumulative voting rights in the election of Trustees and,
accordingly, the holders of more than 50% of the aggregate voting power of the
Trust may elect all of the Trustees, irrespective of the vote of the other
shareholders. Meetings of shareholders of the Trust, or any series or class
thereof, may be called by the Trustees, certain officers or upon the written
request of holders of 10% or more of the shares entitled to vote at such
meeting. To the extent required by law, the Trust will assist in shareholder
communications in connection with a meeting called by shareholders. The
shareholders of the Trust will have voting rights only with respect to the
limited number of matters specified in the Trust Agreement and such other
matters as the Trustees may determine or may be required by law.
The Trust Agreement authorizes the Trustees, without shareholder approval
(except as stated in the next paragraph), to cause the Trust, or any series
thereof, to merge or consolidate with any corporation, association, trust or
other organization or sell or exchange all or substantially all of the property
belonging to the Trust, or any series thereof. In addition, the Trustees,
without shareholder approval, may adopt a "master-feeder" structure by investing
substantially all of the assets of a series of the Trust in the securities of
another open-end investment company or pooled portfolio.
The Trust Agreement also authorizes the Trustees, in connection with the
merger, consolidation, termination or other reorganization of the Trust or any
series or class, to classify the shareholders of any class into one or more
separate groups and to provide for the different treatment of shares held by the
different groups, provided that such merger, consolidation, termination or other
reorganization is approved by a majority of the outstanding voting securities
(as defined in the 1940 Act) of each group of shareholders that are so
classified.
The Trust Agreement permits the Trustees to amend the Trust Agreement
without a shareholder vote. However, shareholders of the Trust have the right to
vote on any amendment (i) that would adversely affect the voting rights of
shareholders; (ii) that is required by law to be approved by shareholders; (iii)
that would amend the voting provisions of the Trust Agreement; or (iv) that the
Trustees determine to submit to shareholders.
The Trust Agreement permits the termination of the Trust or of any series
or class of the Trust (i) by a majority of the affected shareholders at a
meeting of shareholders of the Trust, series or class; or (ii) by a majority of
the Trustees without shareholder approval if the Trustees determine that such
action is in the best interest of the Trust or its shareholders. The factors and
events that the Trustees may take into account in making such determination
include (i) the inability of the Trust or any series or class to maintain its
assets at an appropriate size; (ii) changes in laws or regulations governing the
Trust, or any series or class thereof, or affecting assets of the type in which
it invests; or (iii) economic developments or trends having a significant
adverse impact on their business or operations.
Under the Delaware Business Trust Act (the "Delaware Act"), shareholders
are not personally liable for obligations of the Trust. The Delaware Act
entitles shareholders of the Trust to the same limitation of liability as is
available to shareholders of private for-profit corporations. However, no
similar statutory or other authority limiting business trust shareholder
liability exists in many other states. As a result, to the extent that the Trust
or a shareholder is subject to the jurisdiction of courts in such other states,
those courts may not apply Delaware law and may subject the shareholders to
liability. To offset this risk, the Trust Agreement (i) contains an express
disclaimer of shareholder liability for acts or obligations of the Trust and
requires that notice of such disclaimer be given in each agreement, obligation
and instrument entered into or executed by the Trust or its Trustees and (ii)
provides for indemnification out of the property of the applicable series of the
Trust of any shareholder held personally liable for the obligations of the Trust
solely by reason of being or having been a shareholder and not because of the
shareholder's acts or omissions or for some other reason. Thus, the risk of a
shareholder incurring financial loss beyond his or her investment because of
shareholder liability is limited to circumstances in which all of the following
factors are present: (i) a court refuses to apply Delaware law; (ii) the
liability arises under tort
51
<PAGE>
law or, if not, no contractual limitation of liability is in effect; and (iii)
the applicable series of the Trust is unable to meet its obligations.
The Trust Agreement provides that the Trustees will not be liable to any
person other than the Trust or a shareholder and that a Trustee will not be
liable for any act as a Trustee. However, nothing in the Trust Agreement
protects a Trustee against any liability to which he or she would otherwise be
subject by reason of willful misfeasance, bad faith, gross negligence or
reckless disregard of the duties involved in the conduct of his or her office.
The Trust Agreement provides for indemnification of Trustees, officers and
agents of the Trust unless the recipient is liable by reason of willful
misfeasance, bad faith, gross negligence or reckless disregard of the duties
involved in the conduct of such person's office.
The Trust Agreement provides that each shareholder, by virtue of becoming
such, will be held to have expressly assented and agreed to the terms of the
Trust Agreement and to have become a party thereto.
In addition to the requirements of Delaware law, the Trust Agreement
provides that a shareholder of the Trust may bring a derivative action on behalf
of the Trust only if the following conditions are met: (i) shareholders eligible
to bring such derivative action under Delaware law who hold at least 10% of the
outstanding shares of the Trust, or 10% of the outstanding shares of the series
or class to which such action relates, must join in the request for the Trustees
to commence such action; and (ii) the Trustees must be afforded a reasonable
amount of time to consider such shareholder request and to investigate the basis
of such claim. The Trust Agreement also provides that no person, other than the
Trustees, who is not a shareholder of a particular series or class shall be
entitled to bring any derivative action, suit or other proceeding on behalf of
or with respect to such series or class. The Trustees will be entitled to retain
counsel or other advisers in considering the merits of the request and may
require an undertaking by the shareholders making such request to reimburse the
Trust for the expense of any such advisers in the event that the Trustees
determine not to bring such action.
The Trustees may appoint separate Trustees with respect to one or more
series or classes of the Trust's shares (the "Series Trustees"). To the extent
provided by the Trustees in the appointment of Series Trustees, Series Trustees
(i) may, but are not required to, serve as Trustees of the Trust or any other
series or class of the Trust; (ii) may have, to the exclusion of any other
Trustee of the Trust, all the powers and authorities of Trustees under the Trust
Agreement with respect to such series or class; and/or (iii) may have no power
or authority with respect to any other series or class. The Trustees are not
currently considering the appointment of Series Trustees for the Trust.
As of February 29, 2000, substantially all of the Portfolios' outstanding
shares were held of record by Northern for the benefit of its customers and the
customers of its affiliates and correspondent banks that have invested in the
Portfolios. As of the same date, Northern possessed sole or shared voting
and/or investment power for its customer accounts with respect to less than 10%
of the Trust's outstanding shares. As of the same date, the Trust's Trustees
and officers as a group owned beneficially less than 1% of the outstanding
shares of each class of each Portfolio. Northern has advised the Trust that the
following persons (whose mailing address is: c/o The Northern Trust Company, 50
South LaSalle, Chicago, IL 60675) beneficially owned five percent or more of the
outstanding shares of the Portfolios' classes as of February 29, 2000:
52
<PAGE>
<TABLE>
<CAPTION>
Number Percentage
of Shares of Shares
----------- ---------
<S> <C> <C>
BALANCED PORTFOLIO
Class A
The Northern Trust Thrift Plan 1,769,943.97 35.4%
Gregian Delight, Inc. Employee Profit 243,075.90 5.2%
Sharing & Savings Plan & Trust
Goodyear Tire & Rubber Co. 249,468.91 5.3%
Sealed Air Corp. 984,982.08 19.7%
Class C
Kitch Drutchas Wagner Kenney PC 61,847.36 100.0%
Class D
First National Bank of LaGrange 32,893.35 100.0%
DIVERSIFIED GROWTH PORTFOLIO
Class A
The Northern Trust Co. Pension Plan 3,012,666.79 33.8%
Pension Plan for the Home Office Employees 521,827.73 5.9%
A Finkl & Sons Employee Pension 469,907.92 5.3%
Seiko Corp. 665,519.78 7.5%
Class D
First National Bank of LaGrange 32,562.59 100.0%
EQUITY INDEX PORTFOLIO
Class A
The Northern Trust Thrift Plan 8,672,457.31 15.9%
Libbey-Owens-Ford Co. 3,230,929.80 5.9%
Army Air Force 2,986,047.44 5.5%
Meadows Foundation 4,800,825.02 8.8%
Class C
Wilson Sports Goods 401K Plan 1,159,621.26 23.6%
American Medical Association 401K Plan 1,579,429.08 32.2%
Clark Schwebel, Inc. 410,676.87 8.4%
U.S. Silica Co. 693,459.75 14.1%
Sierra Technologies, Inc. 330,928.70 6.7%
Children's Hospital San Diego 590,486.63 12.0%
Class D
Marquette Trust Co. 551,897.53 82.1%
Great Plains Trust Co. 81,131.36 12.1%
</TABLE>
53
<PAGE>
<TABLE>
<CAPTION>
Number Percentage
of Shares of Shares
--------- ---------
<S> <C> <C>
FOCUSED GROWTH PORTFOLIO
Class A
The Northern Trust Thrift Plan 6,083,288.96 53.4%
Doe Run Resources Corp. 712,558.56 6.3%
Woodmen Home Office Employees 657,370.87 5.8%
Class C
Kitch Drutchas Wagner Kenney PC 648,737.52 100.0%
Class D
First National Bank of LaGrange 32,670.52 97.2%
MID CAP GROWTH PORTFOLIO
Class A
NISource-Bay Area VEBA 217,500.00 28.1%
Presbytery of Chicago 41,472.54 5.4%
Mercy Medical Center Foundation 66,302.97 8.6%
Merrill Merchants Bank 61,706.11 8.0%
E Nakamichi Foundation 118,938.81 15.4%
Iowa Measurement Research Foundation 108,931.81 14.1%
Class D
BankIllinois Trust Co. 30,014.25 76.6%
Great Plains Trust Co. 9,182.76 23.4%
SMALL COMPANY GROWTH PORTFOLIO
Class A
Iowa Measurement Research Foundation 96,068.25 13.4%
NISource-Bay Area VEBA 109,680.28 15.3%
Schulze & Burch Employee Pension Plan 48,169.56 6.7%
Brazos Electric 76,277.65 10.7%
Illinois Masonic 36,162.01 5.1%
NiSource - Bay State VEBA 109,680.28 24.8%
SMALL COMPANY INDEX PORTFOLIO
Class A
Saxon & Co. 1,503,407.81 7.7%
Lifepoint Hospitals, Inc. 1,139,354.70 5.9%
General Dynamics Small Cap Fund 1,819,553.03 9.4%
Pfizer 1,385,000.64 7.1%
PWC Group Investment Savings Plan 1,653,989.59 8.5%
MASCO 1,898,941.40 9.8%
Class D
BankIllinois Trust Co. 30,014.25 76.6%
Great Plains Trust Co. 9,182.76 23.4%
</TABLE>
54
<PAGE>
<TABLE>
<CAPTION>
Number Percentage
of Shares of Shares
--------- ---------
<S> <C> <C>
INTERNATIONAL EQUITY INDEX PORTFOLIO
Class A
The Northern Trust Co. Pension Plan 1,491,296.58 27.7%
The Northern Trust Thrift Plan 1,271,719.59 23.6%
AutoLic ASP, Inc. 303,462.50 5.6%
NI-Gas Savings & Thrift Trust 941,227.19 17.5%
Lifepoint Hospitals, Inc. 549,540.13 10.2%
Class D
People's National Bank 1,137.92 100.0%
INTERNATIONAL GROWTH PORTFOLIO
Class A
The Northern Trust Co. Pension Plan 1,578,693.67 11.6%
White Cap, Inc. 890,541.92 6.5%
Tuthill Corp. Supplement Investment 780,135.83 5.7%
Retirement Plan
Indresco 769,865.34 5.7%
Doe Run Resources Corp. 874,281.62 6.4%
</TABLE>
OTHER INFORMATION
The Prospectus and this Additional Statement do not contain all the
information included in the Registration Statement filed with the SEC under the
Securities Act of 1933 with respect to the securities offered by the Trust's
Prospectus. Certain portions of the Registration Statement have been omitted
from the Prospectus and this Additional Statement pursuant to the rules and
regulations of the SEC. The Registration Statement including the exhibits filed
therewith may be examined at the office of the SEC in Washington, D.C.
Each Portfolio is responsible for the payment of its expenses. Such
expenses include, without limitation, the fees and expenses payable to Northern,
NTQA and PFPC, brokerage fees and commissions, fees for the registration or
qualification of Portfolio shares under Federal or state securities laws,
expenses of the organization of the Portfolio, taxes, interest, costs of
liability insurance, fidelity bonds, indemnification or contribution, any costs,
expenses or losses arising out of any liability of, or claim for damages or
other relief asserted against, the Trust for violation of any law, legal, tax
and auditing fees and expenses, servicing fees, expenses of preparing and
printing prospectuses, statements of additional information, proxy materials,
reports and notices and the printing and distributing of the same to the Trust's
shareholders and regulatory authorities, compensation and expenses of its
Trustees, expenses for industry organizations such as the Investment Company
Institute, miscellaneous expenses and extraordinary expenses incurred by the
Trust.
The term "majority of the outstanding shares" of either the Trust or a
particular Portfolio means, with respect to the approval of an investment
advisory agreement or a change in a fundamental investment policy, the vote of
the lesser of (i) 67% or more of the shares of the Trust or such Portfolio
present at a meeting, if the holders of more than 50% of the outstanding shares
of the Trust or such Portfolio are present or represented by proxy, or (ii) more
than 50% of the outstanding shares of the Trust or such Portfolio.
Statements contained in the Prospectus or in this Additional Statement as
to the contents of any contract or other documents referred to are not
necessarily complete, and in each instance reference is made to the copy of such
contract or other document filed as an exhibit to the Registration Statement of
which the Prospectus and this Additional Statement form a part, each such
statement being qualified in all respects by such reference.
55
<PAGE>
FINANCIAL STATEMENTS
The audited financial statements and related report of Ernst & Young LLP,
independent auditors, contained in the annual report to the Portfolios'
shareholders for the fiscal year ended November 30, 1999 (the "Annual Report")
are hereby incorporated herein by reference and attached hereto. No other parts
of the Annual Report, including without limitation, "Management's Discussion of
Portfolio Performance," are incorporated by reference herein. Copies of the
Semi-Annual Report and the Annual Report may be obtained upon request and
without charge by calling 1-800-637-1380 (toll-free). No financial statements
are supplied for the Mid Cap Growth and Small Cap Growth Portfolios because they
did not commence operations during the period ended November 30, 1999.
56
<PAGE>
APPENDIX A
Commercial Paper Ratings
------------------------
A Standard & Poor's Ratings Group, Inc. ("S&P") commercial paper rating is a
current assessment of the likelihood of timely payment of debt having an
original maturity of no more than 365 days. The following summarizes the rating
categories used by Standard and Poor's for commercial paper:
"A-1" - Obligations are rated in the highest category indicating that the
obligor's capacity to meet its financial commitment on the obligation is
strong. Within this category, certain obligations are designated with a
plus sign (+). This indicates that the obligor's capacity to meet its
financial commitment on these obligations is extremely strong.
"A-2" - Obligations are somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than obligations in higher
rating categories. However, the obligor's capacity to meet its financial
commitment on the obligation is satisfactory.
"A-3" - Obligations exhibit adequate protection parameters. However,
adverse economic conditions or changing circumstances are more likely to
lead to a weakened capacity of the obligor to meet its financial commitment
on the obligation.
"B" - Obligations are regarded as having significant speculative
characteristics. The obligor currently has the capacity to meet its
financial commitment on the obligation; however, it faces major ongoing
uncertainties which could lead to the obligor's inadequate capacity to meet
its financial commitment on the obligation.
"C" - Obligations are currently vulnerable to nonpayment and are dependent
upon favorable business, financial, and economic conditions for the obligor
to meet its financial commitment on the obligation.
"D" - Obligations are in payment default. The "D" rating category is used
when payments on an obligation are not made on the date due even if the
applicable grace period has not expired, unless S&P believes that such
payments will be made during such grace period. The "D" rating will be
used upon the filing of a bankruptcy petition or the taking of a similar
action if payments on an obligation are jeopardized.
Moody's Investors Service, Inc. ("Moody's") commercial paper ratings are
opinions of the ability of issuers to repay punctually senior debt obligations
not having an original maturity in excess of one year, unless explicitly noted.
The following summarizes the rating categories used by Moody's for commercial
paper:
"Prime-1" - Issuers (or supporting institutions) have a superior ability
for repayment of senior short-term debt obligations. Prime-1 repayment
ability will often be evidenced by many of the following characteristics:
leading market positions in well-established industries; high rates of
return on funds employed; conservative capitalization structure with
moderate reliance on debt and ample asset protection; broad margins in
earnings coverage of fixed financial charges and high internal cash
generation; and well-established access to a range of financial markets and
assured sources of alternate liquidity.
"Prime-2" - Issuers (or supporting institutions) have a strong ability for
repayment of senior short-term debt obligations. This will normally be
evidenced by many of the characteristics cited above but to a lesser
degree. Earnings trends and coverage ratios, while sound, may be more
subject to variation. Capitalization characteristics, while still
appropriate, may be more affected by external conditions. Ample alternate
liquidity is maintained.
"Prime-3" - Issuers (or supporting institutions) have an acceptable ability
for repayment of senior short-term debt obligations. The effect of industry
characteristics and market compositions may be more pronounced. Variability
in earnings and profitability may result in changes in the level of debt
protection measurements and may require relatively high financial leverage.
Adequate alternate liquidity is maintained.
"Not Prime" - Issuers do not fall within any of the Prime rating
categories.
The three rating categories of Duff & Phelps Credit Rating Co. ("D&P") for
investment grade commercial paper and short-term debt are "D-1," "D-2" and "D-
3." D&P employs three designations, "D-1+," "D-1" and "D-1-," within the highest
rating category. The following summarizes the rating categories used by D&P for
commercial paper:
A-1
<PAGE>
"D-1+" - Debt possesses the highest certainty of timely payment. Short-term
liquidity, including internal operating factors and/or access to
alternative sources of funds, is outstanding, and safety is just below
risk-free U.S. Treasury short-term obligations.
"D-1" - Debt possesses very high certainty of timely payment. Liquidity
factors are excellent and supported by good fundamental protection factors.
Risk factors are minor.
"D-1-" - Debt possesses high certainty of timely payment. Liquidity factors
are strong and supported by good fundamental protection factors. Risk
factors are very small.
"D-2" - Debt possesses good certainty of timely payment. Liquidity factors
and company fundamentals are sound. Although ongoing funding needs may
enlarge total financing requirements, access to capital markets is good.
Risk factors are small.
"D-3" - Debt possesses satisfactory liquidity and other protection factors
qualify issues as to investment grade. Risk factors are larger and subject
to more variation. Nevertheless, timely payment is expected.
"D-4" - Debt possesses speculative investment characteristics. Liquidity is
not sufficient to insure against disruption in debt service. Operating
factors and market access may be subject to a high degree of variation.
"D-5" - Issuer has failed to meet scheduled principal and/or interest
payments.
Fitch IBCA ("Fitch") short-term ratings apply to debt obligations that have time
horizons of less than 12 months for most obligations, or up to three years for
U.S. public finance securities. The following summarizes the rating categories
used by Fitch for short-term obligations:
"F1" - Securities possess the highest credit quality. This designation
indicates the strongest capacity for timely payment of financial
commitments and may have an added "+" to denote any exceptionally strong
credit feature.
"F2" - Securities possess good credit quality. This designation indicates a
satisfactory capacity for timely payment of financial commitments, but the
margin of safety is not as great as in the case of the higher ratings.
"F3" - Securities possess fair credit quality. This designation indicates
that the capacity for timely payment of financial commitments is adequate;
however, near-term adverse changes could result in a reduction to non-
investment grade.
"B" - Securities possess speculative credit quality. This designation
indicates minimal capacity for timely payment of financial commitments,
plus vulnerability to near-term adverse changes in financial and economic
conditions.
"C" - Securities possess high default risk. This designation indicates that
default is a real possibility and that the capacity for meeting financial
commitments is solely reliant upon a sustained, favorable business and
economic environment.
"D" - Securities are in actual or imminent payment default.
Thomson BankWatch, Inc. ("TBW") short-term ratings assess the likelihood of an
untimely payment of principal and interest of debt instruments with original
maturities of one year or less. The following summarizes the ratings used by
TBW:
"TBW-1" - This designation represents TBW's highest category and indicates a
very high likelihood that principal and interest will be paid on a timely
basis.
"TBW-2" - This designation represents TBW's second-highest category and
indicates that while the degree of safety regarding timely repayment of
principal and interest is strong, the relative degree of safety is not as
high as for issues rated "TBW-1."
"TBW-3" - This designation represents TBW's lowest investment-grade category
and indicates that while the obligation is more susceptible to adverse
developments (both internal and external) than those with higher ratings, the
capacity to service principal and interest in a timely fashion is considered
adequate.
A-2
<PAGE>
"TBW-4" - This designation represents TBW's lowest rating category and
indicates that the obligation is regarded as non-investment grade and
therefore speculative.
Corporate and Municipal Long-Term Debt Ratings
----------------------------------------------
The following summarizes the ratings used by S&P for corporate and municipal
debt:
"AAA" - An obligation rated "AAA" has the highest rating assigned by
Standard & Poor's. The obligor's capacity to meet its financial commitment
on the obligation is extremely strong.
"AA" - An obligation rated "AA" differs from the highest rated obligations
only in small degree. The obligor's capacity to meet its financial
commitment on the obligation is very strong.
"A" - An obligation rated "A" is somewhat more susceptible to the adverse
effects of changes in circumstances and economic conditions than
obligations in higher-rated categories. However, the obligor's capacity to
meet its financial commitment on the obligation is still strong.
"BBB" - An obligation rated "BBB" exhibits adequate protection parameters.
However, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity of the obligor to meet its financial
commitment on the obligation.
Obligations rated "BB," "B," "CCC," "CC" and "C" are regarded as having
significant speculative characteristics. "BB" indicates the least degree of
speculation and "C" the highest. While such obligations will likely have some
quality and protective characteristics, these may be outweighed by large
uncertainties or major exposures to adverse conditions.
"BB" - An obligation rated "BB" is less vulnerable to nonpayment than other
speculative issues. However, it faces major ongoing uncertainties or
exposure to adverse business, financial or economic conditions which could
lead to the obligor's inadequate capacity to meet its financial commitment
on the obligation.
"B" - An obligation rated "B" is more vulnerable to nonpayment than
obligations rated "BB," but the obligor currently has the capacity to meet
its financial commitment on the obligation. Adverse business, financial or
economic conditions will likely impair the obligor's capacity or
willingness to meet its financial commitment on the obligation.
"CCC" - An obligation rated "CCC" is currently vulnerable to nonpayment,
and is dependent upon favorable business, financial and economic conditions
for the obligor to meet its financial commitment on the obligation. In the
event of adverse business, financial, or economic conditions, the obligor
is not likely to have the capacity to meet its financial commitment on the
obligation.
"CC" - An obligation rated "CC" is currently highly vulnerable to
nonpayment.
"C" - The "C" rating may be used to cover a situation where a bankruptcy
petition has been filed or similar action has been taken, but payments on
this obligation are being continued.
"D" - An obligation rated "D" is in payment default. The "D" rating
category is used when payments on an obligation are not made on the date
due even if the applicable grace period has not expired, unless S&P
believes that such payments will be made during such grace period. The "D"
rating also will be used upon the filing of a bankruptcy petition or the
taking of a similar action if payments on an obligation are jeopardized.
PLUS (+) OR MINUS (-) - The ratings from "AA" through "CCC" may be modified by
the addition of a plus or minus sign to show relative standing within the major
rating categories.
"r" - This symbol is attached to the ratings of instruments with significant
noncredit risks. It highlights risks to principal or volatility of expected
returns which are not addressed in the credit rating. Examples include:
obligations linked or indexed to equities, currencies, or commodities;
obligations exposed to severe prepayment risk - such as interest-only or
principal-only mortgage securities; and obligations with unusually risky
interest terms, such as inverse floaters.
The following summarizes the ratings used by Moody's for corporate and municipal
long-term debt:
A-3
<PAGE>
"Aaa" - Bonds are judged to be of the best quality. They carry the smallest
degree of investment risk and are generally referred to as "gilt edged."
Interest payments are protected by a large or by an exceptionally stable
margin and principal is secure. While the various protective elements are
likely to change, such changes as can be visualized are most unlikely to
impair the fundamentally strong position of such issues.
"Aa" - Bonds are judged to be of high quality by all standards. Together
with the "Aaa" group they comprise what are generally known as high-grade
bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in "Aaa" securities or fluctuation of
protective elements may be of greater amplitude or there may be other
elements present which make the long-term risk appear somewhat larger than
the "Aaa" securities.
"A" - Bonds 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 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," "B," "Caa," "Ca," and "C" - Bonds that possess one of these ratings
provide questionable protection of interest and principal ("Ba" indicates
speculative elements; "B" indicates a general lack of characteristics of
desirable investment; "Caa" are of poor standing; "Ca" represents obligations
which are speculative in a high degree; and "C" represents the lowest rated
class of bonds). "Caa," "Ca" and "C" bonds may be in default.
Con. (---) - Bonds for which the security depends upon the completion of some
act or the fulfillment of some condition are rated conditionally. These are
bonds secured by (i) earnings of projects under construction, (ii) earnings of
projects unseasoned in operating experience, (iii) rentals which begin when
facilities are completed, or (iv) payments to which some other limiting
condition attaches. Parenthetical rating denotes probable credit stature upon
completion of construction or elimination of basis of condition.
Note: Moody's applies numerical modifiers 1, 2, and 3 in each generic rating
classification from "Aa" through "Caa." The modifier 1 indicates that the
obligation ranks in the higher end of its generic rating category; the modifier
2 indicates a mid-range ranking; and the modifier 3 indicates a ranking in the
lower end of its generic rating category.
The following summarizes the long-term debt ratings used by D&P for corporate
and municipal long-term debt:
"AAA" - Debt is considered to be of the highest credit quality. The risk
factors are negligible, being only slightly more than for risk-free U.S.
Treasury debt.
"AA" - Debt is considered to be of high credit quality. Protection factors
are strong. Risk is modest but may vary slightly from time to time because
of economic conditions.
"A" - Debt possesses protection factors which are average but adequate.
However, risk factors are more variable in periods of greater economic
stress.
"BBB" - Debt possesses below-average protection factors but such protection
factors are still considered sufficient for prudent investment.
Considerable variability in risk is present during economic cycles.
"BB," "B," "CCC," "DD" and "DP" - Debt that possesses one of these ratings
is considered to be below investment grade. Although below investment
grade, debt rated "BB" is deemed likely to meet obligations when due. Debt
rated "B" possesses the risk that obligations will not be met when due.
Debt rated "CCC" is well below investment grade and has considerable
uncertainty as to timely payment of principal, interest or preferred
dividends. Debt rated "DD" is a defaulted debt obligation, and the rating
"DP" represents preferred stock with dividend arrearages.
To provide more detailed indications of credit quality, the "AA," "A," "BBB,"
"BB" and "B" ratings may be modified by the addition of a plus (+) or minus (-)
sign to show relative standing within these major categories.
The following summarizes the ratings used by Fitch for corporate and municipal
bonds:
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"AAA" - Bonds considered to be investment grade and of the highest credit
quality. These ratings denote the lowest expectation of credit risk and are
assigned only in case of exceptionally strong capacity for timely payment
of financial commitments. This capacity is highly unlikely to be adversely
affected by foreseeable events.
"AA" - Bonds considered to be investment grade and of very high credit
quality. These ratings denote a very low expectation of credit risk and
indicate very strong capacity for timely payment of financial commitments.
This capacity is not significantly vulnerable to foreseeable events.
"A" - Bonds considered to be investment grade and of high credit quality.
These ratings denote a low expectation of credit risk and indicate strong
capacity for timely payment of financial commitments. This capacity may,
nevertheless, be more vulnerable to changes in circumstances or in economic
conditions than is the case for higher ratings.
"BBB" - Bonds considered to be investment grade and of good credit quality.
These ratings denote that there is currently a low expectation of credit
risk. The capacity for timely payment of financial commitments is
considered adequate, but adverse changes in circumstances and in economic
conditions are more likely to impair this capacity.
"BB" - Bonds considered to be speculative. These ratings indicate that
there is a possibility of credit risk developing, particularly as the
result of adverse economic changes over time; however, business or
financial alternatives may be available to allow financial commitments to
be met. Securities rated in this category are not investment grade.
"B" - Bonds are considered highly speculative. These ratings indicate that
significant credit risk is present, but a limited margin of safety remains.
Financial commitments are currently being met; however, capacity for
continued payment is contingent upon a sustained, favorable business and
economic environment.
"CCC," "CC" and "C" - Bonds have high default risk. Default is a real
possibility, and capacity for meeting financial commitments is solely
reliant upon sustained, favorable business or economic developments. "CC"
ratings indicate that default of some kind appears probable, and "C"
ratings signal imminent default.
"DDD," "DD" and "D" - Bonds are in default. Securities are not meeting
obligations and are extremely speculative. "DDD" designates the highest
potential for recovery of amounts outstanding on any securities involved
and "D" represents the lowest potential for recovery.
To provide more detailed indications of credit quality, the Fitch IBCA ratings
from and including "AA" to "B" may be modified by the addition of a plus (+) or
minus (-) sign to show relative standing within these major rating categories.
TBW assesses the likelihood of an untimely repayment of principal or interest
over the term to maturity of long term debt and preferred stock which are issued
by United States commercial banks, thrifts and non-bank banks; non-United States
banks; and broker-dealers. The following summarizes the rating categories used
by TBW for long-term debt ratings:
"AAA" - This designation indicates that the ability to repay principal and
interest on a timely basis is extremely high.
"AA" - This designation indicates a very strong ability to repay principal
and interest on a timely basis, with limited incremental risk compared to
issues rated in the highest category.
"A" - This designation indicates that the ability to repay principal and
interest is strong. Issues rated "A" could be more vulnerable to adverse
developments (both internal and external) than obligations with higher
ratings.
"BBB" - This designation represents the lowest investment-grade category
and indicates an acceptable capacity to repay principal and interest.
Issues rated "BBB" are more vulnerable to adverse developments (both
internal and external) than obligations with higher ratings.
"BB," "B," "CCC" and "CC" - These designations are assigned by Thomson
BankWatch to non-investment grade long-term debt. Such issues are regarded
as having speculative characteristics regarding the likelihood of timely
payment of principal and interest. "BB" indicates the lowest degree of
speculation and "CC" the highest degree of speculation.
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"D" - This designation indicates that the long-term debt is in default.
PLUS (+) OR MINUS (-) - The ratings from "AAA" through "CC" may include a plus
or minus sign designation which indicates where within the respective category
the issue is placed.
Municipal Note Ratings
----------------------
A S&P's rating reflects the liquidity concerns and market access risks unique to
notes due in three years or less. The following summarizes the ratings used by
S&P for municipal notes:
"SP-1" - The issuers of these municipal notes exhibit a strong capacity to
pay principal and interest. Those issues determined to possess very strong
characteristics are given a plus (+) designation.
"SP-2" - The issuers of these municipal notes exhibit satisfactory capacity
to pay principal and interest, with some vulnerability to adverse financial
and economic changes over the term of the notes.
"SP-3" - The issuers of these municipal notes exhibit speculative capacity
to pay principal and interest.
Moody's ratings for state and municipal notes and other short-term loans are
designated Moody's Investment Grade ("MIG") and variable rate demand obligations
are designated Variable Moody's Investment Grade ("VMIG"). Such ratings
recognize the differences between short-term credit risk and long-term risk. The
following summarizes the ratings by Moody's for short-term notes:
"MIG-1"/"VMIG-1" - This designation denotes best quality. There is present
strong protection by established cash flows, superior liquidity support or
demonstrated broad-based access to the market for refinancing.
"MIG-2"/"VMIG-2" - This designation denotes high quality, with margins of
protection that are ample although not so large as in the preceding group.
"MIG-3"/"VMIG-3" - This designation denotes favorable quality, with all
security elements accounted for but lacking the undeniable strength of the
preceding grades. Liquidity and cash flow protection may be narrow and
market access for refinancing is likely to be less well established.
"MIG-4"/"VMIG-4" - This designation denotes adequate quality. Protection
commonly regarded as required of an investment security is present and
although not distinctly or predominantly speculative, there is specific
risk.
"SG" - This designation denotes speculative quality. Debt instruments in
this category lack of margins of protection.
Fitch and D&P use the short-term ratings described under Commercial Paper
Ratings for municipal notes.
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APPENDIX B
As stated in the Prospectus, the Portfolios may enter into certain futures
transactions. Such transactions are described in this Appendix.
I. Interest Rate Futures Contracts
-------------------------------
Use of Interest Rate Futures Contracts. Bond prices are established in
--------------------------------------
both the cash market and the futures market. In the cash market, bonds are
purchased and sold with payment for the full purchase price of the bond being
made in cash, generally within five business days after the trade. In the
futures market, only a contract is made to purchase or sell a bond in the future
for a set price on a certain date. Historically, the prices for bonds
established in the futures markets have tended to move generally in the
aggregate in concert with the cash market prices and have maintained fairly
predictable relationships. Accordingly, a Portfolio may use interest rate
futures contracts as a defense, or hedge, against anticipated interest rate
changes. As described below, this would include the use of futures contract
sales to protect against expected increases in interest rates and futures
contract purchases to offset the impact of interest rate declines.
A Portfolio presently could accomplish a similar result to that which it
hopes to achieve through the use of futures contracts by selling bonds with long
maturities and investing in bonds with short maturities when interest rates are
expected to increase, or conversely, selling short-term bonds and investing in
long-term bonds when interest rates are expected to decline. However, because of
the liquidity that is often available in the futures market, the protection is
more likely to be achieved, perhaps at a lower cost and without changing the
rate of interest being earned by a Portfolio, by using futures contracts.
Interest rate future contracts can also be used by a Portfolio for non-
hedging (speculative) purposes to increase total return.
Description of Interest Rate Futures Contracts. An interest rate futures
----------------------------------------------
contract sale would create an obligation by a Portfolio, as seller, to deliver
the specific type of financial instrument called for in the contract at a
specific future time for a specified price. A futures contract purchase would
create an obligation by a Portfolio, as purchaser, to take delivery of the
specific type of financial instrument at a specific future time at a specific
price. The specific securities delivered or taken, respectively, at settlement
date, would not be determined until at or near that date. The determination
would be in accordance with the rules of the exchange on which the futures
contract sale or purchase was made.
Although interest rate futures contracts by their terms call for actual
delivery or acceptance of securities, in most cases the contracts are closed out
before the settlement date without the making or taking of delivery of
securities. Closing out a futures contract sale is effected by the Portfolio's
entering into a futures contract purchase for the same aggregate amount of the
specific type of financial instrument and the same delivery date. If the price
of the sale exceeds the price of the offsetting purchase, the Portfolio is
immediately paid the difference and thus realizes a gain. If the offsetting
purchase price exceeds the sale price, the Portfolio pays the difference and
realizes a loss. Similarly, the closing out of a futures contract purchase is
effected by the Portfolio entering into a futures contract sale. If the
offsetting sale price exceeds the purchase price, the Portfolio realizes a gain,
and if the purchase price exceeds the offsetting sale price, the Portfolio
realizes a loss.
Interest rate futures contracts are traded in an auction environment on the
floors of several exchanges -- principally, the Chicago Board of Trade, the
Chicago Mercantile Exchange and the New York Futures Exchange. Each exchange
guarantees performance under contract provisions through a clearing corporation,
a nonprofit organization managed by the exchange membership.
A public market now exists in futures contracts covering various financial
instruments including long-term U.S. Treasury Bonds and Notes; Government
National Mortgage Association (GNMA) modified pass-through mortgage backed
securities; three-month U.S. Treasury Bills; and ninety-day commercial paper.
The Portfolios may trade in any interest rate futures contracts for which there
exists a public market, including, without limitation, the foregoing
instruments.
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II. Index Futures Contracts
----------------------------
General. A stock or bond index assigns relative values to the stocks or
-------
bonds included in the index, which fluctuates with changes in the market values
of the stocks or bonds included. Some stock index futures contracts are based on
broad market indexes, such as S&P's 500 Index or the New York Stock Exchange
Composite Index. In contrast, certain exchanges offer futures contracts on
narrower market indexes, such as the S&P's 100 Index or indexes based on an
industry or market indexes, such as S&P's 100 Index or indexes based on an
industry or market segment, such as oil and gas stocks. Futures contracts are
traded on organized exchanges regulated by the Commodity Futures Trading
Commission. Transactions on such exchanges are cleared through a clearing
corporation, which guarantees the performance of the parties to each contract.
To the extent consistent with its investment objective, a Portfolio may also
engage in transactions, from time to time, in foreign stock index futures such
as the ALL-ORDS (Australia), CAC-40 (France), TOPIX (Japan) and the FTSE-100
(United Kingdom).
A Portfolio may sell index futures contracts in order to offset a decrease
in market value of its portfolio securities that might otherwise result from a
market decline. A Portfolio may do so either to hedge the value of its portfolio
as a whole, or to protect against declines, occurring prior to sales of
securities, in the value of the securities to be sold. Conversely, a Portfolio
will purchase index futures contracts in anticipation of purchases of
securities. A long futures position may be terminated without a corresponding
purchase of securities.
In addition, a Portfolio may utilize index futures contracts in
anticipation of changes in the composition of its portfolio holdings. For
example, in the event that a Portfolio expects to narrow the range of industry
groups represented in its holdings it may, prior to making purchases of the
actual securities, establish a long futures position based on a more restricted
index, such as an index comprised of securities of a particular industry group.
A Portfolio may also sell futures contracts in connection with this strategy, in
order to protect against the possibility that the value of the securities to be
sold as part of the restructuring of the portfolio will decline prior to the
time of sale.
Index futures contracts may also be used by a Portfolio for non-hedging
(speculative) purposes to increase total return.
III. Futures Contracts on Foreign Currencies
--------------------------------------------
A futures contract on foreign currency creates a binding obligation on one
party to deliver, and a corresponding obligation on another party to accept
delivery of, a stated quantity of foreign currency, for an amount fixed in U.S.
dollars. Foreign currency futures may be used by a Portfolio to hedge against
exposure to fluctuations in exchange rates between the U.S. dollar and other
currencies arising from multinational transactions.
A Portfolio may also use futures contracts on foreign currencies for non-
hedging (speculative) purposes to increase total return.
IV. Margin Payments
--------------------
Unlike purchases or sales of portfolio securities, no price is paid or
received by a Portfolio upon the purchase or sale of a futures contract.
Initially, a Portfolio will be required to deposit with the broker or in a
segregated account with a custodian or sub-custodian an amount of liquid assets,
known as initial margin, based on the value of the contract. The nature of
initial margin in futures transactions is different from that of margin in
security transactions in that futures contract margin does not involve the
borrowing of funds by the customer to finance the transactions. Rather, the
initial margin is in the nature of a performance bond or good faith deposit on
the contract which is returned to the Portfolio upon termination of the futures
contract assuming all contractual obligations have been satisfied. Subsequent
payments, called variation margin, to and from the broker, will be made on a
daily basis as the price of the underlying instruments fluctuates making the
long and short positions in the futures contract more or less valuable, a
process known as "marking-to-market." For example, when a particular Portfolio
has purchased a futures contract and the price of the contract has risen in
response to a rise in the underlying instruments, that position will have
increased in value and the Portfolio will be entitled to receive from the broker
a variation margin payment equal to that increase in value. Conversely, where
the Portfolio has purchased a futures contract and the price of the future
contract has declined in response to a decrease in the underlying instruments,
the position would be less valuable and the Portfolio would be required to make
a variation margin payment to the broker. Prior to expiration of the futures
contract, Northern Trust or NTQA may elect to close the position by taking an
opposite position, subject to the availability of a secondary market, which will
operate to terminate the Portfolio's position in the futures contract. A final
determination of variation margin is then made, additional cash is required to
be paid by or released to the Portfolio, and the Portfolio realizes a loss or
gain.
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<PAGE>
V. Risks of Transactions in Futures Contracts
------------------------------------------
There are several risks in connection with the use of futures by a
Portfolio, even if the futures are used for hedging (non-speculative) purposes.
One risk arises because of the imperfect correlation between movements in the
price of the futures and movements in the price of the instruments which are the
subject of a hedge. The price of the future may move more than or less than the
price of the instruments being hedged. If the price of the futures moves less
than the price of the instruments which are the subject of the hedge, the hedge
will not be fully effective but, if the price of the instruments being hedged
has moved in an unfavorable direction, the Portfolio would be in a better
position than if it had not hedged at all. If the price of the instruments being
hedged has moved in a favorable direction, this advantage will be partially
offset by the loss on the futures. If the price of the futures moves more than
the price of the hedged instruments, the Portfolio involved will experience
either a loss or gain on the futures which will not be completely offset by
movements in the price of the instruments which are the subject of the hedge. To
compensate for the imperfect correlation of movements in the price of
instruments being hedged and movements in the price of futures contracts, a
Portfolio may buy or sell futures contracts in a greater dollar amount than the
dollar amount of instruments being hedged if the volatility over a particular
time period of the prices of such instruments has been greater than the
volatility over such time period of the futures, or if otherwise deemed to be
appropriate by the Investment Advisers. Conversely, a Portfolio may buy or sell
fewer futures contracts if the volatility over a particular time period of the
prices of the instruments being hedged is less than the volatility over such
time period of the futures contract being used, or if otherwise deemed to be
appropriate by the Investment Advisers. It is also possible that, where a
Portfolio has sold futures to hedge its portfolio against a decline in the
market, the market may advance and the value of instruments held in the
Portfolio may decline. If this occurred, the Portfolio would lose money on the
futures and also experience a decline in value in its portfolio securities.
When futures are purchased to hedge against a possible increase in the
price of securities or a currency before a Portfolio is able to invest its cash
(or cash equivalents) in an orderly fashion, it is possible that the market may
decline instead; if the Portfolio then concludes not to invest its cash at that
time because of concern as to possible further market decline or for other
reasons, the Portfolio will realize a loss on the futures contract that is not
offset by a reduction in the price of the instruments that were to be purchased.
In addition to the possibility that there may be an imperfect correlation,
or no correlation at all, between movements in the futures and the instruments
being hedged, the price of futures may not correlate perfectly with movement in
the cash market due to certain market distortions. First, rather than meeting
additional margin deposit requirements, investors may close futures contracts
through off-setting transactions which could distort the normal relationship
between the cash and futures markets. Second, with respect to financial futures
contracts, the liquidity of the futures market depends on participants entering
into off-setting transactions rather than making or taking delivery. To the
extent participants decide to make or take delivery, liquidity in the futures
market could be reduced thus producing distortions. Third, from the point of
view of speculators, the deposit requirements in the futures market are less
onerous than margin requirements in the securities market. Therefore, increased
participation by speculators in the futures market may also cause temporary
price distortions. Due to the possibility of price distortion in the futures
market, and because of the imperfect correlation between the movements in the
cash market and movements in the price of futures, a correct forecast of general
market trends or interest rate movements by the Investment Adviser may still not
result in a successful hedging transaction over a short time frame.
Positions in futures may be closed out only on an exchange or board of
trade which provides a secondary market for such futures. Although the
Portfolios intend to purchase or sell futures only on exchanges or boards of
trade where there appear to be active secondary markets, there is no assurance
that a liquid secondary market on any exchange or board of trade will exist for
any particular contract or at any particular time. In such event, it may not be
possible to close a futures investment position, and in the event of adverse
price movements, a Portfolio would continue to be required to make daily cash
payments of variation margin. However, in the event futures contracts have been
used to hedge portfolio securities, such securities will not be sold until the
futures contract can be terminated. In such circumstances, an increase in the
price of the securities, if any, may partially or completely offset losses on
the futures contract. However, as described above, there is no guarantee that
the price of the securities will in fact correlate with the price movements in
the futures contract and thus provide an offset on a futures contract.
Further, it should be noted that the liquidity of a secondary market in a
futures contract may be adversely affected by "daily price fluctuation limits"
established by commodity exchanges which limit the amount of fluctuation in a
futures contract price during a single trading day. Once the daily limit has
been reached in the contract, no trades may be entered into at a price beyond
the limit, thus preventing the liquidation of open futures positions. The
trading of futures contracts is also subject to the risk of trading halts,
suspensions, exchange or clearing house equipment failures, government
B-3
<PAGE>
intervention, insolvency of a brokerage firm or clearing house or other
disruptions of normal trading activity, which could at times make it difficult
or impossible to liquidate existing positions or to recover excess variation
margin payments.
Successful use of futures by a Portfolio is also subject to the Investment
Advisers' ability to predict correctly movements in the direction of the market.
For example, if a particular Portfolio has hedged against the possibility of a
decline in the market adversely affecting securities held by it and securities
prices increase instead, the Portfolio will lose part or all of the benefit to
the increased value of its securities which it has hedged because it will have
offsetting losses in its futures positions. In addition, in such situations, if
the Portfolio has insufficient cash, it may have to sell securities to meet
daily variation margin requirements. Such sales of securities may be, but will
not necessarily be, at increased prices which reflect the rising market. A
Portfolio may have to sell securities at a time when it may be disadvantageous
to do so.
Futures purchased or sold by a Portfolio (and related options) may be
traded on foreign exchanges. Participation in foreign futures and foreign
options transactions involves the execution and clearing of trades on or subject
to the rules of a foreign board of trade. Neither the National Futures
Association nor any domestic exchange regulates activities of any foreign boards
of trade, including the execution, delivery and clearing of transactions, or has
the power to compel enforcement of the rules of a foreign board of trade or any
applicable foreign law. This is true even if the exchange is formally linked to
a domestic market so that a position taken on the market may be liquidated by a
transaction on another market. Moreover, such laws or regulations will vary
depending on the foreign country in which the foreign futures or foreign options
transaction occurs. For these reasons, customers who trade foreign futures of
foreign options contracts may not be afforded certain of the protective measures
provided by the Commodity Exchange Act, the Commodity Futures Trading
Commission's ("CFTC") regulations and the rules of the National Futures
Association and any domestic exchange, including the right to use reparations
proceedings before the CFTC and arbitration proceedings provided by the National
Futures Association or any domestic futures exchange. In particular, the
investments of a Portfolio in foreign futures or foreign options transactions
may not be provided the same protections in respect of transactions on United
States futures exchanges. In addition, the price of any foreign futures or
foreign options contract and, therefore the potential profit and loss thereon
may be affected by any variance in the foreign exchange rate between the time an
order is placed and the time it is liquidated, offset or exercised.
VI. Options on Futures Contracts
----------------------------------
A Portfolio may purchase and write options on the futures contracts
described above. A futures option gives the holder, in return for the premium
paid, the right to buy (call) from or sell (put) to the writer of the option a
futures contract at a specified price at any time during the period of the
option. Upon exercise, the writer of the option is obligated to pay the
difference between the cash value of the futures contract and the exercise
price. Like the buyer or seller of a futures contract, the holder, or writer, of
an option has the right to terminate its position prior to the scheduled
expiration of the option by selling, or purchasing an option of the same series,
at which time the person entering into the closing transaction will realize a
gain or loss. A Portfolio will be required to deposit initial margin and
variation margin with respect to put and call options on futures contracts
written by it pursuant to brokers' requirements similar to those described
above. Net option premiums received will be included as initial margin deposits.
As an example, in anticipation of a decline in interest rates, a Portfolio may
purchase call options on futures contracts as a substitute for the purchase of
futures contracts to hedge against a possible increase in the price of
securities which the Portfolio intends to purchase. Similarly, if the value of
the securities held by a Portfolio is expected to decline as a result of an
increase in interest rates, the Portfolio might purchase put options or sell
call options on futures contracts rather than sell futures contracts.
Investments in futures options involve some of the same considerations that
are involved in connection with investments in futures contracts (for example,
the existence of a liquid secondary market). See "Risks of Transactions in
Futures Contracts" above. In addition, the purchase or sale of an option also
entails the risk that changes in the value of the underlying futures contract
will not correspond to changes in the value of the option purchased. Depending
on the pricing of the option compared to either the futures contract upon which
it is based, or upon the price of the securities being hedged, an option may or
may not be less risky than ownership of the futures contract or such securities.
In general, the market prices of options can be expected to be more volatile
than the market prices on the underlying futures contract. Compared to the
purchase or sale of futures contracts, however, the purchase of call or put
options on futures contracts may frequently involve less potential risk to the
Portfolio because the maximum amount at risk is the premium paid for the options
(plus transaction costs). The writing of an option on a futures contract
involves risks similar to those risks relating to the sale of futures contracts.
VII. Other Matters
-------------------
Each Portfolio intends to comply with the regulations of the CFTC exempting
it from registration as a "Commodity
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Pool Operator." Accounting for futures contracts will be in accordance with
generally accepted accounting principles.
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